Wagner: The cost analysis muddle

I believe in benefit/cost analysis, and this may put me in the minority in Washington. I think of benefit/cost analysis as a tool for making better decisions. Too many people see it as a tool to justify things they already want to do. Let’s take a look at a simple case — the make-or-buy decision — to see why a good analytical framework would be helpful.

In a make-or-buy decision, people  compare the cost of doing something in-house with the cost of getting it from outside. The benefit is the money saved by going to the cheaper alternative. You can also use the monetary difference to evaluate whether other benefits are worth the additional cost.

Let’s take some examples. Recently, an inspector general criticized a federal agency for using the General Services Administration to manage its task orders under an indefinite-delivery, indefinite-quanity contract. The IG said the money paid to GSA for the work was wasted. This is a classic make-or-buy situation, so any wasted money would be the difference between the amount paid GSA to do the work and the cost of doing it in-house.

In this case, the agency’s evaluators estimated their internal acquisition costs to be zero when they compared the direct cost of salaried employees with the fully burdened rate of contractors.  However, such an analysis assumes that the government has no overhead. Having worked in government for 30 years, I can assure you that the government has overhead. It just  doesn’t measure it.

And that’s the problem: Whoever keeps the worst accounts wins. This is a recipe for stunning misallocation of federal resources. The much maligned A-76 process at least tries to estimate the loaded costs of the internal and external choices. Interestingly, Congress is starting to address the same question for interagency contracts. The current version of the Accountability in Government Contracting Act of 2007 includes a requirement to use fully burdened costs when comparing internal sourcing with interagency contracting.

Let’s not wait another decade for a governmentwide activity-based cost accounting system and rules for overhead allocation. Let’s start now by recognizing that not knowing what something costs
doesn’t make it free. At least, we need to estimate those unknown costs. We also need to recognize that being cheaper on paper may not mean we have the capacity to do the work. Lots of work is contracted out because agencies don’t have the ability to do it internally.

Finally, many of the most important issues in interagency contracting or outsourcing involve far more than simple cost comparisons. They involve strategic questions about core capabilities or the ability to manage a function. The benefits side is every bit as important as the cost side.

I prefer good decisions, so I am going to stick to my belief in the value of using good analysis to make decisions. I also don’t want to be embarrassed by someone pointing out that I can’t do arithmetic.

Wagner (marty.wagner@us.ibm.com) is a senior fellow at the IBM Center for the Business of Government. In 2007, he retired after more than 30 years in government, serving for a time as the acting commissioner of the General Services Administration’s Federal Acquisition Service.