Four methods of cost estimation are (1) the industrial engineering method, (2) the conference method, (3) the account analysis method, and (4) the quantitative analysis method (which takes different forms). These methods differ in how expensive they are to implement, the assumptions they make, and information about the accuracy of the estimated cost function. The methods are not mutually exclusive, so many organizations use a combination of methods.
The industrial engineering method, also called the work-measurement method, estimates cost functions by analyzing the relationship between inputs and outputs in physical terms. Elegant Rugs uses inputs of cotton, wool, dyes, direct manufacturing labor, machine time, and power. Production output is square yards of carpet. Time-and-motion studies analyze the time required to perform various operations. Suppose producing 10 square feet of carpet requires 1 hour of direct manufacturing labor. Standards and budgets transform these physical input measures into costs. The result is an estimated cost function relating direct manufacturing labor costs to the cost driver, square feet of carpet produced.
The industrial engineering method is a thorough and detailed way to estimate a cost function when there is a physical relationship between inputs and outputs. Some government contracts mandate its use. Many organizations, such as Bose and Nokia, use it to estimate direct manufacturing costs, but find it too costly or impractical to analyze their entire cost structure. For example, the physical relationships between inputs and outputs are difficult to specify for items such as indirect manufacturing costs, research and development costs, and advertising costs.