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

Abstract

The purpose of this report is to explore the possibility of improving DoD cost estimation methods by including explanatory variables that capture the coordination and motivation problems associated with the program. Accordingly, we note that cost overruns remain a well-documented and significant problem for DoD, and consider why that problem continues. We review the current state (and limitations) of DoD cost estimation methodology and Transaction Cost Economics (TCE). We then consider reasons why including TCE explanatory variables might (or might not) improve cost estimation. To explore the potential contribution of TCE variables, we considered two cases of Army surface-to-surface missiles: Javelin and the Army Tactical Missile System (ATACMS); we also analyzed standard program cost data bases for indications of transaction costs. While the case studies indicated that TCE variables have promise in improving the explanatory power of cost estimates, the standard data bases are poorly designed (at best) to shed light on program transaction costs. Our policy conclusion is that the complete costs of major transactions together with key characteristics of the market, need to be captured and understood in order to properly anticipate the full costs of major defense acquisition programs.