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

Abstract

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.