Analysis of pricing models in the defense industry to support cost projections
Lin, Kyle Y.
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The government runs a program to develop a technologically advanced weapon system. In the competition phase, the government provides initial funding to several defense contractors to develop system prototypes. Based on the demonstration of these prototypes, the government selects one defense contractor as the sole source to produce the final product. We develop a mathematical model to describe this process. By analyzing the model and conducting a numerical study, we find three main reasons why such a program often suffers delay and cost overrun. First, the selected contractor tends to be luckier than usual in the competition phase, so the government tends to overestimate its capability. Second, once a contractor becomes the sole source, their goal is to complete the scheduled tasks within each fiscal year on time, but not to deliver the final product as soon as possible. Third, the contractor may be motivated to exert extra effort during the competition phase in order to improve their chance of getting selected as the sole source, which may result in an overly optimistic estimation on program completion time. Based on a cost structure, our model offers recommendations on the optimal length of the competition phase and the number of contractors to invite, in order to minimize the program completion time and total cost.
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NPS Report NumberNPS-OR-16-002
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