Management Office (PMO) Budget Estimate
DAU GLOSSARY DEFINITION
Designated individual with responsibility for and authority to accomplish program objectives for development, production, and sustainment to meet the user's operational needs. The PM shall be accountable for credible cost, schedule, and performance reporting to the Milestone Decision Authority (MDA).
An acquisition program (whether a weapon system or an information technology (IT) system) is initiated to provide a materiel solution to fill a capability gap identified by the warfighter community. Other methods of a non-materiel nature to provide that capability include changes in doctrine, organization, training, leadership and education, personnel, and facilities. As part of the early analysis process to evaluate potential methods to provide the needed capability, representatives of the warfighter community will prepare an Initial Requirements Document (ICD), which provides the operational goals and description of the required capabilities to address the specific gap. If a materiel solution is considered the most appropriate method to resolve the identified gap, the next step is to start action on an acquisition program. At this point, the requirement enters the Defense Acquisition System, which is a phased process with multiple milestones and decision points. The next action is the completion of an Analysis of Alternatives (AoA). Successful passage of an initial decision point known as the Materiel Development Decision (MDD) normally leads to creation of an acquisition program; however, this is not considered an “official” program until successful passage through a later milestone decision point. Thereafter, actions pertaining to programming and budgeting are relatively dependent upon where the program is in the acquisition life cycle.
The first phase of the acquisition life cycle is the Materiel Solution Analysis (MSA) phase. According to DoDI 5000.02, the minimum funding for this phase is normally that needed to analyze and select an alternative for materiel development and to complete the activities necessary to support a decision to proceed to the next phase. During the MSA phase, the responsible Component Acquisition Executive (CAE) will select a Program Manager and establish a Program Office. The first major milestone occurs at the end of the MSA phase; that is Milestone A. Among other important actions required for successful passage at Milestone A is presentation of an affordability analysis and demonstration that the program will be fully funded within the next Future Years Defense Program (FYDP). Thereafter, the PMO and Component are to ensure that adequate funding will be requested in follow-on program and budget submissions.
One of the first actions required once the materiel solution decision is made is the following: determination of the estimated cost of that solution. The initial program office cost estimate (POE) is the responsibility of the lead military service or Component, specifically the project leader (i.e., before there is an “official” acquisition program) and updated by the follow-on Program Manager (PM) after “official” program initiation (usually at Milestone B). That cost estimate may be performed by individuals assigned to the project, by individuals provided by a higher headquarters through a matrix support arrangement, or by a contractor firm. This is the PMO life cycle cost estimate, which is prepared in constant year dollars (i.e., computed on the basis that all costs would be incurred in the year the estimate is prepared even though it is known those costs would be incurred over the entire life of the program – there is no inflation built into this estimate). Depending on the total estimated cost of the program – and other factors – there will be at least one other cost estimate done at the component level and potentially a third at the OSD level.
Cost estimates are intended to capture all costs of the program, regardless of fund source or management control; they should not be arbitrarily limited to certain budget accounts or to categories controlled by the various lines of authority. Cost estimates for acquisition programs are also to be time phased by fiscal year for all years of the program acquisition (from initiation to ultimate disposal of the system; i.e., unconstrained by the FYDP years); time phasing also becomes important as the program transitions from research and development efforts, to production of the militarily useable end item, to operating and supporting that end item once deployed to the operational forces. In addition to being time phased by fiscal year, estimated costs are to be shown in each of the following three manners: (1) by required appropriation (e.g., RDT&E, procurement, and operation and maintenance); (2) by life-cycle cost category (e.g., R&D, investment, operating and support, and disposal); and (3) by work breakdown structure (e.g., hardware, software, services, and facilities). A typical acquisition program starts in some type of research and development effort, transitions into production of the end item, and then is deployed to the operational forces for its intended use; the multiple year time phasing of its life cycle becomes extremely important.
After an acquisition program office understands (1) what activities are to be done during a fiscal year to accomplish its mission; (2) which appropriation(s) should be used for the required activities; (3) the funding policies associated with the appropriations required for those activities; and (4) cost estimates to accomplish those activities, it is time to prepare the resource requirements for input into programming and budgeting documentation that will submitted to higher headquarters. There are four primary considerations when turning the program office estimate (POE) into a budget estimate: accounting for escalation; covering cost estimating risk; covering cost risk in contracting; and the time phasing of the budget request with respect to the contracting, Planning, Programming, Budgeting, and Execution (PPBE), and Congressional enactment processes.
Other considerations when developing a budget estimate and determining a funding level is "Will Cost" and "Should Cost" determinations. The OSD Operating and Support Cost Management Guidebook released in 2016 provides guidance on these factors. "Will Cost estimates must include all costs necessary to sufficiently resource and execute the program under normal conditions, assuming average levels of technical, schedule, and programmatic risk." "Should Cost estimate is derived through continuous analysis of cost drivers and initiatives to reduce the impact of these cost drivers without degrading effectiveness or suitability." "Should Cost initiatives should not focus on short-term savings that ultimately cause long-term expense or degradation of system effectiveness or suitability."
Because the life cycle cost estimate is done in constant year dollars (i.e., does not include inflation for the future years) and program/budget submissions are made in current year dollars (i.e., amounts needed in the future years), it is necessary to escalate those constant year amounts based on USD (Comptroller) guidance on escalation factors for specific appropriations in those submissions. Escalation takes into consideration two factors: inflation and the economic impact associated with those future dollars being outlaid (i.e., paid out of the U.S. Treasury to recipients of actual cash). This escalation process is necessary to ensure the dollars contained in the appropriation acts for those future years will be sufficient to pay for the items or activities planned for those years. In addition, there is the issue of cost risk which is discussed below.
Cost Estimating Risk:
According to Paragraph 010303, Chapter 1, Volume 2A, of DoD Financial Management Regulation (7000.14-R), it is DoD policy to reflect the most likely or expected full cost of the planned work effort for the five fiscal years of the program objective memorandum (POM) and budget estimate submission (BES) the Component submits to OSD on an annual basis. Ultimately, the requested budget estimate becomes the basis upon which the Defense portion of the President’s Budget is determined. Most likely cost should include predictable cost increases due to risk. Therefore, the program office should include “risk dollars” as part of the cost estimate for each element of its Program Work Breakdown Structure (PWBS) that merits such funding. These risk dollars provide the program office some flexibility to deal with high risk areas and contingencies when things go awry in the program. However, the Program Manager (PM) should be aware that budgeting for risk is a somewhat contentious subject within each of the Services, OSD, and Congress and may, therefore, be subject to reduction or deletion as part of the budget review. This is the case even though the FMR specifically states that budgets are to be based on most likely full costs for the required work effort.
There are several ways to estimate and budget for this cost risk funding; the method used should be adapted to specific needs of the acquisition program for which the budget is prepared, consistent with Service or Defense Agency policies. The PM should place “risk dollars” where the risk exists (e.g., in the airframe line, support equipment line, or wherever else it is needed). Most programs have a line item labeled “Engineering Change Orders” (ECOs) to cover general development or production risks which are not easily tied to a specific PWBS element. Several places in Volume 2A of the FMR specifically state that “Engineering Change Orders should be funded commensurate with the level of risk in the program”. There should never be a line item in the budget called "Management Reserve
Cost Risk Associated with Contracting.
Although a PM, and possibly the supporting Procuring Contracting officer (PCO), might like to budget for (and ultimately obligate) as much as possible for an acquisition-related contract to cover every potential contingency, the realities of limited defense budgets and governing policies do not allow this. Instead, PMs are expected to budget to the most likely price of a contract (i.e., the most likely amount the government will pay for the contracted effort).
Again, the requirement to budget on the basis of “most likely price” is tied directly to the funding policies for the various appropriations; those policies are addressed in the DoD Financial Management Regulation, 7000.14-R (FMR). For example, according to Volume 2A, Chapter 1, Paragraph 010214, of the FMR RDT&E funds are to be budgeted on an “incremental” basis, which means that only those funds required for work to be done in a given fiscal year shall be included in the RDT&E budget request for that year. “Work to be done” generally translates to “cost expected to be incurred” to do that work. Hence, for RDT&E, the concept is to budget for the best estimate of the cost to be incurred during the fiscal year. Paragraph 010202 of the FMR applies to the full funding policy associated with acquiring defense systems (i.e., use of a procurement appropriations); that paragraph states the budget estimate should reflect the most likely cost to the government of a procurement action.
The specifics for budgeting to “most likely price” differ depending on the type contract. The below listing addresses those specifics:
- FFP - Budget to the anticipated final negotiated price. Since the price is fixed, this is the best estimate of the amount the government will ultimately pay.
- FP-EPA - Budget to the anticipated final negotiated price, which does not include any economic price adjustments. The EPA clause represents a contingency which should not occur under the most likely scenario if the contract has been appropriately negotiated.
- FPI - Budget to the anticipated target price of the contract. Budgeting to the ceiling price indicates that the program office does not believe the incentives provided in the contract will do anything to change contractor performance.
- CPIF - Budget to the expected cost to be incurred plus the fee earned at that expected cost. Before contract execution begins, the expected cost to be incurred is the target cost and the fee earned at that cost is the target fee, the sum of which is the target price of the contract. Again, if the contract has been properly negotiated and risk appropriately placed, the most likely outcome should be the contractor achieving target cost and, therefore, target fee.
- CPAF - Budget to an amount that is the sum of the expected cost to be incurred plus the base fee plus the entire award fee which can be earned (or paid) during the budget period. The award fee criteria must be structured in such a way that the contractor can actually earn the award fee. If the PM budgets for less than this amount, it is tantamount to saying that the contractor cannot earn the entire award fee for that period, and may taint the evaluation process.
- CPFF - Budget to the sum of the expected cost to be incurred plus the fixed fee.
The guidelines described above govern the initial budgeting for a contract, which is done well in advance of the PCO completing all administrative actions and actually awarding (i.e., signing) the contract. While the original budget estimate for planned contract work would be a specific dollar amount, final decisions (e.g., negotiations with potential contractors) may result in changes to that amount. Circumstances may change the most likely price, which may have implications on the amount obligated on the contract as well as follow-on budget amounts.
Time Phasing of Budget Request:
The PM faces a number of challenges in the development of budget requests associated with contracting for work efforts. The first major challenge is that of accurately predicting in which fiscal year specific work efforts will be required. Consider the fact that the acquisition program office must, in laying out the acquisition strategy for the system being developed and procured, determine a schedule of events to occur over multiple fiscal years in the future (some of which are contracts for specific work to be done by a contractor) several years prior to the first of those events actually occurring and that schedule must be determined very early in the life of that system. As previously stated, DoD regulations require the budget for contractual work effort to be prepared on the basis of “most likely price” of that work. When the program office prepares a budget request for a future year, that preparation is done a minimum of two years before the target fiscal year begins (e.g., once submitted to higher headquarters, that budget request is evaluated within the DoD Planning, Programming, Budgeting and Execution (PPBE) process for a year before becoming part of the President’s Budget request to Congress and, thereafter, another eight or nine months being evaluated within the Congressional Enactment process before becoming part of the Defense Appropriations Act).
The second major challenge is that of the contract negotiation process before the contract is actually awarded for the work effort that was projected to be required when the budget was developed. Many things can happen between the time the program office prepared the initial budget request and when final contract negotiations resulted in a contract award.
If funds for projected contractual work effort are requested in a given fiscal year and, due to technical problems, the work contracted to be completed in a prior year is not completed, the entire schedule could potentially slip. Such schedule slippage puts the budgeted funds requested for the given fiscal year at risk to either being eliminated or reduced during the PPBE evaluation process. On the other hand, if the original budget request is not based on the acquisition strategy laid out by the program manager, there could be the perception that the program is not adequately funded.
If funds for projected contractual work effort are requested and appropriated in a fiscal year earlier than the technical aspects of the development and procurement of the acquisition system allow for the follow-on contract effort, the funds might not be obligated in a timely manner and make the program's budget execution appear inefficient. This puts those funds at risk of being withdrawn by higher headquarters during the year of budget execution. If not withdrawn, the funds could expire before the contract can be awarded. If the funds are requested too late, the program schedule could be delayed. Some of the most important factors that PMs should consider in factoring contract awards into their budget formulation are:
- Appropriation type ("color of money") - RDT&E, Procurement, MILCON, O&M) to be used for the contract and the period of obligation availability of that appropriation
- How long does it take to get a Procurement Request (PR) through the command’s "chop chain"?
- Is a milestone decision required before the request for proposal can be released and/or contract awarded?
After considering these issues and others, the program office must develop a time line of events and come up with a reasonable estimate by fiscal year as to when funds must be budgeted for the program's various contract awards.
A rule of thumb in planning for contract awards and developing corresponding budgets for the awards is to avoid planning to award a major contract in either the first or the fourth quarter of a fiscal year. With regard to the first quarter, because Congress frequently does not pass the Defense Appropriations Act prior to the new fiscal year, the total amount of funds requested for contracted actions is not normally available. Because Congress routinely provides the temporary stop-gap funding measure known as the Continuing Resolution Authority (CRA), only a limited amount of funds is usually available for the program office. Language usually associated with a CRA is "at a rate not exceeding the current rate of operations", which is normally based on the lesser of the following levels depending on circumstances specified in the Continuing Resolution: (1) the amount the activity was appropriated in the prior year or (2) the lowest Congressional mark of the President’s Budget currently being enacted. However, if the activity (e.g., program office) has a normal pattern for obligations whereby a large portion of its annual budget is obligated during the early part of the fiscal year (i.e., for on-going contractual actions), the activity may continue that obligation pattern under the CRA. Obviously, there must be coordination between the program office and its higher headquarters to ensure that required amount is actually allotted to the activity under the CRA; otherwise, an Anti-Deficiency Act (ADA) violation could occur.
With regard to a plan to award a major contract in the fourth quarter, there are three factors that make this plan risky. First, in the past several years, Congress has put language in the Defense Appropriations Acts that has stated that, at the appropriation account level, obligations in the fourth quarter of the fiscal year can be no greater than the average of the first three quarters of the year. Second, some contracting offices often impose a “moratorium” on creating obligations in the final weeks of the fiscal year because contract award schedules are full; therefore, a planned significant obligation at the end of the fiscal year might not be executable because of the workload involved in the action. Third, the OSD Comptroller budget analysts who review the Services’ Budget Estimate Submission (BES) in the PPBE process will typically question why proposed fourth quarter contract awards cannot be slipped to the following year. That question frequently results in a Program Budget Decision PBD) or that shifts the requested funds from the targeted budget year into the next fiscal year. The justification used in the PBD for that decision is that all on-going current year contract work effort normally falls behind and, therefore, contract award of the follow-on contract (i.e., the one planned to be awarded with the requested budget) will be delayed. Hence, the funds requested for a fourth quarter contract award in the targeted budget year are considered “excessive” and that budget request should be shifted to the following fiscal year when it will really be needed; therefore, the budget year funds are reduced accordingly.