Implementing Unit Costing: Efficiency in Translating Policy to Practice

Abstract

The Department of Defense (DoD) faces increasing pressure to improve efficiency, productivity and quality and to provide better cost data to support defense decision making. To accomplish this, DoD has introduced an internal pricing system referred to as unit costing. In particular, DoD centrally sets unit costs (prices) so that producers are expected to break-even each year. This paper analyzes the efficiency implications of DoD's unit costing system and finds the following results:

none	Unit costing won't maximize efficiency in using DoD's scarce resources because it bases decisions on average total rather than marginal cost.
none	Unit costs don't provide adequate incentives for managers to undertake cost reducing capital investments.
none	DoD can't use unit costs to make consolidation/closure decisions.
none	Unit costs may be unstable.
none	These types of problems should be expected with unit costing because it is a planned, centralized process designed to mimic autonomous, decentralized markets. While unit costing may improve efficiency over the status quo, a centralized process is unlikely to maximize efficiency.