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Risk-Based Return On Sales (ROS) for Proposals with Mitigating Terms and Conditions

Risk Track

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This paper addresses the unique challenges faced by both cost and risk analysts and decision makers when attempting to compute and convey the percentiles of cost and return on sales (ROS) for proposals with terms and conditions providing for equitable adjustments for certain components of cost growth deemed to be outside the contractor’s control, such as inflation.

It is increasingly common for risk analysis to be performed in conjunction with cost analysis in order to produce a probabilistic cost estimate, usually depicted as an S-curve (technically, the cumulative distribution function, or cdf, of cost). Often decision makers ask for certain percentiles from this distribution to represent a favorable or “upside” scenario (say the 20th percentile); a middle-of-the-road or “probable” scenario (say the 50th percentile); and an unfavorable or “downside” scenario (say the 80th percentile). Of paramount interest, though, is not just cost but also the corresponding price and ROS, or margin. On a major contract, price is the primary concern of the government agency, because it will directly impact needed budgets (together with government-furnished equipment (GFE) and other government costs (OGCs), such as the program office itself). By contrast, ROS is the primary concern of the contractor because it will have a direct impact on the financial performance of the company (together with revenue), ultimately reflected in its stock price.

For all contract types allowable under the Federal Acquisition Regulation (FAR), price is a monotonically non-decreasing function of cost. That is, as cost increases, price must also increase, or possibly stay the same (as in the case of a firm fixed price (FFP) contract). Similarly, ROS is a monotonically decreasing function of cost. That is, as cost increases, the return on sales as a percentage must decrease. It cannot stay the same because even if the fee/profit dollar value remains the same (as in the case of a cost plus fixed fee (CPFF) contract), the denominator of ROS, total revenue, is increasing. These relationships are illustrated, in the case of a fixed price incentive (FPI) contract, in the figure below, adapted from Module 14 Contract Pricing of the Cost Estimating Body of Knowledge (CEBoK). These facts imply that there is a one-to-one correspondence
between the 20th, 50th and 80th percentile of cost and the 20th, 50th, and 80th percentile of price and the 80th, 50th, and 20th percentile of ROS, respectively. In fact, we can use both analytical (probability and calculus) and empirical (Monte Carlo simulation) techniques to produce the distribution of ROS with high fidelity given the distribution of cost and the “contract geometry.”


Peter J. Braxton
Peter J. Braxton holds an AB in Mathematics from Princeton University and an M.S. in Applied Science (Operations Research) from the College of William and Mary. He currently works as a cost and risk analyst as part of the Independent Cost Estimation
(ICE) function within the new Northrop Grumman Information Systems sector. He has worked to advance the state of knowledge of cost estimating and risk analysis, Cost As an Independent Variable (CAIV), and Target Costing on behalf of the Navy Acquisition Reform Office (ARO), the DD(X) development program, and other ship and intelligence community programs. He has co-authored several professional papers, including SCEA/ISPA International Conference award-winners in CAIV (1999) and Management (2005). He served as managing editor for both the original development of the acclaimed Cost Programmed Review Of Fundamentals (CostPROF) body of knowledge and training course materials and its successor, the Cost Estimating Body of Knowledge (CEBoK). He serves as SCEA’s Training Chair and as a Northrop Grumman Technical Fellow. He was named SCEA’s 2007 Estimator of the Year for contributions in Education, and received both a TASC President’s Award and Northrop Grumman Corporate Contracts, Pricing, and Supply Chain Award in 2008.

Richard L. Coleman
Richard L. Coleman is a Naval Academy graduate, received an M. S. with Distinction in Operations Research from the U. S. Naval Postgraduate School and retired from active duty as a Captain, USN, in 1993. His service included tours as Commanding Officer of USS Dewey (DDG 45), and as Director, Naval Center for Cost Analysis. At Northrop Grumman, he has worked extensively in cost, CAIV, and risk for the Missile Defence Agency (MDA), Navy ARO, the intelligence community, NAVAIR, and the DD(X) Design Agent team. He has supported numerous ship programs including the DDG 1000 class, DDG 51 class, Deepwater, LHD 8 and LHA 6, LPD 17 class, Virginia class SSNs, CVN 77, and CVN 78. He is the Director of Independent Cost Estimation for Northrop Grumman Information Systems and conducts Independent Cost Evaluations on Northrop Grumman programs. He has more than 65 professional papers to his credit, including five ISPA/SCEA and SCEA Best Paper Awards and two ADoDCAS Outstanding Contributed Papers. He was a senior reviewer for CostPROF and CEBoK and lead author of the Risk Module. He has served as Regional and National Vice President of SCEA and is currently a Board Member. He received the SCEA Lifetime Achievement Award in 2008.

Eric R. Druker
Eric R. Druker CCE/A graduated from the College of William and Mary with a B.S. in Applied Mathematics in 2005 concentrating in both Operations Research and Probability & Statistics with a minor in Economics. He is employed by Booz Allen Hamilton as a Senior Consultant and currently serves on the St. Louis SCEA Chapter’s Board of Directors. Mr. Druker performs cost and risk analysis on several programs within the Intelligence and DoD communities and NASA. He was a recipient of the 2005 Northrop Grumman IT Sector’s President’s award and the 2008 TASC President’s award for his work on Independent Cost Evaluations (ICEs) during which he developed the risk process currently used by Northrop Grumman’s ICE teams. In addition to multiple SCEA conferences, Eric has also presented papers at the Naval Postgraduate School’s Acquisition Research Symposium, DoDCAS and the NASA PM Challenge. He has also performed decision tree analysis for Northrop Grumman Corporate law, built schedule and cost growth models for Hurricane Katrina Impact Studies and served as lead author of the Regression and Cost/Schedule Risk modules for the 2008 CostPROF update.

Bethia L. Cullis
Bethia L. Cullis is an Operations Research Analyst at Northrop Grumman Information Systems (IS). Her main focus is Independent Cost Evaluations (ICEs) at both the Sector and Corporate Level, as required by IS, Shipbuilding, and Technical Services. In addition to her ICE work, Ms. Cullis has supported numerous ship programs including DD(X), the DDG 51 class, LHD 8 and LHA 6, the LPD 17 class and CVN 21. She is the lead or co-author of five professional papers, presented at various forums including the SCEA 2007 & 2008 Conferences, ISPA/SCEA 2008 Conference and the 2007 Naval Postgraduate School’s Acquisition Research Symposium. For the past three years she has taught at the SCEA national conference. She was the lead author for the Contracts and Data Analysis modules in the 2008 update to CEBoK. Before joining Northrop Grumman in 2004, Ms. Cullis completed her undergraduate degree in Economics and English at Case Western Reserve University. She also worked as an analyst for Newry Corporation, a competitive consulting firm in Cleveland, OH.

Christina M. Kanick
Christina M. Kanick graduated from the University of Pittsburgh in 2006 with a B.S. in Industrial Engineering. Over the past year, she has been employed by Northrop Grumman as an Operations Research Analyst. She supports the CG(X) Team conducting cost and risk analysis. She has performed research for the Air Force Cost Analysis Agency (AFCAA) to develop cost estimating relationships (CERs). In addition, Ms. Kanick was a member of the TASC proposal support team, which was called in by the Northrop Grumman Corporate Staff, in the KC-30 Tanker, as well as the DD(X) Independent Cost Evaluation Team and on other Independent Cost Evaluations (ICEs) in addition to performing risk analysis for Intelligence Community customers.

Ameya V. Bapat
Ameya V. Bapat graduated from Cornell University in May 2008 with a BS in Operations Research and Industrial Engineering. He joined Northrop Grumman as an Operations Research Analyst in July 2008. Since joining, Mr. Bapat has focused his work on the area of risk analysis, supporting customers such as NASA and the Naval Center for Cost Analysis (NCCA). He also supports Independent Cost Evaluation (ICE) teams providing internal risk assessments for Northrop Grumman.

Jeanne M. Callahan
Jeanne M. Callahan holds an MBA from the College of William and Mary, and a BS, Commerce (Finance and Management) from the University of Virginia. She is currently a Director of Contracts and Pricing with Northrop Grumman Shipbuilding, responsible for cross-program contract administration and estimating/pricing as well as C&P governance activities. Prior to her current position, Jeanne held positions in key areas including Program Control, Corporate Strategy, Audit and Financial Management of IT. She supports Independent Cost Evaluation efforts at Northrop Grumman and is responsible for those efforts at Shipbuilding.

Bryan P. Caccavale
Bryan P Caccavale graduated from The University of Virginia in 2002 with a BA in Economics. Since that time he has held positions at Northrop Grumman in Program Control, Program Finance, International Business Management, Financial Planning and now Contracts and Pricing. He is currently Manager, Price Cost Estimating at Northrop Grumman Shipbuilding and focuses on cost risk analysis and estimating system compliance.