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- Herausgeber: John Wiley & Sons
- Kategorie: Wissenschaft und neue Technologien
- Serie: Wiley Series in Operations Research and Management Science
- Sprache: Englisch
Presents an accessible approach to the cost estimation tools, concepts, and techniques needed to support analytical and cost decisions
Written with an easy-to-understand approach, Cost Estimation: Methods and Tools provides comprehensive coverage of the quantitative techniques needed by professional cost estimators and for those wanting to learn about this vibrant career field. Featuring the underlying mathematical and analytical principles of cost estimation, the book focuses on the tools and methods used to predict the research and development, production, and operating and support costs for successful cost estimation in industrial, business, and manufacturing processes.
The book begins with a detailed historical perspective and key terms of the cost estimating field in order to develop the necessary background prior to implementing the presented quantitative methods. The book proceeds to fundamental cost estimation methods utilized in the field of cost estimation, including working with inflation indices, regression analysis, learning curves, analogies, cost factors, and wrap rates. With a step-by-step introduction to the practicality of cost estimation and the available resources for obtaining relevant data, Cost Estimation: Methods and Tools also features:
- Various cost estimating tools, concepts, and techniques needed to support business decisions
- Multiple questions at the end of each chapter to help readers obtain a deeper understanding of the discussed methods and techniques
- An overview of the software used in cost estimation, as well as an introduction to the application of risk and uncertainty analysis
- A Foreword from Dr. Douglas A. Brook, a professor in the Graduate School of Business and Public Policy at the Naval Postgraduate School, who spent many years working in the Department of Defense acquisition environment
Cost Estimation: Methods and Tools is an excellent reference for academics and practitioners in decision science, operations research, operations management, business, and systems and industrial engineering, as well as a useful guide in support of professional cost estimation training and certification courses for practitioners. The book is also appropriate for graduate-level courses in operations research, operations management, engineering economics, and manufacturing and/or production processes.
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Wiley Series in
Operations Research and Management Science
A complete list of the titles in this series appears at the end of this volume.
Methods and Tools
GREGORY K. MISLICK
Department of Operations Research
Naval Postgraduate School
Monterey, California
DANIEL A. NUSSBAUM
Department of Operations Research
Naval Postgraduate School
Monterey, California
Copyright © 2015 by John Wiley & Sons, Inc. All rights reserved
Published by John Wiley & Sons, Inc., Hoboken, New Jersey
Published simultaneously in Canada
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Library of Congress Cataloging-in-Publication Data:
Mislick, Gregory K.
Cost estimation : methods and tools / Gregory K. Mislick, Daniel A. Nussbaum.
pages cm. – (Wiley series in operations research and management science)
Includes bibliographical references and index.
ISBN 978-1-118-53613-1 (hardback)
1. Costs, Industrial–Estimates. 2. Production management. I. Nussbaum, Daniel A., 1943- II. Title.
HD47.M496 2015
658.15’52–dc23
2014043910
Cover image: iStockphoto © sambrogio
iStockphoto © Fertnig
Contents
Cover
Title Page
Copyright
FOREWORD
ABOUT THE AUTHORS
PREFACE
ACRONYMS
1 “LOOKING BACK: REFLECTIONS ON COST ESTIMATING”
References
2 INTRODUCTION TO COST ESTIMATING
2.1 Introduction
2.2 What is Cost Estimating?
2.3 What Are the Characteristics of a Good Cost Estimate?
2.4 Importance of Cost Estimating in DoD and in Congress. Why Do We Do Cost Estimating?
2.5 An Overview of the DoD Acquisition Process
2.6 Acquisition Categories (ACATs)
2.7 Cost Estimating Terminology
Summary
References
Applications and Questions
3 NON-DOD ACQUISITION AND THE COST ESTIMATING PROCESS
3.1 Introduction
3.2 Who Practices Cost Estimation?
3.3 The Government Accountability Office (GAO) and the 12-Step Process
3.4 Cost Estimating in Other Non-DoD Agencies and Organizations
3.5 The Cost Estimating Process
3.6 Definition and Planning. Knowing the Purpose of the Estimate
3.7 Data Collection
3.8 Formulation of the Estimate
3.9 Review and Documentation
3.10 Work Breakdown Structure (WBS)
3.11 Cost Element Structure (CES)
Summary
References
Applications and Questions
4 DATA SOURCES
4.1 Introduction
4.2 Background and Considerations to Data Collection
4.3 Cost Reports and Earned Value Management (EVM)
4.4 Cost Databases
Summary
References
Applications and Questions
5 DATA NORMALIZATION
5.1 Introduction
5.2 Background to Data Normalization
5.3 Normalizing for Content
5.4 Normalizing for Quantity
5.5 Normalizing for Inflation
5.6 DoD Appropriations and Background
5.7 Constant Year Dollars (CY$)
5.8 Base Year Dollars (BY$)
5.9 DoD Inflation Indices
5.10 Then Year Dollars (TY$)
5.11 Using the Joint Inflation Calculator (JIC)
5.12 Expenditure (Outlay) Profile
Summary
References
Applications and Questions
6 STATISTICS FOR COST ESTIMATORS
6.1 Introduction
6.2 Background to Statistics
6.3 Margin of Error
6.4 Taking a Sample
6.5 Measures of Central Tendency
6.6 Dispersion Statistics
6.7 Coefficient of Variation
Summary
References
General Reference
Applications and Questions
7 LINEAR REGRESSION ANALYSIS
7.1 Introduction
7.2 Home Buying Example
7.3 Regression Background and Nomenclature
7.4 Evaluating a Regression
7.5 Standard Error (SE)
7.6 Coefficient of Variation (CV)
7.7 Analysis of Variance (ANOVA)
7.8 Coefficient of Determination (
R
2
)
7.9 F-Statistic and t-Statistics
7.10 Regression Hierarchy
7.11 Staying Within the Range of Your Data
7.12 Treatment of Outliers
7.13 Residual Analysis
7.14 Assumptions of Ordinary Least Squares (OLS) Regression
Summary
References
Applications and Questions
8 MULTI-VARIABLE LINEAR REGRESSION ANALYSIS
8.1 Introduction
8.2 Background of Multi-Variable Linear Regression
8.3 Home Prices
8.4 Multi-Collinearity (MC)
8.5 Detecting Multi-Collinearity (MC), Method #1: Widely Varying Regression Slope Coefficients
8.6 Detecting Multi-Collinearity, Method #2: Correlation Matrix
8.7 Multi-Collinearity Example #1: Home Prices
8.8 Determining Statistical Relationships between Independent Variables
8.9 Multi-Collinearity Example #2: Weapon Systems
8.10 Conclusions of Multi-Collinearity
8.11 Multi-Variable Regression Guidelines
Summary
Applications and Questions
9 INTRINSICALLY LINEAR REGRESSION
9.1 Introduction
9.2 Background of Intrinsically Linear Regression
9.3 The Multiplicative Model
9.4 Data Transformation
9.5 Interpreting the Regression Results
Summary
References
Applications and Questions
10 LEARNING CURVES: UNIT THEORY
10.1 Introduction
10.2 Learning Curve, Scenario #1
10.3 Cumulative Average Theory Overview
10.4 Unit Theory Overview
10.5 Unit Theory
10.6 Estimating Lot Costs
10.7 Fitting a Curve Using Lot Data
10.8 Unit Theory, Final Example (Example 10.5)
10.9 Alternative LMP and Lot Cost Calculations
Summary
References
Applications and Questions
11 LEARNING CURVES: CUMULATIVE AVERAGE THEORY
11.1 Introduction
11.2 Background of Cumulative Average Theory (CAT)
11.3 Cumulative Average Theory
11.4 Estimating Lot Costs
11.5 Cumulative Average Theory, Final Example
11.6 Unit Theory vs. Cumulative Average Theory
Summary
Applications and Questions
12 LEARNING CURVES: PRODUCTION BREAKS/LOST LEARNING
12.1 Introduction
12.2 The Lost Learning Process
12.3 Production Break Scenario
12.4 The Anderlohr Method
12.5 Production Breaks Example
12.6 The Retrograde Method, Example 12.1 (Part 2)
Summary
References
Applications and Questions
13 WRAP RATES AND STEP-DOWN FUNCTIONS
13.1 Introduction
13.2 Wrap Rate Overview
13.3 Wrap Rate Components
13.4 Wrap Rate, Final Example (Example 13.2)
13.5 Summary of Wrap Rates
13.6 Introduction to Step-Down Functions
13.7 Step-Down Function Theory
13.8 Step-Down Function Example 13.1
13.9 Summary of Step-Down Functions
References
Applications and Questions
14 COST FACTORS AND THE ANALOGY TECHNIQUE
14.1 Introduction
14.2 Cost Factors Scenario
14.3 Cost Factors
14.4 Which Factor to Use?
14.5 Cost Factors Handbooks
14.6 Unified Facilities Criteria (UFC)
14.7 Summary of Cost Factors
14.8 Introduction to the Analogy Technique
14.9 Background of Analogy
14.10 Methodology
14.11 Example 14.1, Part 1: The Historical WBS
14.12 Example 14.1, Part 2: The New WBS
14.13 Summary of the Analogy Technique
References
Applications and Questions
15 SOFTWARE COST ESTIMATION
15.1 Introduction
15.2 Background on Software Cost Estimation
15.3 What is Software?
15.4 The WBS Elements in a typical Software Cost Estimating Task
15.5 Software Costing Characteristics and Concerns
15.6 Measuring Software Size: Source Lines of Code (SLOC) and Function Points (FP)
15.7 The Software Cost Estimating Process
15.8 Problems with Software Cost Estimating: Cost Growth
15.9 Commercial Software Availability
15.10 Post Development Software Maintenance Costs
Summary
References
16 COST BENEFIT ANALYSIS AND RISK AND UNCERTAINTY
16.1 Introduction
16.2 Cost Benefit Analysis (CBA) and Net Present Value (NPV) Overview
16.3 Time Value of Money
16.4 Example 16.1. Net Present Value
16.5 Risk and Uncertainty Overview
16.6 Considerations for Handling Risk and Uncertainty
16.7 How do the Uncertainties Affect our Estimate?
16.8 Cumulative Cost and Monte Carlo Simulation
16.9 Suggested Resources on Risk and Uncertainty Analysis
Summary
References
Applications and Questions
17 EPILOGUE: THE FIELD OF COST ESTIMATING AND ANALYSIS
ANSWERS TO QUESTIONS
INDEX
End User License Agreement
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Guide
Cover
Contents
“Looking Back: Reflections on Cost Estimating”
List of Illustrations
FIGURE 2.1
FIGURE 2.2
FIGURE 3.1
FIGURE 3.2
FIGURE 3.3
FIGURE 4.1
FIGURE 4.2
FIGURE 4.3
FIGURE 4.4
FIGURE 5.1
FIGURE 5.3
FIGURE 6.1
FIGURE 6.2
FIGURE 6.3
FIGURE 6.4
FIGURE 7.1
FIGURE 7.2
FIGURE 7.3
FIGURE 7.4
FIGURE 7.5
FIGURE 7.6
FIGURE 7.7
FIGURE 7.8
FIGURE 7.9
FIGURE 7.10
FIGURE 7.11
FIGURE 9.1
FIGURE 9.2
FIGURE 9.3
FIGURE 9.4
FIGURE 10.1
FIGURE 10.2
FIGURE 10.3
FIGURE 10.4
FIGURE 10.5
FIGURE 10.6
FIGURE 10.7
FIGURE 10.8
FIGURE 10.9
FIGURE 11.1
FIGURE 11.2
FIGURE 12.1
FIGURE 12.2
FIGURE 13.1
FIGURE 15.1
FIGURE 15.2
FIGURE 16.1
FIGURE 16.2
FIGURE 16.3
FIGURE 16.4
List of Tables
TABLE 2.1
TABLE 2.2
TABLE 2.3
TABLE 2.4
TABLE 3.1
TABLE 5.1
TABLE 5.2
TABLE 5.3
TABLE 5.4
TABLE 5.5
TABLE 5.6
TABLE 5.7
TABLE 5.8
TABLE 5.9
TABLE 5.10
TABLE 5.11
TABLE 5.12
TABLE 7.1
TABLE 7.2
TABLE 7.3
TABLE 7.4
TABLE 7.5
TABLE 7.6
TABLE 7.7
TABLE 7.8
TABLE 7.9
TABLE 7.10
TABLE 8.1
TABLE 8.2
TABLE 8.3
TABLE 8.4
TABLE 8.5
TABLE 8.6
TABLE 8.7
TABLE 8.8
TABLE 8.9
TABLE 8.10
TABLE 8.11
TABLE 8.12
TABLE 9.1
TABLE 9.2
TABLE 9.3
TABLE 10.1
TABLE 10.2
TABLE 10.3
TABLE 10.5
TABLE 10.6
TABLE 10.7
TABLE 10.8
TABLE 10.9
TABLE 10.10
TABLE 10.11
TABLE 10.12
TABLE 11.1
TABLE 11.2
TABLE 11.3
TABLE 11.4
TABLE 11.5
TABLE 11.6
TABLE 11.7
TABLE 11.8
TABLE 11.9
TABLE 11.10
TABLE 12.1
TABLE 12.2
TABLE 13.1
TABLE 13.2
TABLE 14.1
TABLE 14.2
TABLE 14.3
TABLE 14.4
TABLE 14.5
TABLE 14.6
TABLE 14.7
TABLE 14.8
TABLE 15.1
TABLE 15.2
TABLE 16.1
TABLE 16.2
TABLE 16.3
TABLE 16.4
TABLE 16.5
TABLE 16.6
TABLE 16.7
Foreword
What will be the cost of something we might want to buy? This is a question we frequently ask in our everyday lives. It is a question that can often be answered simply by determining the seller’s price – and maybe with a little haggling. But what if we are a government agency that wants to buy something that has never been made before? Or what if we want a newer version of something we already have, but with greater capabilities and never-yet-seen-or-built equipment? And what if we need to make resource allocation decisions today about something we will pay for in the future? Price is not always available – therefore, we must make a cost estimate. As the Government Accountability Office (GAO) explains: “Cost estimates are necessary for government acquisition programs …. to support decisions about funding one program over another, to develop annual budget requests, to evaluate resource requirements at key decision points …. Having a realistic estimate of projected costs makes for effective resource allocation, and it increases the probability of a program’s success.”1
A cost estimate is the determination of the likely future cost of a product or service based on an analysis of data. Estimating that future cost involves employing inter-disciplinary quantitative analysis techniques. It is partly science, art and judgment. Two of the best scientists, artists and judges in the cost estimating field have joined forces to present this practical guide to cost estimating, primarily (although not exclusively) for Defense practitioners. Dr. Daniel A. Nussbaum is regarded as one of the Navy’s premier experts in cost estimating, having been the Director of the Naval Center for Cost Analysis as a member of the Senior Executive Service (SES), and as the International President of the Society for Cost Estimating and Analysis (SCEA), (now renamed the International Cost Estimating and Analysis Association, ICEAA). LtCol Gregory K. Mislick, USMC (Ret.) has significant practical experience in cost estimating from performing cost analyses as a Marine Corps officer, from over 13 years of teaching cost analysis at the Naval Postgraduate School (NPS), and from leading student research as a thesis advisor at NPS. He has been a finalist for the Richard W. Hamming Teaching Award at NPS. Together they have the knowledge and experience in cost estimating for acquisition programs, and are the right team to bring this book to the public. An example of this is that they have recently been awarded – as part of a NPS Operations Research Department team – the Military Operations Research Society’s (MORS) Barchi prize award, awarded to recognize the best paper given at the MORS Symposium.
The timing is perfect for such an endeavor for at least three reasons. First, DoD’s cost estimating capability has been the subject of severe criticism. According to Senator Carl Levin, chairman of the Senate Armed Services Committee: “The GAO found that report after report indicated that the key to successful acquisition programs is getting things right from the start with sound systems engineering, cost-estimating, and developmental testing early in the program cycle.”2 Secondly, enactment of the Weapons Systems Acquisition Reform Act (WSARA) in 2009 and signed by the President has placed added emphasis on cost analysis, cost estimating and cost management in DoD. Third, fiscal pressures are forcing hard choices inside DoD. Planned budget reductions, lower funding for overseas contingency operations, discretionary budget caps under the Budget Control Act, and short-term sequestrations all mean that DoD will have to work harder to get costs right at the beginning in order to make the optimal resource allocation decisions in a tight fiscal environment.
In such an environment, what is not needed is a book based on theories of cost estimating, but rather a practical book for the community with useful applications for doing the difficult work of cost estimating. That is the purpose of this how-to book – to provide a useful guide that the cost estimator can utilize when engaged in the science, art and judgment of cost estimating.
The chapters in the book follow a logical sequence drawing the reader ever more deeply into the practice and processes of cost estimating. It begins in Chapters 1 and 2 with useful introductory material presenting key definitions, describing the DoD policy, statutory and regulatory environments, and setting the frameworks within which cost estimating is done. Chapter 3 first explains the non-DoD acquisition process, and then takes the reader into the reality of beginning a cost estimating assignment by discussing cost analysis requirements, methodologies and processes. Chapters 4 and 5 explain the sources and uses of data, emphasizing the importance of methods for working with different types of data from disparate sources and different time periods. Chapters 6 through 9 will perhaps become the most worn pages of the book, explicating, as they do, the statistical methodologies and regressions that are essential to cost estimating. The concept of learning curves, perhaps the most misunderstood aspect of cost estimating, is addressed in Chapters 10–12. Chapters 13 through 15 then discuss specific topics in cost estimating: use of analogous costing, single-variable cost factors, step-down functions, allocation of profit and overhead costs, and software cost estimating. Chapter 16 addresses the critical challenges associated with risk and uncertainty, and considerations when conducting a Cost Benefit Analysis. The textbook concludes in Chapter 17 with a summary to tie any loose ends together. Taken together, the chapters of this book provide a one-source primer for the cost estimating professional. It is both a textbook for learning and an easy access reference guide for the working practitioner.
A final word about the broad applicability of this book: cost estimating is a discipline interrelated to the other important processes and functions of Defense management. It is required at key milestones of the acquisition processes, of course, but cost estimating is, or should be, a key element of the processes of requirements determination, programming and budgeting, and program performance evaluation. Ultimately, cost considerations must be part of the toolkit for DoD’s policy and management leaders. While they may never conduct an actual cost estimate themselves, their capabilities for making decisions will be enhanced by an understanding of how cost estimating is done, its strengths and limitations, and its language and art. This book needs to be on their bookshelves, as well.
Dr Douglas A. Brook About the Authors
__________________________
1U.S. Government Accountability Office, GAO Cost Estimating and Assessment Guide, (Washington, GAO-09-3SP, March 2009), p.15.
2“Summary of the Weapons Systems Acquisition Reform Act of 2009,” available at http://www.levin.senate.gov/newsroom/press/release/?id=fc5cf7a4-47b2-4a72-b421-ce324a939ce4, retrieved 20 August 2013.
About the Authors
Reproduced with permission of Javier B. Chagoya.
Gregory K. Mislick is a Senior Lecturer at the Naval Postgraduate School in the Operations Research (OR) Department in Monterey, California. His expertise is in life cycle cost estimating and modeling, probability and statistics, regression analysis, data analysis, and optimization. He is a retired Marine Corps Lieutenant Colonel who flew the CH-46E helicopter and served for 26 years after graduation from the US Naval Academy. He has served as an Associate Dean at NPS and is the Program Manager for the Masters in Cost Estimating and Analysis degree program at NPS. He is also a member of numerous professional societies, including the Military Operations Research Society (MORS) and the International Cost Estimating and Analysis Association (ICEAA). His education includes a BS in Mathematics from the US Naval Academy and an MS in Operations Research from the Naval Postgraduate School. He served as a Board member for Leadership Monterey Peninsula for six years, has been an Associate Board member for the Big Sur Marathon for 13 years, and is Race Director for the JUST RUN Kids 3k event held twice per year in Monterey. He is an active runner, having completed 28 marathons with four marathons under 2:30.
Daniel A. Nussbaum is the Chair of the Energy Academic Group and a faculty member in both the Operations Research Department and the Business School at Naval Postgraduate School (NPS). He has worked in the private sector and in government providing support on a broad range of cost, financial, and economic analyses. He served as the Director, Naval Center for Cost Analysis, during which he was the chief advisor to the Secretary of Navy on all aspects of cost and schedule estimating. He also directed all Navy Independent Cost Estimates as required by Congress and senior Defense leadership on ships, aircraft, missiles, electronics, and automated information systems. His education includes a BA in Mathematics and Economics, Columbia University; Ph.D. in Mathematics, Michigan State University; a Fellowship from National Science Foundation in Econometrics and Operations Research at Washington State University; National Security Management, National Defense University; Employment of Naval Forces, US Naval War College; and Senior Officials in National Security (SONS) Fellowship, Harvard University, Kennedy School of Government.
Preface
How did this journey to write a textbook begin? After graduating from the US Naval Academy with a degree in Mathematics, I flew helicopters and served in the US Marine Corps for 26 years, piloting the mighty CH-46E Sea Knight (the “Battle Phrog”) during four overseas deployments. Along the way I earned my primary Masters Degree in Operations Research from the Naval Postgraduate School. One of my favorite classes while there was in cost estimation, and in particular I liked the usefulness and practicality of the subject matter. After graduation, I was fortunately assigned to the Marine Corps Research, Development and Acquisition Command (MCRDAC, now MARCORSYSCOM) in Quantico, Virginia for three years in Program Support Analysis (PSA), where I exclusively concentrated on Cost Estimation and Test and Evaluation. Those three years calculating costs, utilizing numerous quantitative methods, briefing seniors on the analysis and results found, very much stoked the fire in me for this area of study. I returned to the fleet and flew and deployed a few more times over the next nine years, and then returned to NPS as a military faculty member in the Operations Research Department in August 2000. When I arrived, the cost estimation class was being taught by Tim Anderson. Within a year, Tim retired from the US Navy and the course was seeking a new instructor. I eagerly volunteered to teach the class and have been doing so since 2001. At this time, approximately 250 students take the class each year, either as a resident student or as a distance learning, non-resident student.
While the cost estimation course had been taught with very detailed PowerPoint slides for many years before Dr. Daniel A. Nussbaum and I arrived, numerous students requested a textbook because they wanted either more detail or some “gaps” filled in and thus the idea for this textbook was born. Fortunately, publishers were very interested because little information like this existed on the market! The primary goal of this book is to help provide the tools that a cost estimator needs to predict the research and development, procurement, and/or operating and support costs or for any elements in a work breakdown structure in those phases.
While this textbook took 1.5 years to complete, many people have helped to provide information for it, either directly or indirectly. Anyone who has ever taught the cost estimation class here at NPS has had a hand in developing the slides that have been used for many years. The list of instructors at NPS includes Tim Anderson, Dan Boger, CDR Ron Brown (USN), CAPT Tom Hoivik (USN), CDR Steven E. Myers, (USN), and Mike Sovereign. In addition, a few others who provided significantly to the slides include: Major Tom Tracht (USAF), Dr Steve Vandrew of DAU (now NAVAIR), and the late Dr. Steven Book of the Aerospace Corporation. Thanks to all of these individuals and our apologies in advance if we have missed anyone! A few of the examples in the textbook are exactly from the original slides, while most others have been revamped or upgraded to align with the times.
Our goal when writing this textbook was to make it sound more like a “conversation” than a textbook, as if we were in the same room together and we were speaking to you about the topic. We hope that we have achieved that goal! We have also tried to make this textbook applicable to both DoD and non-DoD entities and organizations, to their cost estimators, and to those involved in Cost Engineering.
When I was a student, a pet peeve of mine was when an instructor would say something like “It is intuitively obvious that …..” and would then proceed from Step A to
Step D without explaining what was happening in Steps B and C! Well, of course, it is intuitively obvious if you have been working in the field for twenty-five years! But for those of us who are reading about a subject for the first time and are just being introduced to the subject matter, maybe it is not so intuitively obvious. Consequently, in the quantitative chapters in this textbook, you will see calculations provided to almost every problem. If the calculations are not provided, it is only because a previous example already went through the same steps.
It was also our intent to try to stay away from really technical math terms like “degrees of freedom” and describing a term as an “unbiased estimator for the variance.” Instead, our goal is to provide explanations in layman’s terms in easy-to-understand language that “just makes sense.” The book is organized as follows:
Chapter 1
: A historical perspective from Dr. Daniel A. Nussbaum on the past thirty years in cost estimation and changes he has observed along the way.
Chapter 2
: Background information on what cost estimation is and why it is important, the DoD acquisition process and the phases and acquisition categories of developmental programs and the key terminologies used in the acquisition environment.
Chapter 3
: The non-DoD acquisition process and the key terminologies, processes and methods used in the cost estimating field.
Chapter 4
: Once you are assigned a cost estimate, where do you get your data from? This chapter discusses many data bases, websites and the most significant cost reports used in cost estimating, as well as providing an introduction to Earned Value Management (EVM).
Chapter 5
: Once you have your data, how do you normalize it so you can accurately use it? You must normalize for content, quantity, and inflation, with normalizing for inflation being the most important of the three.
Chapters 6
–
14
: The “meat” of the book, involving the myriad quantitative methods utilized in the field of cost estimation, including regression analysis, learning curves, cost factors, wrap rates, and the analogy technique.
Chapter 15
: An overview of software cost estimation.
Chapter 16
: An overview of both Cost Benefit Analysis/Net Present Value, and Risk and Uncertainty.
Chapter 17
: Summary.
There are a number of people whom I would like to thank for their help in this textbook endeavor. First, I would like to thank Anne Ryan and Jae Marie Barnes for volunteering to review a number of the chapters in this text and offering ideas, suggestions, and recommendations on what to keep and what to change; Kory Fierstine for keeping me updated on DoD policy and always being there to listen and help when I had questions; Dr. Sam Buttrey for patient answers to my statistical questions; and I would like to thank many of my former students whom I have had in class along the way – your questions, suggestions, and ideas have helped me learn as much from you as I hope you learned from me. I would also like to thank my two sisters, Hope and Barbara, and my mom for their love and support over the years. I wish my dad were still alive to read the book. He may not have understood too much of this subject, but he still would have been one of my biggest supporters along the way!
I owe my biggest thanks to my co-author Dr. Daniel A. Nussbaum, for being such a great friend and mentor over the past ten years that we have worked together. Dan has never hesitated to answer a question, share his knowledge in any subject area that I perhaps needed help in, and provide sanity checks to ideas. We also started the Masters in Cost Estimating and Analysis (MCEA) degree program here at NPS in 2010. It has been a fun journey together.
Gregory K. Mislick
After completing a Ph.D. in theoretical mathematics and teaching mathematics to undergraduates, I was invited to attend a postdoctoral Fellowship in applied mathematics, and within one year I was tackling operations research projects for the US Army Concepts Analysis Agency (now Center for Army Analysis). A few years later, I transferred to the headquarters of US Army Europe, in Germany, in order to head a division called the Economic Analysis and Systems division. The issues facing a major command often required projections of the impact of budget cuts, cost estimates in the ever-changing multiple currency environment, and many other demands for cost estimation and analysis.
Shortly after returning to the US, I began working for the US Navy. Ever since, I have been specializing in cost estimation projects and problems inside the Department of Defense and outside the DoD with other US government agencies, other nations, and with private organizations. In 2004, I was invited to return to teaching at the Naval Postgraduate School, where, together with Greg Mislick and others, we developed the first dedicated Master’s degree program in cost estimating and analysis.
It has been clear to me for many years that a textbook would be helpful to students who are learning this discipline, along with its underlying mathematical and analytical principles and methods. I was delighted to join Greg Mislick in developing this text and I appreciate the hard work he has put into it. He and I have also teamed up successfully, with others, to be awarded the prestigious Cost Analysis and Management Sciences Community Award presented by the Assistant Secretary of the Navy for Financial Management and Comptroller in 2010, and the 2014 Military Operations Research Society’s Barchi prize, awarded to recognize the best paper given at their Symposium.
There are numerous professional heroes who provided me guidance and wisdom through the years and I would like to briefly recognize and thank them for all they have done while I have this opportunity to do so. First, I would like to reach back to August O. Haltmeier, my high school mathematics teacher, an unpretentious, professional man who fired my interest in mathematics, ultimately leading to my interests in econometrics, operations research, and cost estimating. The list also includes my thesis advisor, Dr. John Rankin Kinney, who showed much patience and confidence in me and whose kindnesses I strive to repay indirectly. I also thank Leonard S. Freeman, who showed me that analysis could have impact inside the Department of Defense in order to make better, and more defensible, recommendations about large and important national security issues. Finally, I thank Dr. Richard (“Dick”) Elster and Dr. Douglas A. (“Doug”) Brook, both of whom have been at the Naval Postgraduate School, who showed me by example that one can combine careers that serve both the public interest and the academic world.
There are also my personal and familial heroes. Rosa Meyer Nussbaum, Aaron Nussbaum, Ethel Arac Nussbaum, and Fernand Nussbaum, who form the best quartet of grandparents and parents that anyone could ask for. They lavished love and guidance, conscience and practicality, and unwavering support for family and education. I am strengthened daily by my daughters, Elise Jacobs and Amy Craib, and their families, and I take great delight and pride in watching them shape their own visions, values, professions, and ways of life, creating stability in an ever-more complex world. Their examples solidify and validate my optimism for the future. Closest to home, and therefore of the greatest consequence, is my wife, Beverly Davis Nussbaum, who has lovingly shared all of my adult life and experiences. Her insight, calming words, editorial prowess, and unending love make my achievements possible.
Daniel A. Nussbaum
Acronyms
ACAT
Acquisition Categories
ACWP
Actual Cost of Work Performed
AFCAA
Air Force Cost Analysis Agency
AFIT
Air Force Institute of Technology
AFTOC
Air Force Total Ownership Cost
ANOVA
Analysis of Variance
AoA
Analysis of Alternatives
AUC
Average Unit Cost
B$
Billions (of Dollars)
BCE
Baseline Cost Estimate
BCWP
Budgeted Cost of Work Performed
BCWS
Budgeted Cost of Work Scheduled
BRAC
Base Realignment and Closure
BY$
Base Year Dollars
CAE
Component Acquisition Executive
CAIG
Cost Analysis Improvement Group
CAIV
Cost as an Independent Variable
CARD
Cost Analysis Requirements Description
CBA
Cost Benefit Analysis
CBO
Congressional Budget Office
CCDR
Contractor Cost Data Report
CDD
Capabilities Development Document
CDF
Cumulative Distribution Function
CEBOK®
Cost Estimating Book of Knowledge
CER
Cost Estimating Relationship
CES
Cost Element Structure
COA
Course of Action
COTS/NDI
Commercial Off-the-Shelf/Non-Developmental Item
CPR
Contract Performance Report
CAC
Cumulative Average Cost
CV
Cost Variance (or) Coefficient of Variation
CY$
Constant Year Dollars
DAB
Defense Acquisition Board
DAES
Defense Acquisition Executive Summary
DAMIR
Defense Acquisition Management Information Retrieval
DASA-CE
Deputy Assistant Secretary of the Army for Cost and Economics
DAU
Defense Acquisition University
DCARC
Defense Cost and Resource Center
DoD
Department of Defense
DoDCAS
Department of Defense Cost Analysis Symposium
DOE
Department of Energy
DRPM
Direct Reporting Program Manager
EMD
Engineering and Manufacturing Development
EVM
Earned Value Management
FFRDC
Federally Funded Research and Development Centers
FP
Function Points
FV
Future Value
FY
Fiscal Year
FY$
Fiscal Year Dollars
FYDP
Fiscal Year Defense Plan
GAO
Government Accountability Office
IC
Intelligence Community
ICE
Independent Cost Estimate
ICEAA
International Cost Estimating and Analysis Association
ICD
Initial Capabilities Document
IT
Information Technology
JIC
Joint Inflation Calculator
K$
Thousands (of Dollars)
LCCE
Life Cycle Cost Estimate
LLF
Lost Learning Factor (for production breaks)
LMP
Lot Midpoint
LN
Natural Log
LRIP
Low Rate Initial Production
M$
Millions (of Dollars)
MAIS
Major Automated Information System
MC
Multi-Collinearity
MCEA
Masters in Cost Estimating and Analysis (at NPS)
MDA
Milestone Decision Authority
MDAP
Major Defense Acquisition Program
MILCON
Military Construction
MIL-STD
Military Standard
MTBF
Mean Time Between Failure
NCCA
Naval Center for Cost Analysis
NPS
Naval Postgraduate School
NPV
Net Present Value
O&M
Operations and Maintenance
OSD
Office of the Secretary of Defense
OSD CAIG
Office of the Secretary of Defense Cost Analysis Improvement Group
OSD CAPE
Office of the Secretary of Defense Cost Assessment and Program Evaluation
OSMIS
Operating and Support Management Information System (Army)
Probability Density Function
PDRR
Program Definition and Risk Reduction
PEO
Program Executive Officer
PM
Program Manager
POE
Program Office Estimate
POL
Petroleum, Oil and Lubrication
PPBES
Planning, Programming, Budgeting and Execution System
PV
Present Value
QA
Quality Assurance
RDT&E
Research, Development, Test, and Evaluation
RFP
Requests for Proposals
R-HW
Recurring Hardware
ROI
Return on Investment
ROM
Rough Order of Magnitude
SAR
Selected Acquisition Report
SCEA
Society of Cost Estimating and Analysis
SCP
Service Cost Position
SD
Standard Deviation
SE or SEE
Standard Error or Standard Error of the Estimate
SE/PM
Systems Engineering/Program Management
SLOC
Software Lines of Code
SME
Subject Matter Expert/Expertise
SRDR
Software Resource Data Report
SV
Schedule Variance
SYSCOM
Systems Command
TY$
Then Year Dollars
UFC
Unified Facilities Criteria
USD (AT&L)
Under Secretary of Defense for Acquisition, Technology and Logistics
VAMOSC
Visibility and Management of Operation and Support Costs
WBS
Work Breakdown Structure
WBSE
Work Breakdown Structure Element
WSARA
Weapons Systems Acquisition Reform Act (2009)
“Looking Back: Reflections on Cost Estimating”
We are delighted that you have chosen to learn about a vibrant career field that few people know about in any significant depth: the field of cost estimating. However, before we discuss the background, terminologies, statutory requirements, data sources, and the myriad quantitative methods involved and introduced within this textbook to help you become a better informed or better cost estimator, I would like to first discuss with you the idea of cost estimation as a profession. There are two facts that are most important in this field that are in seeming contradiction of each other: first, that cost estimating is “ubiquitous,” always existing either formally or informally in every organization; and second, that it is often “invisible,” or at least many times overlooked. My goal in this chapter is to provide some personal observations from my 30+ years of experience to shed light on the many significant purposes and roles played by cost estimation. These experiences also provide the opportunity for me to thank the many leaders, mentors, coworkers, and others who have provided me skills and insights throughout my career and whose contributions are reflected in this book. Lastly, I will comment on important changes that have been occurring in the profession within the last 30 years and some forecasts of future changes.
In the past, nobody went to school to become a cost estimator. To illustrate this point, I studied mathematics and economics in school, while my co-author, Greg Mislick, also studied mathematics and flew helicopters for the U.S. Marine Corps in his previous career. By different routes, we became practitioners of operations research and specialists in addressing the issue of “What will it cost?” In recent years, however, there have been graduate-level certificate and master’s degree programs introduced to hone the skills of, and establish professional standards for, cost estimators. This textbook is our attempt to pass those skills and lessons learned on to you and to increase the knowledge and experience of those working in this field.
Every organization – from a typical household to the greatest nation – relies upon the disciplines and processes of this profession. The one question that typically comes up in a conversation about most topics is “What does it (or what will it) cost?” It is a question that you and I will ask numerous times in both our professional and personal lives. The most frequent response that we get to this question (especially from those who do not really want to give us an answer) is “I can’t tell you exactly,” as if this were a useful or satisfactory response. The answer is just a dodge. We were not expecting an exact dollarsand cents answer. Rather, we were looking for an approximate answer to help us plan for the expense while we sort through the various options that we may be considering.
The characteristics of a useful answer to the “What does it cost” question that we look for in the circumstances of our daily lives are remarkably similar to those answers in commercial and government applications of cost estimating, although complexity and scale may camouflage this similarity. The essential characteristics of any good cost estimate are completeness, reasonableness, credibility, and analytic defensibility. Note that this list does not include the need to make sure the answer has plenty of precision. While the budgets we develop and the cost-benefit analyses that we construct require specific numbers in them, our professional work as cost estimators does not rely on getting answers “correct to the penny.” A cost estimator should not agonize over the lack of a narrow range of possible costs for the cost estimate. If the ranges are overly large, the user of the estimate, such as your sponsor, consumer, boss, or other person who asked for the cost estimate, may tell you that they need a tighter range of costs, and you will then need to seek additional data or another methodological approach to support the refinement of your estimate. However, it may also be that a wide-ranging estimate that meets the criteria of completeness, reasonableness, credibility, and analytical defensibility is all that is required in the case of rapidly changing conditions and immature technologies. In fact, in the absence of data, it may be all that is possible.
This textbook is designed specifically to provide context to those cost estimating objectives of completeness, reasonableness, credibility, and analytical defensibility. Moreover, it will teach those mathematical techniques and procedures that are relevant to develop cost estimates and it will provide you with significant guidance through that development process.
I would like to share with you now six examples/stories that illustrate some of the lessons that I have learned while holding various positions in the corporate and government worlds. This includes positions while at a headquarters and during duty in the field, while inside the United States and abroad, and mostly (but not exclusively) while serving in defense-related positions. These examples are diverse, indicating the broad applicability of the tools of cost estimating. I hope that you will find them helpful while tackling programs and assumptions of your own in your present (or possibly future) career in cost estimating.
Example 1.1 Cost Estimation in Support of a Major Ship Program As the Navy proceeded to build the inaugural (lead) ship in a new class of ships, large cost growth began to challenge the project. I was asked to figure out why this was occurring. After much analysis, I found that there were several reasons for the growth. One reason, in particular, that is useful to discuss for the education of new cost estimators, was that one of the cost driving assumptions made during the original cost estimate was simply, and significantly, incorrect. The original cost estimate had assumed that when the Navy’s lead ship was being built in the shipyard, there would be another commercial ship under construction at the same time, and these two ship programs would share the shipyard’s overhead costs. This would relieve the Navy’s ship from carrying the full burden of the shipyard’s overhead costs by spreading these costs over the two ships. The cost estimators who produced the original cost estimate had relied upon credible information and had exercised appropriate due diligence. They had confirmed that the shipyard had the work for the second ship on its order books, and they received confirmation from the Defense Contract Audit Agency (DCAA) of this order, as well as DCAA’s satisfaction that this commercial ship would be built in accordance with the contract. It was thus reasonable to assume that the shipyard’s overhead rates would be split between the two ships. However, when the Navy ship was being built, the commercial firm canceled its ship building order, for its own business reasons. Consequently, it turned out that there was no second ship in the yard with which to share overhead rates, and these overhead costs had to be covered entirely by the US Navy!
Naturally – and through no fault of the US Navy – there were indeed significant (and legitimate) cost increases. They did not occur due to inexperience or due to naïve program management by either the government or the shipyard. Thus, the first lesson learned in this example is that assumptions always drive cost. The second lesson learned is that assumptions can be fragile. While a key assumption in your program may be accurate at one moment in time, it may not be accurate at a later time. This was indeed the case here. The third lesson learned in this example is that the one constant you can always rely on is change. Change will always occur! Even a cost estimate completed with due diligence and reasonableness can be wrong. After all, in this example, all the evidence pointed to the fact that there would be a second ship in the yard. In conclusion, be aware that plans and circumstances do change during the life of your program, and they most likely will. Ultimately, these changes will affect your estimated and actual costs.
Example 1.2 Cost Estimation in Support of a Major Missile Program A frequent root cause of underestimation in a cost estimate (and therefore a strong invitation to a cost overrun) is the omission of the cost of a significant component of the necessary work. In cost estimating, we refer to such a component of the necessary work as a work breakdown structure element (WBSE). Whether the omission occurs purposely or accidentally makes no difference, for as the project is executed, labor costs and material costs associated with the missing WBSE will still accrue, the bills will be presented for payment, and a cost overrun will then occur.
A cost estimate on a missile that was an expensive new major defense weapon system provides an example. Let’s call our missile program that we are costing Program A. Experience with such weapon systems that were part of Program A had taught me that a sensor would be part of this weapon system; in fact, I expected that the development of this sensor would be one of the major cost elements in the research and development (R&D) phase of the lifecycle cost estimate. The program office confirmed that a new sensor was indeed part of the design of this weapon and that the new sensor was integral to the weapon’s successful performance. However, the program manager’s R&D cost estimate did not include the sensor!
When I asked the PM why there were no sensor costs included, he stated that a separate program (which we will call Program B) was developing the sensor and that his Program A would do a “technology lift” from Program B, thereby avoiding any sensor development R&D cost to his program. While I understood this argument, I also knew that there was no guarantee that Program B would be able to complete its development of the sensor and make it available within the timelines of our program, and I was skeptical that there would be no sensor-related R&D charges in our program. The key problem, however, was that if the sensor development in Program B was delayed, it would then delay Program A, extending our schedule until the sensor technology was in fact completed. Any extension would then cause additional costs. Consequently, I argued for the identification of contingency funds in the program to cover this possibility. Fortunately, the program manager agreed, which proved to be fortuitous when Program B (that was developing the sensor) was ultimately canceled. Thus, we had to restructure Program A to incorporate the sensor development project within our own budget.
The major lesson learned here is that technology that is not developed or “mature” always presents the very real possibility that it just may not work, or may be delayed in its development, and a dependent program will then also be delayed, with corresponding increases in costs. For instance, when a program is delayed, personnel costs will increase since the workers still need to be paid, but now over a much longer period of time. There is also a more general lesson, which is that it is important to identify all technological and other risks to any program and consider their cost impacts, and to then develop contingency cost estimates under the assumption that these risks may unfortunately come to pass.
Example 1.3 Cost Estimation in Support of a Major Ship Program For years, the US Navy knew that it needed to modernize its combat logistics fleet (CLF). However, during those years, the shipbuilding appropriations were being used nearly in their entirety to develop and procure surface combatant ships instead. To work around this funding problem, a clever idea suggested that a commercial shipyard build the next generation of CLF ships, with the intention that upon completion of each ship, the Navy would then enter into a “long-term lease” for the ships. This would thus allow the CLF to be funded from the operations and maintenance account (the O&M, N appropriation) of the Navy, rather than funding it from the shipbuilding appropriations, as was the norm. I was asked to analyze whether this arrangement made financial sense, while others were examining the financial and legal implications of this potential arrangement. My analysis was to be a “cash flow” and/or “net present value” cost benefit analysis, comparing the cost of the conventional method of procuring this ship from shipbuilding appropriations with the proposed “build-to-lease” option using operations and maintenance dollars. I also needed to include the many “what-if” analyses to test the sensitivity of the bottom line cost to variations in the assumptions and values of variables being used in the analysis.
After significant study, we found that under a wide variety of reasonable circumstances, the proposed idea of “build-to-lease” made financial sense. If you were to consider only the financial metrics of the analysis, a reasonable person would be led to propose the course of action which leveraged savings from the “build-to-lease” option. This cost beneficial proposal, however, was not brought to the attention of the Secretary of the Navy despite its cost and benefits, since it was deemed to be “poor public policy and practice” for a variety of reasons. In other words, no matter how financially attractive or analytically defensible this proposal was, it was matters of public policy that trumped the analysis and drove the decision to not “build-to-lease.” The lesson learned here is that cost issues are always a major concern, but they are almost never the only concern. Cost estimating is a function that informs and supports decision-making. An analyst should not assume that decision-makers will inevitably follow the recommendations of his or her analysis, regardless of how complete, reasonable, credible, analytically defensible, and even elegant that it may be.
Example 1.4 Cost Estimation in Support of a Major Automated Information System (MAIS) Often, it is important to do rough order of magnitude (ROM) cost estimates to help senior defense personnel sort through the cost implications of alternative courses of action for complicated projects. Knowing whether a program is going to cost roughly $75 Million or roughly $200 Million helps decision-makers distinguish between those options that are potentially viable and those that are not. A memorable example of this was the idea to develop an automated defense-wide system to support civilian and military personnel and pay functions across all of the military services and all “components” (that is, the Active forces, the Reserve Forces and the National Guard). This was intended to be the largest enterprise resource planning program of its kind ever implemented. We were tasked to “develop an estimate of what this new MAIS would cost and to compare that cost with the cost of maintaining approximately 90 legacy personnel and pay systems which this program would replace.” We were tasked long before any specific requirements (other than the broad description given in the previous sentence) had been fully thought out or discussed. At this time, there was certainly no estimate of the size of this program, and size is often a critical variable for developing a credible cost estimate. We recognized that this personnel and pay system would be a very large software and hardware effort, and to reasonably capture the cost of the software program, we needed an estimate of its size, measured either in source lines of code or in function points. The program manager certainly had no estimate of either. We were trying to “bound” the problem by saying (in effect) that this effort was going to be “bigger than a breadbox and smaller than a barn,” or, as we decided, “bigger than any Microsoft product, but smaller than the largest missile-defense project.” Obviously, the estimates we developed had a wide range of outcomes. Was this range of estimates useful to the decision-makers, or did they need exact answers in order to make their decisions? The important lesson learned here was that at the front end of a project, when many unknowns still exist, rough order of magnitude estimates with a wide range of possible cost outcomes may still be sufficient for senior decision-makers to move the decision process forward.
Example 1.5 Cost Estimation in Support of a Major Policy Decision A major overseas US Army command was having difficulty with retention and maintaining its force structure within the enlisted ranks. One significant part of the problem was identified as low re-enlistment rates among the junior enlisted members. Based on US Army regulations at the time, the command’s policy allowed a service member’s family to accompany him or her overseas. The Army would pay for the overseas move and also support the family overseas with a housing allowance and base exchange privileges, but only if the service member had attained at least a minimum rank. The junior enlisted personnel who were not re-enlisting at sufficient rates were precisely those who were below the rank necessary to have their families accompany them and to receive those elements of family support. Consequently, their families usually remained in the US while the service member completed the overseas tour. In that way, retention suffered due to hardships caused by this separation. We proposed a policy that would extend this family support to these junior enlisted members. Our analysis addressed whether the estimated costs of implementing this policy outweighed the benefits of the estimated lower recruiting and training costs due to higher retention rates. The rough order of magnitude estimates that we provided were sufficient to convince the Army to implement this policy and the results of this policy change did indeed increase enlisted retention for the U.S Army. For the cost analysts,it is highly satisfying to see crunched numbers turn into effective policy.
Example 1.6 Cost Estimation in Support of a MAIS Program
