Journal: Pentagon’s Hall of Mirrors Gets a Shine

Chuck Spinney Sounds Off...

The below article in Defense News explains how, in Loren Thompson's words, the Pentagon is trying to embark on a “very important breakthrough” in its effort to determine how much weapons “should” cost.  Thompson also expressed concern that the Pentagon does not have the right technical skills to make “should cost” happen.

Thompson's suggestion that a contract pricing strategy based on what something “should cost” is a new idea and a very important intellectual breakthrough is patently absurd.  This article is a classic example of the amnesia and lack of curiosity infecting both modern American journalism and the courtiers in the Hall of Mirrors that is Versailles on the Potomac.  To wit —

The first point to note is that this report is about a major management reform called “should cost,” but it does not tell the reader what that means or how it compares to current procedures.  That omission begs the more subtle question of what the Pentagon thinks “should cost” means — a question that is also not asked

“Should cost” is hardly a new idea. The famed whistleblower and author of the classic “The High Priests of Waste, A. Ernest (Ernie) Fitzgerald, a senior official in the Office of the Secretary of the Air Force, was hollering about why the Pentagon ought to be using “should cost” analyses in its pricing strategies for weapons' contracts when I first met Ernie in the 1970s … and he was probably hollering about it in the 1960s, when he blew the lid of the C-5 cost overrun scandal.  Fitzgerald, an industrial engineer by training, was a production efficiency expert.  His “revolutionary” agenda was to apply normal industrial engineering practices to the manufacture of weapons.  These practices, which are taught in university industrial engineering programs, included work measurement according to generally accepted industrial engineering standards, the calculation of standard hours for specific manufacturing tasks, and the use of industrial engineering work-breakdown analyses to determine how much touch labour was needed, and therefore, when combined with a bill of materials, they determined a weapon should cost.  You will not find any of these practices mentioned in the attached article — which begs the question of the Pentagon really means by the term “should cost.”

It is an important question, because the weapons contractors hated Fitzgerald's subversive agenda, for the simple reason that his procedures would require the contractors to make their manufacturing practices transparent and in consonance with the standard industrial practices that had been developed since Henry Ford perfected the art of mass production.  Such transparency would make it much more difficult for the front loaders and political engineers in the industrial sector of the MICC to featherbed their costs — particularly with excess overhead costs and excess labour costs — like those that produced absurdities like the $100 bolts, $650 toilette seats and $400 hammers which eventually came to light during the Reagan spending spree.  As Fitzgerald, a folksy humorist, once told me, his agenda was simple: he wanted to make the Pentagon, Congress, and public understand that a high tech weapon like a B-1 bomber was merely a bunch of overpriced spare parts flying in close formation.

The weapons contractors and their shills in the Pentagon prefer to the use what Ernie called “did cost-will cost” estimating procedures.  In the report below, these procedures are referred to less precisely as “will costs.” In this methodology, the Pentagon's cost swamis (usually economists and statisticians who had never worked on a factory floor) gazed at past weapons costs and then stirred the statistical pot to concoct measures of historical costs, together with all their inefficiencies (like those in the aforementioned C-5 horror story), to provide a basis for extrapolating future costs, usually modified downward at the margin by the optimistic biases of the naive projections of so-called learning curves. These are the “valuable and credible” cost estimates highlighted in the report below, which we told will be continued.  Using official Pentagon data, I showed in many un-rebutted testimonies to Congress  in the mid 80s (see my book Defense Facts of Life: The Plans Reality Mismatch, which contains the information presented to Congress in those testimonies and the Time Magazine report of 7 March 1983) as well as in my last testimony to Congress (2002), why the learning curves concocted by the cost swamis are quite useless for predicting what future costs will actually be.  The cost growth in today's procurement mess is completely consistent with these earlier analyses.

On the other hand, learning curves are a great front loading strategy for buying into programs, because learning curves downplay the future consequences of current decisions while making it easy for the political engineers to build a political safety net by spreading dollars, jobs, and profits to as many Congressional districts as quickly as possible (see Defense Power Games for an explanation of how the Front Loading and Political Engineering  games are played).

Now here is the irony: Had those learning curve estimates been accompanied by competent “should cost” estimates, people would have been able to compare the faux defense economics implicit in the “did cost-will cost” methodology to sound commercial industrial economics, and the scam of the horrors implicit in the “did cost-will cost” would have become immediately obvious … that is, the “did cost-will cost” analyses plus learning curves made huge cost overruns inevitable, whereas “should cost” analyses would have revealed that the reasons for these overruns was caused by ignoring sound industrial engineering practices.  Ironically, learning curves over-estimated what weapons “should” cost, but the “did cost-will cost” aspect of learning curves underestimated what weapons “will cost.” This lunacy arises out of the fact that, in the real world, learning curves serve as the base from which actual cost growth was measured, but leaning curves also open the door for early political engineering operations, which make it difficult, if not impossible, to terminate programs.  So, learning curves help to  insure that future decision makers will tolerate the cost growth the learning curve made inevitable.   This nuttiness would be made transparent if the “did cost-will cost” estimates were accompanied by a competent “should cost” estimates, but such transparency might lead to to noisy demands for corrective action and real reform.  That such corrective action has never taken place under the dominant “did cost – will cost” regime is now proved by the fact that the Pentagon's modernization program is awash in cost overruns and production cutbacks, notwithstanding the largest defense budgets since the end of WWII (after removing the effects of inflation).

So, the idea that “should cost” is something new says more about the amnesia and incompetence of the defense press, the Pentagon's acquisition management bureaucracy, and the oily influence of all purpose experts like Thompson who lubricate the discussion by pumping out inanities (his PhD, appropriately enough, is in government not industrial engineering or any other engineering discipline, and his think tank, the Lexington Institute, gets most of its funding from defense contractors and promoters of the MICC).   But that said, Thompson is undoubtably correct when he says the Pentagon does not have the skills to apply the “should cost”concept (which of course he did not explain).  Which goes to show … if you shoot off your mouth often enough, you will eventually get something right.

Nor does the Pentagon want those skills. The problem is not lack of experts. The Pentagon and the defense industry like things just the way they are. Bear also in mind, the Pentagon can not even audit its own books.  The fundamental problem relates to the incentives shaping the emergent  behavour of a faction — in this case, the Military – Industrial – Congressional Complex — that puts its own interest ahead of the general interest.

There is no incentive for the Pentagon or the contractors (or Congress) to clean up their acts.  The only way to begin evolving  meaningful incentives for real reform is to first turn off the Pentagon's money hose and force the Pentagon to think before it spends.

Chuck Spinney

Defense News

September 27, 2010

Lack of Experts May Slow DoD Cost-Cutting Drive


New Pentagon buying guidelines state that all weapon program costs must be justified, but some analysts and former officials doubt the Defense Department has the personnel to fully implement that mandate. In guidelines issued September 14, Pentagon acquisition chief Ashton Carter ordered managers of major DoD programs to “conduct a should-cost analysis justifying each element of program cost and showing how it is improving year by year or meeting other relevant benchmarks for value.” To Pentagon officials, program cost targets typically are set too high. That leads service brass, government program managers and industry to plan for those exaggerated cost figures — and each player has unique reasons for doing so, defense officials said.

But if Carter has his way, this “vicious cycle” might be ending. He intends to force program managers to scrutinize and justify all costs to determine how much major programs should cost. Carter contends this will produce negotiated contracts with price tags “substantially lower” than under current practices.

Defense analysts and former Pentagon officials said the should-cost policy is long overdue, but that the Defense Department lacks enough acquisition specialists with the proper expertise to carry it out.

“The notion of should-cost price is a very important breakthrough that suggests a higher level of proficiency and precision in how DoD goes about pricing its weapon programs. The problem is, few in AT&L [acquisition, technology and logistics] have the analytic skills to effectively apply the concept,” said Loren Thompson of the Lexington Institute.

“Carter has acknowledged and talked about improving the quality — not just the quantity — of the acquisition corps,” he said. “That will take time. It will be interesting to see how the concept is adopted by an acquisition corps in which the talent level is uneven.” What’s more, said former Pentagon acquisition chief Jacques Gansler, many of the department’s acquisition experts “don’t understand business,” meaning they will inevitably estimate some costs differently than would a prime contractor.

Pentagon spokeswoman Cheryl Irwin said the should-cost studies will be a team effort. “Should-cost estimates will be developed by program management teams with qualified expertise from the cost estimating, technical, contracting, and logistics communities,” Irwin said in a September 23 e-mail.

Asked if defense officials feel the DoD wide acquisition corps will need to grow to take on this new, detailed work, Irwin replied: “The department is committed to improving the knowledge and expertise required to effectively implement will-cost and should-cost management with the current work force. This will require training, mentoring, and the realignment of knowledgeable resources to best support all of the department’s initiatives.”

In his memo, Carter said program managers “should be scrutinizing every element of program cost, assessing whether each element can be reduced relative to the year before, challenging learning curves, dissecting overheads and indirect costs, and targeting cost reduction with profit incentive — in short, executing to what the program should cost.” Under current practice, program plans and budgets are based on what Pentagon officials call “will-cost analyses.” These estimates are “based upon reasonable extrapolations from historical experience,” states the memo, which dubs them “valuable and credible.” The Pentagon’s Cost Assessment and Program Evaluation Office will continue to do the will-cost estimates, Irwin said.

But running a program based on the will-cost estimate does not help the program manager drive “leanness into the program,” according to the guidelines.

“In fact, just the opposite can occur: the [independent cost estimate], reflecting business-as-usual management in past pro grams, becomes a self-fulfilling prophesy,” the memo states. “The forecast budget is expected, even required, to be fully obligated and expended.” The should-cost estimates are similar to an analysis that last year led Pentagon officials to revamp the F-35 aircraft program. Carter said then he wasn’t satisfied with what the F-35 program office and prime contractor Lockheed Martin told him the new fleet of jets “will cost.” Carter told Gates the Pentagon should not pay that price, prompting a DoD review to find what the F-35 program “should cost.” Defense officials are now conducting a should-cost scrub of the F-35 program as part of talks with Lockheed over the price of new batches of F-35s. The memo states it will render a “negotiated price substantially lower than” the will-cost analysis done by an independent Pentagon group on which program budgets and schedules are based.

Both estimates will be updated “on at least an annual basis,” Irwin said.

Ordering the new estimates is just one part of the new guidelines, which are designed to help bring about the savings Pentagon brass say is needed to avoid cutting major weapons.

“In the past, the Department has expected its program managers to deliver war fighting capabilities that meet cost and schedule objectives,” Irwin wrote. “In today’s environment of doing more without more, the department must challenge its program mangers to drive productivity improvements into their programs to reduce costs and more effectively use taxpayers’ dollars.”

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