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Pentagon Tests New Way Of Estimating Program Costs

Jun. 23, 2012 - 11:24AM   |  
By SARAH CHACKO   |   Comments
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The Pentagon is putting its new weapons cost-cutting strategy to its first big test as it negotiates with Lockheed Martin over the price of the next batch of F-35 Joint Strike Fighters (JSF).

Contract negotiations for the production of 32 JSFs began earlier this year. This will be the first opportunity for Pentagon officials to see how well their “should-cost” approach to setting weapons prices works.

Under this approach, Defense Department experts review the program’s technical requirements, production and testing processes, and staffing to determine what they think the price should be. That figure is based on reductions that could be made in those areas and efficiencies that should come over time with the program, such as improved supply chain management.

An independent office in the Pentagon — the Cost Assessment and Program Evaluation, and before that, the Cost Analysis Improvement Group — already assesses the cost of weapon systems for budgeting purposes using sophisticated models that consider past weapon costs. Historically, the budget figure is the floor from which costs rise, not the ceiling under which costs are contained, defense officials have said.

“We’re trying to say, ‘OK, we understand this is the budgeted amount of dollars, but can we execute to a lesser amount so we can use that difference between what was budgeted and what we think we can execute in some other way to buy some other good or service,’” said Shay Assad, who oversees the Pentagon’s should-cost effort.

As for the JSF contract talks, it remains to be seen how big of an effect this will have.

Lockheed officials say they have yet to be told what the Pentagon believes the upcoming production lot should cost.

Assad said that during the contract talks, Pentagon officials will share with Lockheed elements of the department’s should-cost calculation — namely, areas where savings are expected. But the department will not share its internal should-cost figures, he said.

The new contract will define the costs of 32 JSFs: 22 F-35As for the Air Force, three F-35Bs for the Marine Corps and seven F-35Cs for the Navy. Experts estimate the costs of the planes will be anywhere from $80 million to $120 million each.

Lockheed has provided historical cost data and other information to support the department’s should-cost estimate and has cut costs to make its proposal for this round of procurements lower than the last, said Tom Burbage, Lockheed’s executive vice president and general manager of the F-35.

“We’re [cutting costs] as aggressively as we know how,” he said.

But Lockheed does not know if its proposal for the next group of F-35s will meet the price point DoD is seeking, said Bruce Tanner, Lockheed’s chief financial officer.

And while DoD has said it would also find ways to improve its processes and create savings, Lockheed has not seen that effort, Tanner said. Instead, the department seems to have based its should-cost estimate on what the program would cost if everything was working under optimal conditions, which could be risky, he said.

“It serves no purpose to either side to negotiate to a level you can’t perform and then overrun to a level that you expected when you began the contract, and call that overrun,” Tanner said. “It’s frustrating to both sides.”

Experts Skeptical

Acquisition experts are anxious to see how well the effort performs, but some are skeptical it will succeed at containing costs on large programs.

“It’s an interesting way to try to impose discipline on what has become an undisciplined process. But I don’t think it gets at the core problem here,” said Todd Harrison, senior fellow at the Center for Strategic and Budgetary Assessments.

The major cost driver on weapon programs is requirements that are added over time with little regard for costs, Harrison said.

“Until they get that process under control — and [until] they develop a rational way to understand the cost they’re imposing on the system with every additional requirement they put on it — I don’t think they’re going to be successful,” he said.

Weapon systems also tend to run over their projected costs because they require innovation and new technology that is unpredictable, said Michael O’Hanlon, who specializes in defense policy at the Brookings Institution.

“It’s not just bad management or profit-hungry corporations or performance-crazed military services that always put added capability ahead of costs,” O’Hanlon said. “The fundamental reason why weapons cost more is because we’re usually inventing something new as we build them.”

Another major cost driver on the Joint Strike Fighter has been the Defense Department’s push to field planes as they are still being developed, Harrison said. As problems are found in testing, contractors not only have to revise the design of new planes, they have to fix the planes that have already been produced, he said.

Should-cost estimates would be more useful as DoD decides which weapon systems to buy, Harrison said. Defense officials could compare their should-cost estimates to the proposals they receive from contractors to see if it’s worth pursuing, he said.

But when programs are already in production, the should-cost is more like a “wish-it-would-cost,” Harrison said.

Assad said the Pentagon has developed ways to measure any savings the should-cost initiative yields.

“We have specific targets for program execution, very specific targets for the size of a program office or other areas that program managers will have defined,” Assad said. “So we can measure that, we can examine that and we can know at the program level whether or not we accomplished it.”

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