9.7 Estimating Methodologies

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 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 9-6).

Figure 9-6  Cost Estimating Methodologies

Estimating is the method of generating a measure of an amount of work to be accomplished or resources required. It requires systematic study of the activity to be estimated and application of knowledge and skills to form a valid judgment regarding the cost of the work. The resulting estimate provides management with quantitative data for making decisions concerning these programs.

The initial decision that must be made in most estimating situations is the selection of an approach that will yield the most accurate, timely and current cost estimate. The choice of an estimating technique is not solely dependent upon the estimator's preference but is dictated by the estimating environment. The conditions that must be considered are:

• Comprehensiveness of the statement of work.
• Availability of pertinent actual cost data and product information.
• Type of contract, program and category of estimate.
• Customer and program requirements.
• Time available for preparation.
• End use of the estimate.

Cost estimating is based on interpretations of observed historical factors relevant to the task to be performed which are then projected into the future. These projections can be made in several different ways as discussed below.

The selection of a particular cost estimating method will be guided by the following considerations:

• Availability of historical data;
• Level of estimating detail required;
• Adequacy of the technical description of the item being estimated;
• Time constraints; and
• Purpose of the estimate.

The manufacturing cost estimator should consider using more than one method to generate the cost estimate. One may use a catalog price or an estimate prepared by a specialist to arrive at a cost estimate for a piece of equipment that represents a technological advance over existing hardware. The estimator may compare the cost of an analogous system element with that derived from using a Cost Estimating Relationship (CEA). Finally, even if one estimating method will suffice to estimate the cost of an item, the estimator should, whenever possible, use a different estimating method to check on the initial estimate.

The analogy method compares a new or proposed system with one homogeneous (i.e., similar) system in which the form, fit, and function are alike. The analogous system should be acquired in the recent past, for which there is accurate cost and technical data. There must be a reasonable and logical correlation between the proposed and "historical" systems identified by the cost estimator. This subjective evaluation of the differences between the new system of interest and the historical system is documented by the estimator. The analogy method is typically performed early in the cost estimating process, such as the pre-Milestone A and Milestone A stages of a program. This is early in the life of a potential acquisition program when there may be a limited number of historical data points and the cost estimator may be dealing with technology that experiences rapid change. The analogy method is also a very common technique used for cross checking more detailed estimates (i.e., sanity check).

With so many new and emerging technologies and ideas, an analogy is often the only method available. Estimating by analogy may be the best technique for estimating the cost of state-of the-art systems such as a space vehicle, next-generation submarine, a future computer or a proposed microprocessor.

The parametric, or statistical, method uses regression analysis of a database of two or more similar systems to develop cost estimating relationships (CERs) which estimate cost based on one or more system performance or design characteristics (e.g., speed, range, weight, thrust). The parametric method is most commonly performed in the initial phases of product description, such as after Milestone B when the program is in the EMD phase. Although during this phase an acquisition program is unable to provide detailed information (e.g., drawings and standards), the program can specify top-level system requirements and design characteristics. In other words, estimating by parametrics is a method to show how parameters influence cost.

Parametric estimating is used widely in government and industry because it can yield a multitude of quantifiable measures of merit and quality (i.e., probability of success, levels of risk, etc.). Additionally, CERs developed using the parametric method can easily be used to evaluate the cost effects of changes in design, performance, and program characteristics. Note the parametric method, which makes statistical inferences about the relationship between cost and one or more system parameters is very different from drawing analogies to multiple systems.

A critical consideration in parametric cost estimating is the similarity of the systems in the underlying database, both to each other and to the system which is being estimated. A good parametric database must be timely and accurate, containing the latest available data reflecting technologies similar to that of the system of interest (design, manufacturing/assembly, material). Of course, a general rule when collecting data for statistical analysis is the more data, the better. Finally, as with estimating by analogy, parametric data must be normalized to represent a given economic year and remove any quantity effects.

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.

With this technique we start at the lowest level of definable work within the Work Breakdown Structure (WBS) (i.e., milling a flange). The direct labor hours required to complete the work are estimated from engineering drawings and specifications, usually by an industrial engineer (IE) using company or general industry "standards." The engineers also estimate raw materials and purchase parts requirements. The remaining elements of cost, such as tooling, quality control, other direct costs, and various overhead charges including systems engineering and project management, are factored from the estimated direct labor and/or material content of the work. The actual portion of the cost estimated directly is thus a fraction of the overall cost of the system.

The IE may use a variety of techniques in estimating the direct labor and material cost of each discrete work element. For example, the IE may use an analogy to estimate one work element; a parametric CER based on an industry database of like work elements to estimate a second work element; and a set of work standards based on work activities (e.g., milling .002 inches from a 6 inch diameter rod 3 inches long) to estimate a third work element. Uncertainty in this type of cost estimate is due to the use of multiplicative factors derived from various methods on the relatively small direct labor/material base that was estimated. This can result in significant error in the total system cost estimate. The uncertainty, however, can be assessed and managed. Another potential problem is that because the cost estimate is the summation of many estimates, it may be hard to maintain the documentation to support the estimate.

Since, in most cases, the engineering estimate is based on standards, either company-specific or industry-wide, the contractor's cost estimate should be "attainable." By definition, standards are attainable values for specific work under given conditions. The engineering estimate is thus a tool for the manufacturer to control the work on the floor (process control). The technique has its greatest value once the design has stabilized and the system is in production.

Actual cost experience on prototype units, early engineering development hardware and early production hardware for the program under consideration should be used to the maximum extent possible. If development or production units (or components) have been produced, the actual cost information should be provided as part of the documentation. Estimates for Full Rate Production decision reviews are to be based at least in part on actual production cost data for the systems under review.

Estimating by actual costs is essentially, an extrapolation of current program cost. In other words, you would estimate a trend from your current contract to estimate your final system's cost. The cost data is internal to current system being constructed, not the same as "actual" historical data. There are several conditions that enable this estimating method to be possible.

• A program must be in low rate initial production (LRIP) or full rate production (FRP) otherwise there is nothing "actual" from which to base actual costs.
• There must be a data management system already in-place that enables the DOD agency the ability to review accumulated actual costs as the system or prototype is being fabricated and assembled. The reporting process typically a.) occurs monthly or quarterly; b.) requires the contracting agent to provide percent-of-work completed to date; and c.) requires the contracting agent to provide the cumulative cost it has expended for the completed work-to-date.

Estimating techniques may be different for every cost element and may change due to:

• Acquisition Phase of the Program, and
• Maturity of the Individual WBS Element.

The techniques used to develop the estimates for cost elements should take into account the acquisition phase that the program is in when the estimate is made and the quality of the data that might be available for the estimate. The matrix presented in Table 9-2 provides a summary of each of the four estimating methods. Each method is described in terms of what it is, when it typically should be or could be used, how it is accomplished, and the advantages (pros) and disadvantages (cons) of using that particular estimating method.

Table 9-2 Cost Estimating Matrix

While the program or system may be in a particular acquisition phase if you take a close look at the work breakdown structure (WBS) you will most likely find that some elements of the WBS are more mature than other elements.  Thus you may have more accurate estimates for the more mature elements. 

Figure 9-7 Maturity as a Consideration