Cost Realism and Analysis Renewed Focus in Todays Environment

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Cost Realism and Analysis Renewed Focus in
Todays Environment

• June 2002

Richard Janda Vice President Independent Cost
Evaluation Lockheed Martin Corp
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Agenda

• Environment
• Cost Performance
• Path Forward
• Audience Questions

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Environment
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Environment
. . .BA 35.80. . . .LMT 43.95. . . .NG 94.80.
. . .Raytheon 31.50. . . .BAE. . . .5.19. . .
.EADS 11.28. . .

• Defense Industry Consolidated into a Few Large
  Players
• Intense Competition
• Budget Impact
• High Debt. . .
• Competitive Stratification

Defense Industry an Oligopoly
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Environment

• Industry Margins Eroded-Single Digit ROS Common

• R D Subsidies of 90s
• Fierce Competition For Few Remaining
  Opportunities
• Performance Issues
• Over Supply Remains
• Corporate Credibility Being Tested
• Enronitis
• Wall Street Ready to Punish Weak Performance

• Industry Operating Margins 1999
  2000 2001
• General Dynamics 12.7 12.8 12.3
• Northrop Grumman 12.7 15.1 7.9
• Raytheon 9.3 9.6 9.0
• Boeing 6.5 6.7 8.6
• Lockheed Martin 7.2 7.0 7.5

Source Annual Reports/10Ks
Industry ROS Below Historic Average
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EnvironmentFavorable DoD Policy Changes Emerging

• Eliminated Paid Cost Rule
• Ordered End of RD Subsidies
• Increased Progress Payments
• Encouraging Performance-based Payments
• Permit Contractor Share in Cost Savings

Under Consideration
Government Receptive To Industry Issues
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Environment Threats Drive Defense Spending
Defense Spending as of GDP
40
Desert Storm
Cuban Missile Crisis
35
WWII
30
25
Vietnam
Korea
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WWI
Berlin Wall
15
9/11/01
12/07/41
10
5
Cold War
0
1910
1950
2007 Est.
1970
1990
1930
Source Lexington Institute
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EnvironmentDoD Budget Authority
Bush Proposed 5 Year Budget Plan
Other
RDTE
Current in Billions
Procurement
OM
MILPERS
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QDR

• From Threat Based to Capability Based
• Key Goals
• Assure Allies
• Dissuade Adversaries
• Deter Aggression
• Decisively Defeat
• Operational Challenges
• Protect the Homeland
• Guarantee Information Systems
• Project Power
• Deny Sanctuary, Greater Surveillance
• Strengthen Space Operations
• Apply New IT Concepts (C4ISR)

Recapitalization, Homeland Security,
Transformation
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Environment
Bush Proposed 5 Year Budget Plan

• Budget Stability Improving
• Spiral Development
• Nunn-McCurdy Enforcement

Other
RDTE
Current in Billions
Procurement
OM
MILPERS
Defense Budgets More Realistic
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Environment

• Summary
• Defense Industry an Oligopoly with Unfavorable
  Operating Margins
• Government Receptive to Improving Industry
• National Security Dependent on Successful
  Transformation From Threat to Capability
  Deterrence
• The Path To Success is Through Solid Execution
  and Improved Performance

The Nation Needs Good Performance!
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Cost Performance
The inability to control the cost of modern
weapons is arguably Americas greatest long-term
military vulnerability. Fallows, James Uncle
Sam Buys An Airplane. The Atlantic Monthly
June 2002 62-74.
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Cost Performance

• Too Many Major Overruns
• SBIRS High
• Space Station
• Global Hawk
• Theater Ballistic Missile Defense
• Whats Causing The Cost Growth. . .?

Source Selected Acquisition Report (SAR)
December 31, 2001
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Top 10 Reasons For Poor Cost Performance
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Top 10 Reasons For Poor Cost Performance
Abbott I say Who's on first, What's on second, I
Don't Know's on third - Costello You know the
fellows' names? Abbott Certainly! Costello Well
then who's on first? Abbott Yes! Costello I
mean the fellow's name! Abbott Who! Costello
The guy on first!

• Proceeding Rightly From a Wrong Premise

• Estimating Cost Based on an Unsound Assumption
  Masks Significant Cost Risk. When (Not If) the
  Program Over-Runs, the Original Estimate will be
  Remembered but the Under-lying Assumptions Will
  Not
• Validate Assumptions. Do Not Assume Away Risk!

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Top 10 Reasons For Poor Cost Performance (Contd)

• New Learning Curve Theory

• As the Quantity Increases, the Unit Price Does
  Not Change, and May Go Up
• If the Tasks are Not Highly Routinized,
  Repetitive, Labor Intensive, and Without Gaps,
  There is No Learning

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Top 10 Reasons For Poor Cost Performance (Contd)
Todays Plan

• Do Not Mistake the Act of Planning for Actually
  Having a Plan

• Series of Program Plans DJour is a Certain
  Indicator of a Program in Trouble

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Top 10 Reasons For Poor Cost Performance (Contd)

• New Moores Law

• For Development, Proven Trend of Less Cost Per
  Unit of Computer Function Equates to Greater
  Functionality for Same Cost, Not Less Cost (e.g.,
  Hrs/Dwg)

Graph Source http//www.intel.com/research/silic
on/mooreslaw.htm
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Top 10 Reasons For Poor Cost Performance (Contd)

• New Math Concepts

• EVM New Math (.9 1.1) 2 1.3 at Complete
• Cum CPIs of 0.9 Can Never Be Offset by 1.1 TCPIs,
  Unless Aided by Outstanding Negotiation of
  Additional Scope
• Synergy Savings Formulae 1.00 30 1.00
• Unless Demonstrated, Benefits of New Initiatives
  Should Not be Assumed
• New Ways of Doing Business to Save Cost is Good
  Practice, Assuming 100 Realization of Same is
  Risky

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Top 10 Reasons For Poor Cost Performance (Contd)

• Test As You Fly

• A Test Plan That Does Not Replicate Flight-like
  Conditions is Incomplete and Underscoped.
• Cutting This Corner Will Cause You To Pay Later
  in Spades.

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Top 10 Reasons For Poor Cost Performance (Contd)

• Schedule, Schedule, Schedule

• Aggressive, Accelerated Program Schedules Ensure
  Major Slips and Cost Growth.

http//www.sotafx.com/Roger/Gallery/Jack.html
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Top 10 Reasons For Poor Cost Performance (Contd)

• COTS Certain Overrun To Schedule

• High Percentage of COTs/Heritage/Re-use Software
  Code in Development Means High Percent Overrun

High Growth
Total S/W Cost Growth
Low Growth
Low COTS Assumed
High COTS Assumed
of COTS/Re-use/Re-host S/W Assumed
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Top 10 Reasons For Poor Cost Performance (Contd)

• Soft Funding Hard Times

• Changes in Funding Are Always Less Than Resulting
  Changes in Cost (Cumulative Impacts)

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Top 10 Reasons For Poor Cost Performance (Contd)

• Precision Without Accuracy

• Poor Up-front Definition of Requirements,
  Including Their Decomposition and Flowdown, and
  Program Plan (Technical, Contractual, Schedule
  and Cost) Portends a Troubled Program and a Cost
  Baseline Without Credibility

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Path Forward
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Path ForwardGood Example - JSF Acquisition
Approach

• Phased Down Select to Award
• Parametric Life Cycle Cost Data by Anticipated
  Phase From Each Competitor
• Shoulder-to-Shoulder Review Reconciliation of
  Cost Estimates Between USG and Contractor
• Encourage, Identify, Fund and Prototype Cost
  Reduction Candidates Early During the Down Select
  Process
• Do Not Encourage Contractor Investment

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Path ForwardGood Example - JSF Acquisition
Approach

• Weight Evaluation Criteria Toward Performance and
  Realistic Cost, Not Lowest Cost
• Recognize the Risk Associated with the Work Scope
  and Use the Appropriate Contract Type
• Development Cost Plus
• Production Wait Until Risk has Been Mitigated
• Incentivize the Winner for Good, Balanced
  Performance Technical, Schedule and Cost

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Path ForwardContractors Should. . .

• Vigilantly Protect Against The Top Ten
• Perform Independent Cost Evaluations (ICE) of
  Their Single Best Estimates to Validate and
  Substantiate Credibility
• Reconcile Program Estimates Independent
  Assessments Between Customer Contractor
• Understand Differences Rationale But. . .
• Maintain Independence Propriety

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Path ForwardContractors Should . . . (Continued)

• Track Estimates Calibrate/Adjust Estimating
  Systems/Process/Models for Improved Accuracy
• Establish Maintain Headlight Metrics Above
  Beyond Standard Earned Value to Assure Early
  Warning of Performance Risk Issues

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Conclusion

• U.S. Government and Aerospace Contractors Must
  Partner For Success While Maintaining Arms
  Length Relationship
• Open and Candid Communication To Ensure Success
• Proper Contract Type
• Successful Business Plans For Customer
  Contractor
• Stable Program Requirements Funding