Defense Acquisitions
DOD Has Paid Billions in Award and Incentive Fees Regardless of Acquisition Outcomes Gao ID: GAO-06-66 December 19, 2005Collectively, the Department of Defense (DOD) gives its contractors the opportunity to earn billions of dollars through monetary incentives--known as award fees and incentive fees. These fees are intended to motivate excellent contractor performance in areas deemed critical to an acquisition program's success, with award fees being appropriate when contracting and program officials cannot devise objective incentive fee targets related to cost, technical performance, or schedule. GAO was asked to determine whether award and incentive fees have been used effectively as a tool for achieving DOD's desired acquisition outcomes. To do this, GAO selected a probability sample of 93 contracts from the study population of 597 DOD award- and incentive-fee contracts that were active and had at least one contract action valued at $10 million or more from fiscal year 1999 through 2003.
The power of monetary incentives to motivate excellent contractor performance and improve acquisition outcomes is diluted by the way DOD structures and implements incentives. While there were two examples in our sample in which the Missile Defense Agency attempted to link award fees directly to desired acquisition outcomes, such as demonstrating a capability within an established schedule, award fees are generally not linked to acquisition outcomes. As a result, DOD has paid out an estimated $8 billion in award fees to date on the contracts in our study population, regardless of outcomes. The following selected programs show this disconnect. When DOD programs did not pay all of the available award fee, DOD gave contractors on an estimated 52 percent of award-fee contracts at least a second opportunity to earn an estimated $669 million in initially unearned or deferred fees. GAO believes these practices, along with paying significant amounts of fee for "acceptable, average, expected, good, or satisfactory" performance, undermine the effectiveness of fees as a motivational tool and marginalize their use in holding contractors accountable for acquisition outcomes. They also serve to waste taxpayer funds. Incentive fees provide a clearer link to acquisition outcomes; however, a majority of the 27 contracts with cost incentives that GAO reviewed failed or are projected to fail to complete the acquisition at or below the target price. Despite paying billions in fees, DOD has little evidence to support its belief that these fees improve contractor performance and acquisition outcomes. The department has not compiled data, conducted analyses, or developed performance measures to evaluate the effectiveness of award and incentive fees. In addition, when contracts have utilized different fee strategies to focus the contractor's attention on specific acquisition outcomes, contracting officials have stated that DOD has few mechanisms to share lessons learned and innovative practices outside the local level.
RecommendationsOur recommendations from this work are listed below with a Contact for more information. Status will change from "In process" to "Open," "Closed - implemented," or "Closed - not implemented" based on our follow up work.
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Report to the Subcommittee on Readiness and Management Support,
Committee on Armed Services, U.S. Senate:
United States Government Accountability Office:
GAO:
December 2005:
Defense Acquisitions:
DOD Has Paid Billions in Award and Incentive Fees Regardless of
Acquisition Outcomes:
GAO-06-66:
GAO Highlights:
Highlights of GAO-06-66, a report to the Subcommittee on Readiness and
Management Support, Committee on Armed Services, U.S. Senate:
Why GAO Did This Study:
Collectively, the Department of Defense (DOD) gives its contractors the
opportunity to earn billions of dollars through monetary
incentives”known as award fees and incentive fees. These fees are
intended to motivate excellent contractor performance in areas deemed
critical to an acquisition program‘s success, with award fees being
appropriate when contracting and program officials cannot devise
objective incentive fee targets related to cost, technical performance,
or schedule.
GAO was asked to determine whether award and incentive fees have been
used effectively as a tool for achieving DOD‘s desired acquisition
outcomes. To do this, GAO selected a probability sample of 93 contracts
from the study population of 597 DOD award- and incentive-fee contracts
that were active and had at least one contract action valued at $10
million or more from fiscal year 1999 through 2003.
What GAO Found:
The power of monetary incentives to motivate excellent contractor
performance and improve acquisition outcomes is diluted by the way DOD
structures and implements incentives. While there were two examples in
our sample in which the Missile Defense Agency attempted to link award
fees directly to desired acquisition outcomes, such as demonstrating a
capability within an established schedule, award fees are generally not
linked to acquisition outcomes. As a result, DOD has paid out an
estimated $8 billion in award fees to date on the contracts in our
study population, regardless of outcomes. The following selected
programs show this disconnect.
Program Performance and Award-Fee Payments on Selected DOD Development
Programs:
[See Table 6]
Sources: DOD submissions to GAO, contract documentation, and GAO-05-301
(data); GAO (analysis).
[A] When calculating the percentage of award fee paid (i.e., percentage
of award fee paid = total fee paid to date/(total fee pool – remaining
fee pool)), we included rolled-over fees in the remaining fee pool when
those fees were still available to be earned in future evaluation
periods.
[End of table]
When DOD programs did not pay all of the available award fee, DOD gave
contractors on an estimated 52 percent of award-fee contracts at least
a second opportunity to earn an estimated $669 million in initially
unearned or deferred fees. GAO believes these practices, along with
paying significant amounts of fee for ’acceptable, average, expected,
good, or satisfactory“ performance, undermine the effectiveness of fees
as a motivational tool and marginalize their use in holding contractors
accountable for acquisition outcomes. They also serve to waste taxpayer
funds. Incentive fees provide a clearer link to acquisition outcomes;
however, a majority of the 27 contracts with cost incentives that GAO
reviewed failed or are projected to fail to complete the acquisition at
or below the target price.
Despite paying billions in fees, DOD has little evidence to support its
belief that these fees improve contractor performance and acquisition
outcomes. The department has not compiled data, conducted analyses, or
developed performance measures to evaluate the effectiveness of award
and incentive fees. In addition, when contracts have utilized different
fee strategies to focus the contractor‘s attention on specific
acquisition outcomes, contracting officials have stated that DOD has
few mechanisms to share lessons learned and innovative practices
outside the local level.
What GAO Recommends:
GAO recommends that DOD improve its use of fees by specifically tying
them to acquisition outcomes in all new award- and incentive-fee
contracts, maximizing contractors‘ motivation to perform, and
collecting data to evaluate the effectiveness of fees. In its comments
on a draft of this report, DOD concurred or partially concurred with
all of the recommendations.
www.gao.gov/cgi-bin/getrpt?GAO-06-66.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Ann Calvaresi-Barr, (202)
512-4841, calvaresibarra@gao.gov.
[End of section]
Contents:
Letter:
Results in Brief:
Background:
Award and Incentive Fees Are Not an Effective Tool for Achieving DOD's
Desired Acquisition Outcomes:
DOD Has Little Evidence That Monetary Incentives Improve Results as
Intended:
Conclusions:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Scope and Methodology:
Appendix II: Comments from the Department of Defense:
Appendix III: Contracting Definitions:
Appendix IV: Sample Characteristics:
Appendix V: GAO Reports on the Weapon Systems Acquisition Environment:
Tables:
Table 1: General Process for Determining Award-Fee Amounts:
Table 2: General Process for Determining Incentive-Fee Amounts:
Table 3: Products and Services, Dollars Obligated, and Contract Types
in GAO's Sample, Fiscal Years 1999-2003:
Table 4: Award Fees as a Percentage of Contract Value:
Table 5: Base Fees as a Percentage of Contract Value:
Table 6: Program Performance and Award-Fee Payments on Selected DOD
Development Programs:
Figures:
Figure 1: Prevalence of Award-and Incentive-Fee Contracts, Fiscal Years
1999-2003:
Figure 2: Weaknesses in DOD's Use of Award and Incentive Fees:
Figure 3: Percentage of Available Award Fee Paid to Date for 63 Award-
Fee Contracts in GAO's Sample:
Figure 4: Percentage of Available Award Fee Earned for 572 Evaluation
Periods in GAO's Sample:
Figure 5: DOD's Use of Rollover on 32 Contracts in GAO's Sample:
Figure 6: Maximum Percentage of Award Fee Available for "Acceptable,
Average, Expected, Good, or Satisfactory" Performance and the Estimated
Percentage of DOD Contracts That Paid These Percentages:
Abbreviations:
DOD: Department of Defense:
FAR: Federal Acquisition Regulation:
United States Government Accountability Office:
Washington, DC 20548:
December 19, 2005:
The Honorable John Ensign:
Chairman:
The Honorable Daniel K. Akaka:
Ranking Minority Member:
Subcommittee on Readiness and Management Support:
Committee on Armed Services:
United States Senate:
The Department of Defense (DOD) contracts with various companies,
institutions, and organizations to provide products and services that
include everything from spare parts for aircraft to ship maintenance to
the development of major weapon systems. With federal discretionary
spending, including defense spending, facing serious budget pressures
in the coming years, fiscal realities demand that DOD maximize its
return on investment for these acquisitions. Each of these acquisitions
poses unique risks and challenges for DOD and its contractors. In an
effort to encourage defense contractors to perform in an innovative,
efficient, and effective way in areas deemed important to an
acquisition's success, DOD gives its contractors the opportunity to
collectively earn billions of dollars through monetary incentives known
as award fees and incentive fees. Award fees and incentive fees can be
used alone or together in contracts, with award fees being appropriate
when contracting and program officials cannot devise predetermined
objective incentive-fee targets applicable to cost, technical
performance, or schedule.
Award and incentive fees operate in an environment where actions taken
by both DOD and the contractor contribute to acquisition outcomes.
Prior GAO work has shown how fundamental acquisition problems within
DOD, especially a lack of key product knowledge at critical junctures,
have contributed to such issues as cost increases, schedule delays, and
performance shortfalls in weapons programs. See appendix V for a list
of GAO reports on weapon systems acquisition. These overarching
problems, along with the selection of an unqualified supplier or
inadequate funding, among other reasons, can negatively affect
acquisition outcomes.
In this context, DOD has looked to monetary incentives as one of the
ways it can promote its desired acquisition outcomes. However, senior
DOD and service acquisition officials have raised concerns about how
effectively these fees are being used because DOD programs have paid
contractors large amounts of fee on acquisitions that are falling
behind schedule, overrunning costs, and experiencing significant
technical problems. Because of these concerns, you requested that we
determine whether award fees and incentive fees have been used
effectively as a management tool for achieving DOD's desired
acquisition outcomes.
To address this objective, we selected a probability sample of 93
contracts from the study population of 597 DOD award-fee and incentive-
fee contracts that were active between fiscal years 1999 and 2003 and
had at least one contract action coded as cost-plus-award-fee, cost-
plus-incentive-fee, fixed-price-award-fee, or fixed-price incentive
valued at $10 million or more during that time. Unless otherwise noted,
the estimates in this report pertain to (1) this population of award-
and incentive-fee contracts, (2) the subpopulation of award-fee
contracts, or (3) the evaluation periods associated with contracts
described in (1) or (2) that had been completed at the time of our
review. Estimates of total award fees earned and total award fees that
contractors received at least two chances to earn are based on all
evaluation periods held from the inception of our sample contracts
through our data collection phase, not just those from fiscal years
1999 through 2003. Because the estimates in this report are derived
from a probability sample, they are subject to sampling error. All
percentage estimates from our review have margins of error not
exceeding plus or minus 10 percentage points unless otherwise noted.
All numerical estimates other than percentages (such as totals and
ratios) have margins of error not exceeding plus or minus 25 percent of
the value of those estimates. See appendix I for more details about the
probability sample and associated sampling error. Fifty-two contracts
in our sample contained only award-fee provisions; 27 contracts
contained only incentive-fee provisions; and 14 included both award-and
incentive-fee provisions. The types of products or services associated
with contracts in our sample include research and development projects,
aircraft and aircraft-related procurements, ship construction, and non-
research-and-development services, among others. For each of the 93
contracts in our sample, we interviewed contracting and program
officials about the development, implementation, and effectiveness of
the award-and incentive-fee structures using a standard questionnaire
and analyzed their responses. We also reviewed contract documentation
related to these areas and examined fee payments in the context of
program performance. Program performance was assessed using GAO's body
of work on DOD weapon systems acquisitions.[Footnote 1] Finally, we
interviewed acquisition policy officials and consulted recent policy
initiatives, reports, and audits related to DOD's use of award and
incentive fees. See appendix I for additional details on scope and
methodology. We performed our review from February 2004 to November
2005 in accordance with generally accepted government auditing
standards.
Results in Brief:
Award fees have generally not been effective at helping DOD achieve its
desired acquisition outcomes. DOD programs engage in practices that
undermine efforts to motivate contractor performance and that do not
hold contractors accountable for achieving desired acquisition
outcomes, such as meeting cost and schedule goals and delivering
desired capabilities. DOD programs frequently pay most of the available
award fee for what they describe as improved contractor performance,
regardless of whether acquisition outcomes fell far short of DOD's
expectations, were satisfactory, or exceeded expectations. Based on our
sample, we estimate that for the study population of DOD contracts, the
median percentage of available award fee paid to date (adjusted for
fees that were deferred) was 90 percent, representing an estimated $8
billion in award fees. DOD programs also provided about half of its
contractors multiple opportunities to earn fees that the contractors
did not earn when the fees were first made available. Based on our
sample, we estimate that, to date, contractors for DOD contracts in our
study population received at least two chances to earn $669 million in
fees that were not initially earned or deferred. In addition, DOD
programs regularly paid contractors a significant portion of the
available fee for what award-fee plans describe as "acceptable,
average, expected, good, or satisfactory" performance when federal
acquisition regulations and military service guidance state that the
purpose of these fees is to motivate excellent performance. These
practices reduce the effectiveness of award fees as motivators of
performance and compromise the integrity of the fee process. DOD does
not define contractor performance in terms of acquisition outcomes.
Rather than focusing on acquisition outcomes, such as delivering a
fielded capability within established cost and schedule baselines, DOD
often places emphasis on such things as the responsiveness of
contractor management to feedback from DOD officials, quality of
contractor proposals, or timeliness of contract data requirements. Some
programs, most notably the Missile Defense Agency's Airborne Laser
program, have structured fees to focus on acquisition outcomes, such as
successfully demonstrating the system, which can help ensure that fee
payments are more representative of program results. Incentive-fee
contracts link contractor performance to acquisition outcomes more
explicitly; however, about half of the 27 incentive-fee contracts that
we reviewed failed or are projected to fail to meet a key measure of
program success--completing the acquisition at or below the target
price. In the one case in which significant savings were realized
through the successful use of an incentive fee, program officials were
able to leverage the knowledge gained about program costs on a previous
contract. However, when contracts have identified seemingly effective
award-and incentive-fee strategies, contracting officials have stated
that DOD has few mechanisms to share lessons learned and innovative
practices outside the local level.
The effectiveness of award and incentive fees as a management tool has
also been limited by DOD's failure to examine the basis for their use,
assess how well they are working, and account for various factors that
arise in the complex acquisition environment. Although DOD has paid
billions in fees over time, the department has little evidence to
support its contention that the use of award and incentive fees results
in the intended effect on contractor performance and acquisition
outcomes. While DOD officials have told us that they believe these fees
improve contractor performance and program outcomes, DOD has not
conducted overall evaluations or compiled data on the effectiveness of
award and incentive fees. In addition, DOD has not developed
performance measures to evaluate whether contracts utilizing these fees
actually produce better outcomes than other contract types. Research on
incentive fees by GAO, Harvard University, and the RAND Corporation
going back decades has concluded that these types of fees do not
consistently motivate contractors to control cost. Other research by
Air Force personnel has shown that award fees are not always
implemented in a way that is consistent with the intent of improving
contractor performance.
To strengthen the link between monetary incentives and acquisition
outcomes and by extension increase the accountability of DOD programs
for fees paid and of contractors for results achieved, we recommend
that the Secretary of Defense direct the Undersecretary of Defense for
Acquisition, Technology, and Logistics to take the following seven
actions. DOD can immediately improve its use of award fees on all new
contracts by (1) instructing the military services to move toward more
outcome-based award-fee criteria that are both achievable and promote
accountability for acquisition outcomes; (2) ensuring that award-fee
structures are motivating excellent contractor performance by only
paying award fees for above satisfactory performance; and (3) requiring
the appropriate approving officials to review new contracts to make
sure these actions are being taken. DOD can improve its use of award
fees on all existing contracts by (4) issuing DOD guidance on when
rollover is appropriate. In the longer term, DOD can improve its use of
award and incentive fees by (5) developing a mechanism for capturing
award-and incentive-fee data within existing data systems, such as the
Defense Acquisition Management Information Retrieval system; (6)
developing performance measures to evaluate the effectiveness of award
and incentive fees as a tool for improving contractor performance and
achieving desired program outcomes; and (7) developing a mechanism to
share proven incentive strategies for the acquisition of different
types of products and services with contracting and program officials
across DOD.
DOD's Office of Defense Procurement and Acquisition Policy provided
written comments on a draft of this report. In its comments, DOD
concurred with three of our seven recommendations--moving toward more
outcome-based award-fee criteria, issuing guidance on rollover, and
developing a mechanism to share proven incentive strategies--and agreed
to address them in a policy memorandum and communications plan that it
indicated will be issued on March 31, 2006. DOD partially concurred
with four of our recommendations--only paying award fees for above
satisfactory performance, requiring the appropriate officials to make
sure these recommendations are implemented in new contracts, collecting
award-and incentive-fee data, and developing performance measures to
evaluate the effectiveness of award and incentive fees in improving
acquisition outcomes. Concerning our recommendation related to the
payment of award fees for satisfactory performance, DOD stated that it
was both fair and reasonable to pay a portion of the award fee for this
level of performance, but agreed that the preponderance of fee should
be paid for excellent performance and that it would reinforce existing
policies in its March memorandum. We continue to believe that award
fees should be primarily reserved for above satisfactory performance,
which as pointed out in this report is not the current practice for
most contracts. On the remaining three recommendations, DOD indicated
that it would conduct a study to determine the appropriate actions to
address these recommendations. DOD plans to complete the study by June
1, 2006. While this study may provide additional insights, we encourage
DOD to use it as a mechanism for identifying the specific steps the
department will take to fully address our recommendations, not to
determine whether the department will take action. Between fiscal years
1999 through 2003, the department obligated $157 billion through award-
and incentive-fee contracts and used these contracts on some of its
largest weapons programs. Given the dollars involved, DOD needs to
collect data and develop performance measures on the use of award and
incentive fees to help it effectively manage these contracts and assure
its resources are well-spent. DOD's comments are reprinted in their
entirety in appendix II of this report.
Background:
Federal agencies, including DOD, can choose among numerous contract
types to acquire products and services. One of the characteristics that
varies across contract types is the amount and nature of the fee that
agencies offer to the contractor for achieving or exceeding specified
objectives or goals. Of all the contract types available, only award-
and incentive-fee contracts allow an agency to adjust the amount of fee
paid to contractors based on the contractor's performance.[Footnote 2]
Typically, award-fee contracts emphasize multiple aspects of contractor
performance in a wide variety of areas, such as quality, timeliness,
technical ingenuity, and cost-effective management. Incentive-fee
contracts usually focus on cost control, although they can also be used
to motivate contractors to achieve specific delivery targets or
performance goals in areas such as missile range, aircraft speed,
engine thrust, or vehicle maneuverability.
Regardless of differences between award-and incentive-fee contracts,
federal acquisition regulations state that these contracts should be
used to achieve specific acquisition objectives, such as delivering
products and services on time or within cost goals and with the
promised capabilities. For award-fee contracts, the assumption
underlying the regulation is that the likelihood of meeting these
acquisition objectives will be enhanced by using a contract that
effectively motivates the contractor toward exceptional performance.
The reason or basis for selecting an award-or incentive-fee contract
can vary, depending on the type of work a contractor is expected to
perform. The acquisition environment, including the knowledge DOD has
prior to starting an acquisition program, the adequacy of resources,
and the soundness of acquisition practices, can also be a critical
factor that affects how well contractor performance translates into
acquisition outcomes.
Award-Fee Contracts:
The development and administration of award-fee contracts involve
substantially more effort over the life of a contract than incentive-
fee contracts.[Footnote 3] For award-fee contracts, DOD personnel
(usually members of an award-fee evaluation board[Footnote 4]) conduct
periodic--typically semiannual--evaluations of the contractor's
performance against specified criteria in an award-fee plan and
recommend the amount of fee to be paid.[Footnote 5] Because award fees
are intended to motivate contractor performance in areas that are
susceptible to judgmental and qualitative measurement and evaluation
(e.g., technical, logistics support, cost, and schedule), these
criteria and evaluations tend to be subjective.[Footnote 6] After
receiving the recommendation of the award-fee evaluation board, a fee-
determining official[Footnote 7] makes the final decision about the
amount of fee the contractor will receive. The fee-determining official
can also decide to move unearned award fee from one evaluation period
to a subsequent evaluation period or periods, thus providing the
contractor an additional opportunity to earn previously unearned fee--
a practice called rollover. Table 1 provides a general look at the
process for evaluating and determining award fee amounts.
Table 1: General Process for Determining Award-Fee Amounts:
1; DOD officials provide input on the contractor's performance for an
evaluation period that just ended.
2;
Program officials compile data and prepare a briefing or summary for
the award-fee evaluation board.
3; Award-fee evaluation board convenes meeting; contractor has the
option to submit a self-assessment and brief the board.
4; Award-fee evaluation board considers all the input and recommends a
fee rating for the contractor.
5; Fee-determining official (usually outside the program) makes an
initial fee determination and notifies the contracting officer.
6; Contracting officer notifies contractor of initial determination;
contractor has the option to appeal the decision to the fee-determining
official.
7; Fee-determining official makes a final determination, including
whether to rollover unearned fee, and notifies contracting officer.
8; Contracting officer issues final determination to contractor and
processes a contract modification authorizing payment.
Sources: Air Force Award Fee Guide, Army Contracting Agency Award Fee
Handbook, Navy/Marine Corp Award Fee Guide (data); GAO (analysis).
[End of table]
Incentive-Fee Contracts:
Incentive-fee contracts use what is considered to be an objective
evaluation of the contractor's performance to adjust the fee paid.
DOD's evaluation usually involves the application of a fee-
determination formula that is specified in the contract. Evaluations
occur at the end of the contract or, in the case of a performance or
delivery incentive, at program milestones. The evaluations do not
require an extensive evaluation process or the participation of a large
number of contracting or program personnel. Table 2 provides a general
look at the process for evaluating and determining the amount of
incentive fee paid for a contract with a cost incentive.
Table 2: General Process for Determining Incentive-Fee Amounts:
1; At the conclusion of the contract, DOD contracting officer compares
the contractor's actual cost to complete the contract with the target
cost specified in the contract.
2;
a. If contractor's actual cost matches the target cost, DOD awards the
contractor an amount called the target fee or target profit[A];
b. If contractor's actual cost falls below the target cost, the
contracting officer applies a formula with a share ratio that specifies
how much the contractor's target fee or profit is increased for every
dollar the actual cost is below the target cost;
c. If contractor's actual cost exceeds the target cost, the contracting
officer applies a formula with a share ratio that specifies how much
the contractor's target fee or profit is reduced for every dollar the
actual cost is above the target cost.
3; Contracting officer processes a contract modification authorizing
payment.
Sources: Federal Acquisition Regulation, DOD Contract Pricing Guide
(data); GAO (analysis).
[A] In federal contracting, the terms "profit" and "fee" refer to the
amount of money paid to the contractor above and beyond either a fixed
price or a contractor's reimbursable costs. The term "profit" is
associated with fixed-price contracts, and the term "fee" is associated
with cost-reimbursable contracts.
[End of table]
Contracts Discussed in This Report:
For this report, we examined fixed-price and cost-reimbursable award-
and incentive-fee contracts, as well as contracts that combined aspects
of both of these contract types. (See app. III for an explanation of
various contract types.) Our probability sample of 93 contracts was
drawn from a total of 597 DOD award-and incentive-fee contracts that
were active from fiscal years 1999 through 2003 and had at least one
contract action coded as cost-plus-award-fee, cost-plus-incentive-fee,
fixed-price award-fee, or fixed-price-incentive valued at $10 million
or more during that time. Among the sample, 52 contracts contained only
award-fee provisions, 27 contracts contained only incentive-fee
provisions, and 14 contracts included both. (App. I contains additional
information on our scope and methodology.)
From fiscal year 1999 through fiscal year 2003, award-and incentive-fee
contract actions[Footnote 8] accounted for 4.6 percent of all DOD
contract actions over $25,000. However, when taking into account the
dollars obligated--award-and incentive-fee contract actions accounted
for 20.6 percent of the dollars obligated on actions over $25,000, or
over $157 billion, as shown in figure 1.[Footnote 9] Our sample of 93
contracts includes $51.6 billion, or almost one-third, of those
obligated award-and incentive-fee contract dollars.
Figure 1: Prevalence of Award-and Incentive-Fee Contracts, Fiscal Years
1999-2003:
[See PDF for image]
[End of figure]
DOD utilized the contracts in our sample for a number of purposes. For
example, research and development contracts accounted for 51 percent
(or $26.4 billion) of the dollars obligated against contracts in our
sample from fiscal years 1999 through 2003, while non-research-and-
development services accounted for the highest number of contracts in
our sample.
Table 3 shows the dollars obligated and the types of contracts by
product and service. Appendix IV contains a breakdown of the contracts
in our sample by contract type and military service.
Table 3: Products and Services, Dollars Obligated, and Contract Types
in GAO's Sample, Fiscal Years 1999-2003:
Product or service: Research and development;
Number of contracts according to product or service: 32;
Total dollars in GAO's sample (in billions): $26.4;
Percentage of dollars in GAO's sample: 51.2%;
Number of contracts with award fees and no incentive fees: 20;
Number of contracts with incentive fees and no award fees: 7;
Number of contracts with both award and incentive fees: 5.
Product or service: Aircraft and aircraft-related procurement;
Number of contracts according to product or service: 7;
Total dollars in GAO's sample (in billions): $8.5;
Percentage of dollars in GAO's sample: 16.5%;
Number of contracts with award fees and no incentive fees: 2;
Number of contracts with incentive fees and no award fees: 5;
Number of contracts with both award and incentive fees: 0.
Product or service: Ship construction;
Number of contracts according to product or service: 6;
Total dollars in GAO's sample (in billions): $8.3;
Percentage of dollars in GAO's sample: 16.0%;
Number of contracts with award fees and no incentive fees: 0;
Number of contracts with incentive fees and no award fees: 2;
Number of contracts with both award and incentive fees: 4.
Product or service: Non-research-and-development services;
Number of contracts according to product or service: 36;
Total dollars in GAO's sample (in billions): $6.0;
Percentage of dollars in GAO's sample: 11.6%;
Number of contracts with award fees and no incentive fees: 23;
Number of contracts with incentive fees and no award fees: 9;
Number of contracts with both award and incentive fees: 4.
Product or service: Other;
Number of contracts according to product or service: 12;
Total dollars in GAO's sample (in billions): $2.4;
Percentage of dollars in GAO's sample: 4.7%;
Number of contracts with award fees and no incentive fees: 7;
Number of contracts with incentive fees and no award fees: 4;
Number of contracts with both award and incentive fees: 1.
Product or service: Total;
Number of contracts according to product or service: 93;
Total dollars in GAO's sample (in billions): $51.6;
Percentage of dollars in GAO's sample: 100%%;
Number of contracts with award fees and no incentive fees: 52;
Number of contracts with incentive fees and no award fees: 27;
Number of contracts with both award and incentive fees: 14.
Sources: Federal Procurement Data System (data); GAO (analysis).
Note: The sample cases include 12 contracts that were selected with
certainty: 7 for research and development, 3 for ship construction, 1
for aircraft procurement, and 1 for non-research-and-development
services. Seven of the contracts selected with certainty had award-fee
provisions, 2 had incentive-fee provisions, and 3 contained both award-
and incentive-fee provisions.
[End of table]
DOD has the flexibility to mix and match characteristics from different
contract types. The risks for both DOD and the contractor vary
depending on the exact combination chosen, which, according to the
Federal Acquisition Regulation, should reflect the uncertainties
involved in contract performance. Based on the results from our sample,
about half of the contracts in our study population were cost-plus-
award-fee contracts. The theory behind these contracts is that although
the government assumes most of the cost risk, it retains control over
most or all of the contractor's potential fee as leverage. On cost-
plus-award-fee contracts, the award fee is often the only source of
potential fee for the contractor. According to defense acquisition
regulations, these contracts can include a base fee--a fixed fee for
performance paid to the contractor--of anywhere from 0 to 3 percent of
the value of the contract; however, based on our sample results, we
estimate that about 60 percent of the cost-plus-award-fee contracts in
our study population included zero base fee.[Footnote 10] Tables 4 and
5 show the estimated percentage of DOD award-fee contracts that had a
particular percentage of the value of the contract available in award
fees and base fees.
Table 4: Award Fees as a Percentage of Contract Value:
Percentage of value of contract available in award fees: 1 percent;
Estimated percentage of award fee contracts with this percentage
available: 0.
Percentage of value of contract available in award fees: 2 percent;
Estimated percentage of award fee contracts with this percentage
available: 4.
Percentage of value of contract available in award fees: 3 percent;
Estimated percentage of award fee contracts with this percentage
available: 10.
Percentage of value of contract available in award fees: 4 percent;
Estimated percentage of award fee contracts with this percentage
available: 2.
Percentage of value of contract available in award fees: 5 percent;
Estimated percentage of award fee contracts with this percentage
available: 4.
Percentage of value of contract available in award fees: 6 percent;
Estimated percentage of award fee contracts with this percentage
available: 4.
Percentage of value of contract available in award fees: 7 percent;
Estimated percentage of award fee contracts with this percentage
available: 23.
Percentage of value of contract available in award fees: 8 percent;
Estimated percentage of award fee contracts with this percentage
available: 4.
Percentage of value of contract available in award fees: 9 percent;
Estimated percentage of award fee contracts with this percentage
available: 6.
Percentage of value of contract available in award fees: 10 percent;
Estimated percentage of award fee contracts with this percentage
available: 15.
Percentage of value of contract available in award fees: 11 percent;
Estimated percentage of award fee contracts with this percentage
available: 4.
Percentage of value of contract available in award fees: 12 percent;
Estimated percentage of award fee contracts with this percentage
available: 7.
Percentage of value of contract available in award fees: 13 percent;
Estimated percentage of award fee contracts with this percentage
available: 4.
Percentage of value of contract available in award fees: 14 percent;
Estimated percentage of award fee contracts with this percentage
available: 0.
Percentage of value of contract available in award fees: 15 percent;
Estimated percentage of award fee contracts with this percentage
available: 14.
Percentage of value of contract available in award fees: 20 percent;
Estimated percentage of award fee contracts with this percentage
available: Less than 1.
Sources: DOD submissions to GAO and contract documentation (data); GAO
(analysis).
Notes: While there is no limit on the maximum percentage of the value
of the contract that can be made available in award fee, the 20 percent
included in the Space-Based Infrared System High development contract
was outside the norm. Percentages do not add to 100 due to rounding.
Sampling errors for percentages in this table do not exceed plus or
minus 12 percentage points.
[End of table]
Table 5: Base Fees as a Percentage of Contract Value:
Percentage of value of contract available in base fees: 0;
Estimated percentage of award fee contracts with this percentage
available: 63.
Percentage of value of contract available in base fees: 1 percent;
Estimated percentage of award fee contracts with this percentage
available: 0.
Percentage of value of contract available in base fees: 2 percent;
Estimated percentage of award fee contracts with this percentage
available: 8.
Percentage of value of contract available in base fees: 3 percent;
Estimated percentage of award fee contracts with this percentage
available: 26.
Percentage of value of contract available in base fees: 4 percent;
Estimated percentage of award fee contracts with this percentage
available: 2.
Sources: DOD submissions to GAO and contract documentation (data); GAO
(analysis).
Notes: The two F/A-22 development contracts in our sample included a 4
percent base fee. The program office received a deviation from the
Defense Federal Acquisition Regulation Supplement, which allows for a
maximum of 3 percent base fee. Percentages do not add to 100 due to
rounding. Sampling errors for percentages in this table do not exceed
plus or minus 13 percentage points.
[End of table]
Based on the results from our sample, an estimated 16 percent of the
contracts in our study population were fixed-price incentive contracts,
and an estimated 13 percent were cost-plus-incentive-fee contracts. In
both of these cases, the government and the contractor share the cost
risks. However, on fixed-price incentive contracts, the contractor
usually assumes more risk because if the contract reaches its ceiling
price, the contractor absorbs the loss. Under a cost-plus-incentive-fee
contract, when costs increase to the point where the contractor will
only earn the minimum fee, no further fee adjustments occur and the
government continues to pay the contractor's reimbursable costs.
DOD Acquisition Practices and Program Success:
When discussing award-and incentive-fee contracts, it is important to
acknowledge the acquisition environment in which they are used. For
instance, based on our sample results, we estimate that most of the
contracts and most of the dollars in our study population are related
to the acquisition of weapon systems. Since 1990, GAO has designated
DOD weapon system acquisition as a high-risk area.[Footnote 11]
Although U.S. weapons are the best in the world, DOD's acquisition
process for weapon programs consistently yields undesirable
consequences--cost increases, late deliveries to the warfighter, and
performance shortfalls. These problems occur because DOD's weapon
programs do not capture early on the requisite knowledge that is needed
to efficiently and effectively manage program risks. For example,
programs move forward with unrealistic program cost and schedule
estimates, lack clearly defined and stable requirements, use immature
technologies in launching product development, and fail to solidify
design and manufacturing processes at appropriate junctures in
development. As a result, wants are not always distinguished from
needs, problems often surface late in the development process, and
fixes tend to be more costly than if made earlier. When programs
require more resources than planned, the buying power of the defense
dollar is reduced, and funds are not available for other competing
needs.
The persistence of these problems reflects the fact that the design,
development, and production of major weapon systems are extremely
complex technical processes that must operate within equally complex
budget and political processes. A program that is not well conceived,
planned, managed, funded, and supported may easily be subject to such
problems as cost growth, schedule delays, and performance shortfalls.
Even properly run programs can experience problems that arise from
unknowns, such as technical obstacles and changes in circumstances. In
short, it takes a myriad of things to go right for a program to be
successful but only a few things to go wrong to cause major problems.
Award and Incentive Fees Are Not an Effective Tool for Achieving DOD's
Desired Acquisition Outcomes:
DOD has not structured and implemented award-fee contracts in a way
that effectively motivates contractors to improve performance and
achieve acquisition outcomes. DOD practices--such as routinely paying
its contractors nearly all of the available award fee, amounting to
billions of dollars, regardless of whether the acquisition outcomes
fell short of, met, or exceeded expectations; rolling an estimated $669
million in unearned or withheld award fees to future evaluation
periods; and paying a significant portion of the available fee for what
award-fee plans describe as "acceptable, average, expected, good, or
satisfactory" performance--all lessen the motivation for the contractor
to strive for excellent performance. In addition, DOD award-fee plans
have not been structured to focus the contractor's attention on
achieving desired acquisition outcomes. DOD generally does not evaluate
contractors on criteria that are directly related to acquisition
outcomes, and the link between the elements of contractor performance
that are included in award-fee criteria and acquisition outcomes is not
always clear. While incentive- fee contracts are more directly linked
to select acquisition outcomes, DOD has not fared well at using these
types of contracts to improve cost control behavior or meet program
goals. However, when contractor performance does not result in the
desired acquisition outcome under an incentive-fee contract, the
reduction of fees is usually automatic and based on the application of
a predetermined formula. Figure 2 summarizes our findings within the
general framework of issues surrounding DOD's use of award and
incentive fees.
Figure 2: Weaknesses in DOD's Use of Award and Incentive Fees:
[See PDF for image]
[End of figure]
Award-Fee Contracts: DOD Practices Do Not Maximize Contractors'
Motivation to Perform:
DOD's practice of routinely paying its contractors nearly all of the
available award fee puts DOD at risk of creating an environment in
which programs pay and contractors expect to receive most of the
available fee, regardless of acquisition outcomes. Based on our sample,
we estimate that for DOD award-fee contracts, the median percentage of
available award fee paid to date (adjusted for rollover)[Footnote 12]
was 90 percent, representing an estimated $8 billion in award fees for
contracts active between fiscal years 1999 through 2003.[Footnote 13]
The lowest percentage of available fee paid to date for contracts in
our sample was 36 percent, and the highest was 100 percent. Figure 3
shows the percentage of available fee earned for the 63 award-fee
contracts in our sample and the lack of variation, especially across
the contracts in the middle of the distribution.
Figure 3: Percentage of Available Award Fee Paid to Date for 63 Award-
Fee Contracts in GAO's Sample:
[See PDF for image]
[End of figure]
The pattern of consistently high award-fee payouts is also present in
DOD's fee decisions from evaluation period to evaluation period. This
pattern is evidence of reluctance among DOD programs to deny
contractors significant amounts of fee, even in the short term. We
estimate that the median percentage of award fee earned for each
evaluation period was 93 percent and the level of variation across the
evaluation periods in our sample was similar to the trend shown in
figure 3. On DOD award-fee contracts, we estimate that the contractor
received 70 percent or less of the available fee in only 9 percent of
the evaluation periods and none of the available fee in only 1 percent
of the evaluation periods. Figure 4 shows the percentage of available
fee earned by evaluation period for the award-fee contracts in our
sample. There were 572 evaluation periods overall for these contracts.
Figure 4: Percentage of Available Award Fee Earned for 572 Evaluation
Periods in GAO's Sample:
[See PDF for image]
[End of figure]
In addition to consistently awarding most of the available award fee on
an evaluation period-by-evaluation period basis, the use of "rollover"
is another indication of DOD's reluctance to withhold fees. Rollover is
the process of moving unearned available award fee from one evaluation
period to a subsequent evaluation period, thereby providing the
contractor an additional opportunity to earn that unearned award-fee
amount. DOD and program officials view rollover as an important
mechanism for maintaining leverage with contractors; however, award-fee
guidance issued by the Air Force, Army, and Navy in the last 3 years
states that this practice should rarely be used in order to avoid
compromising the integrity of the award-fee evaluation process. We
estimate that 52 percent of DOD award-fee contracts rolled over
unearned fees into subsequent evaluation periods.[Footnote 14] We
estimate that unearned fees were rolled over in 42 percent of
evaluation periods of contracts that used this practice.[Footnote 15]
Further, we estimate that the mean percentage of unearned fees that
were rolled over in these periods was 86 percent, and in 52
percent[Footnote 16] of these periods at least 99 percent of the
unearned fee was rolled over. Consequently, in many evaluation periods
when rollover was used, the contractor still had the chance to earn
almost all of the unearned fee, even in instances when the program was
experiencing problems. Across all the evaluation periods for the 32
contracts in our sample that used this practice, the amount rolled over
was almost $500 million, or an average of 51 percent of the total
unearned fees. (See fig. 5 for a depiction of DOD's use of rollover on
the contracts in our sample.) Overall, for DOD award-fee contracts
active between fiscal years 1999 through 2003, we estimate that the
total dollars rolled over across all evaluation periods that had been
conducted by the time of our review was $669 million.
Figure 5: DOD's Use of Rollover on 32 Contracts in GAO's Sample:
[See PDF for image]
[End of figure]
Several of the contracts in our sample routinely rolled over 100
percent of a contractor's unearned award fee into fee pools for use
later in the programs. For example, the Joint Strike Fighter program
has rolled over 100 percent of the unearned award fee for its
development contracts into a reserve award-fee pool that the program
uses to target areas not covered in the award-fee plan, such as
encouraging the contractor to track awards to small businesses and
improving communications with countries that are partners in the
development program.[Footnote 17] However, the program has also used
the reserve award-fee pool to provide additional money to motivate cost
control, even though this area is already a focus of the award-fee
plan. If the contractor does not earn the fee in the targeted area, the
program keeps rolling the unearned fee back into the reserve pool. The
practical effect of this is that the Joint Strike Fighter program's
prime contractors still have the ability to earn the maximum award fee
despite the cost and technical issues the program has experienced.
DOD may also be diluting the motivational effectiveness of award fees
by paying significant amounts of fee for satisfactory performance.
Although DOD guidance and federal acquisition regulations state that
award fees should be used to motivate excellent contractor performance
in key areas, most DOD award-fee contracts pay a significant portion of
the available fee from one evaluation period to the next for what award-
fee plans describe as "acceptable, average, expected, good, or
satisfactory" performance.[Footnote 18] Figure 6 shows the maximum
percentage of award fee paid for "acceptable, average, expected, good,
or satisfactory" performance and the estimated percentage of DOD award-
fee contracts active between fiscal years 1999 through 2003 that paid
these percentages. Some plans for contracts in our sample did not
require the contractor to meet all of the minimum standards or
requirements of the contract to receive one of these ratings. Some DOD
award-fee contracts in our sample also allowed for a portion of the
available award fee to be paid for marginal performance--a rating lower
than satisfactory. Even fixed-price-award-fee contracts, which already
include a normal level of profit in the price, paid out award fees for
satisfactory performance. Six of the eight fixed-price contracts with
award fee provisions in our sample paid out 50 percent or more of the
available award fee for satisfactory performance.
Figure 6: Maximum Percentage of Award Fee Available for "Acceptable,
Average, Expected, Good, or Satisfactory" Performance and the Estimated
Percentage of DOD Contracts That Paid These Percentages:
[See PDF for image]
Note: Sampling errors for percentages in this figure do not exceed plus
or minus 13 percentage points.
[End of figure]
The amount of award fee being paid for performance at or below the
minimum standards or requirements of the contract appears to not only
be inconsistent with the intent of award fees (as explained in DOD
guidance and federal acquisition regulations[Footnote 19]) but also is
inconsistent with the reasons contracting and program officials cited
on our questionnaire for their use. According to responses to our
questionnaire, rewarding satisfactory performance was one reason that
award or incentive fees were used on an estimated 29 percent of DOD
award-and incentive-fee contracts. However, rewarding better than
satisfactory performance was one reason that these fees were used on an
estimated 77 percent of these contracts.[Footnote 20]
The responses provided to our questionnaire also seem to rule out the
administration of award fees as one of the reasons for their general
lack of effectiveness. Several key elements related to development and
administration of award-fee contracts were present on almost all
contracts. Specifically, contracting and program officials'
questionnaire responses showed that the appropriate people were
involved in the development and administration of award-fee contracts,
and there was adequate guidance and training in place. We estimate that
for 91 percent of DOD award-fee contracts, there were designated
performance monitors responsible for evaluating specific areas
described in the award-fee plan. On an estimated 88 percent of DOD
award-fee contracts, award-fee evaluation board members received
training on their roles and responsibilities. We further estimate that
on 85 percent of DOD award-fee contracts, performance monitors also
received training. Evaluation boards were held as planned for an
estimated 86 percent of DOD award-fee contracts, and some programs
conducted interim assessments of contractor performance to support the
end-of-period evaluations. Based on questionnaire responses from
contracting and program officials, an estimated 95 percent of DOD award-
fee contracts had rating category descriptions that provided enough
detail to distinguish between categories. An estimated 79 percent of
the contracting officers responsible for developing and administering
award-fee contracts and an estimated 80 percent of the contracting
officers responsible for incentive-fee contracts believed the training
was adequate. Finally, the contracting and program officials on an
estimated 94 percent of DOD award-and incentive-fee contracts felt that
the guidance they used to develop and administer the contract was
adequate.
Award-Fee Contracts: Fee Criteria and Payouts Not Routinely Linked to
Acquisition Outcomes:
DOD programs do not structure award fees in a way that motivates
contractors to achieve or holds contractors accountable for achieving
desired acquisition outcomes. In several contracts we evaluated, DOD
established award-fee criteria that were focused on broad areas, such
as how well the contractor was managing the program. This can result in
award-fee plans and criteria that seemingly have little to do with
acquisition outcomes, such as meeting cost and schedule goals and
delivering desired capabilities. For example, on a Navy ship
construction contract, 50 percent of the award-fee money, or $28
million, was based on management criterion including how responsive the
contractor was to the government customers, the quality and accuracy of
contract proposals, and the timeliness of contract data requirements.
Elements of the award-fee process, such as the frequency of
evaluations, may also limit DOD's ability to effectively evaluate the
contractor's progress toward acquisition outcomes. For instance, while
holding award-fee evaluations every quarter was successful for three
Pentagon Renovation Management construction contracts because the
contractor's short-term progress could easily be assessed, a similar
strategy might not be effective for a long-term development effort
because quarterly or even semiannual evaluations may not generate
meaningful information about progress.
High award-fee payouts on programs that have fallen or are falling well
short of meeting their stated goals are also indicative of DOD's
failure to implement award fees in a way that promotes accountability.
Several major development programs--accounting for 52 percent of the
available award-fee dollars in our sample and 46 percent of the award-
fee dollars paid to date--are not achieving or have not achieved their
desired acquisition outcomes, yet contractors received most of the
available award fee. The Comanche helicopter, F/A-22 and Joint Strike
Fighter aircraft, and the Space-Based Infrared System High satellite
system, have experienced significant cost increases, technical
problems, and development delays, but the prime systems contractors
have respectively received 85, 91, 100, and 74 percent of the award fee
made available to date (adjusted for rollover), totaling $1.7 billion
(see table 6).
Table 6: Program Performance and Award-Fee Payments on Selected DOD
Development Programs:
Acquisition outcomes: Research and development cost increase over
baseline;
Comanche reconnaissance attack helicopter: $3.7 billion, 41.2 percent;
F/A-22 Raptor tactical fighter aircraft: $10.2 billion ,47.3 percent;
Joint Strike Fighter tactical fighter aircraft: $10.1 billion, 30.1
percent;
Space-Based Infrared System High: $3.7 billion, 99.5 percent.
Acquisition outcomes: Acquisition cycle time increase over baseline;
Comanche reconnaissance attack helicopter: 33 months, 14.8 percent;
F/A- 22 Raptor tactical fighter aircraft: 27 months, 13.3 percent;
Joint Strike Fighter tactical fighter aircraft: 11 months, 5.9 percent;
Space-Based Infrared System High: More than 12 months[A].
Acquisition outcomes: Number of program rebaselines;
Comanche reconnaissance attack helicopter: 1[B];
F/A-22 Raptor tactical fighter aircraft: 14;
Joint Strike Fighter tactical fighter aircraft: 1;
Space- Based Infrared System High: 3.
Acquisition outcomes: Total award fee paid to prime systems contractor;
Comanche reconnaissance attack helicopter: $202.5 million paid through
2004;
F/A-22 Raptor tactical fighter aircraft: $848.7 million;
Joint Strike Fighter tactical fighter aircraft: $494.0 million;
Space-Based Infrared System High: $160.4 million[C].
Acquisition outcomes: Percentage of award fee paid to prime systems
contractor (adjusted for rollover)[ D];
Comanche reconnaissance attack helicopter: 85 percent of available fee;
F/A-22 Raptor tactical fighter aircraft: 91 percent;
Joint Strike Fighter tactical fighter aircraft: 100 percent;
Space-Based Infrared System High: 74 percent.
Acquisition outcomes: Total award fee paid to prime engine contractor;
Comanche reconnaissance attack helicopter: No engine contractor;
F/A-22 Raptor tactical fighter aircraft: $115 million paid through
2004;
Joint Strike Fighter tactical fighter aircraft: $35.8 million;
Space-Based Infrared System High: No engine contractor.
Acquisition outcomes: Percentage of award fee paid to prime engine
contractor (adjusted for rollover)[D];
Comanche reconnaissance attack helicopter: N/A;
F/A-22 Raptor tactical fighter aircraft: 89 percent of available fee;
Joint Strike Fighter tactical fighter aircraft: 100 percent;
Space-Based Infrared System High: N/A.
Sources: DOD submissions to GAO, contract documentation, and GAO-05-301
(data); GAO (analysis).
[A] The Air Force Space Command has not specified the acquisition cycle
time for the Space-Based Infrared System High program; however, the
delivery of the first two satellites has been delayed by more than a
year.
[B] Overall, there were five rebaselines for the Comanche program;
however, only one occurred after development start. The Comanche
program was canceled in 2004.
[C] The program also utilizes incentive fees tied to cost and mission
successes. The award fee paid does not include fees earned through
mission success incentives. To date, the contractor has earned $3
million in these fees and could earn over $70 million over the life of
the contract.
[D] When calculating the percentage of award fee paid to date (i.e.,
percentage of award fee paid to date = total fee paid to date/(total
fee pool - remaining fee pool)), we included rolled-over fees in the
remaining fee pool when those fees were still available to be earned in
future evaluation periods. For instance, even though the Joint Strike
Fighter prime contractor has not been paid 100 percent of the award fee
that was made available for each evaluation period, it retains the
ability to potentially earn all of this unearned fee at a later date.
By reflecting the continued availability of this unearned fee in the
percentage calculation, it becomes clear that the contractor has, in
essence, earned 100 percent of the total award fee to date.
[End of table]
DOD can ensure that fee payments are more representative of program
results by developing fee criteria that focus on its desired
acquisition outcomes. We found two notable examples in which DOD's
Missile Defense Agency attempted to hold contractors accountable for
program outcomes. In the case of the Airborne Laser program, DOD
revised the award-fee plan in June 2002 as part of a program and
contract restructuring. The award-fee plan was changed to focus on
achieving a successful system demonstration by December 2004. Prior to
the restructuring, the contractor had received 95 percent of the
available award fee, even though the program had experienced a series
of cost increases and schedule delays. The contractor did not receive
any of the $73.6 million award fee available under the revised plan
because it did not achieve the key program outcome--successful system
demonstration.[Footnote 21] Similarly, the development contract for the
Terminal High Altitude Area Defense program, a ground-based missile
defense system, contains a portion of the award fee tied specifically
to desired program outcomes--conducting successful flight tests,
including intercepts of incoming missiles. This $50 million special
award-fee pool is separate from and in addition to the subjective award-
fee portion of the contract, which is worth more than $524 million (of
which $275 million has already been paid). If one of the first two test
flights is successful, the contractor will receive $25 million. If the
missile misses the target, the contractor provides DOD with a cost
credit of $15 million. The first of these flight tests is scheduled to
occur before the end of calendar year 2005.
Other programs have utilized different fee strategies to focus the
contractor's attention on specific acquisition outcomes. However,
contracting officials have stated that there are few mechanisms to
share lessons learned and innovative practices outside the local level.
These approaches include conditional fees and linked incentives.
* Conditional fees stipulate that certain requirements must be met for
a contractor to earn and keep fees. For example, we reviewed an
Intercontinental Ballistic Missile program award-fee plan that included
an "After Discover Performance Deficiencies" provision to ensure that
award-fee payouts were consistent with program outcomes. This provision
allowed the program to retrieve funds paid during prior award-fee
periods if the program experienced overruns or if performance
deficiencies were discovered after the award fee has been paid.
* Linked incentives evaluate cooperation across multiple contracts and
contractors. For example, after initial interoperability problems, the
Cooperative Engagement Capability program added award-fee criteria to
evaluate how well the system integrated with the Aegis destroyer.
Incentive-Fee Contracts: Many Contracts Not Meeting Cost or Performance
Targets:
Contracts with incentive fees have also not fared well at motivating
cost-control behavior or meeting program targets; however, fee payments
are more consistent with acquisition outcomes. According to DOD
contracting and program officials, contractors overran or were expected
to overrun the target price on 52 percent of the 27 incentive-fee
contracts in our sample. In these cases, the contractor does not earn
the target fee but may earn a minimum fee, if one is specified in the
contract. For example,
* the Navy's cost-plus-incentive-fee contract for the LPD 17, an
amphibious transport dock ship, is projected to overrun the target
price of $644 million by at least 139 percent;
* on the Army's Brilliant Anti-Armor Submunition program, a fixed-price
incentive contract for test hardware, overran the $75 million target
cost by 27 percent ($20 million); and:
* the fixed-price incentive contract for the Navy's P-3C Sustained
Readiness Program initially called for 50 kits to be produced, but only
13 were delivered before contract funding was exhausted.
Incentive-fee contracts that also included performance and delivery
incentives similarly have not met those key objectives, as shown in the
examples below.
* Even though the system received approval from the Navy in June 2005
for low-rate initial production, the contracting officer and program
manager stated that the cost, delivery, and technical incentives in the
Airborne Laser Mine Detection System program did not improve contractor
performance. During the course of the effort, the contractor
experienced several cost overruns, as well as technical performance
shortfalls. In addition, because of government delays, program
officials decided to eliminate the delivery incentive included in the
initial contract.
* According to the contracting and program officials responsible for
administering and managing one of the Army's chemical demilitarization
contracts, performance milestones with incentive fees were an important
part of the Army's effort to accelerate the destruction of chemical
weapons stockpiles after the events of September 11, 2001. However,
these incentives did not keep the contract on schedule. The contractor
missed the target completion date for the third of its four performance
incentive milestones and the program was delayed by over a year.
According to DOD, the failure to meet this milestone was due to
unforeseen technical difficulties, and could not have been ultimately
influenced by any type of contractual language.
In contrast, the successful use of fee is supported by the level of
product knowledge attained by officials and their ability to leverage
this knowledge. For example, DOD contracting officials for the Patriot
Advanced Capability-3 missile had a well-developed knowledge of the
acquisition's cost risks and were able to reduce costs by $42 million
for the low-rate initial production contract. Contracting officials
stated that the favorable outcome was due to the use of a cost model
that was developed and matured on the previous production contract.
Unlike award-fee contracts, incentive-fee contracts are based on
formula-like mechanisms that determine the amount of fee earned. When a
contractor misses a target in an incentive-fee contract, the reduction
of fees is usually automatic and based on the application of a
predetermined formula.[Footnote 22] The nature of the fee criteria in
these contracts also eliminates most of the subjectivity in the
evaluation process. Cost, schedule or delivery, and performance
incentives are all based on targets that can be evaluated against
actual costs, actual dates, and actual performance. In addition,
negative incentives allow for fee reductions if the contractor does not
meet certain criteria. For example, on one of the Navy's carrier
refueling and overhaul contracts, the contractor's fee could be reduced
if its overhead rate exceeded a certain target. Since incentive fees,
especially those related to cost, are primarily evaluated at the
conclusion of the contract, the officials applying the evaluation
criteria or fee formula have a clear sense of the contractor's
performance.
DOD Has Little Evidence That Monetary Incentives Improve Results as
Intended:
DOD's use of monetary incentives is based on the assumption that such
incentives can improve contractor performance and acquisition outcomes;
however, past studies have challenged the validity of this assumption.
Research on incentive fees going back to the 1960s has concluded these
incentive fees are not effective in controlling cost.[Footnote 23]
Studies conducted by GAO, Harvard University, and the RAND Corporation,
among others, have concluded that these incentives do not motivate cost
efficiency, in part because profit is not the contractor's only
motivation. Other considerations, such as securing future contracts
with the government, can be stronger motivators than earning additional
profit. More recently, research on award fees revealed that while these
fees are an intuitively appealing way to improve contractor
performance, they do not always operate that way in practice.
Contractor respondents in one study stated that award fees motivate
performance to some extent; however, the consensus was that they do not
in and of themselves increase performance significantly. Research has
also pointed to recurring disconnects between the intent and the
administration of award-fee contracts. Award-fee criteria were not
applied as intended; and many award-fee board members and fee-
determining officials approached the process with the assumption the
contractors should earn the full amount unless there were specific
instances of poor performance that warranted deductions, instead of
starting at zero and considering the actions the contractor had taken
to earn the available fee. Finally, the lack of explicit rationale and
documentation in support of performance ratings has led some
researchers to conclude that fees were being paid without adequate
justification.[Footnote 24]
Despite these findings and the concerns raised by senior DOD officials
about the amounts of award fee paid to contractors on acquisitions that
were not performing to their established baselines, very little effort
has gone into determining whether DOD's current use of monetary
incentives is effective. Over the past few years, officials including
the Undersecretary for Acquisition Technology and Logistics and the
Assistant Secretary of the Air Force for Acquisition expressed concerns
that contractors routinely earn high percentages of fee while programs
have experienced performance problems, schedule slips, and cost
growth.[Footnote 25] In 1999, following a report by a DOD-led
integrated process team addressing contractor incentives, the
Undersecretary of Defense also issued a memorandum for all service
secretaries specifically noting that contractors do not always have an
incentive to focus their attention on the government's desired outcomes
and offered several principles for structuring future contract
incentives. However, according to the lead of the integrated process
team from the Office of the Secretary of Defense, the effort did not
result in any new policy directives, changes in guidance, or new
training. In addition, DOD did not assess the results of the study.
In contrast to the concerns expressed by DOD's senior acquisition
leadership, we gathered testimonial evidence that indicates DOD
contracting and program officials believe that these monetary
incentives are effective for improving contractor performance. Based on
responses to our questionnaire, an estimated 77 percent of DOD award-
and incentive-fee contracts had improved performance because of the
incentive provisions, in the opinion of contracting and program
officials. On award-fee contracts, officials pointed to increased
responsiveness or attention from the contractor at the management level
as evidence of this improvement, even if this increased responsiveness
did not result in overall desired program outcomes being achieved.
One of the potential reasons for this disconnect between statements at
the policy level and the opinions of practitioners is the lack of a DOD-
wide system for compiling and aggregating award-and incentive-fee
information and for identifying resulting trends and outcomes. DOD has
not compiled information, conducted evaluations, or used performance
measures to judge how well award and incentive fees are improving or
can improve contractor performance and acquisition outcomes. The lack
of data is exemplified by the fact that DOD does not track such basic
information as how much it pays in award and incentive fees. Such
information collection across DOD is possible. For instance, DOD is
implementing the Defense Acquisition Management Information Retrieval
system to collect data on acquisition costs and variances, schedules,
and program baseline breaches on major acquisition systems. This system
provides DOD policymakers with readily available information they can
use to oversee program performance across the department. If DOD does
not begin to collect similar information on award and incentive fee
payments, it may not be able to measure progress toward meeting one of
the goals listed in its fiscal 2004 performance and accountability
report, that is, invigorating the fiscal well-being of the defense
industry by rewarding good performance.
Conclusions:
The existence or application of a well-developed and well-implemented
monetary incentive alone does not determine the overall success or
failure of an acquisition. DOD acquisition programs operate in an
environment with underlying pressures and incentives that drive both
program and contractor behavior. Competition for funding and contracts
leads to situations, especially in major system acquisitions, in which
costs are underestimated and capabilities are overpromised. Resulting
problems require additional time and money to address. At the same
time, DOD customers are tolerant of cost overruns and delays in order
to get a high-performance weapon system. DOD's current approach toward
monetary incentives reflects these realities and has resulted in a
failure to hold contractors accountable for delivering and supporting
fielded capabilities within cost and schedule baselines. While DOD and
contractors share the responsibility for program success, award and
incentive fees, to be effective, need to be realigned with acquisition
outcomes. Awarding large amounts of fee for satisfactory or lesser
performance and offering contractors multiple chances to earn
previously withheld fees has fostered an environment in which DOD
expects to pay and contractors expect to receive most of the available
award fee regardless of outcomes. In addition, DOD's lack of
information on how well award and incentive fees are achieving their
intended purpose leaves the department vulnerable to millions of
dollars of potential waste. Successes do exist at the individual
contract level, but DOD will need to leverage this knowledge if it
hopes to identify proven incentive strategies across a wide variety of
DOD acquisitions.
Recommendations for Executive Action:
To strengthen the link between monetary incentives and acquisition
outcomes and by extension increase the accountability of DOD programs
for fees paid and of contractors for results achieved, we recommend
that the Secretary of Defense direct the Undersecretary of Defense for
Acquisition, Technology, and Logistics to take the following seven
actions. DOD can immediately improve its use of award fees on all new
contracts by (1) instructing the military services to move toward more
outcome-based award-fee criteria that are both achievable and promote
accountability for acquisition outcomes; (2) ensuring that award-fee
structures are motivating excellent contractor performance by only
paying award fees for above satisfactory performance; and (3) requiring
the appropriate approving officials to review new contracts to make
sure these actions are being taken. DOD can improve its use of award
fees on all existing contracts by (4) issuing DOD guidance on when
rollover is appropriate. In the longer term, DOD can improve its use of
award and incentive fees by (5) developing a mechanism for capturing
award-and incentive-fee data within existing data systems, such as the
Defense Acquisition Management Information Retrieval system; (6)
developing performance measures to evaluate the effectiveness of award
and incentive fees as a tool for improving contractor performance and
achieving desired program outcomes; and (7) developing a mechanism to
share proven incentive strategies for the acquisition of different
types of products and services with contracting and program officials
across DOD.
Agency Comments and Our Evaluation:
DOD's Office of Defense Procurement and Acquisition Policy provided
written comments on a draft of this report. These comments are
reprinted in appendix II. DOD also provided separate technical
comments, which we have incorporated as appropriate.
DOD concurred with three of our seven recommendations--moving toward
more outcome-based award-fee criteria, issuing guidance on rollover,
and developing a mechanism to share proven incentive strategies. The
department indicated that it would implement these recommendations by
issuing a policy memorandum on award fees and completing a
communications plan for sharing incentive strategies on March 31, 2006.
DOD partially concurred with four of our seven recommendations.
Concerning three of the four recommendations--requiring the appropriate
officials to make sure these recommendations are implemented in new
contracts, collecting award and incentive fee data, and developing
performance measures to evaluate the effectiveness of award and
incentive fees in improving acquisition outcomes--DOD indicated that
the Director of the Office of Defense Procurement and Acquisition
Policy, in collaboration with the military departments and defense
agencies, would conduct a study to determine the appropriate actions to
address them. The office plans to complete the study by June 1, 2006.
While this study may provide additional insights, we encourage DOD to
use it as a mechanism for identifying the specific steps the department
will take to fully address our recommendations, not to determine
whether the department will take action. For instance, in its response
to our recommendation on developing a mechanism for capturing award and
incentive fee data, DOD raises the issue of cost. We agree that the
potential cost of implementing this recommendation should be
considered, while deciding on an appropriate course of action. However,
given that the department paid out an estimated $8 billion in award
fees on the contracts in our study population regardless of outcomes,
we believe that a reasonable investment in ensuring that these funds
are well-spent in the future is warranted. Collecting this data is also
necessary to support the development of meaningful performance
measures, which can be used to evaluate the costs and benefits of
continuing to use these contract types and determine if they are
achieving their goal of improving contractor performance and
acquisition outcomes. Further, without data and performance measures,
DOD will not be in a position to measure the effectiveness of any
actions it takes to address the issues identified in this report.
DOD also partially concurred with our recommendation related to only
paying award fees for above satisfactory performance. Specifically, the
department stated that it is fair and reasonable to allow the
contractor to earn a portion of the award fee for satisfactory
performance. However, we believe that this use of award fee should be
the exception, not the rule. Fixed-price-award-fee contracts already
include a normal level of profit in the price which is paid for
satisfactory performance. In addition, the inclusion of base fee in a
cost-plus-award-fee contract may be a more appropriate mechanism for
providing fee for satisfactory performance. According to the Army
Contracting Agency's Handbook for Award Fee Contracts, base fee (not
exceeding three percent of the estimated contract cost) can be paid to
the contractor for acceptable performance and is designed to compensate
the contractor for factors such as risk assumption, investment, and the
nature of the work. DOD also stated that award fee arrangements should
be structured to encourage the contractor to earn the preponderance of
fee by providing excellent performance. According to its comments, DOD
plans to address this issue in the March 2006 policy memorandum on
award fees. While DOD may conclude that it needs the flexibility to pay
a portion of the award fee for satisfactory performance, especially for
high risk efforts, current practice on most award fee contracts is to
pay a significant portion of the available fee for "acceptable,
average, expected, good, or satisfactory" performance. We would
encourage DOD to consider limiting the maximum percentage of fee
available for this level of performance to, consistent with its
comments, keep the preponderance of fee available for excellent
performance.
We are sending copies of this report to interested congressional
committees; the Secretary of Defense; the Secretaries of the Air Force,
Army, and Navy; the Commandant of the Marine Corps; and the Director,
Office of Management and Budget. We will provide copies to others on
request. This report will also be available at no charge on GAO's Web
site at http://www.gao.gov.
If you have any questions about this report or need additional
information, please call me at (202) 512-4841 (calvaresibarra@gao.gov).
Contact points for our Offices of Congressional Relations and Public
Affairs may be found on the last page of this report. Other staff
making key contributions to this report were Thomas J. Denomme,
Assistant Director; Robert Ackley; Heather Barker; Lily J. Chin; Aftab
Hossain; Julia Kennon; John Krump; Jerry Sandau; Sidney Schwartz; Ron
Schwenn; Najeema Davis Washington; and E. Chris Woodard.
Signed by:
Ann M. Calvaresi-Barr:
Director:
Acquisition and Sourcing Management:
[End of section]
Appendix I: Scope and Methodology:
Our objective was to determine whether award and incentive fees are an
effective management tool for achieving the Department of Defense's
(DOD) desired outcomes. To conduct our work, we selected a sample of 93
award-and incentive-fee contracts, interviewed contracting and program
officials, analyzed contract documentation related to incentive
provisions, collected and analyzed data on award-fee payments, reviewed
DOD and military service guidance on award and incentive fees, and
examined the results of initiatives related to improving the use of
these fees.
Our sample for this review was based on contract data from the Federal
Procurement Data System. We extracted information from this database on
all DOD contracts active between fiscal years 1999 through 2003 that
had at least one contract action coded as cost-plus-award-fee, cost-
plus-incentive-fee, fixed-price-award-fee, or fixed-price incentive
valued at $10 million or more during that time. These criteria gave us
a study population of 597 unique contracts, which were associated with
2,474 award-and incentive-fee contract actions.
To ensure the validity of the database from which we drew our sample,
we tested the reliability of the contract type field in the Federal
Procurement Data System.[Footnote 26] We selected a sample of 30
contracts from the population of DOD contracts active between fiscal
years 1999 through 2003 and asked DOD and the military services to
provide data on the contract type(s) for each one using data sources
other than the Federal Procurement Data System or Individual
Contracting Action Reports (DD Form 350). We also requested that DOD
and the military services verify that at least one contract action
between fiscal years 1999 through 2003 was valued at over $10 million.
Of the 30 contracts, DOD and the military services reported that 10
were either incorrectly coded or omitted information on a relevant
contract type in the Federal Procurement Data System. Of these 10
errors, only 3 would have caused a contract to be mistakenly included
or excluded in the population from which our sample was selected. Based
upon these responses and the exclusion of only one contract from our
sample because of miscoding in the Federal Procurement Data System, we
determined that the data were sufficiently reliable for the purposes of
this report.
To select the sample for this review, we stratified the population of
597 contracts based on the total dollar value of award-and incentive-
fee contract actions associated with the contract during this period.
We included all 12 contracts in the sample for which the total value of
the award-and incentive-fee contract actions during this period
exceeded $2 billion. We used probability sampling techniques to select
85 contracts from the remaining 585 contracts in the population,
ensuring that the number of contracts from the Navy, Army, Air Force,
and all other defense agencies and organizations combined were
proportional to their representation among the 585. During our work, we
discovered that 2 of the 85 contracts we sampled from the stratum of
585 contracts were outside of the scope of this review. These contracts
were removed from the sample. We also discovered that for 2 other in-
scope contracts in this stratum, the officials involved in developing
and administering the contract and the contract documentation were not
available. We excluded these contracts from our analysis. We randomly
selected a total of 4 additional contracts from the same stratum to
include in our analysis.
Because we followed a probability procedure based on random selections,
our sample is only one of a large number of samples that we might have
drawn. Since each sample could have provided different estimates, we
express our confidence in the precision of our particular sample's
results as 95 percent confidence intervals (for example, plus or minus
7 percentage points). These are the intervals that would contain the
actual population values for 95 percent of the samples we could have
drawn. As a result, we are 95 percent confident that each of the
confidence intervals in this report will include the true values in the
study population. All percentage estimates from our review have margins
of error (that is, confidence interval widths) not exceeding plus or
minus 10 percentage points, unless otherwise noted. All numerical
estimates other than percentages (such as totals and ratios) have
margins of error not exceeding plus or minus 25 percent of the value of
those estimates. Our analysis also tested the extent to which
statistically significant relationships existed between such factors as
contract type, reasons an incentive contract was chosen, types of
officials involved in developing the incentive structure, use of
rollover, training, and guidance; and contracts that contracting and
program officials have cited improved contractor performance because of
the use of incentive.
To determine whether award and incentive fees are an effective
management tool, we conducted structured interviews with contracting
and program officials about the development, implementation, and
effectiveness of the incentive structure for 92 of the 93 award-and
incentive-fee contracts in our sample; analyzed contract documentation
related to incentive provisions; and collected and analyzed data on
award-fee payments for 63 of the 66 contracts with award-fee provisions
in our sample. For one contract, the office responsible for
administering the contract could not identify any contracting or
program personnel who could address our interview topics and all
questions were coded as "no response." For three contracts, the office
responsible for administering the contract could not provide complete
documentation on award-fee payments.
To conduct our structured interviews on the development,
implementation, and effectiveness of the incentive structure, we used a
questionnaire that was a combination of open-and close-ended questions.
When possible, these interviews were held in person. We visited the
Defense Threat Reduction Agency Headquarters; Joint Strike Fighter
Program Office; Los Angeles Air Force Base; Missile Defense Agency
(Navy Annex); Patuxent Naval Air Station; Pentagon Renovation and
Construction Program Office; Redstone Arsenal; U.S. Army Contracting
Agency's Information Technology, E-Commerce and Commercial Contracting
Center; U.S. Navy's Strategic System Program Office; Warner Robins Air
Force Base; Washington Navy Yard; and Wright Patterson Air Force Base
for this purpose. The remaining interviews were held by video
teleconference or by telephone. All interviews were conducted between
October 2004 and April 2005.
We also reviewed contract documentation related to the development and
implementation of the contracts' incentives, including the basic
contract, statement of work, acquisition planning documents,
modifications related the incentive structure, award-fee plan,
documentation describing fee criteria for specific evaluation periods,
contractor self-assessments, award-fee board evaluation reports, and
fee-determination documents. We used this information to corroborate
and supplement the information provided in the structured interviews,
determine the extent to which linkages exist between fee criteria and
the desired program outcomes identified by contracting and program
officials, and examine fee payments in the context of program
performance. When possible, we evaluated program and contract
performance using GAO's body of work on DOD systems acquisitions,
including the annual assessment of selected major weapon programs and
annual status report on the ballistic missile defense program.
For each of the 66 award-fee contracts in our sample, we collected and
analyzed data on the base fee and maximum award fee, expressed as a
percentage of the estimated cost, exclusive of the cost of money; the
award fee available and paid for each evaluation period; the amount of
unearned fee rolled over into subsequent evaluation periods; the total
award-fee pool; and the remaining award-fee pool, which included any
rolled-over fee still remaining to be potentially earned. In most
cases, contracting and program officials submitted the data on a
standard template we provided. In cases where the program did not
submit data in the requested format, we gathered this information from
fee-determination letters and contract modifications. We also used
these documents to verify the reliability of the data that were
submitted by contracting and program officials. From this data, we
calculated the percentage of the available fee that was awarded for
individual evaluation periods, entire contracts to date, and the
overall sample. We included rollover amounts available and earned in
our calculations of fee awarded for individual evaluation periods. When
calculating the percentage of fee earned for entire contracts, we
excluded rolled-over fees from the available fee pool when those fees
were still available to be earned in future evaluation periods. We also
calculated the percentage of unearned fee that was made available to
the contractor as rollover for individual evaluation periods, entire
contracts, and the overall sample. Estimates of total award fees earned
and total award fees that were rolled over are based on all evaluation
periods held from the inception of our sample contracts through our
data collection phase, not just those from fiscal years 1999 through
2003. We did not analyze incentive fee payments because most fee
determinations are related to cost and are not complete until the
contract is closed out.
We interviewed officials from Defense Acquisition University, Office of
Director of Defense Procurement and Acquisition Policy, Office of the
Deputy Assistant Secretary of the Air Force for Contracting (Policy and
Implementation), Office of Deputy Assistant Secretary of the Army
(Policy and Procurement), Office of the Deputy Assistant Secretary of
the Navy for Acquisition Management, Office of the Air Force Inspector
General, and the U.S. Army Audit Agency, as well as government
contracting experts on recent initiatives and current trends in
incentive contracting. We reviewed previous audit and inspection
reports from the Air Force, Army, and Navy. We analyzed current award-
and incentive-fee guidance provided in the Federal Acquisition
Regulation, Defense Federal Acquisition Regulation Supplement, U.S.
Army Audit Agency's report on Best Practices for Using Award Fees, Air
Force Award Fee Guide, Air Force Material Command Award Fee Guide, and
other service-specific policies, as well as the National Aeronautics
and Space Administration's Award Fee Guide. We identified and reviewed
DOD and military service policy memos and initiatives including DOD's
Contractor Incentives Integrated Process Team; the Assistant Secretary
of the Navy for Research, Development, and Acquisition's policy memo on
Contract Incentives, Profits and Fees; the Deputy Assistant Secretary
of the Army for Procurement's report on Innovation in Contractual
Incentives; and the Office of the Undersecretary of Defense for
Acquisition, Technology, and Logistics' "quick look" at DOD Profit
Policy and Defense Industry Profitability. We identified innovative
monetary incentives used on contracts within our sample and the
mechanisms available to share those across DOD.
We performed our review from February 2004 to November 2005 in
accordance with generally accepted government auditing standards.
[End of section]
Appendix II: Comments from the Department of Defense:
OFFICE OF THE UNDER SECRETARY OF DEFENSE:
ACQUISITION, TECHNOLOGY AND LOGISTICS:
3000 DEFENSE PENTAGON:
WASHINGTON, DC 20301-3000:
DEC 12 2005,
Ms. Ann M. Calvaresi-Barr:
Director, Acquisition and Sourcing Management:
U.S. Government Accountability Office:
441 G Street, N.W.:
Washington, DC 20548:
Dear Ms. Calvaresi-Barn:
This is the Department of Defense response to the GAO draft report,
`DEFENSE ACQUISITIONS: DoD Has Paid Billions in Award and Incentive
Fees Regardless of Acquisition Outcomes,' dated November 4, 2005, (GAO
Code 120326/GAO-06-66)."
The report includes seven recommendations for the Secretary of Defense
on how DoD can improve its use of award fees on new contracts. The
Department's response to the recommendations is enclosed.
Signed by:
Domenic C. Cipicchio:
Acting Director, Defense Procurement and Acquisition Policy:
Enclosure: As stated:
GAO DRAFT REPORT - DATED NOVEMBER 4, 2005 GAO CODE 120326/GAO-06-66:
"DEFENSE ACQUISITIONS: DOD HAS PAID BILLIONS IN AWARD AND INCENTIVE
FEES REGARDLESS OF ACQUISITION OUTCOMES"
DEPARTMENT OF DEFENSE COMMENTS TO THE RECOMMENDATIONS:
RECOMMENDATION 1: The GAO recommended that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology, and
Logistics) to instruct the military services to move towards more
outcomes based award fee criteria that are both achievable and promote
accountability for acquisition outcomes.
(p. 31/GAO Draft Report):
DOD RESPONSE: Concur. The Director, Defense Procurement and Acquisition
Policy (DPAP), will address desired outcomes and the role the award fee
should play in the overall acquisition strategy in a policy memorandum.
The expected issuance date for the memorandum is March 31, 2006.
RECOMMENDATION 2: The GAO recommended that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology and
Logistics) to ensure that award-fee structures are motivating excellent
contractor performance by only paying award fee for above satisfactory
performance. (p. 31/GAO Draft Report).
DOD RESPONSE: Partially Concur. The purpose of award fee arrangements
should be to motivate excellent contractor performance. However, this
does not preclude paying award fee for satisfactory performance. The
Department utilizes Cost Plus Award Fee contracts when the nature of
the work to be performed is such that objective cost and performance
incentives are not appropriate and linking contractor performance to
some performance-based incentive(s) is a more attractive alternative
than using a Cost-Plus-Fixed-Fee contract. In these situations,
allowing the contractor to earn a portion of the award fee for
satisfactory performance is fair and reasonable. Normally, award fee is
not earned when the fee-determining official has determined that the
contractor performance has been submarginal or unsatisfactory (DFARS
216.405-2). Generally, the award fee arrangement should be structured
to encourage the contractor to earn the preponderance of the award fee
by providing excellent performance and a contractor should not receive
the maximum amount of award fee under a contract without a demonstrated
superior level of performance, as provided for in the award fee plan. A
reminder that we should be ensuring that existing policies are being
followed is appropriate. This will be addressed in the policy
memorandum mentioned in the response to Recommendation 1.
RECOMMENDATION 3: The GAO recommended that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology, and
Logistics) to require the appropriate approving officials to review new
contracts to make sure the actions recommended in recommendations 1 and
2 are being taken. (p. 31/GAO Draft Report):
DOD RESPONSE: Partially Concur. The Director, DPAP, in collaboration
with the Military Departments and Defense Agencies, will conduct an
analysis to determine what the appropriate approving official level
should be for new contracts where an award and/or incentive fee
structure is utilized. The analysis and additional guidance, if needed,
are expected to be completed by June 1, 2006.
RECOMMENDATION 4: The GAO recommended that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology, and
Logistics) to issue DoD guidance on when "rollover" is appropriate
(quote added for emphasis). (p. 31/GAO Draft Report):
DOD RESPONSE: Concur. The Director, DPAP, will issue guidance to the
acquisition workforce on "rollover." This will be addressed in the
policy memorandum in the response to Recommendation 1.
RECOMMENDATION 5: The GAO recommended that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology, and
Logistics) to develop a mechanism for capturing award and incentive-fee
data within existing data systems, such as the Defense Acquisition
Management Information Retrieval (DAMIR) system. (p. 31/GAO Draft
Report):
DOD RESPONSE: Partially Concur. The Director, DPAP, will conduct an
analysis of existing systems, including DAMIR, and determine which if
any system is best suited, or with modification is best suited, to
capture this type of data and at what cost. After the study is
completed, the Director, DPAP, will determine the appropriate course of
action. The study is expected to be completed by June 1, 2006.
RECOMMENDATION 6: The GAO recommended that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology, and
Logistics) to develop performance measures to evaluate the
effectiveness of award and incentive fees as a tool for improving
contractor performance and achieving desired program outcomes. (p.
31/GAO Draft Report):
DOD RESPONSE: Partially Concur. The Director, DPAP, in conjunction with
the Military Departments and Defense Agencies, will review and identify
possible performance measures and based on that effort determine the
appropriate action. This effort will be completed by June 1, 2006.
RECOMMENDATION 7: The GAO recommended that the Secretary of Defense
direct the Under Secretary of Defense (Acquisition, Technology and
Logistics) to develop a mechanism to share proven incentive strategies
for the acquisition of different types of products and services with
contracting and program officials across DoD. (p. 31/GAO Draft Report):
DOD RESPONSE: Concur. The Director, DPAP will develop a communication
plan to share proven incentive strategies, such as those attributed in
the report to the Missile Defense Agency, across the entire DoD
acquisition workforce. The expected date for completion of the
communication plan is March 31, 2006.
[End of section]
Appendix III: Contracting Definitions:
Award fee: An amount of money that is added to a contract and that a
contractor may earn in whole or in part during performance and that is
sufficient to provide motivation for excellence in the areas such as
quality, schedule, technical performance, and cost management.
Base fee: An award-fee contract mechanism that is an amount of money
over the estimated costs (typically in the range of 0 to 3 percent of
the contract value), which is fixed at the inception of the contract
and paid to the contractor for performance in a cost-plus-award-fee
contract. A base fee is similar to the fixed fee paid to a contractor
under a cost-plus-fixed-fee contract that does not vary for
performance.
Ceiling price: A prenegotiated maximum price that may be paid to the
contractor.
Cost contract: A cost-reimbursement contract in which the contractor
receives no fee. A cost contract may be appropriate for research and
development work, particularly with nonprofit educational institutions
or other nonprofit organizations, and for facilities contracts.
Cost-plus-award-fee contract: A cost-reimbursement contract that
provides for a fee consisting of a base amount (which may be zero)
fixed at inception of the contract and an award amount, based upon a
judgmental evaluation by the government, sufficient to provide
motivation for excellence in contract performance.
Cost-plus-incentive-fee contract: A cost-reimbursement contract that
provides for an initially negotiated fee to be adjusted by a formula
based on the relationship of total allowable costs to total target
costs.
Cost-reimbursable contract: A contract that provides for payment of the
contractor's allowable cost to the extent prescribed in the contract
not to exceed a ceiling.
Delivery incentives: A monetary incentive used to motivate the
contractor to meet a particular product or service delivery objective.
Fixed-price contract: A contract that provides for a price that is
either fixed or subject to adjustment obligating the contractor to
complete work according to terms and for the government to pay the
specified price regardless of the contractor's cost of performance.
Fixed-price-award-fee contract: A variation of the fixed-price contract
in which the contractor is paid the fixed price and may be paid a
subjectively determined award fee based on periodic evaluation of the
contractor's performance.
Fixed-price incentive contract: A fixed-price contract that provides
for adjusting profit and establishing the final contract price by
application of a formula based on the relationship of total final
negotiated cost to total target cost.
Incentive contract: A contract used to motivate a contractor to provide
supplies or services at lower costs and, in certain instances, with
improved delivery or technical performance, by relating the amount of
fee to contractor performance.
Linked incentives: Incentives tied to performance in areas across
multiple contracts and contractors and used to motivate contractors to
cooperate.
Negative incentives: A method used by the government to allow for fee
reductions if the contractor does not meet certain criteria.
Rollover: The process of moving unearned award fee from one evaluation
period to a subsequent period or periods, thus allowing the contractor
an additional opportunity to earn that unearned award fee.
Share ratio: A fee-adjustment formula written as a ratio of the cost
risk between the government and the contractor.
Target cost: The preestablished cost of the contracted goods/services
that is a reasonable prediction of final incurred costs.
[End of section]
Appendix IV: Sample Characteristics:
GAO's sample of 93 award and incentive contracts comprises the
following contract types:
* 48 cost-plus-award-fee contracts,
* 4 fixed-price-award-fee contracts,
* 12 cost-plus-incentive-fee contracts,
* 14 fixed-price incentive contracts,
* 1 cost-plus-incentive-fee/fixed-price incentive contract, and:
* 14 contracts that are combinations of award-and incentive-fee
contract types.
The sample contracts included the following breakdown by military
service and DOD agency or organization:
* 37 Navy contracts,
* 30 Air Force contracts,
* 18 Army contracts,
* 3 Missile Defense Agency contracts,
* 3 Pentagon Renovation Management Office contracts,
* 1 Marine Corps contract, and:
* 1 Defense Threat Reduction Agency contract.
[End of section]
Appendix V: GAO Reports on the Weapon Systems Acquisition Environment:
Defense Acquisitions: Stronger Management Practices Are Needed to
Improve DOD's Software-Intensive Weapon Acquisitions. GAO-04-393.
Washington, D.C.: March 1, 2004.
Defense Acquisitions: DOD's Revised Policy Emphasizes Best Practices,
but More Controls Are Needed. GAO-04-53. Washington, D.C.: November 10,
2003.
Best Practices: Setting Requirements Differently Could Reduce Weapon
Systems' Total Ownership Costs. GAO-03-57. Washington, D.C.: February
11, 2003.
Best Practices: Capturing Design and Manufacturing Knowledge Early
Improves Acquisition Outcomes. GAO-02-701. Washington, D.C.: July 15,
2002.
Defense Acquisitions: DOD Faces Challenges in Implementing Best
Practices. GAO-02-469T. Washington, D.C.: February 27, 2002.
Best Practices: Better Matching of Needs and Resources Will Lead to
Better Weapon System Outcomes. GAO-01-288. Washington, D.C.: March 8,
2001.
Best Practices: A More Constructive Test Approach Is Key to Better
Weapon System Outcomes. GAO/NSIAD-00-199. Washington, D.C.: July 31,
2000.
Defense Acquisition: Employing Best Practices Can Shape Better Weapon
System Decisions. GAO/T-NSIAD-00-137. Washington, D.C.: April 26, 2000.
Best Practices: DOD Training Can Do More to Help Weapon System Program
Implement Best Practices. GAO/NSIAD-99-206. Washington, D.C.: August
16, 1999.
Best Practices: Better Management of Technology Development Can Improve
Weapon System Outcomes. GAO/NSIAD-99-162. Washington, D.C.: July 30,
1999.
Defense Acquisitions: Best Commercial Practices Can Improve Program
Outcomes. GAO/T-NSIAD-99-116. Washington, D.C.: March 17, 1999.
Defense Acquisition: Improved Program Outcomes Are Possible. GAO/T-
NSIAD-98-123. Washington, D.C.: March 18, 1998.
Best Practices: Successful Application to Weapon Acquisition Requires
Changes in DOD's Environment. GAO/NSIAD-98-56. Washington, D.C.:
February 24, 1998.
Major Acquisitions: Significant Changes Underway in DOD's Earned Value
Management Process. GAO/NSIAD-97-108. Washington, D.C.: May 5, 1997.
Best Practices: Commercial Quality Assurance Practices Offer
Improvements for DOD. GAO/NSIAD-96-162. Washington, D.C.: August 26,
1996.
[End of section]
FOOTNOTES
[1] GAO, Defense Acquisitions: Assessments of Selected Major Weapon
Programs, GAO-05-301 (Washington, D.C.: Mar. 31, 2005).
[2] Other contract types do not provide this same level of control over
fees and profits. The two most prevalent DOD contract types (based on
the number of contract actions) are firm-fixed-price and cost-plus-
fixed-fee. Under firm-fixed-price contracts, DOD and the contractor
agree on a price and the contractor assumes full responsibility for all
costs and the resulting profit or loss. Under cost-plus-fixed-fee
contracts, the contractor receives a fee that was negotiated and fixed
at the inception of the contract.
[3] The Federal Acquisition Regulation (FAR) requires that the expected
benefits of using an award-fee contract must exceed the additional
administrative effort and cost involved (FAR Part 16.404(b)(1) and
16.405-2(b)(1)(iii)).
[4] Award-fee evaluation board members may include personnel from key
organizations knowledgeable about the award-fee evaluation areas, such
as engineering, logistics, program management, contracting, quality
assurance, legal, and financial management; personnel from user
organizations and cognizant contract administration offices; and the
local small business office in cases where subcontracting goals are
important. On major weapons programs, the boards are generally made up
of personnel from the program office.
[5] Award-fee contracts are intended to be flexible, so award-fee plans
allow contracting and program officials to change fee criteria and the
weight given to each criterion from evaluation period to evaluation
period.
[6] The Navy Award Fee Guide suggests that objective measures also be
utilized, to the maximum extent possible, to support the subjective
evaluation of the contractor's performance.
[7] The fee-determining official is generally at a higher level
organizationally than those directly involved in the evaluation of the
contractor (e.g., award-fee board members). For instance, this official
can be the program executive officer for a weapons system acquisition
contract or a garrison commander on a base support services contract.
[8] Contract actions include any action related to the purchasing,
renting, or leasing of supplies, services, or construction. Contract
actions include definitive contracts; letter contracts; purchase
orders; orders made under existing contracts or agreements; and
contract modifications, which would include the payment of award and
incentive fees.
[9] These obligations include award-and incentive-fee payments as well
as other contract costs.
[10] The 95 percent confidence interval surrounding this estimate
ranges from 46 percent to 73 percent.
[11] GAO, High-Risk Series: An Update, GAO-05-207 (Washington, D.C.:
January 2005).
[12] When calculating the percentage of award fee paid (i.e. percentage
of award fee paid = total fee paid to date/(total fee pool - remaining
fee pool)), we included rolled-over fees in the remaining fee pool when
those fees were still available to be earned in future evaluation
periods.
[13] Our estimate is based on award fee periods that were held from the
inception of the contracts in our sample through the data collection
phase of our review. The oldest award fee contracts in our sample were
signed in fiscal year 1991.
[14] The 95 percent confidence interval for this estimate ranges from
40 percent to 64 percent.
[15] The 95 percent confidence interval for this estimate ranges from
31 percent to 53 percent.
[16] The 95 percent confidence interval for this estimate ranges from
34 percent to 69 percent.
[17] In its technical comments on a draft of this report, DOD stressed
that while the Joint Strike Fighter program office has rolled over
unearned fee to a reserve award fee pool, it is under no obligation to
make any of this reserve award fee pool available to the contractor.
[18] For the 53 contracts in our sample that paid at least a portion of
the available fee if the contractor received a rating of "acceptable,
average, expected, good, or satisfactory," there were 40 different fee
ranges associated with these categories.
[19] According to FAR 16.404(a)(1), in a fixed-price-award-fee
contract, the fixed price (including normal profit) will be paid for
satisfactory contract performance. Award fee earned (if any) will be
paid in addition to that fixed price. According to FAR 16.405-2(a)(2),
a cost-plus-award-fee contract should include an award amount that is
sufficient to provide motivation for excellence in such areas as
quality, timeliness, technical ingenuity, and cost-effective
management.
[20] The sum of these estimates exceeds 100 percent because respondents
to our questionnaire were provided seven potential reasons as to why
award and incentives fees were used in the contract and were asked to
choose all that applied.
[21] According to DOD, the contract was restructured again in May 2004
and the cost ceiling was increased from about $2 billion to $3.6
billion and the period of performance of the contract was extended more
than 3 years, from June 2005 to December 2008.
[22] We found one instance of DOD using the equivalent of rollover for
incentive-fee contracts. When the contractor missed the third program
milestone on the Army chemical demilitarization contract, the program
delayed the milestone by 14 months and offered the contractor a chance
to earn 80 percent of the available fee. According to program
officials, the performance incentive milestone was rescheduled to re-
incentivize the contractor.
[23] GAO, Incentive Contracts: Examination of Fixed-Price Incentive
Contracts, GAO/NSIAD-88-36BR (Washington, D.C.: November, 1987).
Frederic M. Scherer, The Weapons Acquisition Process: Economic
Incentives (Boston: Harvard University, 1964). Irving N. Fisher, A
Reappraisal of the Incentive Contracting Experience (Santa Monica: The
RAND Corporation, 1968).
[24] Thomas J. Snyder, Analysis of Air Force Award Fee and Award Term
Contract Implementation (Air Command and Staff College: Air University,
2001).
[25] In its technical comments on a draft of this report, DOD stated
that the Air Force's Acquisition Transformation Action Council is
currently analyzing award-and incentive-fee contracts and aggressively
pursuing solutions to the problems outlined in the draft report. A
Transformation Initiative Group was assembled to provide
recommendations back to the Acquisition Transformation Action Council
for implementation.
[26] See GAO, Reliability of Federal Procurement Data, GAO-04-295R
(Washington D.C.: Dec. 30, 2003), for more information on the
reliability of the data.
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