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Engineering Cost Estimation Method

DAU GLOSSARY DEFINITION

Derived by summing detailed cost estimates of the individual work packages and adding appropriate burdens. Usually determined by a contractor's industrial engineers, price analysts, and cost accountants.

General Information

The engineering or "bottoms-up" method of cost analysis is the most detailed of all the techniques and the most costly to implement. It reflects a detailed build-up of labor, material and overhead costs. Estimating by engineering is typically performed after Milestone C (i.e., Low Rate Initial Production (LRIP) approval) when the design is firm, minimal design changes are expected to occur, data is available to populate the Work Breakdown Structure (WBS), drawings and specifications are complete and production operations are well-defined in terms of labor and material. This method is often used by contractors and usually involves industrial engineers, price analysts, and cost accountants. Based on the system's specifications, engineers estimate the direct labor and material costs of a work package. In calculating labor costs, company or industry standards are often used to estimate what labor categories are required and how many hours will be required for the task. The remaining elements of the work package cost, such as tooling, quality control, other direct costs and various overhead charges are calculated using factors based on the estimated direct labor and or material content of the work.

Engineering cost estimates can be quite accurate since they are usually exhaustive in covering the work to be performed by the virtue of using the work breakdown structure. These estimates also make use of insight into the specific resources and processes used in performing the work. However, a substantial amount of time and effort is required to produce and document such an estimate, making it impractical to use this method for all elements of an acquisition program's costs. In addition, insufficient information may exist to use this method effectively, particularly early in the program when little is know about the details of the item design and production processes. Finally, the factors used to extrapolate other costs from direct labor and materials may not accurately reflect the company's current business base or facilities.

 

The source and structure of an engineering estimate provides much more detail than estimates by analogy or parametrics. Therefore, an engineering estimate enables better visibility into cost drivers. The tradeoff, however, is that producing an engineering estimate is labor intensive, slow and expensive. In addition, there are still risks. We often apply factors or overhead rates (known as wrap rates) to the estimated costs to estimate those costs that are not directly attributed to parts and direct labor. A small error at a lower level can translate into a huge error once the wrap rates have been applied.

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Over the past decade, the Department of Defense (DoD) has developed fewer estimates by engineering. The reason for this is that Acquisition Reform encourages DoD to let industry (contractor) retain detail design drawings. Many more DoD programs are strictly using Earned Value to evaluate cost and contractor performance. As a result, the contractor performs the bottoms-up estimate but provides its DoD customer only what it (the customer) needs in terms of cost and Earned Value data.