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BUSINESS APPLICATIONS OF PARAMETRIC ESTIMATING

BUSINESS APPLICATIONS OF

PARAMETRIC ESTIMATING

CHAPTER VII

BUSINESS APPLICATIONS OF PARAMETRIC ESTIMATING

INTRODUCTION

Recent initiatives affecting government procurement practices have further stressed an already fragile world-wide estimating capability. Competition, accuracy, flexibility, and method-proven credibility dictate reformation in the estimating process, especially for new business pursuits. Parametric estimating methods for planning and strategizing new business cost issues is a critical element in the reform of traditional bottoms-up approaches.

A paper written by Roy Summers and Bruce Fad summarized here discusses the need for parametric modeling in the new business development process. The arguments are based on experience gained through use of parametrics in this type environment. The role of parametric modeling is examined along with the presentation of a process in which parametrics and bottoms-up estimating are complementary. Organizational conditions leading to effective use of parametrics are also considered. The questions of job responsibilities, management interface, and functional structures are treated from the practitioners' viewpoint. Finally, the issue of credibility includes perspectives from both the using and auditing organizations, with emphasis on calibration and the use of testable databases.

PARAMETRIC ESTIMATING IN NEW BUSINESS DEVELOPMENT

Why do programs die? Why do CEO's, Boards of Directors, DoD, or Congress kill or cancel technically superior projects? There are many examples, and, generally, it is not due to technical viability. Even though millions or even billions are lost, the program graveyard claims many projects. Sommers and Fad suggest that these events happen partly because of an inattention to future cost issues during program development. There is a need to recognize and react to help solve the cost problems. Technical success can often mask future cost issues.

The authors propose that an organization responsible for costing use parametric techniques early on, and that cost and technical objectives be treated together. Parametrics are perfect for cost estimating during a program's conceptual phase, and the tools connect technical and cost parameters together in a very effective way.

New business development actions can attack the problem. These actions include:

1) Parallel and coordinated development of technical and programmatic (cost, schedule and quantity) concepts from requirements.

2) Iterative and continuous cost improvement

3) Develop cost targets (bogeys) as the result of 1 & 2, above. 4) A review/reconciliation process that focuses on cost/risk analysis.

The authors go on to suggest that organizations not put off the cost estimating activity, and that cost analysts immediately begin to explore technical/cost alternatives. They also suggest that the parametric function belong to an independent department and not reside within another function outside the organization that owns new business development.

To effectively integrate parametrics into an organization, upper management needs to be involved. Upper management involvement will insure the creation of a cooperative team spirit, and more effective management and customer acceptance including estimate credibility.

ESTIMATING PRODUCTION BUYS USING PARAMETRICS

A parametric approach can be used to calibrate production cost and then estimate future production buy(s) and options using a commercial model. The benefit here is a simpler cost proposal with no bill of material and no labor hours roll-up. The model can be calibrated and estimates derived at any level of the WBS, hence useful for spare parts pricing. In either case, the CERs or cost models can be used as the basis of estimate, and delivered to a proposal pricing system via a post processor, or a spread sheet. In either event, the cost estimating process is greatly simplified, and resource economies of scale can be realized.

What follows is an example of the comparative or analogous estimating approach.

RFQ And Historical Data

PDQ Inc., has received an RFQ for 84 XYZ-L Systems to be built and delivered in 1995. A 120-lot of this same system was delivered in 1993, so recent cost history exists. The cost history yields the following data:

Manufacturing labor (Hands-on) of 42,000 hours divided into: Plant A - 18,000 hours

Plant B - 12,000 hours Plant C - 12,000 hours Purchased parts: $9,000,000

Manufacturing Support Labor: 17,280 hours which was generated from 1 Mechanical Engineer, 1 Quality Engineer, and 1 Test Engineer at each of the three plant locations.

Engineering Support Labor: 7,680 hours generated by 2 Engineers at Plant A, and 1 Engineer each at Plants B and C.

Tooling Costs: $15,000

Test Equipment Costs: $25,000

The Interview Process

How will the proposed 84-lot be different from the historical (baseline) 120-lot?

VECP - AB123 has altered the system configuration. Mechanical Engineering has estimated the VECP will reduce the assembly time at Plant A by 5 hours per system.

Plant B is over-capacity so five of the parts in the system will be resourced to Plant C. These parts are similar in assembly and take 3 hours each to build.

Part number XYZ456, previously assembled at Plant A, is being purchased from an outside vendor. Assembly time for this part at Plant A was 4 hours. It is currently being purchased for $200.

Preparation Of The Estimate

Manufacturing Labor Calculations:

Plant A: 150 Hours Historical Baseline unitized

-5 Hours Adjustment for VECP-AB123

-4 Hours Make to Buy Change for P/N XYZ456

141 Hours Proposed Unit Hours Estimate for 84-lot

Plant B: 100 Hours Historical Baseline unitized

-15 Hours* Five parts (@ 3 hours per part) resourced to Plant C 85 Hours Proposed Unit Hours Estimate for 84-lot

Plant C: 100 Hours Historical Baseline unitized +17.5 Hours Five parts resourced from Plant B 117.5 Hours Proposed Unit Hours Estimate for 84-lot

* The 15 hours for the 5 parts were adjusted to account for performance differences between Plants B and C. Performance factor (inverse of efficiency) at Plant B was 1.5. The current performance factor at Plant C is 1.75. Adjustment: 15 hours divided by 1.5 times 1.75 equals 17.5.

Purchased Parts Calculations:

$75,000 Baseline Costs unitized (purchased 50% in 1992 and 50% in 1993)

Material for 84-lot will be purchased in 1994. Escalation is 3% per year.

$39,784 Baseline (50%) escalated from 1992 to 1994

$38,625 Baseline (50%) escalated from 1993 to 1994

$200 Make to Buy Change for P/N XYZ456 (not in baseline)

$78,609 Proposed Unit Base Estimate for 84-lot

Manufacturing Support Labor Calculations:

Support labor has historically followed a semi-variable pattern; i.e., when the production quantity is halved, support can be reduced by 25%, or when production is doubled, support cost is increased by 50%.

The proposed 84-lot is 60% of a halving of the baseline 120-lot. Therefore, the support labor adjustment is -15% (60% X 25% = 15%) .

9.00 People Baseline

7.65 People Baseline Adjusted (-15%)

14,688 Hours Proposed support labor @ 1920 hours per person/year

Engineering Support Labor Calculations:

4 People Baseline

3 People Adjusted Baseline (Management Challenge)

5,760 Hours Proposed engineering labor @ 1920 hours per person/year

Tooling And Test Equipment Calculations:

$40,000 Baseline costs

$ 1,200 Adjusted for escalation from 1994 to 1995 (3% per year)

$ 4,120 Adjusted for age of equipment

$45,320 Proposed tooling and test equipment costs

Summary Of Direct Costs

Manufacturing Labor:

Plant A 141.0 Hours X 84 Systems X $75.80 per Hr. = $ 897,775

Plant B 85.0 Hours X 84 Systems X $81.50 per Hr. = $ 581,910

Plant C 117.5 Hours X 84 Systems X $77.10 per Hr. = $ 760,977

Subtotal Manufacturing Labor = $2,240,662

Purchased Parts:

Base $78,609 X 84 Systems = $6,603,156

Raw Material 2.5% = $165,079

Material Overhead (Applied to Purchase Parts Only) 8.0% = $528,252

Sub-Total Purchased Parts: = $7,626,645

Manufacturing Support: 14,688 Hours X $74.75 per Hr = $1,097,928

Engineering Support: 5,760 Hours X $83.00 per Hr. = $478,080

Tooling & Test Equipment: = $45,320

TOTAL DIRECT COSTS: $11,488,635

ESTIMATING SPARES AND CHANGE ORDERS

Parametric techniques can sometimes be used for estimating spares and change order proposals. Using a calibrated system model for spares, select the WBS element that represents the spare part(s) that need to be estimated. Then exercise the model at that point, either a commercial version or one developed for the specific program. The estimate can be exercised very quickly, and the calibrated model will yield accurate results.

Engineering Change Proposals (VECPs) or other change proposals have to be accounted for by adjusting the actuals or a delta to the current estimate. The comparative approach is normally well supported by history, as accurate as any other technique. It is much easier to do "what if" analysis and compute option prices, and the proposals are less complex and smaller in volume and more "user friendly", with significantly reduced preparation, review, audit and negotiation time.

Table VII-1 indicates the potential parametric applicability for various firm business proposals. Appendix G contains a parametric estimating system checklist.

Type of Proposal Engineering Manufacturing Test Support

1. New Business Development VA VA VA VA

2. Production VA VA VA VA

3. Follow-on Production VA VA VA VA

4. Development Contract Change-Order NVA NVA NVA VA

5. Production Contract Change-Order NVA NVA NVA VA

6. Spares MBA MBA MBA VA

NOTE:

Use of parametric estimating may be very applicable for new business development proposals/RFPs; their application may not be as good for unique development contract change orders with little, if any, relevant history to use for CER development or Cost Model calibration. In addition, change order data is collected at too low a level in the WBS for meaningful utilization.

KEY:

VA = Very Applicable; NVA = Not Very Applicable; MBA = May Be Applicable

APPENDIX A

APPENDIX A

DEFINITIONS OF ESTIMATING TERMINOLOGY

Algorithmic Models - (also known as Parametric models) produce a cost estimate using one or more mathematical algorithms using a number of variables considered to be the major cost drivers. These models estimate effort or cost based primarily on the Hardware/Software size, and other productivity factors known as cost driver attributes.

Analogy - A method of estimating developed on the basis of similarities between two or more programs, systems, items, etc.

Analogy Models - use a method of estimating that involves comparing a proposed project with one or more similar and completed projects where costs and schedules are known. Then, extrapolating from the actual costs of completed projects, the model(s) estimates the cost of a proposed project.

Analometric - A recent term meaning a method of combining the analogy and parametric estimating methods to form a cost estimate when only 2 relevant data points are available. It is usually combined with the "D" Factor to adjust (up or down) complexity from the 2 point CER regression line.

Analysis - decision making context involving time horizons extending into the future. A concrete set of specifications are not usually available. There could be many major uncertainties, and a wide range of alternatives, each having several configurations. Analysis is usually concerned with new equipment proposals and new methods of operation of systems never produced before. Analysis Objectives are to find significant differences in resource requirements among alternatives; and, how will resource requirements for any alternative change as key

configuration characteristics vary over their relevant ranges. It is often a "sensitivity" type of investigation.

Analysis (NES Dictionary) - a systematic approach to problem solving. Complex problems are simplified by separating them into more understandable elements.

Annual Change Traffic (ACT) - the fraction of a software product's source instructions which undergoes change during a year, either through addition or modification. The ACT is the quantity used to determine the product size for software maintenance effort estimation.

Anomalies - variances in cost related data caused by an unusual event(s) not expected to recur in the future.

As Spent Dollars - the cost, in real year dollars, of a project recorded as the dollars were spent without normalization for inflation.

Audit - the systematic examination of records and documents and the securing of evidence by confirmation, physical inspection, or examination.

Audit Trail - information allowing the data being used in an estimate to be tracked back to the original source for verification.

Benefit (NES Dictionary) - Result(s) attained in terms of the goal or objective rather than in terms of output.

Benefit Cost Analysis (NES Dictionary) - an analytical approach to solving problems of choice. It requires: (a) the definition of objectives; (b) identification of alternative ways of achieving each objective; and (c) the identification for each objective or alternative which yields the required level of benefits at the lowest cost. It is often referred to as cost-effectiveness analysis when the benefits of the alternatives cannot be quantified in terms of dollars.

Benefits (NES Dictionary) - advantages which may be quantifiable or non-quantifiable. For example, lowest cost is a benefit, so is the best accuracy and longest range.

Bottom-Up Models - use a method of estimation that estimates each component of the project separately, and the results are combined ("Rolled Up") to produce an estimate of the entire project.

Calibration - in terms of a cost model, a technique used to allow application of a general model to a specific set of data. This is accomplished by calculating adjustment factor(s) to compensate for differences between the referenced historical costs and the costs predicted by the cost model using default values.

Computer-Aided Software Engineering: CASE - identifies a sector of the computer software industry concerned with producing software development environments and tools. The main components of a CASE product are individual tools which aid the software developer or project manager during one or more phases of software development (or maintenance). Other features are a common user interface; interoperability of tools; and a repository or encyclopedia to provide a common tool base and central project database. CASE may also provide for code generation.

Configuration Item - hardware or software, or an aggregate of both, which is designated by the project configuration manager (or contracting agency) for configuration management.

Configuration Management - a discipline applying technical and administrative controls to (1) identification and documentation of physical and functional characteristics of configuration items; (2) any changes to characteristics of those configuration items; and (3) recording and reporting of change processing and implementation of the system.

Constant Dollars - Computed values which remove the effect of price changes over time (inflation). An estimate is said to be in constant dollars if costs for all work are adjusted to reflect the level of prices of a base year.

Contract Work Breakdown Structure - Contract work breakdown structure is defined as the complete work breakdown structure for a contract, i.e., the DoD approved work breakdown structure for reporting purposes and its discretionary extension to the lower levels by the contractor, in accordance with this standard and the contract work statement.

Cost (Fisher) - "Economic costs" are benefits lost. It is for this reason that economic costs are often referred to as "alternative costs" or "opportunity costs." It is in alternatives, it is in foregone opportunities, that the real meaning of "cost" must always be found. The only reason you hesitate to spend a dollar, incidentally, is because of the alternative things that it could buy. Some use the word "cost" when referring to resources. Cost of something is measured by the resources used to attain it. Cost of attaining an objective at some point in time is measured by the resources not available for use in attaining alternative objectives. Costs are a measure of other defense capabilities foregone. Money cost is not necessarily the same as economic cost. "Economic cost" implies the use of resources - manpower, raw materials, etc. Dollars are used merely as a convenient common denominator for aggregating numerous heterogeneous physical quantities into meaningful "packages" for purposes of analysis and decision mating.

Cost (NES Dictionary) - the amount paid or payable for the acquisition of materials, property, or services. In contract and proposal usage, denotes dollars and amounts exclusive of fee or profit. Also used with descriptive adjectives such as “acquisition cost," or "product cost," etc. Although dollars normally are used as the unit of measure, the broad definition of cost equates to economic resources, i.e., manpower, equipment, real facilities, supplies, and all other resources necessary for weapon, project, program, or agency support systems and activities.

Cost Analysis (NES Dictionary) - the accumulation and analysis of actual costs, statistical data, and other information on current and completed contracts or groups of contracts (programs).

Cost analysis also includes the extrapolation of these cost data to completion, comparisons and analyses of these data, and cost extrapolations on a current contract with the cost data in the contract value for reports to customers, program and functional managers, and price estimators. In the procurement organizations of the Department of Defense, cost analysis is the review and evaluation of a contractor's cost or pricing data and of the judgmental factors applied projecting from the data to the estimated costs, in order to form an opinion on the degree to which the contractor's proposed costs represent what performance of the contract should cost, assuming reasonable economy and efficiency.

Cost Analysis (Large) - the primary purpose of cost analysis is comparison - to provide estimates of the comparative or relative costs of competing systems, not to forecast precisely accurate costs suitable for budget administration. In this context consistency of method is just as important, perhaps more so, as accuracy in some absolute sense. In comparing the costs of military systems, we prefer to speak of "cost analysis" rather than "cost estimation," because the identification of the appropriate elements of cost -- the analytical breakdown of many complex interrelated activities and equipment -- is so important a part of the method. Weapon system cost analysis is much more than an estimate of the cost of the weapon itself. Weapon procurement costs may be relatively small compared to other necessary costs, such as base facilities, training of personnel, and operating expenses; and these other costs may vary greatly from system to system.

Cost Benefit Analysis (NES Dictionary) - a technique for assessing the range of costs and benefits associated with a given option, usually to determine feasibility. Costs are generally in monetary terms.

Cost Driver Attributes - productivity factors in the software product development process that include software product attributes, computer attributes, personnel attributes, and project attributes.

Cost Drivers - The controllable system design or planning characteristics that have a predominant effect on the system's costs. Those few items, using Pareto's law, that have the most significant cost impact.

Cost Effectiveness (NES Dictionary) - the measure of the benefits to be derived from a system with cost as a primary or one of the primary measures.

Cost Effectiveness Analysis (NES Dictionary) - a method for examining alternative means of accomplishing a desired military objective/mission for the purpose of selecting weapons and forces which will provide the greatest military effectiveness for the cost.

Cost Estimating (Fisher) - "making an estimate" of the cost of something implies taking a rather detailed set of specifications and "pricing them out."

Cost Estimating (NES Dictionary) - cost and price estimating is defined as the art of predetermining the lowest realistic cost and price of an item or activity which assure a normal profit.

Cost Estimating Relationship - An algorithm relating the cost of an element to physical or functional characteristics of that cost element or a separate cost element; or relating the cost of one cost element to the cost of another element.

Cost Estimating Relationships: CER - a mathematical expression which describes, for predicative purposes, the cost of an item or activity as a function of one or more independent variables.

Cost Factor - a brief arithmetic expression wherein cost is determined by the application of a factor as a proportion.

Cost Model - an estimating tool consisting of one or more cost estimating relationships, estimating methodologies, or estimating techniques used to predict the cost of a system or one of its lower level elements.

Cost/Schedule Control System Criteria: C/SCSC - a set of criteria specified by the Federal Government for reporting project schedule and financial information.

Current Dollars - Level of costs in the year actual cost will be incurred. When prior costs are stated in current dollars, the figures given are the actual amounts paid. When future costs are stated in current dollars, the figures given are the actual amounts expected to be paid including any amount due to future price changes.

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