SHOULD COSTS FOR THE DEPARTMENT OF DEFENSE 2 Breakout Session #: A14 Name: James Gill Date: July 30, 2012 Time:11:15

DOD Should Cost Data from last 30 years shows 80% of programs overrun their initial 50/50 independent cost estimates. This coupled with the fiscal constraints the nation now faces means the DoD may not have an opportunity to recapitalize its inventory of equipment for a decade or longer. AT&L says that we must focus on cutting and controlling costs as ordered by the SecDef in order to get the systems we need and sustain the ones we have. Solution: Conduct Should Cost analysis; establish a culture of savings and constraint; and reduce program costs if reasonable efficiency and productivity enhancing efforts identified by the Should Cost analysis are implemented

DOD Should Cost DOD Budget Environment Dramatically Shifts in 2008 Similar to end of Vietnam and Cold War periods but fiscal crisis is greater than Peace Dividends Ashton Carter implements Better Buying Power (Efficiency) Initiatives in 2010 Should Cost versus Will Cost - one of the core principals

DOD Should Cost Should Cost concept has been around for many years FAR-based Should Cost no longer in vogue AT&L Should Costs concept articulated in the “Better Buying Power” Initiatives is not the same as a traditional Should Cost What is the Difference? Focus of Presentation

DOD Should Cost FAR Should-Cost Review –Two types Program Should Cost Overhead Should Cost –Resource Intensive –Time Consuming –Costly to perform

DOD Should Cost Definition of a Should Cost –FAR says: Should-cost reviews are a specialized form of cost analysis. Should-cost reviews differ from traditional evaluation methods because they do not assume that a contractor’s historical costs reflect efficient and economical operation. Instead, these reviews evaluate the economy and efficiency of the contractor’s existing work force, methods, materials, equipment, real property, operating systems, and management. These reviews are accomplished by a multi-functional team of Government contracting, contract administration, pricing, audit, and engineering representatives. The objective of should-cost reviews is to promote both short and long-range improvements in the contractor’s economy and efficiency in order to reduce the cost of performance of Government contracts. In addition, by providing rationale for any recommendations and quantifying their impact on cost, the Government will be better able to develop realistic objectives for negotiation.

DOD Should Cost Program should-cost review. (1) A program should-cost review is used to evaluate significant elements of direct costs, such as material and labor, and associated indirect costs, usually associated with the production of major systems. When a program should-cost review is conducted relative to a contractor proposal, a separate audit report on the proposal is required. (2) A program should-cost review should be considered, particularly in the case of a major system acquisition (see part 34), when -- (i) Some initial production has already taken place; (ii) The contract will be awarded on a sole source basis; (iii) There are future year production requirements for substantial quantities of like items; (iv) The items being acquired have a history of increasing costs; (v) The work is sufficiently defined to permit an effective analysis and major changes are unlikely; (vi) Sufficient time is available to plan and adequately conduct the should-cost review; and (vii) Personnel with the required skills are available or can be assigned for the duration of the should-cost review.

DOD Should Cost Overhead should-cost review. (1) An overhead should-cost review is used to evaluate indirect costs, such as fringe benefits, shipping and receiving, real property and equipment, depreciation, plant maintenance and security, taxes, and general and administrative activities. It is normally used to evaluate and negotiate an FPRA with the contractor. When an overhead should-cost review is conducted, a separate audit report is required. (2) The following factors should be considered when selecting contractor sites for overhead should-cost reviews: (i) Dollar amount of Government business. (ii) Level of Government participation. (iii) Level of noncompetitive Government contracts. (iv) Volume of proposal activity. (v) Major system or program. (vi) Corporate reorganizations, mergers, acquisitions, or takeovers. (vii) Other conditions (e.g., changes in accounting systems, management, or business activity).

DOD Should Cost What It Means: Should Cost is a technique for driving productivity improvement in programs. It involves continuous scrutiny of all cost elements, such as challenging learning curves, dissecting overhead and indirect costs, and targeting cost reduction with profit incentives Allows managers to improve on the “will cost” model created by Independent Cost Estimates (what a program will cost if we keep doing what we’ve done in the past) Why We’re Doing It: Improve focus on cost reduction Allow finite resources to be used to best effect

DOD Should Cost By Time line – Near-term (within the program manager’s tenure) – Long-term initiatives By Control – Program Driven - within program manager’s control – Service Driven - within the services control – Externally Driven - outside service control

DOD Should Cost What is the difference between “Should Cost” and “Will Cost”? –Should Cost – means what a program/service should cost after incorporation of efficiencies and elimination of wasteful practices –Will Cost – means what a Program/Service would cost based upon historical data drawn from the performance of similar/actual work

DOD Should Cost Key Implementers :* Set “ten ingredients” of Should Cost Management Established Should Cost reporting requirements for program reviews and milestones * Carter Memo dated 22 Apr 11

Ten Ingredients of S/C Management: 1.Scrutinize each contributing ingredient of program cost and justify it. Why is it as reported or negotiated? What reasonable measures might reduce it? 2.Particularly challenge the basis for indirect costs in contractor proposals. 3.Track recent program cost, schedule, and performance trends and identify ways to reverse negative trends.

Ten Ingredients of S/C Management: 4.Benchmark against similar DoD programs and commercial analogues (where possible), and against other programs performed by the same contractor or in the same facilities. 5. Promote Supply Chain Management to encourage competition and incentivize cost performance at lower tiers. 6. Reconstruct the program (government and contractor) team to be more streamlined and efficient. 7.Identify opportunities to breakout GFE versus prime contractor-provided items.

Ten Ingredients of S/C Management: 8. Identify items or services contracted through a second or third party vehicle. Eliminate unnecessary pass- through costs by considering other contracting options. 9. In the area of test: a. Take full advantage of integrated Development and Operational Testing to reduce overall cost of testing; b. Integrate modeling and simulation into the test construct to reduce overall costs and ensure optimal use of National test facilities and ranges. 10.Identify an alternative technology/material that can potentially reduce development or life cycle costs for a program. Ensure the prime product contract includes the development of this technology/material at the right time.

DOD Should Cost Each Program Manager must establish a culture of savings and constraint It’s about cost analysis, not cost estimating and the setting of cost targets Everyone on the PM’s team must become a “Cost Warrior” Cost Warrior skills include understanding of the operations context, communication, a savings mindset, business acumen, courage and thick skin, analytical skills and a willingness to try new ideas Each Program Office needs to look for options and alternatives that reduce costs Everyone needs to maximize the ROI for taxpayer dollars

DOD Should Cost Adopt Will- and Should-Cost management - use historically informed independent estimation (will-cost estimates) to inform managing of programs to cost objectives (should-cost estimates) Managers should be driving productivity into their program - need to scrutinize every element of program cost

DOD Should Cost Use will-cost estimate to support budgeting and programming Reasonable extrapolations from history Represents business-as-usual management To interrupt cycle of self-fulfilling prophecy to will- cost estimate, program manager must bring forward a should-cost estimate Justify every element Show how it is improving year by year or meeting other benchmarks for value

DOD Should Cost Applies to ACAT I, II, and III programs Metric for success - few percent per year of programs/ contracts executing below budget Industry can succeed in this environment –Tie performance to higher profit –Affordable programs won’t face cancellation

DOD Should Cost Two separate cost estimates A non-advocate will-cost estimate for budgeting and programming A program manager should-cost estimate for program management execution

DOD Should Cost The budget baseline will be based on the non-advocate will-cost estimate. –Aims to provide sufficient resources to execute the program under normal conditions, encountering average levels of technical, schedule, and programmatic risk (usually no less than 50% confidence level). –Supports the budget and ensures sufficient funding to provide confidence that: 1) the program can be completed without the need for significant adjustment to program budgets, and 2) the program can avoid Nunn-McCurdy or critical change breaches.

DOD Should Cost “ Program-Level Should Cost Estimate” - not just the immediate contract ! Who owns the responsibility for S/C? –Program office develops, owns, reports & tracks the program-level should cost estimate. Program manager (PM) recommends to MDA (AT&L/CAE) for approval.

DOD Should Cost Intent: –A DoD internal management tool used to incentivize performance to targets. –Based on realistic technical and schedule baselines and assumes success-oriented outcomes from implementation of efficiencies, lessons learned, and best practices. –Designed to drive productivity improvements in our programs and will incorporate results of contract direct and indirect cost reviews

DOD Should Cost Three Recommended Approaches: –Use will-cost estimate as the base and apply discrete, measurable items and/or specific initiatives for savings against that base –Use bottoms-up approach (different methods from will-cost estimate) without a detailed FAR/DFARS should-cost review and include actionable content to achieve cost below the will-cost estimate –Use bottoms-up approach (different methods from will-cost estimate) with a detailed FAR/DFARS should-cost review and include actionable content to achieve cost below the will-cost estimate

DOD Should Cost Most items outside the control of the program office and inconsistent with the current program of record are outside excursions and not appropriate for the should-cost estimate. –Example: economic production rates Anything requiring significant investment for completion and an increase to the budget is outside the scope of the should-cost estimate and should be shown separately for consideration.

DOD Should Cost PMs should consider: –Seeking assistance from outside organizations (e.g., the Air Force Cost Analysis Agency, DCMA, SAF/AQC) as they develop should-cost estimate –Close collaboration with appropriate center level functional organizations –Will-cost estimate excursions from the non- advocate organization and all previously defined should-cost estimates

DOD Should Cost Supporting Evidence for Should Cost :  Production rates economical and historically stable  Shorten program timeline  Complete R&D effort in FY16 vs. FY17 as currently planned in ICE  Potential production rate increase  Strong negotiation positions  Historical cost, learning curve, and understanding of production efficiencies  Long-term supplier agreements  Parametric model MOA established with contractor for key routine functions/costs  Open system architecture design eases future enhancements  Aggressive “Breakout” IPT established for appropriate technical data packages (TDP) and data rights

DOD Should Cost Should Costs should be considered for the following program events : -Critical Design Review -First LRIP award out of option contracts -Interim Contractor Support and Contractor Logistic Support first contract awards -Organic Logistics Infrastructure (e.g., depot stand- up, DLA, ALC)

SMC BBP Pilot Should Cost Programs Three of the 15 Pilot Programs in Dr Carter’s memo come from AF PEO Space Portfolio. They are: Advanced EHF (AEHF) Space Based Infra-Red System (SBIRS) Launch Programs

SMC Should Cost Objectives PRIMARY Establish well-supported Should-Cost targets and achieve them SECONDARY Comply with OSD, HAF Will-Cost/Should-Cost policy Perform Should-Cost efforts on required programs and report status to HAF and OSD Execute Should-Cost efforts in a deliberate, structured, and coordinated manner Document process to codify systematic, repeatable approach to Should-Cost management

SHOULD COST ORGANIZATIONAL RESPONSIBILITIES AT SMC SMC/SPD Integrate PM, Lead Engr, Cost Chief, Cost Analysts (Govt/SETA), FFRDC Execute robust SC effort for required programs (develop Plan & Estimates) Assist cross-cutting SC activities/efforts Brief PEO, AQ & other SMC leadership Collaborate with Industry SMC/FM Role Oversee cost estimating across SPOs Ensure estimates realistic, include appropriate risk Establish OIs, Financial policies & guidance on EV & SC estimating Ensure research reflects latest DoD guidance

ORGANIZATIONAL RESPONSIBILITIES AT SMC SMC/PI Enable SPD SC efforts by providing processes/structure, training, tracking/reporting, & SMC Staff support Integrate SMC Staff on cross-cutting initiatives (OH Rates, EVM, CDRLs, etc) Engagement/support thru proposal evaluations Data for PEO budget inputs SMC/PK Work with DCMA on overhead rate efficiencies Vet standardized RFP/contract language Posture SPOs for negotiations

ORGANIZATIONAL RESPONSIBILITIES AT SMC SMC/EN Lead Tech Team Assess production flow & test reductions thru robust technical risk analysis OTHER SUPPORT DCMA Aerospace

Should Cost Presentation Template 35 The Program’s “should cost” is the set of program’s initiatives or opportunities to reduce costs below the Independent Cost Estimate (ICE) level. It is primarily the basis for a negotiating position and result for pending contracts that will be below the ICE, but it also includes measures taken to reduce cost beyond near term contract actions. See AT&L guidance memos on developing should-cost positions ( : –“Better Buying Power: Guidance for Obtaining Greater Efficiency and Productivity in Defense Spending,” September 14, 2010 –“Implementation Directive for Better Buying Power – Obtaining Greater Efficiency and Productivity in Defense Spending,” November 3, 2010 –“Implementation of Will-Cost and Should-Cost Management,” April 22, 2011 –“Should-Cost and Affordability,” August 24, 2011.

Should Cost Presentation Template 36 The following charts provide a notional guide for presenting a summary of a program’s “should cost” plans and estimates for various program activities; see slide notes pages for key points and tailor format as appropriate to suit the particular initiatives of program.

Program Should-Cost Summary Example Pre-EMD MS BMS CFRPCDRAcquisition Milestones RFPCA EMUs Risk Reduction EMD Sys Integration Labs Flight Test Production AV Risk Reduction GS Risk Reduction RFPLRIP 1 RFPLRIP 2 Combined DT/OT OA-1OA-2 IOT&E Govt SIL Highlight phase being entered Key Should-Cost Opportunities

DOD Should Cost Should Cost Initiatives:  EMD Initiative 1: Short description and basis for Should-Cost Estimate savings Initiative 2: Short description and basis for Should-Cost Estimate savings Initiative 3: Short description and basis for Should-Cost Estimate savings  Production & Deployment (notional) Initiative 1 Initiative 2  Operations and Support (notional) Initiative 1  Other Initiative 1

P-8A Should Cost Opportunities Map Identification and Prioritization 39 Operations and Support Full Rate Production LRIP 1-3 C

40 Initiative Name:  Short Narrative Description of Basis for Should Cost Estimates: (List reasons should cost estimate is below will cost, with dollar impact)  Adjustments and Impacts to Spend Plan  Contract Implications Incentive/fee structure, timing of evaluations & savings realized  Risks List risks to achieving these savings Key Events/Schedule (Plan):  Event and Target Date Short description  Event and Target Date Short description  Event and Target Date Short description  Event and Target Date Short description Progress Update/Results:  Key events accomplished / not accomplished / reason One slide for each major S-C initiative in EMD phase

Production Should-Cost Estimate Example 41 Key Events/Schedule (Plan):  Event and Target Date Short description  Event and Target Date Short description  Event and Target Date Short description  Event and Target Date Short description Progress Update/Results:  Key events accomplished / not accomplished / reason Initiative Name:  Short Narrative Description of Basis for Should Cost Estimates: (List reasons should cost estimate is below will cost, with dollar impact)  Adjustments and Impacts to Spend Plan  Contract Implications Incentive/fee structure, timing of evaluations & savings realized  Risks List risks to achieving these savings One slide for each major S-C initiative in Production phase

Copyright © 2011 by A.T. Kearney. ALL RIGHTS RESERVED. Material Solution Analysis Technology Development Engineering and Manufacturing Development Production & Deployment Operations & Support Planning / Budgeting Execution ABC Materiel Dev. Decision Post CDR FRP Decision LRIP/ IOT&E Should Costing can support lean cost methodologies throughout a program lifecycle Defense Acquisition Lifecycle Should Costing Affordability targeting Commonality Complexity Reduction Design to Cost Design Cost Reduction Joint Process Improvement Lean Manufacturing Lean Cost Methodologies Design for Mfg/Assy. Specification Demand Mgt. Outcomes Lean Budgeting Assumptions Lean Program Execution Taking cost out

DOD Should Cost Key Takeaways: Should Cost allows the Program Manager to find savings within the program, in parallel with preserving the program’s viability This type of affordability initiative has been done several times in the past…most recently during the post Cold War era, when the “peace dividend” was taken – aka Acquisition Reform Results from previous attempts have not been overly successful in retrospect.

BBP Should Cost 44 Conclusion - Marginal Chances for Success Budget Exercise to drive costs down Risk Transference to Contractors (Target Cost, Ceiling Price, Share Ratio etc.) Will Likely Lead to Claims and REA’s if/when performance does not meet expectations May end up in Court if efficiencies do not materialize Unknown Spector of Sequestration looms over Major Programs