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Mort AnvariAcquisition Costing Directorate
[email protected] (703) 601-4200
19 July 2006
Acquisition Cost Estimating Introductory Course
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HQDA
ASA(FM&C)
DASA-CEDASA-CE
SAUNDER
BudgetFO RB
CSAVCSA
ASA(CW)
ASA(ALT)
ASA(MR&A)
ASA(I&E)
3
Situation
• You have just been tasked to develop a cost estimate, that is, a professional opinion about the cost of an item, a service or a thing.
• Let’s discuss a process for organizing and developing this cost estimate.
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Cost Estimating Process
• Definition & Planning– Purpose of the Estimate– Defining the System and Schedule– Ground rules & Assumptions– Estimating Approach– Estimating Team
• Data Collection and Analysis• Estimate Formulation• Review and Presentation• Final Documentation
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Definition and Planning
• Influences the success of the estimate
• Understanding the requirements and how you approach the process will establish the guidelines and procedures for the estimate.
• Ask lots of questions…They help you understand the requirement.
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Questions
• Why is this cost estimate needed?• What decisions are pending on the results of this
estimate?• Will the estimate be briefed and to whom?• Will the results be incorporated into some
document?• What does the recipient expect to have included or
excluded?• What excursions or variations from the baseline
are anticipated?
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Questions Continued
• What are the program and funding constraints especially if the program is a Joint Program?
• What are the time constraints for this estimate?• What is the acquisition phase of the program?• Is the program definition mature?• Does technology exist today to design, develop, test
and manufacture the system?• What is the interrelationship with other systems?• Are there previous contracts? How many? What type?• How have the contractors performed to date?
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Definition and PlanningKnow Purpose of the Estimate
• Main purposes of estimates:
– Budget Formulation
– Comparative Studies
– Source Selection
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Types of Cost Estimates
• Life Cycle Cost Estimate (LCCE): Cradle-to-grave estimate includes R&D, production, operations/support, and disposal
• Independent Cost Estimate (ICE): LCCE of most likely cost developed by an independent organization
• Budget Estimate: For inclusion in budget to support current activities• Rough-Order-of-Magnitude (ROM): Pre design effort, with very little
specific information about the project
• Analysis of Alternatives (AoA): Evaluates costs, benefits, advantages and disadvantages of different alternatives
• Activity Based Costing (ABC): Accounting methodology that assigns resources and overhead costs to activities, products and services to support making decisions about pricing, outsourcing, capital expenditures and operational efficiency
There are many types of cost estimates, each with a different purpose. Know the purpose of the cost estimate before you start
There are many types of cost estimates, each with a different purpose. Know the purpose of the cost estimate before you start
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Purpose of EstimateBudget Formulation Estimates
• Program Office Estimate (POE)• Component Cost Analysis (CCA)• Independent Cost Estimate (ICE)• What-if exercises• Rough Order of Magnitude (ROM)• Cost Risk Analysis• Should Cost Estimates• CAIV
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Purpose of EstimateComparative Studies Estimates
• Making cost & benefit comparisons between alternatives– Economic Analysis (EA)– Analysis of Alternatives (AoA)– Force Structure– Trade-off Studies– Source Selection– Prioritization
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Definition and PlanningDefining the System
• Adequate description of the technical and program characteristics of the system
• What are the physical and performance characteristics?
• What are the development, production, and deployment schedules?
• How many systems are to be produced?• How will the systems be supported: contract, in-
house, two or three levels of maintenance?
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ACTIVITY J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D
1993 1994 1995 1996 1997 1998 1999 2000J A S O N D
PROGRAM REVIEWS
ENGINEERING & MANUFACTURING DEVELOPMENT
TEST & EVALUATION
LIVE FIRE TEST
LOG DEMO II
PROD VER TEST
ENHANCED PRODUCIBILITY PROGRAMLOW RATE INITIAL PRODUCTION
FY94
FY95
FY96
MULTIYEAR I & II (3 YR CONTRACT)
FY97
FY98
FY99
FIELDING
LLTI PEO IPR LRIP DECISION MILESTONE III
IOTE
TECH SUPPORT
QLFTT
QUAL
UE
FUE FUEUSMC
MSLS - 3316 741 CLUs - 423 133
MSLS - 1080 194 CLUs - 270 140
MSLS - 1020 141 CLUs - 206 48
MSLS - 1015 CLUs - 108
MSLS - 872 CLUs - 97
MSLS - 698 CLUs - 55
CA CA
CA
CA
CA
LEAD TIME PRODUCTION
PRODUCTION
LEAD TIMELLTI
LD II
LFT (A)(26)
(3)LUT
CA
LEGEND
QL - QUICK LOOK FTT - FIELD TACTICAL TRAINER UE - USER EVALUATION LUT - LIMITED USER TEST CA - CONTRACT AWARD MRRB - MATERIEL RELEASE
REVIEW BOARD
(6)
TODAY
MRRB
PRODUCTION
LFT (B,C) (8,4)
USA
LEAD TIME
LEAD TIME
AWEHANDOFF NTC
PRODUCTION
PVT(25 MSL + 10 CLU)
FT. HOOD
RANGER COMPL
82nd FIELDING BEGINS
82nd COMPLETE
ARMY USMC
LETHALITY ENHANCEMENT
LITE I / WARHEAD / LOW COST BST
DEVELOPMENT
CA MYII
(9)CLU
(28)MSL
II, III, FLIGHTI
Defining the SystemIntegrated System Schedule
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Defining the System Work Breakdown Structure (WBS)
• WBS defined in MIL-HDBK-881 as:– product-oriented breakdown of hardware,
software, services, data and facilities that define the system.
• WBS breaks a total job down into manageable pieces & portrays the way work is to be done.
• WBS displays a company’s reporting structure.• Program managers may cite MIL-HDBK-881 “for
guidance only” in contract solicitations.
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MIL-Handbook-881 (WBS)
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Defining the System COST ELEMENT STRUCTURE (CES)
1.0 Research Development Test & Evaluation (RDT&E)
2.0 Production
3.0 Military Construction (MILCON)
4.0 Military Pay and Allowances (MPA)
5.0 Operating and Maintenance Army (OMA)
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Defining the System COST ELEMENT STRUCTURE – 1.0 RDT&E
CES# ELEMENT: FY00C$M TY$M1.01 DEV. ENG.
1.02 PEP
1.03 DEV. TOOL.
1.04 PROTO MFG.
1.05 SEPM
1.06 SYS T&E
1.07 TRAINING
1.08 DATA
1.09 SUPP EQUIP.
1.10 DEV. FACILITIES
1.11 OTHER
$ 39.039M $38.260M
0.408 0.386
0.457 0.450
110.421 107.724
78.266 76.363
11.112 10.927
1.989 1.954
3.439 3.413
4.897 4.758
0.0 0.0
0.968 0.928
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CES# ELEMENT: FY06C$M TY$M2.01 NON REC PROD. 2.02 REC. PROD 2.03 ENG. CHG2.04 SEPM2.05 SYS T&E2.06 TRAINING2.07 DATA 2.08 SUPP. EQUIP. 2.09 OPER./SITE/ACT. 2.10 FIELDING 2.11 TRAIN. AMMO/MSLS 2.12 WAR RESV. 2.13 MODS 2.14 OTHER
$ 16.110M $ 16.583M 1,169.348 1,312.377 0.0 0.0 116.637 132.258 12.564 14.437 28.880 31.499 2.073 2.300 146.460 158.304 0.0 0.0 89.525 101.635 59.001 79.482 0.0 0.0 236.619 280.729 51.739 64.129
Defining the System COST ELEMENT STRUCTURE – 2.0 PROCUREMENT
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CES# ELEMENT: FY06C$M TY$M3.01 DEVELOP. CONSTRUCTION 3.02 PRODUCT. CONSTRUCTION 3.03 OPERATION/SITE ACTIVATION3.04 OTHER MILCON
Defining the System COST ELEMENT STRUCTURE – 3.0 MILCON
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CES# ELEMENT: FY06C$M TY$M4.01 CREW 4.02 MAINTENANCE 4.03 SYSTEM SPECIFIC SUPPORT4.04 SEPM4.05 REPLACEMENT PERSONNEL4.06 OTHER MPA
Defining the System COST ELEMENT STRUCTURE – 4.0
Military Pay&Allowances (MPA)
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CES# ELEMENT: FY06C$M TY$M5.01 FIELD MAINT., CIV LABOR5.02 SYS. SPECIFIC BASE OPS 5.03 REPLENISHMENT DLRs5.04 REPLEN. CONSUMMABLES5.05 POL5.06 END ITEM MAINTENANCE5.07 TRANSPORTATION 5.08 SOFTWARE5.09 SEPM 5.10 TRAINING
5.11 OTHER OMA
Defining the System COST ELEMENT STRUCTURE – 5.0
Operating & Maintenance Army (OMA)
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Defining the System Cost Analysis Requirements Description
(CARD)
• Source of a system’s description• Describes important features• Is provided to other groups preparing cost
estimates• Helps ensure all groups are costing out the same
“program.”• Prepared by program office; approved by
DoD Component Program Executive Officer
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Divided into a number of sections, each focusing on a particular aspect of the program being assessed.
1.1.1 System Description
1.1.4 Government-Furnished Equipment and Property
1.2.1 Technical and Physical Description
1.2.1. x (..x..) Subsystem Description
1.2.1.x.3 Material, Processes, and Parts
1.2.2 Software Description.
Defining the System Cost Analysis Requirements Description
(CARD)
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Defining the System Cost Analysis Requirements Description
(CARD) Continued1.0 System Overview1.1 System Characterization
1.1.1 System Description1.1.2 System Funcitonal Relationships1.1.3 System Configuration1.1.4 Government Furnished Equipment/Information
1.2 System Characteristics1.2.1 Technical/Physical Description 1.2.1.1 Subsystem Description 1.2.1.2 Functional and Performance Description 1.2.2 Software Description
1.3 System Quality Factors1.3.1 Reliability1.3.2 Maintainability1.3.3 Availability1.3.4 Portability and Transportability1.3.5 Additional Quality Factors
1.4 Embedded Security1.5 Predecessor/Reference System2.0 Risk
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Defining the SystemCARD Continued
3.0 System Operational Concept3.1 Organizational Structure3.2 Basing and Deployment Description3.3 Security3.4 Logistics
4.0 Quantity Requirements5.0 System Manpower Requirements6.0 System Activity Rates7.0 System Milestone Schedule8.0 Acquisition Plan or Strategy9.0 System Development Plan
10.0 Element Facilities Requirements11.0 Track to Prior Card12.0 Contractor Cost Data Reporting Plan
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Definition and PlanningGround Rules & Assumptions
• State the conditions which must take place in order for the estimate to be valid
• Ground rules and assumptions must be documented since changes in these areas provide an audit trail for changes in the cost estimate.
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Definition and PlanningSelect the Estimating Approach
• Techniques available– Analogy– Parametric– Engineering– Extrapolation– Expert OpinionSelect the technique that is most applicable
to a specific WBS element
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Definition and PlanningEstimating Methods
• Analogy– Basic Comparison– Factors
• Parametric– Regression Analysis
• Engineering– Detailed
• Expert Opinion– Committee– Delphi
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Cost Estimating MethodsAnalogy Method
• Based on direct comparison with historical information of similar existing activities, systems, or components.
• Compares new system with one or more existing similar systems where there is accurate cost and technical data.
• Analyst must show validity of comparison.
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Cost Estimating MethodsAnalogy Method
• Based on known costs of a similar program• Adjustments for complexity, technical, physical• Strengths
– Based on representative experience– Less time consuming than others– Can be used as a check on other techniques
• Weaknesses– Small sample size– Heavy reliance on judgment– Sometimes difficult to identify analogy and associated
costs
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Analogy Estimating with Factors
Element Old Sys1 Old Sys2Old Sys3
New Sys
Airframe $500/lb $250/lb $750/lb 1.25xS1
Engine 2M/Unit 3M/Unit 5M/Unit .8xS3
Avionics $3K/lb $2K/lb $4K/lb 1.0S2
Payload 6M/Unit 8M/Unit 7M/Unit .65xS1
Cost(New) = Cost(Old) x Adjustment Factor
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Cost Estimating MethodsParametric Method
• Known as Statistical Method or Top Down Method
• Relates cost to physical attributes or performance characteristics
• Uses database of elements from similar systems• Uses multiple systems• Most beneficial in earlier stages of the system or
project life cycle
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Cost Estimating MethodsParametric Method
• Statistical relationships between cost and physical or performance parameters of past systems.
• Strengths– Captures major portion of cost– Quick what if type estimates
• Weaknesses– Less detailed– Getting accurate data
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Cost Estimating MethodsParametric Method
(Extrapolation)
• Use historical values to establish a trend for the future.
• Example problem: Given the actual productivity and labor rates in the given table. How much will it take to complete a 3-year software development project of 10K lines of code, if 50% is completed in the second year and 25% is completed in first and third years?
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As the quantity of a product produced doubles, the man-hours- per-unit expended to produce the product decreases at a fixed rate or constant percentage (usually 10% to 20%).
Learning Curve Theory
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• Job familiarization by both production workers and supervisory personnel.• Changes in product design which do not materially affect the product, but result in increased ease and speed of production.• Changes in tooling, machinery, and equipment which simplify or speed up the production process.• Improved production planning and scheduling, and improvements in production techniques and operational methods.• Improvements in shop organization, engineering coordination and liaison.• Improvements in the handling and flow of materials, and in the materials and parts supply systems
Learning Curve TheoryFactors Contributing to Efficiency
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TABLE FOR FIGURESF-1-1 and F-1-2
Unit No. Unit Person-hours
1 100.002 80.004 64.008 51.2016 40.9632 32.7764 26.21
The table is based on the assumption that the first unit required 100 person-hours to produce. The table indicates a constant rate of reduction of 20% for each doubling of the unit number; the value of the second and each succeeding item in the table is 80% of the value of the preceding item.
Learning Curve Theory
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80% Unit Curve on Arithmetic Paper
Learning Curve Theory
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Learning Curve Theory
1
10
100
1000
1 10 100 1000 10000
90%
85%
80%
70%
Production Unit Number (LOG)
UnitCost
(LOG)
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Learning Curve TheoryUses
– Evaluating contract production costs.– Assessing impact of production interruptions, product
changes and production rate change. – Rate of improvement experienced by a particular contractor
on a prior product may be indicative of rate of improvement expected on new product of similar size, complexity, and construction.
– Improvement curve pattern experienced in the production of past item can be extended to calculate costs of future items.
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Cost Estimating MethodsEngineering Method
• Known as bottom up method• Requires extensive knowledge of system
characteristics• Divide into segments; estimate costs for each
segment• Combine segments plus integration cost• Uses a combination of cost estimating methods• Detailed knowledge of new technologies may not
be available.
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Cost Estimating MethodsEngineering Method
• Strengths– Detailed
• Best when long stable production process
• Weaknesses– Requires a lot of time– Cost– Cannot be used until system well defined
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Cost Estimating MethodsExpert Opinion Method
• Subjective judgment of an experienced individual or group
• Use if time does not permit a more thorough analysis
• Document source(s) of opinion of experts• List attributes of the source(s) Example: Delphi Technique
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Cost Estimating MethodsExpert Opinion Method
• Consulting with one or more experts who use their knowledge and experience to arrive at an estimate
• Group techniques include– Consensus (Committee)– Delphi
• Strengths and weaknesses
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Expert Opinion MethodDelphi Technique
• Query expert opinion from group• Seek information from each expert• Summarize the results• Send report to each expert• Gather second opinion after each individual
reviews report• Summarize results• Iterative process continues until the experts reach
a consensus, or near‑consensus.
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Expert Opinion Method Example
Labor typeHours Needed
Hourly Rate% of Total Hrs
%*rate
Senior Engineer 1000 $13 10.5 $1.37
Design Engineer 3000 $11 31.6 $3.48
Tool & Die 500 $11 5.3 $.58
Machinist5000 $9 52.6 $4.73
Totals 9500 $10.16
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Cost Estimating MethodsLaying Out the Estimating Approach
Aircraft System – sum of level II elements (cross-check with analogy)Air Vehicle – sum of level III elements
Airframe – CERsAir Vehicle Software – Expert OpinionPropulsion – CERsAvionics – AnalogyArmament – Catalog Price
System Eng/Program Mgt – Factor of Air VehicleSystem Test & Evaluation – Factor of Air VehicleTraining – Factor of Air VehicleData – Factor of Air VehiclePeculiar Support Equipment – Factor of Air VehicleInitial Spares – Factor of Air Vehicle
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Data Collection and Analysis
• The direction we take in collecting historical data will be determined by our choice of estimating methodologies.
• This step may also dictate a change in estimating approach due to the availability or non-availability of certain data.
• Data collection is not limited to cost data. We must also collect technical and program data if we want the total picture of the historical systems. This will help us ensure the comparability of the systems that we are collecting data on with the system we are estimating.
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Data Collection and Analysis Most Difficult Task in Cost Estimating
• Data Sources– Data Types: Cost/Resource, Technical, Program– Categories: Primary, Secondary
• Data Problems– Wrong Format – Matching up – Definition– Temporal Factors - comparability
• Normalization• Data Location
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Data Collection and Analysis
• Collection and analysis represent a significant amount of the overall estimating task in terms of time. The analysis will include decisions on what programs to include in the data set to whether to truncate lot data on a program for which you are calculating a learning curve.
• Document data in your analysis, and any assumptions you make
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Estimate Formulation
• We have defined our tasks, planned the estimate, assigned cost responsibilities, and performed data collection and analysis.
• Here we apply our estimating methodologies and tools: develop the factors, analogies, CERs, and learning curves.
• We will aggregate the various cost elements into development, production, and O&S estimates, fiscally spread the costs, and apply inflation.
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Total cost to the Government of a system over itsentire life. LCC:
• Serves as cost input for decisions whetheror not to continue, modify, or terminatedevelopment, production, and fielding
• Provides basis for budget requests toCongress
Estimate FormulationLife Cycle Cost (LCC)
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Total Ownership Cost (TOC)Total Ownership Cost Includes All Costs Associated With the Research, Development, Procurement, Operation, Logistical Support and Disposal of an Individual Weapon System Including the Total Supporting Infrastructure That Plans, Manages and Executes That Weapon System Program Over Its Full Life.
And: "The Cost of Requirements for Common Support Items and Systems That Are Incurred Because of Introduction of That Weapon System."
But: "Excludes Indirect "Non-linked" Infrastructure Costs That Are Not Affected by Individual Weapon Systems' Development, Introduction, Deployment or Operations.“
Generally, TOC Is Synonymous With Life Cycle Costs.
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Army Tools for Total Ownership Cost Estimating
Life Cycle Cost Management Tools
APPN ACEIT PRICE SEER ACDB AMCOS OSMIS SBC/ISR CO$TAT
RDT&E X X X X X X
PROC X X X X X X
MILCON X X X X X
MILPERS X X X X X
O&M X X X X X X X
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Automated Cost Estimator (ACE)• Automated Cost Estimator (Ace)—is a Model-building Tool. Part Spreadsheet, Part Database, It Incorporates Enough Structure to Eliminate Most of the Automation Tasks You Would Have to Perform If You Used a Spreadsheet, Yet It’s Flexible Enough to Perform Nearly Any Kind of Analysis. The Analyst’s Productivity Is Increased Through Built-in Inflation, Learning, Time Phasing, Documentation, Sensitivity/what-if, and Other Analysis Capabilities.
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Automated Cost Data Base (ACDB)
ACDB Is ACEIT’s Automated Cost Database. Just As ACE Is a Model-building Tool, ACDB Is a Database- Building Tool. It Contains Powerful Database Entry and Administration Tools to Enable Any Site/office to Create Its Own Tailored Database. When You Populate It, ACDB Lets You Search and Retrieve Cost, Schedule, Technical, and Programmatic Data.
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Operating Support (O&S) Costing
Operating & Support Operating & Support Management Management
Information System Information System (OSMIS)(OSMIS)
Force CostForce CostModel(s)Model(s)
Installation CostInstallation Cost(Base Operations / (Base Operations /
Real Property Real Property Maintenance) Maintenance)
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Force Costing / ModelsForce Costing / ModelsFORCES: Unit Operations & SupportFORCES: Unit Operations & Support
• Updated Annually• Provides Input to 5 Defense Models• Supports 9 Separate Study Groups• Avg 25 Major Estimates Per Year
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OSMIS
Database
OSMISOperating & Support
Management Information System
• Parts (NSN Level) & Fuel• Ammunition• Intermediate Maintenance• Depot Maintenance• Activity Data (miles/Hours)• Year of Manufacture
U.S. ArmyCost & EconomicAnalysis Center
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Review and Presentation
• We want to ensure that the estimate is reasonable, realistic, and complete.
• Reasonableness addresses areas such as: using appropriate and acceptable methodologies; presenting methodologies systematically; the use of relevant data; and ensuring that assumptions are valid and clearly stated.
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Review and Presentation (Continued)
• The realism test checks to see if the assumptions and ground rules are consistent with the statement of work and if the costs are in line with historical data.
• We evaluate completeness by determining whether the estimate includes all the work stated in the request for proposal and whether the costs are traceable and reconcilable.
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Final Documentation
• Provide the means for other analysts to get the same results that we have in our cost estimate.
• Providing good directions and a clear trail to follow are essential in having an estimate that can be replicated.
• Provide step-by-step documentation of the methodologies, supporting data, ground rules, and assumptions, equations, examples, etc.,
• Ability to interpret or evaluate someone else’s cost documentation is as important as ability to prepare good cost documentation.
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Cost Estimating Process
Final Document
Data CollectNormalize
EstimateFormulation
Review/ Presentation
DefinitionPlanning
DOCUMENTATION
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Cost Estimating ProcessQuestions
• We have talked about a process for estimating the project as well as various techniques for estimating specific cost elements.
• Questions?
• Let’s talk about the current scenario of cost estimating for SMART.
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Cost Review Board is a quality assurance built in the
Cost Analysis Process in support of decisions and PPBES
PM - develops Program OfficeEstimate (POE)
CEAC - developsIndependent
Cost Estimate
RecommendedACP Briefed toCRB Principles
CRBWG - Reconciles &RecommendsACP to CRB
ASA(FM&C)Approves
ArmyCost Position
• OSD CAIG develops ICE for ACAT ID programs as part of the DAB process
• CEAC develop ICE for ACAT IC programs
• ASARC• OSD• PPBES• APB• CAIV• AOA
Cost Review Board (CRB) Process Overview
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Cost Analysis Requirement
BA ConceptExploration
Concept & Technology Development
System Development& Demonstration
Production & Deployment
Pre-SystemsAcquisition
Systems Acquisition(Engineering and Manufacturing
Development, Demonstration, LRIP &Production)
Support
C
Sustainment
ReviewReviewReview
ComponentAdvanced
Development
SystemIntegration
SystemDemo
ProductionReadiness & LRIP
Rate Production &DeploymentN
EW
OLD
ConceptExploration
Program Definition &
Risk Reduction
Engineering & Manufacturing Development
(EMD)
Production, Fielding/
Deployment
MS 0 MS I MS II MS III
Cost Estimates Needed
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Cost Analysis ProcessDatabases, Tools, & Models
Requirements Acquisition Assumptions
Design Parameters Risk Assessment
ASARCCAIG, DABAPBPPBESAOA
Inputs (Descriptions) Process (Models) Outputs (Costs)
Types of Cost StudiesStudies Should be Known Unknown Class
Cost Estimating Descriptions, Models Costs Analysis
CER DevelopmentDescription, Historical
CostsModels Synthesis
Needed Capability CAIV Cost Goals, Models
Descriptions ( Design and Performance Parameters)
Control
Current Capability
Performance Based and Design Based Cost Models Currently do not Exist
Cost Analysis Domain
69
Top Level Tool Requirement Models
1. Cost tools to communicate with engineering and requirements models.
2. Component level to assist engineers and designers with cost capability.
3. Integrated Performance-Based Cost Model
Arm
y C
ost &
Eco
nom
ic A
naly
sis
Cen
ter’
s M
&S
Arc
hite
ctur
e
70
Top Level Tool Requirement Models
CAI*
Interface Protocols
Pro-E
Interface Protocols
*Composite Affordability Initiative
Databases
Others
SEER
PRICE
ACDB
ACEIT
CAD
Others
Auto-CAD
Cost Tools
Engineering Tools
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Cost As An Independent Variable (CAIV)
• Best time to reduce cost is early in the process.
• Involves the stakeholders in the process.• Cost tradeoffs must be addressed early in
the acquisition process and embedded in program requirement documents, Request For Proposals (RFPs), contract provisions, and source selection process.
72
CAIV Process
• Set realistic but aggressive cost objectivesearly in acquisition program
• Manage risks
• Track progress using appropriate metrics
• Motivate Government and industrymanagers to achieve program objectives
• Incorporate incentives to reduce O&S costsfor fielded systems
73
Analysis of Alternatives
• Set realistic, aggressive cost objectives earlyin development
• Manage risks
• Track progress with appropriate metrics
• Motivate government/industry managersto achieve program objectives
• Incorporate incentives to reduce O&S costsfor fielded systems.
74
Reduce Total Ownership Cost (TOC) with M&S
• Link Cost/Performance Models to Engineering Design Models to reduce TOC & Sustainment
• Optimize performance/cost of system by addressing in early design phase
75
Cost Terminology• Recurring vs Nonrecurring costs
• Direct Costs vs Indirect Costs
• Fixed Costs vs Variable Costs
• Overhead Costs
• Sunk Costs
• Opportunity Costs
• Life Cycle CostsCost is not a uniquely defined termCost is not a uniquely defined term
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Cost Terminology
• Recurring Costs are those costs that are repetitive and occur when a company produces similar goods or services on a continuing basis. A fixed cost that is paid on a repeatable basis is a recurring cost (i.e., rent). For example, for a company that provides architectural services, office space rental - which is a fixed cost - is also a recurring cost. Can be tied to Quantity Produced.
• Nonrecurring Costs are those costs that are not repetitive, even though the total expenditure may be cumulative over a relatively short period of time. Nonrecurring costs typically involve developing or establishing a capacity to operate. For example, the cost of purchasing real estate upon which a plant will be built is a nonrecurring cost, as the cost of constructing the plant itself. Cannot be tied to Quantity.
77
Cost Terminology
• Direct Costs are those costs that can be reasonably measured and allocated to a specific output/product or work activity– Typical direct costs include the labor and material costs directly
associated with a product, service, or construction activity
• Indirect Costs are those costs that are difficult to attribute or allocate to a specific output or work activity. Costs that involve too much effort to allocate directly to a specific output; instead, they are allocated through a selected formula (i.e., proportional to direct labor hours or direct material dollars). Cannot be tied to a specific product.– Typical indirect costs include the costs of common tools, general
supplies, equipment maintenance
78
Cost Terminology
• Fixed Costs are those costs which are unaffected by changes in output quantity over a feasible range of operations for the available production capability– Typical fixed costs include insurance and taxes on facilities,
general management and administrative salaries, and interest costs on borrowed capital. These are Non-Recurring Costs.
• Variable Costs are those costs associated with production that vary with quantity of output. Variable costs are the primary costs that should be considered when making an economic analysis of a proposed change to an existing operation. – Typical variable costs include material and labor; these are
Recurring Costs
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Cost Terminology
• Overhead Costs consist of plant operating costs that are not direct labor or direct material costs. (Indirect costs, overhead, and burden are terms that are sometimes used interchangeably)
– Typical overhead costs include electricity, general repairs, property taxes, supervision
– Various methods are used to allocate overhead costs among products, services, or activities
• Most commonly used methods involve allocation in proportion to direct labor costs, direct labor hours, direct materials costs, the sum of direct labor and material costs, or machine hours (refer to example)
80
Cost Terminology
• Sunk Costs are those costs that have occurred in the past and have no relevance to estimates of future costs and revenues for alternative course of action– Common to all alternatives, not part of prospective cash flows
in the future– Not used in cost analysis but required in OMB-300
• Opportunity Costs are those costs incurred because of the use of a limited resource. The opportunity to use that same resource to monetary advantage in an alternative use is foregone.– The cost of the best rejected or foregone opportunity– Often hidden or implied
