By Ramani Sundaram, CCP, CEP, MRICS, PMP
Posted: July 31, 2018 | Estimating
A simple definition of economy of scale (EOS) is “a reduction in unit costs with increased volume.”
For example, unit price (dollar per square foot) for asphalt paving over a 100,000-square-foot area would be less per square foot than paving over a 10,000-square-foot area.
If it is equipment that you are estimating, cost of equipment that is twice the size need not be double the cost of equipment of the original size, but slightly less than twice. If equipment of size X costs $50K, equipment of size 2X won’t be $100K but slightly less than that.
Those who are familiar with the capacity reduction factor method for estimating might have used equations relating cost of an equipment of a known size to calculate cost of equipment of a different size, knowing the reduction factor from published tables for equipment costs.
When it comes to building or general construction, we do not commonly find published tables available for applying modification factors according to scale. Some cost data publications indicate scale factors for selected items, but for other items, estimators must develop their own. Economy of scale is applicable for any estimate – from conception to the final design. In the absence of published tables, estimators develop their own adjustment factors with available data.
Adjusting Unit Rates According to Economy of Scale
Depending upon the items, estimators may develop adjustment factors according to quantity ranges, and adjust the unit costs. An example would be reducing unit costs by 25% for a certain range, and reducing unit costs by 50% for a higher range, etc.
The estimator should also make a note of items that may be exceptions to EOS; such as when there is no economy of scale for some items or there would be diseconomy of scale.
In some instances, EOS may be applicable for the material component but not for the labor. For example, floor tiles in a hotel project: Compared to a hotel having 100 guest rooms, a hotel with 300 guest rooms may have more bathrooms, but the unit cost of labor per square foot of the tile area may not differ much because the labor hours to finish each bathroom may be similar, due to the similarity of finish areas. However, EOS may be applicable to the material component of the unit cost because the tile supplier may offer volume discounts for a larger quantity of material for the hotel with 300 guest rooms.
Reduced unit costs may apply to both the labor and material component of the unit costs for certain other items (asphalt paving over a small area vs. a larger area, smaller quantity of excavation for building footings vs. building areas requiring bulk excavation).
Reduction factors may be applicable to both the labor and material component of unit costs if the work is in a large open area, compared to a smaller area. For example, there may be significant difference in labor unit cost if the work is in an auditorium or reception area instead of several smaller rooms.
For shop-fabricated items like steel or precast concrete elements produced off-site, EOS may be applicable. However, for site installation, it may vary, based on site conditions.
When it comes to material volume discounts, it may also depend upon the contractor’s relationship with the supplier or a general contractor’s relationship with the subcontractor.
Item Based vs. Project Based
When applying reduction factors, it may be better to develop and apply them for specific items rather than develop one common factor for all items in a project. For instance, when there is data of overall project cost for a 100,000-square-foot building and the estimator is preparing an estimate for a new 500,000-square-foot building, it may not always be realistic to scale the overall dollar-per-square-foot cost of one building to the other. Buildings are comparable in gross square foot area, but there may also be other dimensions to consider, like the number of floors, number of below ground floors, and so forth. Due to the additional factors to be considered, sometimes the estimator may find that there is no EOS even though the new building has a larger gross floor area.
If estimators want to create a benchmarking database for future use, item-specific data may be recorded with detailed notes of other associated factors, if any, such as such as overtime, phasing, or other constraints.
Minimum Labor and Equipment Requirements
The estimator must also consider the minimum labor and equipment requirements when scaling from historical estimating data, and take this factor into account when preparing estimates for very small quantities of work.
Quite often, the talk is more about large quantities of work and adjusting their unit costs, but the scale factor is to be considered even for markups that are applied to direct costs. When markups are applied as percentages to the project totals, like overhead, profit, or Architect’s fee, a billion-dollar project cannot have the same percentage of markup as a $100 million job. The magnitude of total dollar value is to be considered and the estimator should modify markups accordingly.
Developing in-house scale factors is key for estimators. It may require a substantial volume of data of historical actual costs from past estimates, but this effort can serve to aid estimators immensely. Applying EOS and developing adjustment factors to unit costs will certainly enable estimators to prepare competitive bids and forecast the right budget.
About the Author: Ramani Sundaram CCP, CEP, MRICS, PMP, is an experienced and certified Project Management and Cost Professional with specialization in Cost Management and Cost Estimating. He has worked on various types of construction projects in the U.S. and overseas. He is also a blog writer and content producer. He can be reached at firstname.lastname@example.org