Modeling of Inflation Uncertainty in Cost-Risk Analysis
Completion of a thorough cost-risk analysis is a vital part of a credible cost estimate. The GAO Cost Estimating and Assessment Guide identifies seven steps which should be completed in order to complete a valid cost-risk analysis. These steps include: placement of probability distributions around WBS elements or inputs to WBS elements to capture various types of uncertainty, accounting for correlation between inputs and interpreting results from a Monte Carlo simulation model.
One portion of cost-risk analysis which is often neglected or inadequately modeled is the incorporation of uncertainty around future-year inflation factors which are used to inflate costs from base-year dollars to then-year dollars. The GAO Cost Estimating and Assessment Guide identifies uncertainty in inflation factors as a source of uncertainty in determining program costs, yet there does not appear to be consensus in how to model inflation uncertainty. Recent experiences of ours have shown the importance of including inflation uncertainty in cost-risk analysis; omission can result in underestimation in the variability associated with life-cycle program costs by over 35%.
This paper will present an approach for modeling uncertainty in future-year inflation factors in a cost-risk analysis. The approach examines historical yearly percentage changes in published DoD inflation factors to define appropriate distributions to place around out-year inflation factors. This paper will also illustrate how inflation uncertainty can be incorporated into a cost- risk analysis in commonly used applications such as Crystal Ball. The paper will conclude by discussing future enhancements to the approach.
Mr. Glenn has a wide variety of expertise, including over 5 years of experience in the area of cost estimation and analysis. He has previously worked as a process engineer at two separate Tier-1 automotive parts manufacturing companies, identifying and implementing cost-saving initiatives. As an independent consultant and business owner, he developed a patent-pending software application for evaluating the financial implications of implementing lean process improvements and developed the pricing programs in use for all major product lines of a worldwide plastics processing manufacturer. Since joining the staff at Technomics in June 2009, Mr. Glenn has served as the primary Navy point of contact for the joint O&S cost estimate for the Sea Based X-Band (SBX) Radar and has performed applied software cost estimation for the Office of the Deputy Assistant Secretary of the Army for Cost and Economics (ODASA-CE).
Mr. Glenn graduated from Clemson University with a B.S. degree in Industrial Engineering in 2003 and completed a M.S. degree in Industrial and Systems Engineering from Virginia Tech in 2005. He has completed an additional 21 graduate credits at Virginia Tech toward a Ph.D. in Industrial and Systems Engineering.
Mr. Meyer has over 33 years experience in the analysis and estimation of costs associated with the development, production, and operations and support of Navy systems to include submarines, surface ships, carriers, electronics, combat systems and associated Industrial base analyses, 27 of which were spent at NAVSEA, where he was an analyst and group director.
Mr. Meyer graduated from Pratt Institute with a Bachelor’s degree in Mechanical Engineering in 1972. He also attended the Program Manager’s Course (91-1) at the Defense Systems Management College in 1991. Mr. Meyer has been employed at Technomics since February 2006.
Paul Hardin is presently employed as Technical Director with Technomics, Inc. Mr. Hardin’s principal areas of expertise are methodology design and model development, including expert application of non-linear optimization techniques. Over the last several years, he has developed improved, innovative methodologies for high-risk, non-recurring acquisition cost elements (e.g., design engineering, software development and integration) and operating and support (O&S) cost elements. Mr. Hardin has played a key role in the development of two Navy cost tools, Operating and Support Cost Analysis Model
(OSCAM) and Navy Visibility and Management of Operating and Support Cost (VAMOSC) VIEWS. Prior to accepting a position with Technomics, Mr. Hardin worked for the Office of the Secretary of Defense (OSD), Cost Analysis Improvement Group (CAIG) and the Naval Center for Cost Analysis (NCCA).
Mr. Hardin graduated from the Georgia Institute of Technology with a Bachelor’s degree in Industrial Engineering in 1991 and received a Master’s degree in Systems Engineering from Virginia Polytechnic Institute and State University in May 1999. He has been employed at Technomics since January 2001.