Cost Estimation Methods
DAU GLOSSARY DEFINITION
A cost estimate is an evaluation and analysis of future costs generally derived by relating historical cost, performance, schedule and technical data of similar items or services. The four major analytical methods or cost estimation techniques used to develop cost estimates for acquisition programs are Analogy, Parametric (Statistical), Engineering (Bottoms Up), and Actual Costs.
Generally, the cost estimating technique used for an acquisition program progresses from the analogy to actual cost method as that program becomes more mature and more information is known. The analogy method is most appropriate early in the program life cycle when the system is not yet fully defined. This assumes there are analogous systems available for comparative evaluation. As systems begin to be more defined (such as when the program enters the Engineering and Manufacturing Development Phase (EMD)), estimators are able to apply the parametric method. Estimating by engineering tends to begin in the latter stages of EMD and LRIP when the design is fixed and more detailed technical and cost data are available. Once the system is being produced or constructed (i.e., LRIP and Full Rate Production), the actual cost method can be more readily applied (See Figure 1).
Few estimates employ the same estimating technique for every cost element. The techniques used to develop the estimates for various cost elements should take into account the stage of the acquisition cycle that the program is in when the estimate is made (e.g., EMD). OSD prefers that heavy reliance be placed on the parametric method (although the analogy and engineering methods could be acceptable), for Milestone B and C reviews; while extrapolation from actual costs should be used to the maximum extent possible in preparing estimates for the Full Rate Production Review and any subsequent actions. A comparison of several estimates using different cost estimating methods is encouraged.
Of the four cost estimation methods presented, the use of actual costs is the most supportable, but difficult to accomplish early in the acquisition program. The analogy method is most often used early in the program, when little is known about the specific system to be developed. The parametric technique is useful throughout the program, provided there is a database of sufficient size, quality, and homogeneity to develop valid cost estimating relationships. The engineering estimate is used later in program development and production, when the scope of work is well defined and an exhaustive Work Breakdown Structure can be developed. Finally, estimating by actual costs produces the lowest risk estimate due to the fact that the system cost is derived from a trend from the current contract to estimate.
Expert opinion, although not addressed in this article, can be used to support any or all the four estimating methods. One or more experts can provide the basis for the cost estimate by bringing a wealth of experience and knowledge. Experts can identify analogous systems and recommend “most intuitive” cost estimating relationships. Expert judgment can prove invaluable for estimating parameter impacts along with impacts to labor and material costs. For example, experts have been used to provide estimates of software lines of code (SLOC), weight, dimensions, system complexity, specifications and performance impacts. Many times, experts have already collected data on labor hours to build, operate or maintain a system. At the very least, an expert can provide his or her opinion on cost drivers, functional form of a regression and engineering general guidelines.
No matter what the estimation technique, the program manager must ensure the cost estimate completely defines the program and is technically sound and reasonable. The cost estimate must be defensible with well-reasoned analysis. A program manager who is totally familiar with the program's cost estimate, including the rationale for the method(s) used to develop that estimate, generally has a greater chance of maintaining control of the cost of that program.