Cost Estimates in Acquisition

An acquisition program focuses on the cost of developing and producing an end item and whether enough resources and funding are available. The end goal of the acquisition process is a program capability that meets users’ requirements at an affordable price. During the acquisition process, decisions must be made on how best to consume labor, capital, equipment, and other finite resources. A realistic cost estimate facilitates trade-offs among cost, schedule, and requirements, which allow better decision making in order to increase a program’s probability of success.

Acquisition is an event-driven process. Programs typically pass through various milestones or investment decision reviews in which program management is held accountable for program accomplishments. Cost estimates play an important role in these decisions. In government programs, a cost estimate should be validated if a major program is to continue through its many acquisition reviews and other key decision points. Validation involves testing an estimate to see if it is reasonable and to ensure it includes all necessary costs to successfully execute the program. Testing can be as simple as comparing results with historical data from similar programs or using another estimating method to see if results are similar. Industry programs require similar scrutiny throughout development, where management approves a program’s entry to the next phase or stage based on successful completion of prior phases.

Once a cost estimate has been accepted and approved, it should be updated periodically as the program matures. It should also be updated when there are changes in schedules or requirements. Updated estimates give management the latest information on resource needs and assist with decision making. This is especially important early in a program, when less is known about requirements and the opportunity for change (and cost growth) is greater. As more knowledge is gained, programs can retire some risk and reduce the potential for unexpected cost and schedule growth. Thus, cost estimates tend to become more certain as actual costs begin to replace earlier estimates. This happens when risks are either mitigated or realized. If risks do occur, any resulting cost growth is included in an updated cost estimate. This effect of estimates becoming more certain over time is commonly referred to as the “cone of uncertainty” and is depicted in figure 3.

Figure 3: Cone of Uncertainty

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For this reason, it is important to continually update estimates with actual costs, so that management has the best information available for making informed decisions. It is important to have a track record of the estimate in order to measure growth from the original estimate.