The Need for Cost Risk and Uncertainty Analysis
Because risks and uncertainty occur, there is always a chance that the actual cost will differ from the estimate. Thus, cost estimates are forecasts based on the best information available at the time. Assumptions regarding resource availability and productivity, required effort, and availability of materials, among other things, allow for the determination of the program estimate. In addition, programs have risks—in the form of threats and opportunities—that may lead to increased or decreased program costs. If these risks are not accounted for and analyzed, cost estimators may underestimate or overestimate program costs. Some threats to the program that could arise are changes in requirements that cause schedule delays, test failures that require rework, the unavailability of critical resources, software defect rates being higher than estimated, development of unproven technology taking longer than expected, and late deliveries of subcontracted components. Opportunities to the program may include improvements to labor productivity, more efficient production techniques, or an accelerated schedule from concurrent activities.
Lack of knowledge about the future is only one possible reason for the difference between actual and estimated costs. There is also inherent uncertainty in estimated costs caused by, for example, estimating error, and perhaps, estimating bias. The biases may be cognitive—that is, based on estimators’ inexperience—or motivational, where management intentionally reduces the estimate or shortens the schedule to make the program appeal to stakeholders. Cost estimates should account for both risk and uncertainty. There will always be some aspect of the unknowable, and there will never be enough data available in most situations to develop a known distribution of possible costs or parameters affecting cost estimates.
A program estimate typically has a greater range of potential costs at the beginning of a program because less is known about the program’s detailed requirements, and the potential for program changes is greater. As a program matures, general program requirements are refined into clearer and more detailed requirements, thus narrowing the range of costs. However, more refined requirements can lead to cost increases, as illustrated in figure 13.
Figure 13: Notional Changes in Cost Ranges across the Life Cycle
The notional example in figure 13 shows that as the estimate increases, the range around the estimate decreases. As the program matures, a better understanding of the risks is achieved, and some risk is either retired or some form of risk response lessens the potential cost or effect on schedule.
Thus, a point estimate by itself provides no information about the underlying uncertainty of the estimate and is insufficient for making good decisions about the program. Using a risk and uncertainty analysis, a cost estimator can inform decision-makers about a program’s potential range of costs and cost drivers. Management, in turn, can use these data to decide whether the program fits within the overall risk range of the agency’s portfolio.