Cost Growth, a brief interpretation

Today’s quote is from page 273 of the Second Hoover Commission Hearings (1957):

“Mr. Brown. [The Department of Defense] seldom get anything for the price tag originally put on it…

“Mr. McNeil. That was certainly true some years ago… For about 4 years now, most estimates are on the beam. And it was always possible.”

It is hard to believe that between 1953 and 1957 defense cost estimates had been “on the beam,” particularly when Martin Peck and Frederic Scherer found substantial cost growth in the 1950s in their classic The Weapons Acquisition Process: An Economic Analysis. Maybe they were just better than the estimates developed during the Korean War crisis.

Cost estimation continues to be a major problem today. In fact, it is widely agreed that cost growth has come down relative to the 1950s period. I doubt any informed observer would say we have contained cost growth, or that we are doing better today than in the 1950s, despite the fact that the AT&L’s “Performance of the Defense Acquisition System” repeatedly trumpets cost containment.

It may not take a searching review to understand that cost growth need not have any relationship with program outcomes. As Robert Devons wrote, cost growth studies “showed that most of the so called cost growth was the direct result of low initial cost estimates.”

So, as Donald Srull said, “One could not after all, buy the new Cadillac automobile for $5,000. When it turned out to cost $25,000 it was not “cost growth”—it was an unrealistic, poor initial underestimate!” (Srull was the first chairman of the Cost Analysis Improvement Group, or CAIG.)

Our problem today is that in a decision maker’s mind, a higher cost estimate is a more “realistic” one. If a realistic cost estimate for a $25,000 Cadillac comes out to be $40,000, anything other than large cost underruns signal escalating backend prices. Unfortunately, “should cost” initiatives cannot deliver the required information. We only know a $25,000 Cadillac doesn’t cost $40,000 because there is a market for Cadillacs which is embedded in an even broader market framework. You cannot just add up the labor and materials required to produce technological innovation.

The problem more pernicious than cost growth is simply high costs (similar to the “cost disease” inflicting the commanding heights of education and healthcare). It might be stunning to some that the Bruce Harmon of the Institute for Defense Analysis found that the fighter aircraft industry experiences price escalation at nearly twice the rate seen in the economy at large. (In other words, for a constant quality fighter aircraft our “buying power” is falling by about 2%-3% per year—every couple decades we can only afford half as much with the same inflation-adjusted dollars.)

Harmon’s conclusion… the F-35 is an average performing program and it experienced “cost growth” because of its artificially low Milestone B cost estimate that did not assume fast enough price growth in line with experience! If the F-35 is not really a cost growth problem, then cost growth is not the problem we should be looking at.