How to Calculate Cost Components in Contract Negotiations - Ethical Processes Guide
- Arvind Dang
- Jan 21
- 6 min read
Every successful contract begins with a solid foundation of cost estimation and negotiation.
Contract negotiations require precision and strategy, especially when it comes to cost estimation. In this Blog, we’ll break down the 9 essential cost components you need to consider, including material, labour, equipment, manufacturing variable costs ,Tools, Jigs /fixtures, Marketing variable costs, overhead and other costs."
Whether you're negotiating for manufacturing, construction, or Other industries, understanding the financial nuances can mean the difference between profit and loss.
Cost components in contract negotiations (9 numbers)
Material Costs" Material costs form the foundation of any project budget. Accurate estimation involves analyzing supplier prices, market trends, and procurement methods."
Labor CostsLabour costs can vary based on skill levels, project timelines, and regional wage standards. Efficient workforce planning can reduce unnecessary expenses.
Equipment Costs
Equipment expenses can vary based on types of equipment used, number of shifts used, depreciation rates and maintenance cost
Manufacturing Variable Costs
Understanding variable costs in manufacturing, monitoring, and controlling expenses is crucial.
Tools Costs
It involves estimating tools cost breakdown in contracts
Jigs and Fixtures Costs
Calculating jigs and fixtures expenses
Marketing Variable Costs
Analysing Marketing variable costs & reducing these in negotiations
Overhead Costs
Estimating break up of Overhead costs and reducing overhead expenses in contracts
Other Costs
Installation and commissioning cost analysis, estimating statutory costs, taxes and negotiating vendor margins
Overlooking even a single cost element can lead to unexpected overruns, strained relationships, or project delays.
This Blog includes references of illustrations and templates for determining each cost element included in my course in Udemy as per the link below
Please also refer to the video link below on this article
Cost estimation for the below cost elements has been included in my Udemy course, comprising 60 lectures for cost estimations and negotiation .
1 Grey Iron casting (Bought out contract named as Type 1)
2 Hot Forgings ( Bought out contract named as Type 1)
3 Machined components ( Bought out contract named as Type 1)
4 Jacuzzi system involving supply installation, testing and commissioning ( low value contract named as Type 2)
5. Lift system for high rise building involving supply installation, testing and commissioning ( High value contract needing integration with other site contracts and named as Type 3)
In this article, the following aspects will be covered to analyse each of the nine cost elements to help you gain clarity, minimize risks, and negotiate better terms for long-term success.
Key Components
Cost Estimation How to compute
1. Material Costs
Materials often represent a significant portion of project costs. These include raw materials, semi-finished products, consumables, and spare parts. Estimating material costs requires:
Key Components:: Raw materials like steel, wood, or chemicals; traded items, semi-finished goods; and any consumables used during production or delivery.
Material Cost Estimation involves identifying the raw materials used in the item, their quantities, and unit prices based on market rates or supplier quotes)
Illustration: My Udemy lecture includes such Illustrations for material costs of GI Castings: Material cost key components include Pig Iron, Or & steel scrap, Or & GI Casting Scrap, Ferroalloys, Coke, Limestone, Sand, Binder & so on
Template: A resource template named S3RT6 is included in my course at Udemy for estimating material costs in case of a variety of materials are included in the contract.
2. Labor Costs
Labor costs encompass cost to company including wages, salaries benefits, welfare costs etc These can vary greatly based on geography, skill requirements, and project duration.
Key Components: Salaries of skilled and unskilled workers, overtime pay, and training costs.
Labour Cost Estimation : Involve identifying direct manpower and indirect manpower (skilled and unskilled) engaged for bought out operations or for supply, installation, testing and commissioning
Illustration: My Udemy lecture includes such Illustrations for hot forgings depicting : : Payroll/welfare costs for Die Makers, Punch Makers, Metallurgists, Quality Control Inspectors, Maintenance Technicians, and so on
Template: A resource template named S3RT7 is included in my course at Udemy for estimating manpower costs including skilled and unskilled manpower.
3. Equipment Costs
Equipment costs can be substantial, especially in industries like construction and manufacturing. This includes the purchase, lease, or maintenance of machinery.
Key Components: Acquisition or leasing of machinery, maintenance costs, and operational expenses.
Plant & Machinery costs :estimation : Includes Determining Depreciation, AMC, and allocating these to Items/material based on throughput time and annual production
Illustration: My Udemy lecture includes such Illustrations for equipment for GI foundry depicting : Cupola Furnace, Electric Arc Furnace, Ladle Furnace, Moulding Machines, Core Machines, Shakeout Machines, Tumbling Machines, Sand Handling Equipment and so on
4. Manufacturing variable Costs
These costs cover the transformation of raw materials into finished products. They include energy consumption, process time, and waste management.
Key Components: Utility bills, machinery wear and tear, and process optimization costs.
Manufacturing Variables costs: Estimate costs based on direct power, fuel/ consumables, inward Freight, marine premium, rejection rate at the receipts stage, and WIP rejection at the client end. This may also include QC costs and any other costs related to manufacturing.
Illustration: My Udemy lecture includes such Illustrations for Manufacturing variable costs for GI foundry depicting : Power, Furnace Oil, Natural Gas, Water, Compressed Air, Labor wages (Mold Makers, Core Makers, Pattern Makers, Machinists etc), QC gauges,% rejection of casting, and so on
5 . Tools Costs
Tools include hand tools, power tools, and machining equipment necessary for production or service delivery.
Key Components: Purchase or rental of tools, wear and tear, and replacements.
Tools costs estimation Tools/Jigs - cost, tool resharpening costs & wear rate/consumption
Illustration: My Udemy lecture includes such Illustrations for cutting tool costs for machined parts depicting:Tool costs for machines like Lathes, Boring machine, Grinding machine based on process sequence, throughput time.
6 Jigs and Fixtures Costs
Jigs and fixtures are specialized tools used in manufacturing to hold or guide parts during production. These are essential for precision and efficiency.
Key Components: Design, fabrication, and maintenance of jigs and fixtures.
Jigs and Fixtures Costs estimation : Based on annual consumption, usage frequency, and material durability. and replacement of wear and tear parts
Illustration: My Udemy lecture includes such Illustrations for Jigs/ fixture costs for GI Castings depicting: Pattern Equipment, Core Boxes, Gating & Risering Systems, Moulding Boxes, Pouring Ladles and so on.
7. Marketing Variable Costs
Marketing costs include branding, advertising, and promotional activities. Variable costs can also include unexpected or fluctuating expenses.
· Key Components: Campaign costs , market research, and customer engagement initiatives.
· Marketing Variables Costs: estimation : Consider costs based on direct packing costs, labeling, markings, and estimated warranty costs. freight and insurance
· Illustration: My Udemy lecture includes such Illustrations for Marketing Variable Costs for any item depicting: Packaging materials, Protective coatings, Labelling and branding, Mandatory Certification, Costs for freight, Insurance, Warranty and so on as applicable
8. Overhead Costs
Overhead costs include administrative expenses, building insurance, and utilities that support the project but are not directly tied to production.
· Key Components: for offices, HVAC running costs, Depreciation of buildings, vehicles, office equipment, their repair and maintenance, insurance, lease rentals-others, communications, travel and conveyance, legal and professional, entertainment and so on
Overheads cost estimation approach: based on actual estimates from financial books
Illustration: In my Udemy lecture overheads are depicted as % of costs based on the profile of vendor and technology used
9 Other costs
These may include applicable costs not included in above as :
· Key Components:
i)Installation, testing and commissioning, Statutory costs , QC costs
ii) Vendor/contractor margin : It must be added as %
iii). Taxes : As per statutory norms
· Illustration: My Udemy lecture includes such Illustrations for various other costs
Negotiation Strategies for Cost Elements
To achieve cost-efficient contracts, focus on areas with the highest cost impact.
Some strategies include:
1. Use competitive bidding processes to find the best value.
2. Conduct a Thorough Cost Analysis
3. Involve Key Stakeholders for cost estimations
4. Leverage bulk purchasing agreements for economies of scale.
5. Explore outsourcing or subcontracting for non-core activities.
6. Offer long-term commitments to suppliers in exchange for better rates.
7. Agree on cost-sharing formulas for escalations or and substitute items
8. Standardization
9. Risk mitigation for rates and payment terms
10. Ethical buying at arm’s length
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