The Role of Inflation and Price Escalation Adjustments in Properly Estimating Program Costs: F-35 Case Study

Abstract

Applying price indexes presents a challenge in estimating the costs of new defense systems. An inappropriate price index can introduce errors in both development of cost estimating relationships (CERs) and in development of out-year budgets. In this paper we apply two sets of price indexes to the F-35 Joint Strike Fighter procurement program, both to help cost analysts understand the impacts of different price indexes and to provide guidance in their choice. We approach this problem via hedonic price indexes derived from CERs. These indexes isolate changes in price due to factors other than changes in quality over time. We develop a Baseline CER model using data on historical tactical aircraft programs available at the F 35's late-2001 Milestone B decision. Comparisons are made between the Baseline model estimates, F-35 program office estimates, and estimates using cost models employing more conventional approaches to inflation adjustment. We find that the Baseline hedonic model provides estimates close to actual F-35 costs. As the hedonic index is directly estimated only for the historic period, we develop a procedure to project inflation rates based on historical hedonic index values.