Step 8 “Conduct Sensitivity Analysis” should be included in all cost estimates because it examines the effects of changing assumptions and ground rules. Since uncertainty cannot be avoided, it is necessary to identify the cost elements that represent the most risk and, if possible, cost estimators should quantify the risk. This can be done through both a sensitivity analysis and an uncertainty analysis.

**For more information see:** **GAO Cost Estimating and Assessment Guide – Chapter 13**

Sensitivity analysis helps decision makers choose the alternative. For example, it could allow a Program Managers (PM) to determine how sensitive a program is to changes in gasoline prices and at what gasoline price a program alternative is no longer attractive. By using information from a sensitivity analysis, a PM can take certain risk mitigation steps, such as assigning someone to monitor gasoline price changes, deploying more vehicles with smaller payloads, or decreasing the number of patrols.

Tasks that should be conducted for a sensitivity analysis: [1]

- Test the sensitivity of cost elements to changes in estimating input values and key assumptions;
- Identify effects on the overall estimate of changing the program schedule or quantities;
- Determine which assumptions are key cost drivers and which cost elements are affected most by changes

Sensitivity analysis involves recalculating the cost estimate with different quantitative values for selected input values, or parameters, in order to compare the results with the original estimate. If a small change in the value of a cost element’s parameter or assumption yields a large change in the overall cost estimate, the results are considered sensitive to that parameter or assumption. Therefore, a sensitivity analysis can provide helpful information for the system designer because it highlights elements that are cost sensitive. In this way, sensitivity analysis can be useful for identifying areas where more design research could result in less production cost or where increased performance could be implemented without substantially increasing cost. This type of analysis is typically called a what-if analysis and is often used for optimizing cost estimate parameters.

**Steps in Performing a Sensitivity Analysis**

A sensitivity analysis addresses some of the estimating uncertainty by testing discrete cases of assumptions and other factors that could change. By examining each assumption or factor independently, while holding all others constant, the cost estimator can evaluate the results to discover which assumptions or factors most influence the estimate. A sensitivity analysis also requires estimating the high and low uncertainty ranges for significant cost driver input factors. To determine what the key cost drivers are, a cost estimator needs to determine the percentage of total cost that each cost element represents. The major contributing variables within the highest percentage cost elements are the key cost drivers that should be varied in a sensitivity analysis. [1]

A credible sensitivity analysis typically has five (5) steps: [1]

- Identify key cost drivers, ground rules, and assumptions for sensitivity testing;
- Re-estimate the total cost by choosing one of these cost drivers to vary between two set amounts; for example, maximum and minimum or performance thresholds;
- Document the results;
- Repeat 2 and 3 until all factors identified in step 1 have been tested independently;
- Evaluate the results to determine which drivers affect the cost estimate most.

**AcqLinks and References:**

- Defense Acquisition Guidebook (DAG) – Chapter 3
- GAO Cost Estimating and Assessment Guide – Chapter 8
- NASA Cost Estimating Handbook – 2008
- DoD 5000.04-M, “DoD Cost Analysis Guidance and Procedures” – Dec 1992
- DoD Directive 5000.04 “DoD Cost Analysis Improvement Group (CAIG)” – 16 Aug 06
- 10 USC Sec. 2434 “Independent cost estimates; operational manpower requirements”
- Website: CAIG Operating and Support Cost-Estimating Guide
- Website: OSD Director of Cost Assessment and Program Evaluation (DCAPE)

Updated: 7/29/2017