The Importance of Cost Estimates in Establishing Budgets
A program’s approved cost estimate should be used to create the budget spending plan. This plan outlines how and at what rate the program funding will be spent over time. Since resources are finite, budgeting requires a delicate balancing act to ensure that the rate of spending closely mirrors available resources and funding. Additionally, because cost estimates are based on assumptions that certain tasks will happen at specific times, it is imperative that funding be available when needed so as to not disrupt the program schedule.
A reasonable and supportable budget is essential to a program’s efficient and timely execution and a reliable estimate is the basis of a reasonable budget. Cost estimates help in assessing the reasonableness of existing budgets and of contractor’s proposals. Cost estimates also help program offices justify budgets to the Congress, OMB, and department secretaries, among others. Moreover, cost estimates are often used to help determine how budget cuts may hinder a program’s progress or effectiveness.
While contractors occasionally bid unrealistically low to win a competition, low cost estimates can often be attributed to poor cost estimating. Unrealistically low cost estimates occur when contractors are overly optimistic about program challenges and underestimate potential risks. When a program’s budget is based on such an estimate, it soon becomes apparent that either the contractor or the customer must pay for a cost overrun, as case study 4 shows.
The cost estimate for the second Ford-Class aircraft carrier, CVN 79, did not address lessons learned from the performance of the lead ship, CVN 78. As a result, the estimate did not demonstrate that the program could meet its $11.4 billion cost cap. Cost growth for the lead ship was driven by challenges with technology development, design, and construction, compounded by an optimistic budget estimate. Instead of learning from the mistakes of CVN 78, the Navy developed an estimate for CVN 79 that assumed a reduction in labor hours needed to construct the ship that was unprecedented in the past 50 years of aircraft carrier construction.
After developing the program estimate, the Navy negotiated 18 percent fewer labor hours for CVN 79 than were required for CVN 78. CVN 79’s estimate was optimistic compared to the labor hour reductions calculated in independent cost reviews conducted in 2015 by the Naval Center for Cost Analysis and the Office of Cost Assessment and Program Evaluation. Navy analysis showed that the CVN 79 cost estimate may not have sufficiently accounted for program risks, with the current budget likely insufficient to complete ship construction.