Applying Insights from Transaction Cost Economics (TCE) to Improve DoD Cost Estimation

摘要

There is mounting evidence of a systematic bias in initial cost estimates of new weapon systems. A comprehensive 2006 RAND report on major weapons programs concludes: The analysis indicates a systematic bias toward underestimating the costs of a weapon system. (Arena 2006, p.1). This bias could threaten our national security. Unrealistically low cost estimates result in cost overruns. Fixing cost overruns can impact military readiness. Two factors are usually blamed for unrealistically low cost forecasts: bad incentives (psychological and political-economic explanations) and bad estimates (methodological explanations). The focus of this study is on cost methodology. Our goal is to contribute some new ideas to the current literature on cost estimating. This paper applies Transaction Cost Economics (TCE) (e.g., Williamson, 1985; Dillard, Franck & Melese, 2006) to help characterize, explain, and ultimately reduce the cost growth that plagues many of today's major investments in military capabilities. In business, two costs are typically factored into the 'make-or-buy' decision: production costs and the costs of managing transactions -- 'transaction costs' (Coase 1937). Conventional estimation techniques tend to focus on production costs (input costs, learning curves, economies of scale and scope, etc.). TCE emphasizes another set of costs -- primarily the costs of coordination and motivation (e.g., search and information costs, decision and contracting costs, monitoring and enforcement costs). The primary insight drawn from TCE is that correctly estimating the economic production costs of an acquisition is necessary, but not sufficient. The choice of contract, organization, and incentives, along with key characteristics of markets and transactions (uncertainty, complexity, asset specificity, frequency, and contestability), must be included to obtain reliable cost estimates.