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Code of Practice For Life Cycle Costing NATO RTO 2009

Life cycle costing is a process that estimates the total costs of a system over its entire life, from concept development through production, deployment, and support to retirement. It helps decision makers evaluate alternatives and identify opportunities to reduce costs. A life cycle cost estimate considers factors like research, development, production, training, maintenance, support and disposal costs. Conducting life cycle costing requires defining objectives, collecting data, making assumptions, assessing risk, and presenting results. It is an ongoing process that supports decision making at all stages of a system's life cycle.

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0% found this document useful (0 votes)
267 views64 pages

Code of Practice For Life Cycle Costing NATO RTO 2009

Life cycle costing is a process that estimates the total costs of a system over its entire life, from concept development through production, deployment, and support to retirement. It helps decision makers evaluate alternatives and identify opportunities to reduce costs. A life cycle cost estimate considers factors like research, development, production, training, maintenance, support and disposal costs. Conducting life cycle costing requires defining objectives, collecting data, making assumptions, assessing risk, and presenting results. It is an ongoing process that supports decision making at all stages of a system's life cycle.

Uploaded by

Maggy62d
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 64

RESEARCH AND TECHNOLOGY

ORGANISATION

NORTH ATLANTIC TREATY


ORGANISATION

RTO PUBLICATION

SAS-069

Code of Practice for


Life Cycle Costing
(Code de bonne conduite pour une
valuation du cot global
de possession)

Acquisition Cost
(R & D, Production)
Training
Cost

Test & Support


Equipment
Cost

Supply Support
(Inventory &
Distribution)
Cost
t&
en ost
em C
tir sal
Re spo
Di

Cu
sto
m
( P e er S
rso ervic
Co nnel) e
st

Transportation &
Handling Cost

Poor Procurement
Decision
Facilities
Cost

Technical
Data Cost

Published September 2009


www.rto.nato.int

RESEARCH AND TECHNOLOGY


ORGANISATION

NORTH ATLANTIC TREATY


ORGANISATION

RTO PUBLICATION

SAS-069

Code of Practice for


Life Cycle Costing
(Code de bonne conduite pour une
valuation du cot global
de possession)

Acquisition Cost
(R & D, Production)
Training
Cost

Test & Support


Equipment
Cost

Supply Support
(Inventory &
Distribution)
Cost
t&
en ost
em C
tir sal
e
R spo
Di

Cu
sto
m
( P e er S
rso ervic
Co nnel) e
st

Transportation &
Handling Cost

Poor Procurement
Decision
Facilities
Cost

Technical
Data Cost

www.rto.nato.int

Preface
The purpose of this document is to familiarise the reader on the application
and use of life cycle costing for a system of interest (including individual
weapon systems, system of systems, and military and business software)
from an early conceptual stage in the product life cycle through to disposal.
It provides illustrations on the types of life cycle cost studies that can be
conducted and examples to demonstrate the benefits of conducting life cycle
costing to inform the decision making process.
This handbook was prepared as part of the NATO Research
Technology Organisation, System Analysis and Studies Panel,
Task Group 069 and was based on the work conducted by
SAS-028, SAS-054 and AC/327 WG3 and is in accordance
with AAP-48.
Contributors included:
P. Paganis
M. Pica
S. Gulichsen
F. Ramaroson
G. Berg
P. Abegglen
T. Biedermann
M. Smit
M. Cakmak
I. Kolagasioglu
A. Koprulu
N. Uygunlar
A. Griffiths
D. Baggley
B. Flynn

ii

Greece
Italy
Norway
OCCAR
Sweden
Switzerland
Switzerland
Netherlands
Turkey
Turkey
Turkey
Turkey
United Kingdom
United Kingdom
United States

RTO-SAS-069

Table of Contents
Page
Preface

Executive Summary and Synthse

ii

ES-1

Chapter 1 What is Life Cycle Costing?


1.1 Description
1.2 Use of Life Cycle Costing
1.3 Life Cycle Costing Process
1.4 Life Cycle Cost Plan

1
1
2
2
3

Chapter 2 Why Do Life Cycle Costing?


2.1 NATO Guidance
2.2 Motivation and Application
2.3 Benefits

5
5
5
6

Chapter 3 Who Can Benefit from Life Cycle Costing?

Chapter 4 What is Required to Conduct Life Cycle


Costing?
4.1 Objective
4.2 Requirements
4.3 Identification of Constraints
4.4 Data
4.5 Methods
4.6 Assumptions
4.7 Cost Breakdown Structure

RTO-SAS-069

9
9
10
11
12
13
13
iii

4.8 Risk and Uncertainty


4.9 Presentation and Reporting
4.10 Multi-National Aspects

16
17
20

Chapter 5 When to Conduct Life Cycle Costing?


5.1 Concept Stage
5.2 Development Stage
5.3 Production Stage
5.4 Utilisation Stage
5.5 Support Stage
5.6 Retirement Stage
5.7 Additional Aspects

23
23
23
23
24
24
24
24

Chapter 6 Life Cycle Costing during the Life Cycle


Stages
6.1 Introduction
6.2 Concept Stage
6.3 Development Stage
6.4 Production Stage
6.5 Utilisation Stage
6.6 Support Stage
6.7 Retirement Stage

27

Chapter 7 Data Collection, Formats and Exchange


7.1 Data Evolution
7.2 Data Sources
7.3 Data Formats and Exchange
7.4 Data Normalisation
7.5 Data Recording

41
41
41
42
42
43

iv

27
27
30
31
33
35
37

RTO-SAS-069

Chapter 8 Future Developments Using Portfolio


Analysis Techniques in Defence Applications
8.1 Introduction
8.2 Portfolio Analysis
8.3 Methodology
8.4 Benefits

45

Chapter 9 Bibliography and Useful Websites

49

RTO-SAS-069

45
45
46
47

vi

RTO-SAS-069

Code of Practice for Life Cycle Costing


(RTO-SAS-069)

Executive Summary
The objective of the SAS-069 task group was to produce a Code of Practice
that draws on the conclusions and recommendations of SAS-054 and to
produce a practical guide to the use of life cycle costing methods and models
in a succinct booklet form.
The purpose of this booklet is to familiarise anybody interested in life cycle
cost analysis on the application and use of life cycle costing for a system of
interest (including individual weapon systems, system of systems, and military
and business software) from an early conceptual stage in the product life cycle
through to disposal.
The booklet provides illustrations on the types of life cycle cost studies that
can be conducted and examples to demonstrate the benefits of conducting
life cycle costing to inform the decision making process.

RTO-SAS-069

ES-1

Code de bonne conduite pour une valuation


du cot global de possession
(RTO-SAS-069)

Synthse
Lobjectif du groupe oprationnel SAS-069 tait de fournir un code de bonne
conduite qui tire les conclusions et les recommandations du SAS-054 et
de fournir un guide pratique dutilisation des mthodes et des modles
dvaluation du cot global de possession sous forme dune notice succincte.
Lobjet de cette notice est de familiariser toute personne intresse par
lanalyse du cot global de possession avec lapplication et lutilisation de la
mthode de dtermination de ce cot pour un systme digne dintrt
(comprenant des systmes darmes individuelles, un systme de systmes et
des logiciels militaires et de gestion) tout au long de son cycle de vie depuis
le premier stade de la conception du produit jusqu son limination.
La notice fournit des illustrations sur les types dtudes de cot global de
possession qui peuvent tre effectues et des exemples afin de dmontrer les
avantages dune valuation de ce cot global de possession pour renseigner
le processus de prise de dcision.

ES-2

RTO-SAS-069

Chapter 1 WHAT IS LIFE CYCLE COSTING?


1.1

DESCRIPTION

Life cycle costing is the discipline or process of collecting, interpreting and


analysing data and applying quantitative tools and techniques to predict the
future resources that will be required in any life cycle stage of a system of
interest.
The life cycle costs which are the output of this process include not only the
costs of the acquisition but also other costs that are logically attributed to
the programme throughout its life. The concept of total ownership or whole
life cost is related but broader in scope. Detailed cost related definitions can
be found in the NATO RTO SAS-028 report [1]. When used as a key measure,
it can reflect differences in alternative procurement options and support
solutions expressed in monetary terms.
Simply put, life cycle costing is a powerful technique that supports the
analytical processes by which managers can make the most cost-effective
decisions on options presented to them at differing life cycle stages and at
different levels of the life cycle cost estimate. Note however that life cycle
cost is just one of many criteria (e.g. operational need, government
constraints) that could influence an investment decision.
100

% of LCC

80
LCC c om mitted

60

Cost incurred

40
20

RTO-SAS-069

Di
se
ng
ag
em

en
t

Life Cycle
In
-se
rv
ice

(P
p r re oj ) F
ec ea
t d si
e f bil
in it
iti y /
on
D
De esig
ve n a
lo n
pm d
en
t
Pr
od
uc
tio
n

The greatest
opportunity to
reduce life cycle
costs usually occurs
during the early
stages of a
programme

WHAT IS LIFE CYCLE COSTING?

1.2

USE OF LIFE CYCLE COSTING

The principles and practices of this booklet apply to systems of interest,


including individual weapon systems, system of systems, and military and
business software.
Life cycle costing is not an exact science. A life cycle cost estimate does not
provide the exact figure for the costs; it merely gives an insight into the
major cost factors and it may also help to compare alternative solutions.
It highlights the magnitude of the costs and identifies areas for potential cost
savings as well as areas for technical and organisational improvements.
Life cycle costing should not be considered as a one-off task but should be
recognised as an ongoing activity throughout the project life cycle.

1.3

LIFE CYCLE COSTING PROCESS

The method(s) and model(s) used to develop the life cycle cost estimates will
depend upon the availability of data, the purpose of the cost estimate and the
time available to conduct the work.
Once the scope (objective, requirements and constraints) of the life cycle
cost study has been established the overall cost estimating process can
commence. It may be necessary to undertake several iterations following the
first set of results due to the availability of more data, clarification of the
assumptions or just general refinement. The process is completed with the
presentation of the results, assumptions and financial implications.
This process is described in more detail in Chapter 4.
Data Sources
Parametric
Analogy
Ba yesian
Detailed design
Industry data
Reliability data
Logistic data

Generic NATO
CBS
All Line Items

Assumption
Generic
Specific
Financial
Program

Life Cycle Cost


Model

Risk

Spreadsheet
Proprietary
Detailed level

Quantified
Risk Register
Optimism Bias

Various data sources


and cost estimating
techniques can
be used to derive
the likely life
cycle costs of the
System of Interest.

Life Cycle Cost


Output

RTO-SAS-069

WHAT IS LIFE CYCLE COSTING?

1.4

LIFE CYCLE COST PLAN

In order to control the process a life cycle cost plan should be developed and
maintained throughout the life cycle of the system of interest. The purpose of
the life cycle cost plan should be to provide the stakeholders with a clear
understanding of the life cycle costing requirements and how it can be used
to support their life cycle management plan. The life cycle cost plan must
therefore provide sufficient detail on:

What is the life cycle cost analyst going to do?

How does it link in with other associated activities?

Who is going to do it?

How is the analyst going to do it?

When is the analyst going to do it?

How are the life cycle costs going to be presented?

RTO-SAS-069

WHAT IS LIFE CYCLE COSTING?

RTO-SAS-069

Chapter 2 WHY DO LIFE CYCLE COSTING?


2.1

NATO GUIDANCE

The NATO ALP-10 guidance [2] states that all multi-national programmes
must implement a life cycle cost programme. However, this should not be
considered a burden as it will provide full visibility of all the costs in the
overall programme and system of interest.

2.2

MOTIVATION AND APPLICATION

A life cycle cost estimate, done properly, is the single best metric for
measuring the value for money of defence resources. This metric, in turn,
is useful in wide range of applications including:

Evaluating alternative solutions and source selection.

Assessing the affordability of the programme.

Managing existing budgets.

Developing future expenditure profiles.

Evaluating cost reduction opportunities.

Evaluating areas of financial risk and uncertainty.

Improving the business processes of the organisation.

Analysing Capability Portfolios.

Minimise the risk of cost


growth by developing
realistic and well documented
life cycle cost estimates.

RTO-SAS-069

WHY DO LIFE CYCLE COSTING?

2.3

BENEFITS

There are clear and unequivocal benefits to be gained by all the stakeholders
through undertaking a life cycle cost analysis on the system of interest.
These include:

Providing a better insight of all the costs in the programme and


identifying the key cost drivers for potential cost savings.

Providing a realistic planning programme and budgeting through a


methodical and consistent estimating approach.

Providing the basis for measurement of effective organisational and


logistic scenarios and provisions.

Providing a measure to evaluate two or more technically different


solutions to assist the decision making process.

RTO-SAS-069

Chapter 3 WHO CAN BENEFIT


FROM LIFE CYCLE COSTING?
Life cycle costing is a very useful process to support the control and management
of all the mandatory and stakeholders multi-criteria requirements in the most
effective and economical way.
The stakeholders in the life cycle are those who have a justifiable claim to be
allowed to influence requirements which defines the system of interest.
These include, but are not limited to:

Those affected by the system of interest, such as clients and suppliers;

Project and programme managers who are concerned for the system
of interest to succeed;

Regulators such as defence decision makers, local and state


governments and standardisation bodies; and

Those involved in the development, acquisition and support


organisation such as engineers, architects, planners and financial
personnel.

A clear understanding of the life cycle cost principles, methodologies and


techniques will enable all these people to apply life cycle cost to their
defence programmes and to successfully deliver and control the system of
interest throughout its life cycle.

RTO-SAS-069

WHO CAN BENEFIT FROM LIFE CYCLE COSTING?

RTO-SAS-069

Chapter 4 WHAT IS REQUIRED TO


CONDUCT LIFE CYCLE COSTING?
4.1

OBJECTIVE

Prior to any costing activity it is essential to define what is to be estimated


and understand what the estimates will be used for (e.g. setting budgets,
options evaluation, pricing).
The system of interest could range from a large turnkey project (e.g. a major
capital investment), a stand-alone system (e.g. individual platforms such as a
ship, aircraft or tank) to a worldwide application (e.g. theatre(s) of operation
and use). The approach to be adopted needs to be tailored to suit the
questions to be answered, the costing requirements and the availability of
suitable data. With some variation (to the level of detail), the same basic
approach to life cycle costing can be applied to all projects regardless of their
specifications.

4.2

REQUIREMENTS

A requirement is a singular documented need of what a particular product or


service should be or do. It is a statement that identifies a necessary attribute,
capability, characteristic, or quality of a system in order for it to have value
and utility to a user.
A clear understanding of the requirements, which is a statement of needs,
relating to the system of interest is essential to conduct life cycle costing.
There are three (3) main categories of requirements and each one of them
represents a specific area of the stakeholders and users interest for the new
system of interest:

Operational requirements are a set of information representing all


identified needs of the stakeholder, in order to fill an existing
operational gap.

Technical requirements are the information deriving from the


translation of the stakeholder operational requirements into a set of
measurable technical specifications of the new system of interest.

RTO-SAS-069

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

Performance requirements represent the services that the new system


of interest should provide to the user, according to the stakeholder
requirements.

Analysing the stakeholder requirements is called the Requirements Analysis


Process and is performed during the Conceptual Stage of the Life Cycle Stages
ISO 15288 [3].
In order to define the Stakeholder requirements, the steps of the Stakeholder
Requirements Definition Process, as described in AAP-48 [4] must be followed.
Once the requirements are defined then the estimation of the life cycle cost
of the system of interest can begin.

4.3

IDENTIFICATION OF CONSTRAINTS

The identification of the constraints is required as they will influence the life
cycle costing process. There are two types of constraints.

4.3.1

External Constraints

Though the benefits of life cycle costing are recognised, the approach for its
use and implementation could vary from Nation to Nation, due to:

Time constraints imposed by decision makers.

Potential high number of organisations involved.

Limited and suitable resources to support life cycle costing.

4.3.2

Internal Constraints

These constraints are inherent to:

10

Data availability.

Limited and suitable resources to conduct life cycle costing.

Maturity of requirements definition.

Economic and Commercial conditions.

RTO-SAS-069

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

4.4

DATA

Data is required in order to conduct a life cycle cost analysis. In terms of


time, effort, and resources consumed, collection of data is a major part of the
life cycle costing effort. Life cycle costing is a data driven process, as the
amount, quality and other characteristics of the available data often define
what methods and models can be applied, what analyses can be performed,
and hence, the results that can be achieved.
The figure below illustrates the relationship between data maturity and level
of assumptions to be applied.

Assumptions for
application of
methods by
analogy,
parametric

Requirements

Concept

Development

Production

Assumptions
for utilisation,
support and
retirement
costs

Assumptions
for production,
utilisation,
support and
retirement
costs
Firm prices
from
manufacturer
Engineering
Fixed prices for
and logistic
on going spares
data (RAM&T)
and maintenance
CONOPS

Development

Production

Utilization

Support

Retirement

Assumptions for
retirement costs

Data from utilisation


and support

Utilization

Viability,
Socioeconomical
considerations
, financial
aspects

Support

Level of data maturity

Level of assumptions

Concept

Retirement

The amount and quality of data available often increases in time with the
maturity of the system of interest, and the level of assumptions decreases.
As more data becomes available less assumptions have to be made, and more
detailed methods can be used to estimate costs.
Chapter 7 gives more details on data collection, data sources and data
normalisation.

RTO-SAS-069

11

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

4.5

METHODS

Previous study findings have confirmed that almost all nations use a similar
process to develop life cycle cost estimates; that the quality of the available
data nearly always determines the method to be applied; and, in addition,
that the type of study also influences the process and the selection of the
appropriate method.
The figure below shows an example of the most common application of
methods in each stage of the programme life cycle. A more detailed
overview of appropriate methods can be found in the report of NATO RTO
SAS-054 [5].

Programme Life Cycle


Concept

Development

Parametric
(This pattern holds)

Analogy
(Its like one of these)

Gross Estimates

Production

Utilization

Support

Extrapolation
(of actual costs)

Retirement

Analogy
(Similarities)

Engineering
(Its made up of these)

Detailed Estimates

Gross Estimates

Cost Estimating Methods

To improve the confidence on the results, two or more alternative methods


should be used for each major cost breakdown structure element whenever
possible. However, the use of alternative methods should always be evaluated
from a cost-benefit point of view.
12

RTO-SAS-069

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

Typically, further confidence can be gained by conducting a trend analysis to


place the programme cost and time estimates in context with previous
historical outcomes as illustrated in the figure below.

Here an estimate
is compared with
known previous
programme
outcomes to
provide
confidence in
the estimate.

4.6

ASSUMPTIONS

The lack of information (e.g. data related to an operational scenario, system


life and support organisation) of any kind or in any stage makes it necessary
to identify and record assumptions in order to develop a complete life cycle
cost of the system of interest.
In order to maintain an appropriate audit trail it is necessary to record and
document all changes to data and assumptions during the estimating process.
It is good practice to undertake a sensitivity or what if analysis on key
assumptions. An example would be to examine how maintenance costs
would vary with different values of system reliability.

4.7

COST BREAKDOWN STRUCTURE

A Cost Breakdown Structure (CBS) is used to ensure that all relevant costs
related to the system of interest are considered. This may be defined as an
organised list of all cost items related to the life cycle of a system or
programme. A CBS must satisfy some requirements such as:

Being easy to develop, use and update;

Sufficiently comprehensive to include all relevant cost items;

RTO-SAS-069

13

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

Being clear in terms of cost definitions;

Be flexible in order to be adapted to different systems; and

Comparable to other cost breakdown structures enabling decision


makers to make option analyses.

Life Cycle Cost can be broken down in a number of ways. Examples of


breakdowns are:

By time (year, month, or life cycle stage).

By type of costs (direct, indirect, linked, variable or fixed).

By product (systems, subsystems, components).

By process/activity (management, engineering, maintenance, etc.).

By resources (personnel, equipment, consumables).

By organisation:

Unit, service branch, etc.;

Nation (multi-national programme); and

Public/private company.

Most of these breakdowns are not mutually exclusive, and a CBS will
typically involve a combination of a number of these types of breakdowns.
More details about developing a Cost Breakdown Structure can be found in
the NATO RTO SAS-028 report [1].
It is quite common to develop or illustrate a CBS as a tree structure, as it is
in the example shown below. This gives an instant overview of a CBS,
based on stages and activities.
For large, complex and very detailed CBS structures, however, it is useful to
assign a numeric order code to each cost element in the CBS.

14

RTO-SAS-069

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

RTO-SAS-069

15

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

4.8

RISK AND UNCERTAINTY

Life cycle cost estimates of any new system of interest will inevitably
contain uncertainty and risk. Much effort is required to accurately estimate
the system development and production costs, as well as future decades of
operation and maintenance costs. At the end of this estimation process a cost
estimate is produced which is stochastic rather than deterministic with
uncertainty and risk determining the shape of the distribution. The definition
of each term is given as:

Uncertainty is the variance associated with the data and assumptions.

Risk is the consideration of potential adverse events and has two


components:
1)

The probability of occurrence of an unfavourable event, and

2)

The consequences of that event.

Conducting risk and uncertainty analysis on life cycle cost estimates of the
systems of interest is required to fully understand the possible variances in
programme estimates in terms of cost.
By conducting risk and uncertainty analysis decision makers can determine
what degree of risk may be acceptable (e.g. the probability of exceeding the
budget).
While there is a wide variety of methods and models for conducting risk and
uncertainty analysis on life cycle cost estimates, the principle for estimating
risk and uncertainty given in the figure below is highly recommended.
By using this process for the estimation of risk and uncertainty, decision
makers can budget a programme at a specific cumulative percentage level of
risk and they will be able to know the financial impact of specific risk events.

16

RTO-SAS-069

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

Baseline Probability Distribution

Likelihood

Modeling Uncertainty
Monte Carlo Simulation

Costs in Millions

For each stochastic CBS element, choose:


Type of probability distribution
Parameters of the distribution (e.g., , )

l i
ih h
l

2 1 =
Cost Risk

Risk-Adjusted Probability Distribution

Likelihood

Modeling Uncertainty & Risk


Monte Carlo Simulation

Costs in Millions

Principles of Estimating Risk and Uncertainty

4.9

PRESENTATION AND REPORTING

The results of cost studies are very important, as they should provide the
stakeholders with an answer to their question. It is therefore very important
that the results should be presented and reported in a manner that the
stakeholders can easily understand.

RTO-SAS-069

17

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

Results can be presented in a wide range of tabular and graphical forms.


The favour is to include graphical presentations of the results wherever
possible. This enables the widest possible audience to have a clear picture of
the overall results while retaining the detailed tabular presentations for those
that require them.
Two typical forms of graphical presentation (the spend profile and cost
allocation pie chart) are shown below. These figures indicate costs at a high
level but can also be used to present a more detailed level as required.
For presentation purposes these costs have been truncated at Financial Year
(FY) 18.
60.0

(M)

DEVELOPMENT
PRODUCTION

50.0

SUPPORT
OPERATION
40.0

Example of a
Baseline Life
Cycle Cost
Spend Profile

30.0

20.0

10.0

0.0
FY96

(M)
DEVELOPMENT
PRODUCTION
SUPPORT
OPERATION

FY97

FY98

FY99

FY00

FY01

FY02

FY03

FY04

FY05

FY96 FY97 FY98 FY99 FY00 FY01 FY02 FY03 FY04


4.0 8.1 8.1 5.1 4.0 3.0
25.3 37.4 43.4
3.0 5.1
2.0 4.0

FY06

FY07

FY08

FY09

FY10

FY11

FY12

FY13

FY14

FY15

FY16

FY17

FY18

FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16 FY17 FY18
35.4 25.3
10.1 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2 15.2
7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1

Example of a Life
Cycle Cost Allocation

Support
30%

Development
22%

Production
29%

Operations
19%

Note: The cost allocation percentage shown in the example above should not
be considered as being representative of all life cycle cost estimates.

18

RTO-SAS-069

WHAT IS REQUIRED
TO CONDUCT LIFE CYCLE COSTING?

The output of the life cycle cost study should be a report incorporating the
results and conclusions as well as a presentation on the basis of those results.
It should include a full definition of the aims and conduct of the study,
the definitions of the options studied, the costing boundary considered and
the assumptions underlying the cost elements.
The figures above represent single point estimates with no consideration to
the presentation of uncertainty and risk. The following figure presents a
recommended approach for communicating results of a life cycle cost
estimate to senior decision makers (see [6]).
The top line shows a three point range of estimates, and conveys the idea that
a cost estimate is not a single number but rather a continuum or distribution
of possible values.
Low
Estimate
585M

500M

600M

> Low-end historical cost growth factor


of -18%

High
Estimate
895M

Baseline Estimate
715M

700M
> Baseline estimate

800M

900M

> Historical cost growth factor of 25%

Cost Growth Factor, Sensitivity Analysis, or Risk Register from the UK


> 40th percentile estimate using Monte
Carlo simulation

> Mean estimate using Monte Carlo


simulation

> 80th percentile estimate using Monte


Carlo simulation

Risk and Uncertainty Analysis Using Monte Carlo Simulation


> X month schedule
> 80% learning curve
> 65% commonality with predecesor
> Business base strong
> No inflation

> Y month schedule


> 85% learning curve
> 60% commonality with predecesor
> Business base solid
> Moderate inflation

> Z month schedule


> 90% learning curve
> 20% commonality with predecesor
> Business base weak
> Accelerating inflation rate

Underlying Assumptions or Scenarios

Recommended Presentation of
Cost Estimating Risk Analysis

The top two shaded bars of the figure show the results of a historical trend
analysis on similar programmes and the results obtained from the risk and
uncertainty analysis reported at a given percentile. The bottom shaded
section, which should always be included in the presentation of the estimate,
shows the key assumptions or scenarios associated with the low, baseline,
and high estimates.
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This approach will lead to the establishment of a sound, well-structured


methodology for the conduct of and presentation of life cycle cost estimates.

4.10 MULTI-NATIONAL ASPECTS


The life cycle cost estimates for multi-national programmes follow the same
principles as defined for national ones. However, some specifics must be
considered and it is worth identifying the special requirements regarding life
cycle costing on multi-national programmes.

NATO ALP-10 guidance


states that all multi-national
programmes must implement
a life cycle cost programme

A significant added value of a multi-national programme is the possibility to


achieve savings by common procurement and support. Therefore the scope
of the multi-national life cycle cost studies could be focused on the
evaluation of alternatives linked to the development of commonalities.

The basic principle for multi-national life cycle cost estimates is the
definition of a common framework managed centrally by the entity in
charge of the management of the Programme. This entity could be a Pilot
Nation or an International Programme Office or a NATO Agency.
The common framework should include:

The selection of common life cycle cost models that allow an easy
interface with those defined at national level.

A common Cost Breakdown Structure based for example on the


generic CBS as presented at sub-section 4.7.

Development of shared data and assumptions by considering


common aspects and nations specifics.

Definition of a reference currency and the exchange rate.


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Included in the cost estimates, some specific requirements such as fair return
on investment, deployment assumptions and the previously conducted
national cost estimate must be carefully considered.

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Chapter 5 WHEN TO CONDUCT


LIFE CYCLE COSTING?
The approach taken to conduct life cycle costing is highly dependent on the
life cycle stage of the system of interest as this determines the availability of
data and the technical maturity of the system.
NATO, through the AAP-48 Life Cycle Stages and Processes [4], has adopted
ISO 15288 System Engineering System Life Cycle Process [3] for dividing
the life cycle into the following stages.
Each stage requires a different approach in conducting Life Cycle Costing.
For more details how to conduct a Life Cycle Cost Analysis in each stage,
please refer to Chapter 6.

Concept

5.1

Development

Production

Utilization

Support

Retirement

CONCEPT STAGE

The concept stage starts after the decision to fill a capability gap with a
materiel solution and ends with the requirements specification for this
materiel solution.

5.2

DEVELOPMENT STAGE

The development stage is executed to develop a system of interest that meets


the user requirements and can be produced, tested, evaluated, operated,
supported and retired.

5.3

PRODUCTION STAGE

The production stage is executed to produce or manufacture the product,


to test the product and to produce related supporting and enabling systems as
needed.
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WHEN TO CONDUCT LIFE CYCLE COSTING?

5.4

UTILISATION STAGE

The utilisation stage is executed to operate the product at the intended


operational sites, to deliver the required services with continued operational
and cost effectiveness.

5.5

SUPPORT STAGE

The support stage is executed to provide logistics, maintenance, and support


services that enable the continued system of interest in operational and
sustainable service. The support stage is completed with the retirement of the
system of interest and termination of support services.

5.6

RETIREMENT STAGE

The retirement stage provides for the removal of a system of interest and
related operational and support services and to operate and support the
retirement system itself. This stage begins when a system of interest is taken
out of service.

5.7

24

ADDITIONAL ASPECTS
AAP-48 describes the stages and processes to be followed in developing
and procuring a new system in order to fulfil a capability gap. At some
point in the NATO life cycle, the decision has to be made either to
develop a new system or to procure an off-the-shelf system (e.g. make
or buy decision). If the decision is made to buy a system of interest the
following type of Life Cycle Cost studies can be performed:

Supporting the tender evaluation process.

Comparing alternative solutions or options on costs, in order to


choose the best solution.

Determining the total life cycle costs.

It is not uncommon to repeat or refine the types of studies as the


programme progresses through the stages of the life cycle.

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The utilisation stage starts at the same time as the support stage and
together they are often referred to as the in-service stage. The utilisation
stage ends when the system of interest is taken out of service.

Life cycle costing should not be considered as a one-off task, but should be
recognised as an ongoing activity throughout all stages of the life cycle.
Life cycle costing should, in each stage of a programme, support stakeholders
in making the best decisions on options presented to them. These options may
include evaluation of future expenditure, comparison between alternative
solutions, management of existing budgets, options for procurement and
evaluation of cost reduction opportunities. Life cycle costing is also used for
affordability assessment and determining the cost drivers associated with the
Key Performance Indicators or Key User Requirements.

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Chapter 6 LIFE CYCLE COSTING DURING


THE LIFE CYCLE STAGES
6.1

INTRODUCTION

This chapter describes the appropriate estimating methods and likely


applications of life cycle costing across the various life cycle stages for a
system of interest.

6.2

CONCEPT STAGE

The greatest opportunity to reduce life cycle costs usually occurs during the
early stages of a programme. The concept stage is where decisions are made
when the amount of supporting information is at a minimum.
The types of studies conducted at this stage are typically: high level balance
of investment, cost benefit analysis and cost-effectiveness plots utilising life
cycle cost as one of the key measures.
Since cost and performance data is likely to be immature care should be
taken to avoid new conceptual proposals being given unwarranted advantage
in comparison with those that have been more thoroughly explored. For this
reason, the processes employed to support and undertake conceptual studies
rely on:

Qualitative approaches such as military judgement and subject matter


experts to draw on operational evidence and technology application
opportunities.

Quantitative approaches that will employ mathematical modelling of


physical system behaviour (principal measurable attributes) within
the context of representative operational or business situations.

6.2.1

Input

Input data will be derived from the requirements documentation, outline


concept of operation and operational analysis.

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6.2.2

Output

The LCC output from this stage should support the decision as to whether the
options being considered are feasible. The LCC output from this stage should
also support the requirements definition process.

6.2.3

Types of Studies

Some examples1 of the type of studies in the concept stage are Cost Benefit
Analysis and Cost Effectiveness Analysis. Cost Benefit Analysis is widely
accepted as a vital support tool for economic analysis on defence
programmes. The example shown below explores the benefits trade-off
between live flying, synthetic training environments and aircraft in-service
life in the provision of current and future heavy lift helicopter and light
utility helicopter, rotary wing capabilities.
Training
Syllabus
Simulator
capability

Number required
for operations

Live/SE training
balance
(Functional Analysis
Framework)

Crew
ratios and
turnover

Live flying
hours
Fleet Size Calculator

SME
opinion
Simulator types &
hours usage for
training

Hours for
peacetime
operations

Peacetime
attrition
rate
Number of
aircraft to buy
Aircraft
Service Life

Trainer system
purchase,
operating and
support costs

Aircraft purchase
and support cost
estimates

Items in bold
text indicate
calculation
steps leading
to the whole
life cost
output. Input
data values
are shown as
regular text

Whole Life Cost Estimate

A cost-effectiveness analysis helps to identify, from a number of proposed


options offering the best value for money. This type of analysis includes only
an assessment of military and financial issues therefore its results must be
considered alongside other factors (e.g. industrial, diplomatic) that might
influence the decision.

28

Figures reproduced with kind permission from HVR Consulting Services Ltd.

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Costeffectiveness
plots are
more
commonly
used. The
size of
the bubble
show the
uncertainty
in the data
and method
used
6.2.4

Cost-Performance Comparison
12.0000

10.0000

8.0000
Figure of Merit
Op 7

Op 6
Op 5

Op 3

6.0000

Op 4

Op 2

4.0000

Op 1
2.0000

0.0000
12000.0000

10000.0000

8000.0000

6000.0000

4000.0000

2000.0000

0.0000

Cost

Estimating Methods

Typical methods used for developing a cost estimate at this stage are Bayesian,
Parametric, Analogous, Expert Opinion or Rule of Thumb techniques.
To overcome the lack of data found at this stage, life cycle cost estimates can
be produced using proprietary estimating tools containing embedded Cost
Estimating Relationships such as ACES, FACET, PRICE and SEER.

6.2.5

Risk and Uncertainty Assessment

In the absence of data required to perform a detailed risk analysis,


an alternative, appropriate to this stage, is to apply percentages to a bottomline estimate. These adjustments should be based on data from past, similar
projects and calibrated for the unique characteristics of the programme under
consideration. The table below taken from the UK Joint Service Publication
507 [7] shows a build up of these percentages that should be factored to the
cost estimate when any of the following conditions is applicable.

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Project Information
Complexity of the contract structure

Percentage
Total Cost Uplift
7%

Late contractor involvement in design

7%

Inexperience or poor contractor capabilities

4%

Immature Information Management controls

5%

High degree of design complexity

10%

High degree of technical innovation

17%

Immaturity or inadequacy of the business case

18%

Immature or poor management team

5%

Immature or poor project intelligence

18%

Unknown Legislation/Regulations

5%

Immature Technology

18%

These values can then be applied to provide an illustration of optimism


bias in a programme review.

6.3

DEVELOPMENT STAGE

This stage of a programme calls for design engineering work aimed at


full validation of the system requirements and ensures complete system
integration to the point where production contract action can be taken.
6.3.1

Input

At this stage much information from the concept stage should be available
together with in-house historical data, results from early tests and technical
demonstration.
In addition, the Concept of Operations document and the requirement
documentation should be used in conjunction with information provided by
the supplier to refine the life cycle cost estimates.

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6.3.2

Output

On completion of this stage life cycle costing will be sufficiently comprehensive


and complete to support the production objective and provide a realistic forecast
of the likely life cycle cost.

6.3.3

Type of Studies

Examples of the studies in the development stage are:

Affordability studies; and

Tender evaluation.

6.3.4

Estimating Methods

At this stage the life cycle cost estimates will be developed by using engineering
(bottom-up) estimates supported by analogy cost estimating, parametric cost
estimating, historical trend analysis.

6.3.5

Risk and Uncertainty Assessment

The risk and uncertainty will be measured at a detailed level utilising a


quantified detailed risk register and recognised risk simulation models.
There should also be mitigation plans for all the major risk areas and the cost
of undertaking these mitigation actions should also be included in the cost
estimates.
At the completion of this stage the life cycle cost output should be a detailed
account of the uncertainties of the line items contained in the Cost Breakdown
Structure along with a comprehensive risk analysis in terms of cost impact.

6.4

PRODUCTION STAGE

This stage incorporates the production investment and the manufacture of a


system of interest, sub-system or equipment in a plant or factory using series
manufacturing techniques.

6.4.1

Input

The input data and assumptions for life cycle costing from earlier stages will
be supplemented by data provided by industry through a response to an
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invitation to tender or similarly a request for quotation. This may also


include a response to a life cycle cost questionnaire that will provide details
on system and component reliability (e.g. MTBF, MTTR) and costs.
At this stage industry would provide Firm prices for manufacture broken
down into detail for audit and negotiating purposes. Also, budgetary or Fixed
(allowing agreed variation) prices for ongoing spares and maintenance
should be available.
In addition Earned Value Management data can be used if provided by the
supplier.

6.4.2

Output

The output of the life cycle cost analysis will support the negotiating process
by establishing a should cost or investment appraisal for comparison
with the industry quotation.

6.4.3

Type of Studies

Besides the aforementioned establishment of a should cost or investment


appraisal, a review and update of the financial element of the systems life
cycle management plan can be undertaken during the production stage.
During production a study should be undertaken to assess how the forecasted
costs compare to the actual cost.
Other life cycle costing studies may be initiated if there is radical change
brought about by the failure to achieve the forecasted plan or a change in
policy or procurement strategy.

6.4.4

Estimating Methods

The primary method to be used in this stage is the engineering (bottom up)
methods using the detailed Cost Breakdown Structure populated from actual
data from industry.
In order to provide confidence in the life cycle cost estimate a second method
should be performed using analogy or parametric methods.

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An important aspect in this stage is the consideration of the relationship


between the reduction of production time and the quantities produced.
Care must be taken to ensure that all cost benefits arising from increased
quantities (learning factor) must be taken into account.

6.4.5

Risk and Uncertainty Assessment

During the production stage all the risks will be reviewed and managed on a
regular basis. Mitigation plans will be put into action and their progress
monitored. This will be a comprehensive management and analysis activity
and will regularly report the possible outcomes in cost and schedule to the
project manager.

6.5

UTILISATION STAGE

In the utilisation stage the system of interest will operate at the intended
operational sites to deliver the required capability with continued operational
and cost effectiveness in accordance with the user requirements.
During the utilisation stage the system of interest is continuously monitored
for performance in accordance with user requirements, e.g. by In-Process
Reviews (IPR), to determine how the system can be made more efficient and
effective. Another way to monitor the performance of the system of interest
is to conduct a User Satisfaction survey to determine if the system of interest
performs accurately and reliable.
Operations with the system of interest continue as long as it can be effectively
adapted to respond to an organisations requirements. The need for a major
modification or upgrade of the system of interest may arise from a change in
the threat, a deficiency identified in the system, a recommendation from the
operators or an opportunity to reduce costs. When modifications or changes for
upgrade are identified as necessary, the system may re-enter the concept or the
development stage.
The utilisation stage starts at the same time as the support stage and together
they are often referred to as the in-service stage. The utilisation stage ends
when the system of interest is taken out of service.

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6.5.1

Input

In order to pursue a cost effective utilisation of the system of interest, input


data is required. This data will be derived from information from earlier
stages, like the use study, operational requirements or earlier conducted cost
studies. Also, information related to personnel, training, infrastructure/
facilities and consumables is required.
Furthermore, assumptions and data related to deployment are required.
Especially in multi-national operations recording these inputs is vital to
estimate costs of alternatives for common utilization.
Finally, during this stage information from users, e.g. user satisfaction or
operating experience and other actual data information will be gathered.

6.5.2

Output

The main output of cost analyses in this stage is the cost of operating the
system of interest. These costs are primarily driven by the stakeholders
operational doctrine and the assigned mission, the operational environment
of usage, the operating rate (up-tempo), and the ability skills and the efficient
training of the personnel.
This output will support decision makers to forecast future costs, manage existing
budgets and undertake options analysis where necessary. The forecasting of
future expenditure requires a sound knowledge of the actual utilisation profiles.
Actual costs can also be compared with earlier estimates.
When analysing this output together with the users satisfaction forms a cost
effective utilisation of the system of interest can be obtained.

6.5.3

Type of Studies

During the utilisation stage studies are conducted in order to refine or validate the
life cycle cost estimate of the systems in use by using actual recorded data. This
should always be in line with the Measure of Effectiveness obtained for a given
life cycle cost estimate.
Also at this stage, any change in the costs of operating the system of interest
can be analysed, as a result of a change in operational use. Furthermore,
the cost of deployment can be determined and analysed.
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In addition to the traditional studies conducted during this phase on evaluating


cost reduction opportunities, studies on the likely costs and other implications
on the phasing out of the systems are likely to be conducted.
For multi-national programmes, alternatives for common operations can be
evaluated.

6.5.4

Estimating Methods

Methods employed during the utilisation stage include system dynamics and
discrete event simulation to provide dynamic predictive outcomes.
Additionally, a parametric method could be used. In order to capture actual
costs methods such as activity based costing can also be used.

6.5.5

Risk and Uncertainty Assessment

Risk and uncertainty analysis at this stage usually takes the form of a
sensitivity analysis around the major cost drivers related to the operation and
support of the system of interest.

6.6

SUPPORT STAGE

In the support stage, support services (including maintenance) necessary to


maintain the readiness and the operational capability of the system of interest
will be provided.
In order to provide the best possible support services to the system of interest
a specific support (including maintenance) concept must be followed in
accordance with NATO or National maintenance policy. The support
concept shall be established early in the programme. The support concept
will satisfy user specified requirements for sustaining support performance at
the lowest possible life cycle cost.
An important part of the support concept is the support plan describing the
support organisation, the support process and the support resources and
facilities.
During the support stage the support concept will be refined and validated.
A key role in this process is the optimisation of costs.
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The support stage starts at the same time as the utilisation stage and together
they are often referred to as the in-service stage. The support stage ends
when the system of interest is taken out of service.

6.6.1

Input

In order to pursue a cost effective support of the system, input data is required.
This data will be derived from the operational requirements, the support concept
and information from earlier stages, such as the integrated logistic support study
(including data related to the supply chain, reliability, etc.), requirements related
to support or earlier conducted cost studies. Also information related to support
personnel, training support personnel, infrastructure/facilities, spare and repair
parts, documentation, test and support equipment and tools, Packaging, Handling,
Storage and Transportation (PHST) or contract data is required.
Furthermore for multi-national programmes, assumptions and data related to
common support solutions are required. Especially in multi-national operations
recording these inputs is vital to estimate alternatives for commonalities.
Finally, during this stage information and operating experience from support
personnel and other actual data information will be gathered.

6.6.2

Output

The main output of cost analyses in this stage is the cost of supporting the
system of interest. These costs are primarily driven by the stakeholders
support concept, the operational environment of usage, the operating rate
(op-tempo), and the ability skills and the efficient training of the personnel.
This output will support decision makers to forecast future costs, manage
existing budgets related to the support of the system of interest and to
undertake options analysis where necessary. The forecasting of future
expenditure requires a sound knowledge of the actual support costs. Actual
costs can also be compared with earlier estimates.
When analysing this output together with the users satisfaction a costeffective utilisation of the system of interest can be obtained.

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6.6.3

Type of Studies

During the support stage studies are conducted in order to refine or validate
the life cycle cost estimate of the support of the system of interest by using
actual recorded data. This should always be in line with the Measure of
Effectiveness obtained for a given life cycle cost estimate. The actual data
may also be used to validate earlier estimates.
At this stage also the change in costs of supporting the system of interest can
be analysed, as a result of any change in operational use or support concepts.
Furthermore, obsolescence and life extension studies can be conducted and
the cost of upgrades and modifications can be determined and analysed.
For multi-national programmes, alternatives for common support solutions
can be evaluated.

6.6.4

Estimating Methods

Methods employed during the support stage include system dynamics and
discrete event simulation to provide dynamic predictive outcomes. Additionally,
parametric methods can be used. Also optimisation methods can be used.
In order to capture actual costs methods such as activity based costing can be
used.

6.6.5

Risk and Uncertainty Assessment

Risk and uncertainty analysis at this stage usually takes the form of a
sensitivity analysis around the major cost drivers related to the operation and
support of the system of interest.

6.7

RETIREMENT STAGE

This stage starts with an intention to retire the System of Interest. However,
the decision to retire a system of interest and the studies (including an
estimate of likely revenue and expenses) related to this decision may be
conducted at an earlier stage in the project life cycle.
A system may enter the retirement stage for several reasons, including:
a change in operational requirements, a change in the socio-political
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environment (e.g. personnel mines), system obsolescence, increasing support


costs, etc.
In addition, a system of interest may be retired earlier than planned due to a
change in strategic priorities.

6.7.1

Input

A number of considerations are made to support the disposal decision


making process. These considerations are predominantly based on market
opportunities and the impact from new legislation. The inputs required to
support the life cycle costing process therefore include, but may not be
limited to:

A market survey conducted to establish the potential viability of


sale and scrap value. This is not as clear cut as previously
experienced. A number of commercial companies throughout the
world have taken this as an opportunistic venture by providing
facilities to handle toxic material such as asbestos in response to
overcoming the change in legislation. Therefore, the scrap value of
the raw material alone can be superseded and increased by selling
the complete asset to a licensed disposal company.

Determination of the residual value of the system of interest to


support baseline comparisons.

A review of the financial liabilities arising from environmental and


legislative impacts. For example the changes in maritime legislation
have resulted in the scrapping of all single hull tankers wishing to
use international territorial waters and recognised shipping canals.

It is expected that the life cycle cost analyst will be a recipient of the findings
from these studies to support the subsequent cost analysis.

6.7.2

Output

By conducting a life cycle cost analysis the following options can be


assessed:

38

Re-deployment (can the equipment be used for training/


instructional use, as a heritage/museum asset, for spare recovery,
etc.).
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Reclamation, recycling, re-manufacture (is there a possible other


use as opposed to disposal).

Sale (potential customers).

Disposal at cost.

6.7.3

Type of Studies

Analyse options for retirement.

6.7.4

Estimating Methods

Predicting cost estimates for equipment disposal is not dissimilar to the


methods employed at the concept stage. The most common methods of
estimating the likely disposal cost currently used is by analogy and parametric.
These methods are well established and can calculate the negative and positive
financial impact depending on the alternative disposal options being assessed.
To avoid error, it is essential that as much historical data as possible is gathered
and evaluated to provide a degree of normalisation such that a like for like
basis is achieved.

6.7.5

Risk and Uncertainty Assessment

The identification of risk for this stage will be conducted at a very high level.
It is likely to be a combination of single line statements and will probably
contain a mixture of issues as well as risks. The cost analyst will need to
distinguish the difference between them in order to ensure that only those
appropriate risks are to be included in the cost risk analysis.
Where there is no risk register or risk record then another approach would be
to employ an optimism bias technique. Here it could be employed to redress
overly optimistic tendencies by making empirically based adjustments to the
cost estimates (see Sub-section 6.2.5).
At the very minimum, the life cycle cost estimate produced at this stage
should include or indicate the level of financial risk exposure and liabilities.

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Chapter 7 DATA COLLECTION,


FORMATS AND EXCHANGE
Data is required in order to conduct a life cycle cost analysis. In terms of
time, effort and resources consumed, collection of data is a major part of any
life cycle cost study. Life cycle costing is a data driven process as the
amount, quality and other characteristics of the available data often defines
what methods and models can be applied, what analysis can be performed,
and hence, the results that can be achieved.

7.1

DATA EVOLUTION

As a system progresses through the life cycle, the types of data available
evolve in a number of ways. The characteristics of the available data will
change as well as the progress of the life cycle. Early data will tend to be
softer and be in a more aggregated form, because hard numbers and detailed
information will not yet be available.

7.2

DATA SOURCES

Life cycle costing requires a wide variety of data and these must be collected
from an even wider variety of sources. When preparing a cost estimate,
analysts should consider all credible data sources. A distinction can be made
between internal and external data:

Internal data can be defined as data generated internal to the


programme.

External data is provided by a data source outside the programme.


External data sources can be industry or other military branches or
other organisations.

In order to collect data from external sources cost estimators and the
programme managers may use templates for a life cycle cost questionnaires
as part of an Invitation to Tender, Request for Information, Request for
Quotation or Request for Proposal.

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7.3

DATA FORMATS AND EXCHANGE

Electronic exchange of data between multiple databases from industry and


governments (e.g. Enterprise Resource Planning systems) can be time
consuming if data formats and data models differ. A number of standards
exist for the exchange of data. NATO has introduced STANAG 4661 [8] for
life cycle data exchange which is based on ISO 10303-239 Product Life
Cycle Support [9]. However, it is important to understand that the ISO
represents only information relating to product data and provides no support
for life cycle costing data.

7.4

DATA NORMALISATION

Raw data for life cycle costing originates from a variety of sources. There is
generally a lack of uniformity in the data and therefore a certain amount of
normalisation is unavoidable. Generally, data normalisation covers changes
and adaptations to make it applicable for use in a cost model. The main areas
of data normalisation include:

42

Adjusting all data to a Base Year. This will facilitate the analysis of
the financial data on a comparative basis.

Appropriation of constant and current year cost data to account for


anticipated inflation.

Selection of correct indices for conversion.

Selection of correct exchange rates.

Adjusting costs and/or data for technical specifications such as size,


weight, complexity, maturity, etc.

Adjusting costs and/or data or performance data for different


operating profiles, temperatures, mileage, etc.

Adjusting prices for lot sizes, learning curves, producer capability,


etc.

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7.5

DATA RECORDING

Various mechanisms are used to gather data (e.g. questionnaire, databases,


ERP Systems). It will be necessary to generate a single document to capture
and record all the data used for the life cycle cost estimate.
The Master Data
and Assumptions
List needs to be
dynamic and
iterative. It must
also reflect the
basis of the cost
estimate at any
given point in time
and provide a
sound data
audit trail.

Similarly, much of the information needed is often available in other


programme documents. The Cost Analysis Requirements Description or the
Master Data and Assumptions List should stand alone as a readable
document but can make liberal use of appropriate references to the source
documents to minimise duplication and effort.

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RTO-SAS-069

Chapter 8 FUTURE DEVELOPMENTS USING


PORTFOLIO ANALYSIS TECHNIQUES IN
DEFENCE APPLICATIONS
8.1

INTRODUCTION

Life cycle costing is a discipline that is constantly in development. One of the


new developments foreseen is using capability portfolio analysis techniques in
defence applications. This new development may also have an impact on the
way that life cycle costing is conducted in the future.

8.2

PORTFOLIO ANALYSIS

Portfolio analysis is a technique of measuring the allocation of scarce resources


to satisfy strategic objectives. It is commonly described as a dynamic decision
process, a resource allocation process, or a manifestation of a business
strategy. In government as well as in the private sector, portfolio analysis
helps senior management determine where and how to invest for the future.
In short, it is a technique to determine how to best spend limited funding.
Three basic goals of portfolio analysis are:

Managing the trade-off between risk and return;

Establishing a healthy balance of projects in terms of maturity, cost,


and risk; and

Selecting only those projects that meet the long-term, strategic goals
of the organisation.

For the private sector, the value of a project is typically measured by return on
investment (ROI), or discounted projected net earnings divided by investment
funds. On the other hand, in a national defence setting, ROI might be expressed
in terms of future flows of military capability divided by life cycle costs.

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45

FUTURE DEVELOPMENTS
USING PORTFOLIO ANALYSIS
TECHNIQUES IN DEFENCE APPLICATIONS

8.3

METHODOLOGY

In defence planning, capability is defined as [10]:


the enduring ability to generate a desired operational outcome
or effect, and is relative to the threat, physical environment, and
contributions of coalition partners.
Measuring capability is difficult. It requires specifying one or more war
fighting scenarios and assessing the importance of strategic, operational,
and tactical tasks, and alternative weapon systems, needed to achieve mission
objectives. An amalgam of informed opinions from subject matter experts and
knowledge of the performance characteristics of an entire set of weapon
systems are usually employed in this endeavour.
Depending upon where a system is in its acquisition cycle, costs might need to
be estimated for science and technology, development, production, operation
and support. These costs should be estimated in constant costs, with risk and
uncertainty assessed.
Meshing capability assessments with the life cycle cost estimates yields a
risk-reward bubble diagram for the portfolio, with an example shown below
for mine countermeasure warfare. Here, the bubbles represent the costs of
current and prospective weapon systems in the portfolio. They are sized
according to resources to be expended, i.e. estimated life cycle costs.
The ROIs are the numbers associated with the bubbles. Roughly speaking,
they equal capability divided by bubble size.

46

RTO-SAS-069

FUTURE DEVELOPMENTS
USING PORTFOLIO ANALYSIS
TECHNIQUES IN DEFENCE APPLICATIONS

High

1.8

In S&T
In Acquisition
Operational

1.6

1.4

Reference
= $100M

2
9

Risk

1.2

49

11

0.8

80

0.6

0.4

18

0.2

60

18

Low

0.2

0.4

Low

8.4

0.6

0.8

1.2

Estimated Military Value

1.4

1.6

1.8
High

BENEFITS

Armed with the results of the life cycle cost estimates and capability
assessments, data are displayed to illustrate portfolio balance, systems value
and strategic fit. Ideally, results can be generated near real-time so that decision
makers can conduct what-if questioning with answers provided in short order.
Portfolio analysis promises to give stakeholders valuable metrics, including the
risks and uncertainties of costs, capabilities, and requirements, with which to
make more informed decisions on the allocation of scarce defence resources.
As noted above, life cycle cost analysis is a critical component of this work.

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FUTURE DEVELOPMENTS
USING PORTFOLIO ANALYSIS
TECHNIQUES IN DEFENCE APPLICATIONS

48

RTO-SAS-069

Chapter 9 BIBLIOGRAPHY
AND USEFUL WEBSITES
9.1

REFERENCES

[1]

RTO TR-058 / SAS-028, Cost Structure and Life Cycle Costs for
Military Systems, RTO-SAS-028 Task Group Technical Report,
September 2003.

[2]

ALP-10, Guidance on Integrated Logistics Support for Multinational


Equipment Projects (ILS) Allied Logistic Publication, June 1990.

[3]

ISO/IEC-15288, Systems Engineering System Life Cycle Processes,


International Standards Organisation/International Electrotechnical
Commission, November 2002.

[4]

AAP-48, NATO System Life Cycle Stages and Processes, PFP


(AC/327)D2006(0009) Allied Administrative Publication; Edition 1,
February 2007.

[5]

RTO TR-SAS-054, Methods and Models for Life Cycle Costing,


RTO-SAS-054 Task Group Technical Report, June 2007.

[6]

MG-415, Impossible Certainty: Cost Risk Analysis for Air Force


Systems, RAND, 2006, pp. 84-86.

[7]

JSP 507, MOD Guide to Investment Appraisal and Evaluation, UK


Joint Service Publication, Version 3.0, December 2006, p. 195.

[8]

STANAG 4661, Product Life Cycle Support, PFP(AC_327)D(2006)


0002, Draft Edition 1, 2006.

[9]

ISO 10303-239:2005, Industrial Automation Systems and Integration


Product Data Representation and Exchange Part 239: Application
Protocol: Product Life Cycle Support, International Organisation for
Standardization, 2005.

[10] IQPC, Through life Capability conference, IQPC London, June 2007.

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49

BIBLIOGRAPHY AND USEFUL WEBSITES

9.2

USEFUL WEBSITES

www.rto.nato.int
www.scea.org
www.scaf.org.uk
www.ispa-cost.org
www.dodcas.org
www.aof.mod.uk
www.gao.gov
www.nao.org.uk
www.ncca.navy.mil
www.vivaceproject.com

9.3

FURTHER READING

C-M(2005) 0108-AS1, NATO Policy for Systems Life Cycle Management,


January 2006.
Dunn, B., Cost Estimating Methodologies, Defence Acquisition University,
Business, Cost Estimating and Financial Management Department, October
2002.
Fabrycky, W.J. and Blanchard, B.S., Life-Cycle Cost and Economic Analysis,
Prentice-Hall, Englewood Cliffs, N.J, 1991.
ASD-410, FAA Life Cycle Cost Estimating Handbook, Investment Cost
Analysis Branch, June 2002.
DoD 5000.4M, Cost Analysis Guidance and Procedures, December 1992.
DoD 5000.M-1, Cost and Software Data Reporting (CSDR) Manual, Office
of the Secretary of Defense Cost Analysis Improvement Group, April 2007.
Operating and Support Cost-Estimating Guide, Office of the Secretary of
Defense Cost Analysis Improvement Group, October 2007.
50

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BIBLIOGRAPHY AND USEFUL WEBSITES

ANEP-41, Ship Costing, Allied Naval Engineering Publication, Edition 4,


NATO NG/6 Specialist Team on Ship Costing, October 2005.
ANEP-49; Ways to Reduce Costs of Ships, Allied Naval Engineering
Publication, Edition 2, NATO NG/6 Specialist Team on Ship Costing, June
2001.
Boussabaine, A. and Kirkham, R., Whole Life-cycle Costing: Risk and Risk
Responses, Blackwell Publishing, Oxford, UK, 2005.
Nas, T.F., Cost-Benefit Analysis: Theory and Application, Thousand Oaks,
CA, Sage, 1996.
Boardman, A.E., Greenberg, D.H., Vining, A.R. and Weimer D.L., CostBenefit Analysis: Concepts and Practice (2nd Edition), Prentice Hall, 2000.
MIL-HDBK-881A, Work Breakdown Structures for Defence Materiel Items,
DoD Handbook, 30 July 2005.
Goldberg, M.S. and Touw, A.E., Statistical Methods for Learning Curves
and Cost Analysis, 2003.
Flanagan, R., Norman, G., Meadows, J. and Robinson, G., Life Cycle
Costing: Theory and Practice, BSP Professional Books, Oxford, 1989.
Stewart, R.D., Wyskida, R.M. and Johannes, J.D., Cost Estimators Reference
Manual (Second Edition), Chapter 7, John Wiley & Sons Ltd., 1995.
Jones, James V., Integrated Logistics Support Handbook (Third Edition),
McGraw-Hill, 2007.
Pugh, P.G., Source Book of Defence Equipment Costs, Dandy Booksellers,
2007.
Boehm, B., Software Engineering Economics, Prentice Hall, Englewood
Cliffs, NJ, 1981.
Jones, C., Applied Software Measurement, Assuring Productivity and
Quality, McGraw-Hill, NY, 1997.
Lee, D., The Cost Analysts Companion, ISBN 0-9661916-09.
RTO-SAS-069

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BIBLIOGRAPHY AND USEFUL WEBSITES

Londeix, B., Cost Estimation for Software Development, Addison-Wesley,


Wokingham, England, 1987.
Alexander, I.F. and Stevens, R., Writing Better Requirements; Pearson
Education Ltd., 2002.
Cost Risk and Uncertainty Analysis Handbook, US Air Force, April 2007.
Dependability Management Application Guide Life Cycle Costing, British
Standard EN 60300-3-3:2004.

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