Overview

INTRODUCTION TO COST ANALYSIS

Background

All Department of Defense (DoD) Military Departments and Defense Agencies (herein referred to as "DoD Components") prepare life cycle cost estimates (LCCEs) in support of their acquisition programs.  A LCCE attempts to identify all the costs of an acquisition program, from its initiation through disposal of the resulting system at the end of its useful life and to properly phase, or spread, the costs for inclusion in budget submission documents.

LCCEs for DoD systems serve two primary purposes.  First, they are used at acquisition program milestone and decision reviews to assess whether the system's cost is affordable, or consistent with the DoD Component's and DoD's overall long-range investment and force structure plans. Second, LCCEs form the basis for budget requests to Congress.

As in other aspects of acquisition management, maximum use should be made of the Integrated Product and Process Development (IPPD) concept and Integrated Product Teams (IPTs) in the development and review of LCCEs.

The Defense Life Cycle Management System

New acquisition programs arise from the existence of either warfighting deficiencies or opportunities to provide new capabilities as documented in an Initial Capabilities Document (ICD).  The ICD describes the broadly defined operational capability required to satisfy a deficiency and documents reasons why non-materiel changes (e.g., tactics or doctrine) cannot meet this need, thereby requiring a materiel solution (i.e., an acquisition program).  These broad capabilities are then refined into system operational requirements consistent with the type of system proposed to remedy the mission need.

Based on all known requirements, the program office prepares an initial LCCE for its acquisition program.  As the program passes through its various phases and milestone decision points, the LCCE is updated by the program office and reviewed by decision makers.  In the cases of major weapon system and major automated information system (AIS) acquisitions, at least one additional LCCE must be prepared by an organization independent of the program office and the acquisition chain of command (see "Cost Estimating/Analysis Review Process" section later in this note.)

For weapon system acquisition programs, the LCCE helps decision makers assess the affordability of the system.  For AIS acquisition programs, the LCCE provides input for the required cost-benefit analysis.  The cost-benefit analysis enables decision makers to assess whether the AIS will produce satisfactory returns for the investment.

LCCEs are prepared in terms of base year dollars (also known as constant year dollars) for a selected base year (usually the year of program initiation or last major milestone review).  For budgeting purposes, the estimate is escalated to then year dollars (also known as current year dollars) to reflect inflation and outlay patterns, and is used as the basis for input to the Planning, Programming, Budgeting and Execution (PPBE) process.  These estimates ultimately become the foundation for the program's funding request in the President's Budget submitted to Congress.

The Life Cycle Cost Model

Life cycle cost(LCC) can be defined as the total cost to the government of a program over its full life, including costs for research and development, testing, production, facilities, operations, maintenance, personnel, environmental compliance, and disposal.  Each of the program's stakeholders (Congress, program office, contractors, and DoD decision makers) prefers to view life cycle costs grouped in a way that reflects its particular perspective.  The three major ways of grouping and viewing program LCC are by:

1. Funding appropriation:  DoD receives appropriations from Congress falling into five major categories: Research, Development, Test and Evaluation (RDT&E), Procurement, Operations and Maintenance (O&M), Military Construction (MILCON), and Military Personnel (MILPERS).  Program life cycle costs are broken out along these lines for internal budgets, as well as budget requests to Congress.
2. Work Breakdown Structure (WBS): A program WBS provides a framework for program and technical planning, cost estimating, resource allocations, performance measurements, and status reporting.  The WBS should define the total system to be developed or produced; display the total system as a product-oriented hierarchy composed of hardware, software, services, data, and facilities; and relate the elements of work to one another, as well as to the end product.  Major acquisition program offices shall tailor a program WBS in accordance with MIL-STD-881.  MIL-STD-881 contains appendices with a strawman WBS and dictionary for eleven types of systems down to at least WBS level 3.  Elements common to all system are contained in a separate "common elements" appendix. Cost breakouts by WBS elements are useful to the program office and contractors in managing the program.
3. Life cycle cost categories:  DoD 5000.04-M, Cost Analysis Guidance and Procedures, defines these cost categories (This document was rescinded by DODI 5000.73, but replacement guidance on LCC categories is still pending):
   • Research & Development (R&D): Cost of all research and development, from program initiation through the Low Rate Initial Production decision (end of engineering and manufacturing development).
   • Investment:  Cost of the investment phase, including total cost of procuring the prime equipment; related support equipment; training; initial and war reserve spares; pre-planned product improvements and military construction.
   • Operating and Support (O&S): Cost of operating and supporting the fielded system, including all direct and indirect costs incurred in using the system, e.g., personnel, maintenance (unit and depot), and sustaining investment (replenishment spares).  The bulk of life cycle costs occur in this category.
   • Operating and Support (O&S): Cost of operating and supporting the fielded system, including all direct and indirect costs incurred in using the system, e.g., personnel, maintenance (unit and depot), and sustaining investment (replenishment spares).  The bulk of life cycle costs occur in this category.
   • Disposal:  Cost to dispose of the system after its useful life. This includes demilitarization, detoxification, long-term waste storage, environmental restoration and related costs.

Common Cost Terms

DoD uses a number of different cost terms in various PPBE documents, such as the Program Objectives Memoranda (POM), Budget Estimate Submissions (BES), etc.; in acquisition program reports such as the Defense Acquisition Executive Summary (DAES) and the Selected Acquisition Report (SAR); and in various Congressional information sheets.  The seven cost terms shown in Figure 1 have been standardized to ensure consistency in the defense acquisition process.  DoD 5000.04-M (this document was rescinded by DODI 5000.73, but replacement guidance on common cost terms is still pending) specifically defines what is included or excluded from each term and identifies relationships to WBS elements, funding appropriations and cost categories.  Note that a WBS element can be funded by multiple appropriations.

Figure 1

In Figure 1, the appropriation(s) which may be covered by a particular cost term are shown in bold and underlined at the top of the cost term box.  The items shown below the appropriation(s) describe the segments of the WBS that are included in that cost term.

• Development Cost is the cost of all research and development-related activities, contract and in-house, necessary to design and test the system.  It includes all WBS elements.  Prototypes and test articles are included in this cost category.  Development costs are funded with only the RDT&E appropriation and are included only in the R&D cost category.
• Flyaway Cost (Rollaway, Sailaway, etc.) refers to the cost of procuring prime mission equipment (e.g., an aircraft, ship, tank, etc.).  It is funded with Procurement appropriations and is part of the Investment cost category.  Figure 1 shows that this term includes Prime Mission Equipment, System Engineering/Program Management, System Test and Evaluation, Warranties, and Engineering Changes.  Note: DoD 5000.04-M defines flyaway cost as being funded out of the RDT&E and Procurement appropriations, but in practice, only the Procurement-funded portion of flyaway is considered relevant by decision makers in DoD and in Congress. This document was rescinded by DODI 5000.73.
• Weapon System Cost is funded completely from the Procurement appropriations. It is the procurement counterpart of Development Cost in that it contains the same WBS elements as Development Cost. Weapon System Cost consists of the Flyaway Cost plus the additional WBS elements shown in Figure 1.
• Procurement Cost is also funded completely from the Procurement appropriations.  It includes Weapon System Cost plus the WBS element of initial spares.  For Navy shipbuilding programs, outfitting and post-delivery costs are also included when these costs are Procurement-funded.
• Program Acquisition Cost is a multi-appropriation cost.  It consists of all costs associated with developing, procuring and housing a weapon system.  Because it consolidates development, procurement and military construction costs, RDT&E, Procurement and MILCON appropriations are included. This is the complete cost of acquiring a weapon system - ready to operate.
• Operating and Support Costs are funded primarily with the O&M and Military Personnel appropriations.  However, RDT&E, Procurement, and/or MILCON appropriations may also be used, as appropriate, based on the nature of the effort, after the weapon system has been deployed. This category includes all costs for personnel, equipment, and supplies associated with operating, modifying, maintaining and supporting a weapon system in the DoD inventory.  This includes all direct and indirect costs. These costs do not include any of the development costs, procurement costs or any other part of the program acquisition costs for the weapon system, nor do they include any disposal costs for the weapon system.  Because the system is already fielded, the MIL-STD 881 WBS does not apply to this cost term.
• Life Cycle Cost includes all WBS elements, all appropriations, and all cost categories.  As shown in Figure 1, it is the sum of Program Acquisition Cost, Operating and Support Cost, and Disposal Cost for a system.

Time Phasing of Costs

In addition to looking at program costs aggregated in the various ways discussed above (i.e., appropriations, WBS and life cycle cost categories), we must also be able to determine when these costs will be incurred. Obviously, all costs of a program are not incurred during one fiscal year and, because DoD requests and receives funding annually from Congress, we need to allocate the costs to the fiscal years when funds will be required.  The time phasing of funding requirements is particularly important in the PPBE process.  This topic is addressed in a separate teaching note entitled "Building the Program Budget."

Risk

By its very nature, a cost estimate is uncertain.  A Program Office Estimate (POE) is a point estimate of the ultimate cost of a future weapon system.  A great deal of uncertainty is associated with the development of a new weapon system and the estimate of its cost.  Quantifying this inherent uncertainty provides useful additional information to the decision maker.  Uncertainty in cost estimates arises from many sources and may be grouped into three categories:  requirements, cost estimating, and technical.  Although these uncertainties occur simultaneously in practice, each is treated analytically independent of the other with sensitivity analysis or mathematical probability techniques.

Total Ownership Cost

In light of shrinking defense budgets, DoD is focusing on reducing the overall cost of the DoD establishment and its major subdivisions (i.e., the DoD Components), with the goal of freeing up funding for modernization and recapitalization of weapon systems.  Total Ownership Cost (TOC) is defined as the sum of financial resources needed to organize, equip, sustain, and operate the system, while meeting national goals, policies, and standards of readiness, environmental compliance, safety, and quality of life concerns. The TOC for Defense systems consists of the costs to research, develop, acquire, own, operate, and dispose of weapon and support systems. The TOC of a Defense system should be the same as its Life Cycle Cost (LCC).

LCC includes not only acquisition program direct costs, but also the indirect costs attributable to the acquisition program (i.e., costs that would not occur if the program did not exist). For example, indirect costs would include the infrastructure that plans, manages, and executes a program over its full life and common support items and systems.

Acquisition program managers are charged with minimizing TOC through the continuous reduction of LCC for their systems. DoD TOC reduction efforts are being implemented by all DoD Components.

Cost Analysis Requirements Description (CARD)

Analysts need extensive information about an acquisition program in order to estimate its cost to the detail required by the various display formats identified in the life cycle cost model. This information is provided in the document known as the Cost Analysis Requirements Description (CARD). The CARD completely describes the system whose costs are to be estimated; it should define the program in sufficient detail so that no confusion exists among the many parties who may be concerned with estimating the program's cost.  DoD 5000.04-M provides guidance regarding CARD preparation.  NOTE: This document was rescinded by DODI 5000.73.

Per the DoD 5000 series, a CARD shall be prepared for all ACAT I and ACAT IA programs.  The DoD component sponsoring the acquisition program is responsible for preparation of the CARD, in coordination with appropriate IPT members.  The CARD should be considered a "living document," updated in preparation for all milestone and program reviews, if not annually.  The updates reflect any changes that have occurred, or new data that have become available, since the previous milestone or program review.  DoD Instruction 5000.02 requires ACAT I and IA programs to update the CARD at Program Initiation for Ships (which may begin during the Technology Maturation and Risk Reduction phase), at Milestone B, at Milestone C, and at the Full Rate Production Decision Review.  A draft version of the CARD is required 180 days prior to the milestone or decision review; the final version is required 45 days prior to the milestone or decision review.  Preparation of the CARD should be coordinated with other program documents so that all final program documents are consistent with one another.

Cost Estimating/Analysis Review Process

Legal and Regulatory Requirements

• Title 10, United States Code, Section 2434 requires that the Secretary of Defense consider an independent estimate of the life cycle cost of a Major Defense Acquisition Program (MDAP) cost prior to granting Milestone B (Milestone II for grandfathered programs) and Milestone C (Low Rate Initial Production) approval. This LCCE is known as the "Independent Cost Estimate" (ICE).  This independent estimate must be produced by an entity outside the development and acquisition chain(s) of command.
• Title 44, United States Code, Section 3506 and the Clinger-Cohen Act of 1996, Section 5122 require that cost-benefit analysis be performed for all Major Automated Information System (MAIS) acquisitions.
• DoD Instruction 5000.02 implements the legal requirements above and mandates additional cost estimating requirements for ACAT I (MDAP) and ACAT IA (MAIS) programs.  Requirements for preparation and review of LCCEs for these programs are summarized below.
• The Director of Cost Assessment and Program Evaluation (DCAPE) performs the ICE for all ACAT ID programs and for certain ACAT IC programs as requested by the USD (AT&L).  This ICE is prepared for Milestone B, Milestone C  and the Full Rate Production Decision Review. Component cost analysis agencies that are not part of the development or acquisition chain are tasked to complete the statutorily required independent LCCE for remaining ACAT IC programs.  The regulation also requires that the Program Office prepare a LCCE (known as the Program Office Estimate (POE)) in support of program initiation.  The POE is to be updated for each subsequent milestone and decision review.  For ACAT ID programs with significant cost risk or high visibility, the Component Acquisition Executive (CAE) may request a Component Cost Estimate (CCE) be prepared in addition to the POE and the Cost Assessment Directorate ICE.
• For ACAT IA programs, neither law nor regulation prescribes an ICE; however, the DoD 5000 series does require the cognizant OSD Principal Staff Assistant or sponsoring DoD Component ensures that a CCE is created at Program Initiation and each time the MDA requests an Economic Analysis. The regulation also requires that the Program Office prepare a POE in support of program initiation and all subsequent milestone and decision reviews.  Unlike an ACAT I POE, the ACAT IA POE must include life cycle benefits as well as life cycle costs. The cost/benefit element structure must be agreed to by the program's IPT.

OSD Cost Assessment and Program Evaluation

The OSD CAPE acts as the principal advisory body to the OIPT (Overarching Integrated Product Team), the Defense Acquisition Board (DAB) and the Secretary of Defense on matters relating to cost.  The CAPE has the following functions related to cost analysis:

1. Conduct independent cost estimates and cost analyses.
2. Prescribe policies and procedures for the conduct of cost estimation and cost analyses in the DoD.
3. Review all cost estimates and cost analyses conducted in connection with Major Defense Acquisition Programs (MDAPs) and Major Automated Information System (MAIS) programs.
4. Conduct cost analyses of defense acquisition programs to be carried out using multiyear contract authority.
5. Issue guidance for the treatment of risk and confidence levels in support of preparation of cost estimates within the DoD.
6. Periodically assess and update cost indexes, including the labor and material inflation indexes used in the preparation of cost estimates in the DoD.
7. Initiate or participate in any discussions relating to program costs deemed appropriate by the CAPE.
8. Prescribe policies and procedures for reporting and collection.
9. Issue guidance relating to full consideration of life-cycle management and sustainability costs in MDAPs and MAIS programs.
10. Prepare or approve independent cost estimates, pursuant to section 415a-1(b)(2) of title 50, United States Code (Reference *f)), for joint DoD and intelligence community programs.

Component Cost Analysis Agencies

All DoD Components have established their own agencies to serve as their lead organization for cost analysis and cost estimating actions and to act as liaison between the component and the CAPE.  Program office personnel involved with conducting or reviewing POEs should be aware of their respective Component's agency and contact that organization as appropriate.