Raymond Franck

Applying Insights from Transaction Cost Economics to Improve Cost Estimates for Public Sector Purchases: The Case of U.S. Military Acquisition

ABSTRACT This article uses Transaction Cost Economics (TCE) to help characterize, explain, and ultimately reduce the cost growth that plagues many of todays major investments in military capabilities. There is mounting evidence of a systematic bias in initial cost estimates of new weapon systems purchased by the U.S. military. Unrealistically low cost estimates result in cost overruns. Fixing cost overruns can substantially impact public budgets and military readiness. Cost estimates serve a dual function: first, as an integral part of the decision-making process to evaluate military purchases/investments, and second, as a baseline for future defense budgets. In the first case, underestimating costs can result in too many new weapon program starts and excessive investments in those systems. In the second case, unrealistically low cost estimates result in overly optimistic budgets. Budgets planned on the basis of optimistic cost estimates create the illusion of more resources available than actually exist. Two factors are often blamed for unrealistically low cost estimates: bad incentives (psychological and political-economic explanations), and bad forecasts (methodological explanations). While briefly exploring the former, the focus of this study is on cost estimating methodology. Conventional public cost estimating techniques focus on the production costs of public purchases (input costs, learning curves, economies of scale and scope, etc.). The goal of this article is to improve cost estimates by expanding conventional cost estimating methodology to include TCE considerations. The primary insight of TCE is that correctly forecasting economic production costs of government purchases or acquisitions is necessary, but not sufficient. TCE emphasizes another set of costs—coordination and motivation costs (search and information costs; decision, contracting, and incentive costs; measurement, monitoring, and enforcement costs, etc.). This study encourages public officials and cost analysts to capture these costs and to understand key characteristics of public-private transactions (uncertainty, complexity, frequency, asset specificity, and market contestability) to generate more complete and reliable cost estimates and improve public sector purchases.

Defense Acquisition: New Insights from Transaction Cost Economics∗

* We are grateful to the editors of this journal, participants at the RAND sessions of theWestern Economic Association meetings, and colleagues at the Naval Postgraduate School for many helpful comments and suggestions.We would specifically like to thank our colleagues Dr Keith Snyder, John Dillard and Admiral James Greene of the Graduate School of Business and Public Policy for research sponsorship and for organizing a yearly Acquisition Research Symposium where we were invited to present this work. The usual disclaimers apply.

Exploring the structure of terrorists' WMD decisions: A game theory approach

One relatively recent, and especially ominous, development in global terrorism is the threat of weapons of mass destruction (WMD) unleashed against target populations. While terrorist groups have long known about WMD, in 1995 the Japanese group Aum Shinrikyo first used chemical weapons in an attack. Since then, there appears to have been a disturbing trend towards fewer but more deadly terrorist incidents. The growing consensus among experts in the field is that this could well represent a long-term change in the nature of terrorist methods and behavior. This paper explores the structure of the WMD decision by terrorist organizations. The working hypothesis is that understanding the attractiveness of WMD depends on two key factors: the type of terrorist organization (“political” or “fanatic”), and the relative cost and benefits of their obtaining and using WMD. The cost partly depends on the “macrotechnology of conflict”, or the characteristics of counter-measures adopted by potential terrorist targets (“defensive” or “disruptive”). An assessment of the benefits by a terrorist organization contemplating WMD is likely to include both how effective WMD is in attacking a target, and how impressive the results would be in terms of influencing an audience. A key to solving the mystery surrounding a terrorist group’s decision to adopt WMD is to understand the strategic interaction between terrorists, their targets and their audience. The terrorists’ decision to use WMD is explored using simple game theory tools. Sandler and Arce, among others, point out that highlighting the interaction between terrorists and their opponents is one of the major strengths of game theoretic methods. Defense & Security Analysis Vol. 20, No. 4, pp. 355–372, December 2004

Disruptive military innovation and the War on Terror: Some thoughts for perfect opponents

(2006). Disruptive military innovation and the War on Terror: Some thoughts for perfect opponents. Defense & Security Analysis: Vol. 22, No. 2, pp. 123-140.

Innovation and the Technology of Conflict During the Napoleonic Revolution in Military Affairs

This essay is intended as a modest response to Prof. Hirshleifers call for research in the “macrotechnology” of conflict. It specifically considers innovations undertaken by the Prussian and British Armies in response to the problems posed by the Napoleonic Revolution in Military Affairs (RMA) and the resulting ascendancy of the French Army. For various reasons, the Prussians chose an “emulating” response to the French; the British chose “offsetting.” The discussion following considers the Napoleonic innovations and the two responses, both of which proved effective. As a result, there is support for the view that military innovation is, to a significant extent, a military choice made from a menu of military measures within the context of military-political competition.

Industry perspectives on Plug-&-Play Spacecraft Avionics

This paper describes the methodologies and findings from an industry survey of awareness and utility of Spacecraft Plug-&-Play Avionics (SPA). The survey was conducted via interviews, in-person and teleconference, with spacecraft prime contractors and suppliers. It focuses primarily on AFRLs SPA technology development activities but also explores the broader applicability and utility of Plug-&-Play (PnP) architectures for spacecraft. Interviews include large and small suppliers as well as large and small spacecraft prime contractors. Through these “product marketing” interviews, awareness and attitudes can be assessed, key technical and market barriers can be identified, and opportunities for improvement can be uncovered. Although this effort focuses on a high-level assessment, similar processes can be used to develop business cases and economic models which may be necessary to support investment decisions.