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A balanced view of cost overruns
IDEAtional Items
f r o m the desk o f DAVID NOVICK
A balanced view of cost overruns
70
Mr. Novick is a member of the Research Council, The RAND Corporation.
Recent announcements of cost overruns in military procurement have produced cries of anguish. They come primarily from persons concerned about the military-industrial complex, a term brought to public notice by President Eisenhower in his farewell address. What the public seems not to realize is that the problem is neither new nor peculiar to the military, and that we may be forced to live with it indefinitely. Two issues are involved in the problem of "surprise" or cost overrun: the formulation of the original estimate of the cost of the item, and the control of the cost once the decision is made to undertake the project. Attempts to deal with the issues have been made by government and industry both in the United States and abroad. The General Accounting Office, for example, recently recommended that all defense contractors be required to adopt a set of uniform accounting practices. Although practices and overruns are clearly separate and separable matters, they are combined here because the public information media have identified them as cause and effect. (Probably the most noteworthy of these identifications
appeared in a N e w York Times editorial of Jan. 27, 1970.) The idea of uniform accounting practices for defense contractors is not new, and, at all times, has seemed both appropriate and feasible. Such bookkeeping is now covered by the A r m e d Services Procurement Regulations (ASPRs), which fall far short of what might be hoped for in terms of information and really do not require uniformity. Although uniform accounting procedures are desirable, they can be eliminated from a discussion of cost overruns because they deal only with history. The GAO proposal, therefore, would provide little or no help with the first of the difficulties involved in the problem of cost overrunestimates of future costs. Although it might be useful for the second problem-cost control-it could be expected to accomplish this only at some time far in the future. A most significant contribution to the literature on the problem is the report of Great Britain's Plowden committee. 1 This report recognized that efficiency in cost control derives from both the quality of the forward 1.
The Control of Public Expenditures (London:
HMS Stationery Office, 1961).
BUSINESS HORIZONS
Balanced View of Cost Overruns
estimate and the reliability of the instruments of financial control applied to the work to be done. Although the committee dealt with problems of procurement by the British Defence Ministry, its findings apply equally to the United States, to private business, and to all undertakings to produce goods for delivery five or more years in the future. The matter of cost overruns can be viewed in a more sensible perspective if we understand that overruns are neither new nor peculiar to the military. History could doubtless provide a more ancient example, but perhaps the reader will be content with the experience of the Romans shortly after the beginning of the Christian era. At that time, the government of Rome decided to provide an aqueduct for the town of Troas in Asia. Work was started, and costs began to outrun the estimates. According to the historian Edward Gibbon, "When it was evident that costs would be more than double the original estimate, the officers of the revenue began to murmur. ''2 The complaint of the revenue collectors was silenced by the generosity of the very rich Julius Atticus, who met all of the extra cost out of his own pocket. Since there is no Julius Atticus around today, the taxpayer and the public treasury must foot the bill, whether the project is civil or military. Examples can be chosen from an ample supply accumulated in more recent times. In the early 1950's, when nuclear reactor technology was first made available for peaceful uses, a major public utility contracted with an established boilermaker for an atomic core for a power plant. The public utility had had long experience with fossil fuel and hydroelectric plants, and this was its first entry into the nuclear field. For this reason, even though the boilermaker was experienced in the atomic field through its contribution to the World War II Manhattan Project, the utility engaged a consuiting firm which also had had a long history as a technical consultant in the nuclear field. The contract awarded by the public utility
2.
Edward Gibbon, The Decline and Fall of the
Roman Empire, Ch.2.
APRIL, 1970
called for delivery of the reactor core within four years at a price of $35 million. On the original delivery date the boilermaker had run out of money and was not able to make delivery. Delivery was made several years later and the cost overrun was some 200 percent of the original price. The cost overrun results were the same for one of the nation's largest commications companies when it decided to introduce a new transmission technology after World War II. Here again, although there had been an accumulation of knowledge over the years, the new technique selected for introduction was not fully developed, and time was an important factor. In this case, the time schedule was met, but the cost overrun was in the 3 0 0 - 4 0 0 percent range. Again, in the early 1950's, one of the country's auto manufacturers decided to reintroduce an old body frame concept. Although it had been used previously by the company and was currently being used by other manufacturers both in the United States and Europe, it was new "to the company at that time." All went well until the first units were delivered to the company's proving ground. There, the front end turned out to be completely unstable and unmanageable. When the car was accelerated, the front left the ground, and the vehicle went out of control. A quick fix was achieved by adding several hundred pounds of metal to the front end. This additional weight held the car on the ground, but it meant cost overruns of about $200 a unit. In the automobile industry where budgets are very tight, even a $10 per unit change is a large amount. In the public field, we are all familiar with the story of the cost overruns on the Rayburn addition to the House Office Building. Most of us have also heard about the very large additions to the original contract required for some of the elevated highways built in Chicago. To this list of ordinary experiences, all well within the state-of-the-art construction activities, one or two items from the 1968 hearings on Atomic Energy Commission appropriations might be added. The most striking AEC overrun cited at that time was on modification of reactor
DAVID NOVICK
72
facilities at Hanford, Wash., where the original cost estimate was $12,300,000 and the final figures added to $21,728,000. The zero gradient synchrotron at Argonne went in at an original estimate of $29,000,000, and the final cost was $51,402,000; its Project Sherwood started with an original cost estimate of $30,000,000, and the actual cost was $57,004,000. An office building is not a very complicated structure in comparison with modern military aircraft and guided missiles. Standard grades of steel are used for beams, reinforcement rods, and mesh. A large number of suppliers stand ready to sell ready-mixed concrete, sheathing materials for the exterior, sash, flooring, roofing materials, and every other part of the structure. Yet we all know of office building after office building for commercial account in which substantial cost overruns were experienced. The same thing is true in the history of innumerable people who contracted for a house. They wind up paying substantially
more than they originally bargained for in the building of their home. These examples are cited simply to remind us that the phenomenon of cost overrun is not uniquely the province of either the Department of Defense or military goods. To be sure,.this will always be a fruitful area of study for both military and civilian parts of the economy. But let us not be carried away by the current list of horrible examples in the military and assume that this is the product of some evil conspiracy between the government and manufacturers of military goods. In the design, procurement, and production of future goods, errors will always be made, whether in the purchase of new space vehicles for government use, the introduction of new power plants by privately owned electric companies, or the purchase of new office buildings and homes by private individt~als. This has been the case since Roman times and can be expected to continue to be the situation in the foreseeable future.
When a corporation and the Defense Department enter into long and detailed negotiations regarding provisions in a cost-plus contract, the issue may violently stir the two protagonists without creating a ripple on the surface of public opinion. When, however, an issue like Taft-Hartley Bill involves three parties (business, unions, and government) the simple fact of triangulating the debate may precipitate a public stir. In short, elitism does exist in the United States, but it tends to shift in composition or in power potential at different levels of the system simply because the higher the position held by a given issue, the larger the number of claimants. Hence, a greater variety of forces begins to play on the contenders. In this interplay, the existence of a common economic goal can give a greater capacity for power to the economic elite than to the non-economic organizations that so often appear incapable of inspiring the sustained interests of their members. If economic unity is lacking as it was, for example, in the famous TFX controversy,.then the assumption of ascendancy for the economic interests, all other things being equal, appears to be questionable. - I v a r Berg, The Business o f America
BUSINESS HORIZONS
f r o m the desk o f DAVID NOVICK
A balanced view of cost overruns
70
Mr. Novick is a member of the Research Council, The RAND Corporation.
Recent announcements of cost overruns in military procurement have produced cries of anguish. They come primarily from persons concerned about the military-industrial complex, a term brought to public notice by President Eisenhower in his farewell address. What the public seems not to realize is that the problem is neither new nor peculiar to the military, and that we may be forced to live with it indefinitely. Two issues are involved in the problem of "surprise" or cost overrun: the formulation of the original estimate of the cost of the item, and the control of the cost once the decision is made to undertake the project. Attempts to deal with the issues have been made by government and industry both in the United States and abroad. The General Accounting Office, for example, recently recommended that all defense contractors be required to adopt a set of uniform accounting practices. Although practices and overruns are clearly separate and separable matters, they are combined here because the public information media have identified them as cause and effect. (Probably the most noteworthy of these identifications
appeared in a N e w York Times editorial of Jan. 27, 1970.) The idea of uniform accounting practices for defense contractors is not new, and, at all times, has seemed both appropriate and feasible. Such bookkeeping is now covered by the A r m e d Services Procurement Regulations (ASPRs), which fall far short of what might be hoped for in terms of information and really do not require uniformity. Although uniform accounting procedures are desirable, they can be eliminated from a discussion of cost overruns because they deal only with history. The GAO proposal, therefore, would provide little or no help with the first of the difficulties involved in the problem of cost overrunestimates of future costs. Although it might be useful for the second problem-cost control-it could be expected to accomplish this only at some time far in the future. A most significant contribution to the literature on the problem is the report of Great Britain's Plowden committee. 1 This report recognized that efficiency in cost control derives from both the quality of the forward 1.
The Control of Public Expenditures (London:
HMS Stationery Office, 1961).
BUSINESS HORIZONS
Balanced View of Cost Overruns
estimate and the reliability of the instruments of financial control applied to the work to be done. Although the committee dealt with problems of procurement by the British Defence Ministry, its findings apply equally to the United States, to private business, and to all undertakings to produce goods for delivery five or more years in the future. The matter of cost overruns can be viewed in a more sensible perspective if we understand that overruns are neither new nor peculiar to the military. History could doubtless provide a more ancient example, but perhaps the reader will be content with the experience of the Romans shortly after the beginning of the Christian era. At that time, the government of Rome decided to provide an aqueduct for the town of Troas in Asia. Work was started, and costs began to outrun the estimates. According to the historian Edward Gibbon, "When it was evident that costs would be more than double the original estimate, the officers of the revenue began to murmur. ''2 The complaint of the revenue collectors was silenced by the generosity of the very rich Julius Atticus, who met all of the extra cost out of his own pocket. Since there is no Julius Atticus around today, the taxpayer and the public treasury must foot the bill, whether the project is civil or military. Examples can be chosen from an ample supply accumulated in more recent times. In the early 1950's, when nuclear reactor technology was first made available for peaceful uses, a major public utility contracted with an established boilermaker for an atomic core for a power plant. The public utility had had long experience with fossil fuel and hydroelectric plants, and this was its first entry into the nuclear field. For this reason, even though the boilermaker was experienced in the atomic field through its contribution to the World War II Manhattan Project, the utility engaged a consuiting firm which also had had a long history as a technical consultant in the nuclear field. The contract awarded by the public utility
2.
Edward Gibbon, The Decline and Fall of the
Roman Empire, Ch.2.
APRIL, 1970
called for delivery of the reactor core within four years at a price of $35 million. On the original delivery date the boilermaker had run out of money and was not able to make delivery. Delivery was made several years later and the cost overrun was some 200 percent of the original price. The cost overrun results were the same for one of the nation's largest commications companies when it decided to introduce a new transmission technology after World War II. Here again, although there had been an accumulation of knowledge over the years, the new technique selected for introduction was not fully developed, and time was an important factor. In this case, the time schedule was met, but the cost overrun was in the 3 0 0 - 4 0 0 percent range. Again, in the early 1950's, one of the country's auto manufacturers decided to reintroduce an old body frame concept. Although it had been used previously by the company and was currently being used by other manufacturers both in the United States and Europe, it was new "to the company at that time." All went well until the first units were delivered to the company's proving ground. There, the front end turned out to be completely unstable and unmanageable. When the car was accelerated, the front left the ground, and the vehicle went out of control. A quick fix was achieved by adding several hundred pounds of metal to the front end. This additional weight held the car on the ground, but it meant cost overruns of about $200 a unit. In the automobile industry where budgets are very tight, even a $10 per unit change is a large amount. In the public field, we are all familiar with the story of the cost overruns on the Rayburn addition to the House Office Building. Most of us have also heard about the very large additions to the original contract required for some of the elevated highways built in Chicago. To this list of ordinary experiences, all well within the state-of-the-art construction activities, one or two items from the 1968 hearings on Atomic Energy Commission appropriations might be added. The most striking AEC overrun cited at that time was on modification of reactor
DAVID NOVICK
72
facilities at Hanford, Wash., where the original cost estimate was $12,300,000 and the final figures added to $21,728,000. The zero gradient synchrotron at Argonne went in at an original estimate of $29,000,000, and the final cost was $51,402,000; its Project Sherwood started with an original cost estimate of $30,000,000, and the actual cost was $57,004,000. An office building is not a very complicated structure in comparison with modern military aircraft and guided missiles. Standard grades of steel are used for beams, reinforcement rods, and mesh. A large number of suppliers stand ready to sell ready-mixed concrete, sheathing materials for the exterior, sash, flooring, roofing materials, and every other part of the structure. Yet we all know of office building after office building for commercial account in which substantial cost overruns were experienced. The same thing is true in the history of innumerable people who contracted for a house. They wind up paying substantially
more than they originally bargained for in the building of their home. These examples are cited simply to remind us that the phenomenon of cost overrun is not uniquely the province of either the Department of Defense or military goods. To be sure,.this will always be a fruitful area of study for both military and civilian parts of the economy. But let us not be carried away by the current list of horrible examples in the military and assume that this is the product of some evil conspiracy between the government and manufacturers of military goods. In the design, procurement, and production of future goods, errors will always be made, whether in the purchase of new space vehicles for government use, the introduction of new power plants by privately owned electric companies, or the purchase of new office buildings and homes by private individt~als. This has been the case since Roman times and can be expected to continue to be the situation in the foreseeable future.
When a corporation and the Defense Department enter into long and detailed negotiations regarding provisions in a cost-plus contract, the issue may violently stir the two protagonists without creating a ripple on the surface of public opinion. When, however, an issue like Taft-Hartley Bill involves three parties (business, unions, and government) the simple fact of triangulating the debate may precipitate a public stir. In short, elitism does exist in the United States, but it tends to shift in composition or in power potential at different levels of the system simply because the higher the position held by a given issue, the larger the number of claimants. Hence, a greater variety of forces begins to play on the contenders. In this interplay, the existence of a common economic goal can give a greater capacity for power to the economic elite than to the non-economic organizations that so often appear incapable of inspiring the sustained interests of their members. If economic unity is lacking as it was, for example, in the famous TFX controversy,.then the assumption of ascendancy for the economic interests, all other things being equal, appears to be questionable. - I v a r Berg, The Business o f America
BUSINESS HORIZONS