Cost Estimation Methods

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.

As per the above figure, the cost estimating techniques used for an acquisition program typically progresses from an analogy to actual cost method as that program matures 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) phase, the cost estimators may be able to apply the parametric (statistically based) method. Estimating by engineering tends to begin in the latter stages of EMD and Low Rate Initial Production (LRIP) when the design is fixed, and more detailed technical and cost data are now 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.

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 applicable stage of the acquisition cycle for that program and the urgency or time available to generate the estimate. For the EMD phase, senior leaders often prefer parametric method, although the analogy and engineering methods may be acceptable, in support of Milestone B and C reviews.  Whereas the extrapolation from actual costs should be used to the maximum extent possible in preparing estimates for the Full Rate Production Review (FRPR) and any subsequent actions, to include Sustainment Reviews (SRs). A comparison of several estimates based on different cost estimating methods as cross-checks is highly 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 a program life cycle, provided there is a sufficient database of size, quality, and homogeneity to develop valid cost estimating relationships (CERs). The engineering estimate is used later in program development, production, and sustainment when the scope of work is well-defined, and a comprehensive Work Breakdown Structure (WBS) or Cost Estimate Structure (CES) can be developed. Finally, estimating by actual costs often produces the lowest risk estimate due to the fact that the projection of the next system cost is derived from a historical trend with recent/current contracts.

Expert opinion, although not addressed in this article, can be used to support any or all the four estimating methods. One or more Subject Matter Experts (SMEs) can provide the basis for the cost estimate through leveraging a wealth of experience and knowledge. Experts can identify analogous systems and recommend “most intuitive” CERs. 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 inputs on potential cost drivers, functional form of a regression and associated engineering general guidelines.

No matter what the estimation technique, the Program Manager (PM) must ensure that the cost estimate completely addresses the program baseline and is technically sound and reasonable. The cost estimate must be defensible with well-reasoned analysis. A PM 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 risks and hence cost for their program.