Original Post Date: Wednesday, September 25, 2013

It is impossible to find a news website or magazine that is not full of articles on the effects of Sequestration.  As a cost estimator, I find the topic very interesting (and troublesome).  The immediate effects of Sequestration are widely discussed.  However, I do not see quite as much news coverage on the second and third order effects of this extremely complex policy decision.

The Department of Defense (DoD) has a specific target that must be removed from the budget over the next 10 years.  Some analysts claim a doomsday scenario.  Others claim it is a small nip to a massively bloated bottom line.  Who is right?  This analyst will spare the political discussion and focus on some unintended consequences that Sequestration could bring.

Take, for example, the most expensive DoD acquisition program of all time.  According to an article on the DoDBuzz website ( http://www.dodbuzz.com/2010/04/01/how-much-will-jsf-cost/),

The F-35 unit cost estimate is incomplete because the $114 million to $135 million “Average Procurement Unit Cost” (APUC) Carter and Fox announced, in “then-year” dollars, to buy 2,443 aircraft does not include any research, development, test and evaluation money for the F-35. The best available estimate of those additional development costs is about $60 billion (to add to the estimate of $278 to $329 billion to produce the F –35s). Including those costs would add about $25 million to the cost of each aircraft, making the Carter-Fox total program unit cost somewhere between $139 million to $160 million.

We see in this example that the development costs are roughly $60 Billion. One repeated target of the Sequestration is the total number of JSF aircraft that will be produced.  Given the politically charged arguments over the unit cost of the JSF, what do we imagine will happen to the amortized unit production cost if the quantities are lowered?  Naturally, the cost will increase because we are spreading a “fixed” development cost across a smaller quantity of aircraft. 

Translating this example into a TruePlanning® estimate, we would also see an increase in the amortized unit production cost, given a drop in production quantities.  As you may know, TruePlanning® calculates a series of metrics with each model run.  These metrics display items such as cost per pound of hardware, production quantity, total weight, software productivity, etc.  There are also two specific metrics with significant impact - unit production cost and amortized unit production cost.  It is important to highlight the costs captured in these two metrics, as the overall meanings are slightly different than what is conveyed in the referenced article above.  In TruePlanning®, the unit production cost is simply the Production Manufacturing activity divided by the production quantity.  The amortized unit production cost is the sum of all production activities divided by the production quantity.  The main difference between the TruePlanning® metrics and the JSF example is that development costs are excluded when calculating these two important production metrics.

There are several reasons why that is prudent.  First, development could be viewed as a “sunk” cost.  We have to develop the technology whether we produce 1 unit or 2,443 units.  In an extreme case, we have to develop the technology even if we do not produce any units at all.  This does happen, as technology or manufacturing capability may not mature at the same rate.  Projects could be cancelled and “shelved” until 1) the technology is mature enough or 2) there is a specific requirement to field a capability to counteract a threat.  Amortizing development costs across the production quantities may not be the best metric to properly evaluate impacts of quantity adjustment.

Second, production costs are generally categorized as either recurring or non-recurring.  The recurring costs are those costs incurred with each subsequent production item.  Think of the labor and material directly required to produce the end item.  Other recurring costs add on those activities that are outside of the labor and material required to produce the end item.  In TruePlanning®, these activities include project initiation, project management, quality assurance, configuration management, documentation, production engineering, and production tool/test.  There is no doubt that these activities are related to production quantities.  As such, these costs need to be amortized across the production quantities to give us a true representation of the production costs per unit.  Including these activities and excluding the development provides this picture.

TruePlanning® offers the modeling flexibility necessary to truly (and quickly) understand the implications of production quantity adjustments.  This can be accomplished through “what if” scenarios, side-by-side project comparison, sensitivity analysis, and risk analysis.  All of these approaches are housed in a robust framework with companion applications that interface with other widely used cost analysis tools.

The convenient targets of Sequestration may be the total quantities of various high profile weapons platforms.  However, we must be willing to accept a higher amortized unit production cost as a result.  Decisions to continue or cancel programs are often based on such information.  An otherwise executable, needed program may find itself sitting on the shelf.  TruePlanning® models can provide the key stakeholders with relevant and timely information to make the best decisions.