Defense Acquisitions
DOD Wastes Billions of Dollars through Poorly Structured Incentives Gao ID: GAO-06-409T April 5, 2006With DOD spending over $200 billion annually to acquire products and services that include everything from spare parts to the development of major weapon systems, our numerous, large, and mounting fiscal challenges demand that DOD maximize its return on investment and provide the warfighter with needed capabilities at the best value for the taxpayer. In an effort to encourage defense contractors to perform in an innovative, efficient, and effective way, DOD gives its contractors the opportunity to collectively earn billions of dollars through monetary incentives known as award and incentive fees. Using these incentives properly--in concert with good acquisition practices--is a key to minimizing waste, maximizing value, and getting our military personnel what they need, when and where they need it. Congress asked GAO to testify on DOD's use of award and incentive fees and the role they play in the acquisition system. This statement highlights the risks of conducting business as usual and identifies the actions DOD needs to take to use these fees more effectively. DOD concurred or partially concurred with the seven recommendations GAO made in a previously issued report on award and incentive fees. GAO looks forward to seeing DOD turn these promised steps into actual policy and practice.
DOD's use of award and incentive fees is an issue at the nexus of two areas that GAO has designated "high risk" for DOD--contract management and weapon system acquisition. Contract management has been a long-standing business management challenge for DOD because it often cannot assure that it is using sound business practices to acquire the goods and services the warfighter needs. For weapon system acquisitions, the persistent and long-standing nature of acquisition problems has perhaps made a range of key decision makers complacent about cost growth, schedule delays, quantity reductions, and performance shortfalls. DOD's strategies for incentivizing its contractors, especially for weapon system development programs, reflect the challenges in these areas. DOD programs routinely engage in award-fee practices that do not hold contractors accountable for achieving desired outcomes and undermine efforts to motivate contractor performance, such as evaluating contractors on award-fee criteria that are not directly related to key acquisition outcomes (e.g., meeting cost and schedule goals and delivering desired capabilities to the warfighter); paying contractors a significant portion of the available fee for what award-fee plans describe as "acceptable, average, expected, good, or satisfactory" performance; and giving contractors at least a second opportunity to earn initially unearned or deferred fees. As a result, DOD has paid out an estimated $8 billion in award fees on contracts in GAO's study population, regardless of whether acquisition outcomes fell short of, met, or exceeded DOD's expectations. Despite paying billions of dollars, DOD has not compiled data or developed performance measures to evaluate the validity of its belief that award and incentive fees improve contractor performance and acquisition outcomes. These issues, along with those GAO has identified in DOD's acquisition and business management processes, present a compelling case for change. By implementing the recommendations GAO has made on award and incentive fees, DOD can improve incentives, increase transparency, and enhance accountability for the fees it pays. At the same time, by working more broadly to improve its acquisition practices, DOD can set the right conditions for getting better acquisition outcomes and making more efficient use of its resources in what is sure to be a more fiscally constrained environment.
GAO-06-409T, Defense Acquisitions: DOD Wastes Billions of Dollars through Poorly Structured Incentives
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Testimony:
Before the Subcommittee on Readiness and Management Support, Committee
on Armed Services, U.S. Senate:
United States Government Accountability Office:
GAO:
For Release on Delivery Expected at 3:00 p.m. EDT:
Wednesday April 5, 2006:
Defense Acquisitions:
DOD Wastes Billions of Dollars through Poorly Structured Incentives:
Statement of David M. Walker:
Comptroller General of the United States:
GAO-06-409T:
GAO Highlights:
Highlights of GAO-06-409T, a testimony before the Subcommittee on
Readiness and Management Support, Committee on Armed Services, U.S.
Senate
Why GAO Did This Study:
With DOD spending over $200 billion annually to acquire products and
services that include everything from spare parts to the development of
major weapon systems, our numerous, large, and mounting fiscal
challenges demand that DOD maximize its return on investment and
provide the warfighter with needed capabilities at the best value for
the taxpayer. In an effort to encourage defense contractors to perform
in an innovative, efficient, and effective way, DOD gives its
contractors the opportunity to collectively earn billions of dollars
through monetary incentives known as award and incentive fees. Using
these incentives properly”in concert with good acquisition practices”is
a key to minimizing waste, maximizing value, and getting our military
personnel what they need, when and where they need it.
The subcommittee asked GAO to testify on DOD‘s use of award and
incentive fees and the role they play in the acquisition system. This
statement highlights the risks of conducting business as usual and
identifies the actions DOD needs to take to use these fees more
effectively. DOD concurred or partially concurred with the seven
recommendations GAO made in a previously issued report on award and
incentive fees. GAO looks forward to seeing DOD turn these promised
steps into actual policy and practice.
What GAO Found:
DOD‘s use of award and incentive fees is an issue at the nexus of two
areas that GAO has designated ’high risk“ for DOD”contract management
and weapon system acquisition. Contract management has been a long-
standing business management challenge for DOD because it often cannot
assure that it is using sound business practices to acquire the goods
and services the warfighter needs. For weapon system acquisitions, the
persistent and long-standing nature of acquisition problems has perhaps
made a range of key decision makers complacent about cost growth,
schedule delays, quantity reductions, and performance shortfalls. DOD‘s
strategies for incentivizing its contractors, especially for weapon
system development programs, reflect the challenges in these areas.
DOD programs routinely engage in award-fee practices that do not hold
contractors accountable for achieving desired outcomes and undermine
efforts to motivate contractor performance, such as
* evaluating contractors on award-fee criteria that are not directly
related to key acquisition outcomes (e.g., meeting cost and schedule
goals and delivering desired capabilities to the warfighter);
* paying contractors a significant portion of the available fee for
what award-fee plans describe as ’acceptable, average, expected, good,
or satisfactory“ performance; and
* giving contractors at least a second opportunity to earn initially
unearned or deferred fees.
As a result, DOD has paid out an estimated $8 billion in award fees on
contracts in GAO‘s study population, regardless of whether acquisition
outcomes fell short of, met, or exceeded DOD‘s expectations. Despite
paying billions of dollars, DOD has not compiled data or developed
performance measures to evaluate the validity of its belief that award
and incentive fees improve contractor performance and acquisition
outcomes.
These issues, along with those GAO has identified in DOD‘s acquisition
and business management processes, present a compelling case for
change. By implementing the recommendations GAO has made on award and
incentive fees, DOD can improve incentives, increase transparency, and
enhance accountability for the fees it pays. At the same time, by
working more broadly to improve its acquisition practices, DOD can set
the right conditions for getting better acquisition outcomes and making
more efficient use of its resources in what is sure to be a more
fiscally constrained environment.
www.gao.gov/cgi-bin/getrpt?GAO-06-409T.
To view the full product, including the scope and methodology, click on
the link above. For more information, contact Katherine Schinasi at
(202) 512-4841 or schinasik@gao.gov.
[End of section]
Mr. Chairman and Members of the Subcommittee:
I am pleased to be here today to discuss the Department of Defense's
(DOD) use of monetary incentives known as award and incentive fees.
With DOD spending over $200 billion annually to acquire products and
services that include everything from spare parts to the development of
major weapon systems, our numerous, large, and mounting fiscal
challenges demand that DOD maximize its return on investment and
provide the warfighter with needed capabilities at the best value for
the taxpayer. In an effort to encourage defense contractors to perform
in an innovative, efficient, and effective way, DOD gives its
contractors the opportunity to collectively earn billions of dollars
through monetary incentives known as award and incentive fees. Using
these incentives properly, in concert with sound acquisition practices,
is a key to minimizing waste, maximizing value, and getting our
military personnel what they need, when and where they need it.
Unfortunately, DOD has not used these incentives effectively. How they
have been used and how we believe they should be used is the focus of
my statement today.
To put the issues related to DOD's use of award and incentive fees in
context, I want to step back and look at some of the broader management
challenges that confront DOD. The department is facing a significant
number of recurring problems in managing its major weapon acquisitions.
Although U.S. weapons are the best in the world, DOD's acquisition
process for weapons programs consistently yields undesirable
consequences--dramatic cost increases, late deliveries to the
warfighter, and performance shortfalls. These problems occur, in part,
because DOD tends to consistently overpromise and underdeliver in
connection with major acquisition efforts. In addition, DOD's weapons
programs do not capture, early on, the requisite knowledge that is
needed to efficiently and effectively manage program risks. For
example, programs lack clearly defined and stable requirements, move
forward with unrealistic program cost and schedule estimates, 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; expectation gaps are the norm; problems often surface late in
the development process; and fixes tend to be much more costly than if
they were caught earlier.
Cost increases incurred while developing new weapon systems typically
mean that DOD cannot produce as many of those weapons as intended nor
can it be relied on to deliver them to the warfighter when promised and
with the initially advertised capabilities. In addition, military
operations in Afghanistan and Iraq are consuming a large share of DOD
resources and causing the department to invest more money sooner than
expected to replace or fix existing weapons. Meanwhile, DOD is intent
on transforming military operations and currently has its eye on
multiple megasystems that are expected to be the most expensive and
complex ever. These new desires and long-standing acquisition and
contract management challenges are running head-on into the nation's
current imprudent and unsustainable fiscal path. At the same time,
DOD's numerous business management weaknesses continue to result in
reduced efficiencies and effectiveness that waste billions of dollars
every year. These business management weaknesses touch on all of DOD's
major business operations, ranging from the department's inadequate
management of its overall business transformation effort to decades-old
financial management and information technology problems to various
contracting and selected supply chain challenges. In fact, all these
areas and more are on GAO's 2005 "high-risk" list of programs and
activities that need urgent attention and fundamental transformation to
ensure that our national government functions in the most economical,
efficient, and effective manner possible.
DOD's use of award and incentive fees is an issue at the nexus of two
of these high-risk areas--DOD contract management and DOD weapon system
acquisition. Contract management has been a long-standing business
management challenge for the department. DOD is the government's
largest purchaser, yet it is often unable to assure that it is using
sound business practices to acquire the goods and services needed to
meet the warfighter's needs. For example, we have found that DOD has
not used various contracting tools and techniques effectively--such as
performance-based service contracting, multiple-award task order
contracts, purchase cards, and, most recently, award and incentive
fees. For DOD weapon system acquisitions, we have found the persistent
and long-standing nature of acquisition problems has perhaps made a
range of key players both in the Pentagon and the Congress complacent
about cost growth, schedule delays, quantity reductions, and
performance shortfalls in weapon system programs. DOD's strategies for
incentivizing its contractors, especially on weapon system development
programs, reflect this complacency and are symptomatic of the lack of
discipline, oversight, transparency, and accountability in DOD's
acquisition process. As a result, DOD programs routinely engage in
practices that undermine efforts to motivate positive 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 to the warfighter.
Specifics follow:
* DOD generally does not evaluate contractors based on award-fee
criteria that are directly related to key acquisition outcomes. In
addition, the link between the elements of contractor performance that
are included in the criteria and these outcomes is not always clear. As
a result, DOD paid out an estimated $8 billion in award fees over the
life of the contracts in our study population (from their inception
through our data collection phase),[Footnote 1] regardless of whether
acquisition outcomes fell short of, met, or exceeded DOD's
expectations.
* DOD programs engage in practices that undermine efforts to motivate
excellent contractor performance by regularly paying contractors a
significant portion of the available fee for what award-fee plans
describe as "acceptable, average, expected, good, or satisfactory"
performance. Although the definition of this level of performance
varies by contract, these definitions are generally not related to
outcomes. About half of the contracts in our sample, allowed 70 percent
or more of the available fee to be paid for this level of performance.
* DOD award fee practices do not promote accountability. DOD programs
gave contractors on about half of the award-fee contracts in our study
population at least a second opportunity to earn an estimated $669
million in initially unearned or deferred fees.
Taken together, DOD's acquisition, business, and contract management
practices are contrary to the purpose of performance-based contracting
concepts and have resulted and, if not corrected in both form and
practice, will continue to result in wasting billions of dollars in
taxpayer funds. My statement today will focus on what steps DOD must
take to strengthen the link between monetary incentives and acquisition
outcomes and by extension increase the transparency and accountability
of DOD programs for fees paid and of contractors for results achieved.
This testimony draws upon our recently issued report on DOD's use of
award and incentive fees as well as the GAO High-Risk series and our
body of work on weapon system acquisitions.
GAO's many acquisition-related reports over the years raise serious
questions about the reasonableness, appropriateness, and affordability
of DOD's current investment plans; the soundness of the acquisition
process which implements those plans; and the effectiveness of the
practices DOD uses to manage its contractors, including the use of
award and incentive fees. These reports collectively present a
compelling case for change.
Appendix I contains information about the scope and methodology for GAO-
06-66, Defense Acquisitions: DOD Has Paid Billions in Award and
Incentive Fees Regardless of Acquisition Outcomes. The work was
conducted in accordance with generally accepted government auditing
standards.
Background:
Federal agencies, including DOD, can choose among numerous contract
types to acquire products and services. One of the characteristics that
vary 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]
Federal acquisition regulations state that award-and incentive-fee
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.
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.[Footnote 3] These
areas are susceptible to judgmental and qualitative measurement and
evaluation, and as a result, award-fee criteria and evaluations tend to
be subjective.[Footnote 4] Table 1 provides a description of the
general process for evaluating the contractor and determining the
amount of award fee earned.
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 briefing or summary for
award-fee evaluation board.[A].
3; Award-fee evaluation board convenes meeting; contractor has 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 contracting officer.[B].
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 final determination, including
whether to roll over unearned fee, and notifies contracting
officer.[C].
8; Contracting officer issues final determination to contractor and
processes a contract modification authorizing payment.
Sources: Army Contracting Agency Award Fee Handbook, Air Force Award
Fee Guide, Navy/Marine Corps Award Fee Guide (data); GAO (analysis).
[A] 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.
[B] 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.
[C] Rollover is the practice of moving 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.
[End of table]
Prevalence and Use of Award and Incentive Fees:
From fiscal year 1999 through fiscal year 2003, award-and incentive-fee
contract actions[Footnote 5] 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. Our sample of 93 contracts
includes $51.6 billion, or almost one-third, of those obligated award-
and incentive-fee contract dollars.[Footnote 6] These obligations
include award-and incentive-fee payments as well as other contract
costs.
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. Further, we estimate that most of the contracts and most of
the dollars in our study population are related to the acquisition of
weapon systems.
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;[Footnote 7] 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 8]
There is no limit on the maximum percentage of the value of the
contract that can be made available in award fee, although the 20
percent included in the Space-Based Infrared Radar System High
development contract we examined was outside the norm. The available
award fees on all the award-fee contracts in our study population
typically ranged from 7 to 15 percent of the estimated value of the
contract.
A System in Need of Reform:
DOD's use of award and incentive fees is symptomatic of an acquisition
system in need of fundamental reform. DOD's historical practice of
routinely paying its contractors nearly all of the available award fee
creates an environment in which programs pay and contractors expect to
receive most of the available fee, regardless of acquisition outcomes.
This is occurring at a time when DOD is giving contractors increased
program management responsibilities to develop requirements, design
products, and select major system and subsystem contractors. 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 9] was 90 percent, representing an estimated $8
billion in award fees for contracts active between fiscal years 1999
and 2003. Estimates of total award fees earned 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.[Footnote 10] Figure 2 shows the percentage of
available fee earned for the 63 award-fee contracts in our sample.
Figure 2: Percentage of Available Fee Paid to Date for 63 Award-Fee
Contracts in GAO's Sample:
[See PDF for image]
Sources: DOD submissions to GAO and contract documentation (data); GAO
(analysis and presentation).
[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 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.
A Case for Change: Moving Toward Outcome-Based Award-Fee Criteria:
Recommendations made:
* Move toward more outcome-based award-fee criteria that are both
achievable and promote accountability for positive acquisition
outcomes;
DOD response:
* DOD issued a policy memo on March 29, 2006, emphasizing the need to
link award fees to desired program outcomes.
Award fees have generally not been effective at helping DOD achieve its
desired acquisition outcomes, in large part, because award-fee criteria
are not linked to desired acquisition outcomes, such as meeting cost
and schedule goals and delivering desired capabilities. Instead, DOD
programs structure award fees to focus on the broad aspects of
contractor performance, such as technical and management performance
and cost control, that they view as keys to a successful program. In
addition, elements of the award-fee process, such as the frequency of
evaluations and the composition of award-fee boards, may also limit
DOD's ability to effectively and impartially evaluate the contractor's
progress toward acquisition outcomes. Most award-fee evaluations are
time-based, generally every six months, rather than event-based; and
award-fee boards are made up primarily of individuals directly
connected to the program. As a result of all these factors, DOD
programs frequently paid most of the available award fee for what they
described as improved contractor performance, regardless of whether
acquisition outcomes fell short of, met, or exceeded DOD's
expectations.
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 positive
performance and adequate 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. These
programs--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 received 85,
91, 100, and 74 percent of the award fee, respectively to date
(adjusted for rollover), totaling $1.7 billion (see table 2).
Table 2: Program Performance and Award-Fee Payments on Selected DOD
Development Programs:
Acquisition outcomes: Research and development cost increase over
original 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 original
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 the 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 and presentation).
[A] The Air Force Space Command has not specified the acquisition cycle
time for the Space-Based Infrared Radar 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 fee 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. For instance, DOD's Missile Defense Agency
attempted to hold contractors accountable for program outcomes on the
Airborne Laser program. On this 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. Importantly, 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 11]
A Case for Change: Motivating Excellent Contractor Performance and
Promoting Accountability:
Recommendations made:
* Ensure that award-fee structures are motivating excellent contractor
performance by only paying award fees for above satisfactory
performance;
DOD response:
* While DOD stated that award fee arrangements should be structured to
encourage the contractor to earn the preponderance of fee by providing
excellent performance, it maintains that paying a portion of the fee
for satisfactory performance is appropriate to ensure that contractors
receive an adequate fee on contracts. In its March 29, 2006 policy
memo, DOD reiterated this position and emphasized that less than
satisfactory performance is not entitled to any award fee.
Recommendations made:
* Issue DOD guidance on when rollover is appropriate;
DOD response:
* In its March 29, 2006 policy memo, DOD provided guidance and placed
several limitations on the use of rollover.
DOD programs routinely engage in award-fee practices that are
inconsistent with the intent of award fees, reduce the effectiveness of
these fees as motivators of performance, compromise the integrity of
the fee process, and waste billions in taxpayer money. Two practices,
in particular, paying significant amounts of fee for "acceptable,
average, expected, good, or satisfactory" performance and providing
contractors multiple opportunities to earn fees that were not earned
when first made available, undermine the effectiveness of fees as a
motivational tool and marginalize their use in holding contractors
accountable for acquisition outcomes.
Although DOD guidance and federal acquisition regulations state that
award fees should be used to motivate excellent contractor performance,
most DOD award-fee contracts pay a significant portion of the available
fee for what award-fee plans describe as "acceptable, average,
expected, good, or satisfactory" performance. Although the definition
of this level of performance varies by contract, these definitions are
generally not related to outcomes. Some plans for contracts in our
sample did not even require the contractor to meet all of the minimum
standards or requirements of the contract to receive one of these
ratings. Some plans also allowed for fee to be paid for marginal
performance. Even fixed-price-award-fee contracts, which already
include a normal level of profit in the price, paid out award fees for
satisfactory performance. Figure 3 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.
Figure 3: 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 use of rollover is another indication that DOD's management of
award-fees lacks the appropriate incentives, transparency, and
accountability necessary for an effective pay-for-performance system.
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 previously
unearned award-fee. We estimate that 52 percent of DOD award-fee
contracts rolled over unearned fees into subsequent evaluation
periods,[Footnote 12] and in 52 percent[Footnote 13] of these periods,
at least 99 percent of the unearned fee was rolled over. 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.
A Case for Change: Ensuring Practice Is Consistent with Policy:
Recommendations made:
* Requiring appropriate approving officials to review new contracts to
make sure award-fee criteria reflect desired acquisition outcomes and
award-fee structures motivate excellent contractor performance by only
providing fees for above satisfactory performance;
DOD response:
* DOD plans to conduct an analysis to determine what the appropriate
approving official level should be for new contracts utilizing award
fees and issue additional guidance if needed by June 1, 2006.
The inconsistent application of DOD's existing policies on award fees
and weapon system development reinforce the need for increased
transparency and accountability in DOD's management of award fees.
Although DOD award-fee guidance and federal acquisition regulations
state that award fees should be used to motivate excellent contractor
performance, most DOD award-fee contracts still pay a significant
portion of the available fee for what award-fee plans describe as
"acceptable, average, expected, good, or satisfactory"
performance.[Footnote 14] Air Force, Army, and Navy guidance that
states rollover should rarely be used in order to avoid compromising
the integrity of the award-fee evaluation process; however, about half
of the contracts in our study population used rollover.
A Case for Change: Developing and Sharing Proven Incentive Strategies:
Recommendations made:
* Develop a mechanism for capturing award-and incentive-fee data within
existing data systems, such as the Defense Acquisition Management
Information Retrieval system;
DOD response:
* DOD will conduct an analysis of existing systems and determine which,
if any, is best suited, to capture this type of data and at what cost.
DOD expects to complete the study by June 1, 2006.
Recommendations made:
* Develop performance measures to evaluate the effectiveness of award
and incentive fees as a tool for improving contractor performance and
achieving desired program outcomes;
DOD response:
* DOD will review and identify possible performance measures and
determine the appropriate actions by June 1, 2006.
Recommendations made:
* 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;
DOD response:
* In its March 29, 2006 policy memo, DOD tasked Defense Acquisition
University to develop an online repository for award-and incentive-fee
policy information, related training courses, and examples of good
award fee arrangements.
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 of Defense 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. However, DOD has not compiled information,
conducted evaluations, shared lessons learned, 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 both necessary and appropriate.
Conclusions:
DOD's use of award-fee contracts, especially for weapon system
development, reflects the fundamental lack of knowledge and program
instability that we have consistently cited as the main reasons for
DOD's poor acquisition outcomes. DOD uses these fees in an attempt to
mitigate the risks that it creates through a flawed approach to major
weapon system development. The DOD requirements, acquisition,
budgeting, and investment processes are broken and need to be fixed.
DOD's requirements process generates much more demand for new programs
than fiscal resources can reasonably support. The acquisition
environment encourages launching product developments that promise the
best capability, but embody too many technical unknowns and too little
knowledge about the performance and production risks they entail.
However, a new program will not be approved unless its costs fall
within forecasts of available funds and, therefore, looks affordable.
Further, because programs are funded annually and departmentwide, cross-
portfolio priorities have not been established, competition for funding
continues over time, forcing programs to view success as the ability to
secure the next funding increment rather than delivering capabilities
when expected and as promised.
The business cases to support weapon system programs that result from
these processes are in many cases not executable because the incentives
inherent in the current defense acquisition system are not conducive to
establishing realistic cost, schedule, and technical goals. As a
result, DOD has to date not been willing to hold its programs or its
contractors accountable for achieving its specified acquisition
outcomes. Instead, faced with a lack of knowledge and the lack of a
sound business case, DOD programs use award-fee contracts, which by
their very nature allow DOD to evaluate its contractors on a subjective
basis. This results in billions of dollars in wasteful payments because
these evaluations are based on contractors' ability to guide programs
through a broken acquisition system, not on achieving desired
acquisition outcomes.
Implementing our recommendations on award and incentive fees will not
fix the broader problems DOD faces with its management of major weapons
or service acquisitions. However, by implementing our recommendations,
DOD can improve incentives, increase transparency, and enhance
accountability for the fees it pays. In particular, moving toward more
outcome-based award-fee criteria would give contractors an increased
stake in helping DOD to develop more realistic targets upfront or risk
receiving less fee when unrealistic cost, schedule, and performance
targets are not met. To make this new approach to incentives function
as intended, DOD would also need to address the more fundamental issues
related to its management approach, such as the lack of a sound
business case, lack of well-defined requirements, lack of product
knowledge at key junctions in development, and program instability
caused by changing requirements and across-the-board budget cuts.
Working in concert, these steps can help DOD set the right conditions
for more successful acquisition outcomes and make more efficient use of
its resources in what is sure to be a more fiscally constrained
environment as the nation approaches the retirement of the "baby boom"
generation.
Recent DOD Actions:
Last week, DOD issued a policy memorandum on award-fee contracts that
takes steps towards addressing several of the recommendations made in
our report, and the department has indicated that further actions are
planned to address the remaining recommendations. This guidance is a
positive first step, but, like so many prior DOD concurrences, its
effectiveness will ultimately be determined by how well it is
implemented. Identifying who will be responsible for ensuring it is
carried out and how progress will be monitored and measured are key
ingredients that are missing in the new guidance. We continue to
believe that DOD must designate appropriate approving officials to
review new contracts to ensure that award-fee criteria are tied to
desired acquisition outcomes; fees are used to promote excellent
performance; and the use of rollover provisions in contracts is the
exception not the rule. Changing DOD award-fee practices will also
require a change in culture and attitude. The policy memorandum's
position that it is appropriate to pay a portion of the available award
fee for satisfactory performance to ensure that contractors receive an
"adequate fee on contracts" is indicative of DOD's resistance to
cultural change. Finally, we encourage the department to fully
implement our remaining recommendations including developing a
mechanism to capture award-and incentive-fee data and developing
performance measures to evaluate the effectiveness of these fees.
Mr. Chairman and Members of the Committee, this concludes my prepared
statement. I would be happy to answer any questions you may have at
this time.
[End of section]
Appendix I: Scope and Methodology:
In this statement, we examine fixed-price and cost-reimbursable award-
and incentive-fee contracts, as well as contracts that featured
combinations of these contract types. These contracts were selected as
part of a probability sample of 93 contracts from a 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 statement 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. In the sample, 52 contracts
contained only award-fee provisions; 27 contracts contained only
incentive-fee provisions; and 14 contracts included both. 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,[Footnote 15] 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.
FOOTNOTES
[1] Estimates of total award fees earned 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. The oldest award fee contracts in our sample were signed in
fiscal year 1991. For some contracts, the data collection phase ended
as early as November 2004. For at least one contract, data collection
was not complete until April 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, DOD provides payment for the contractor's allowable incurred
costs, to the extent prescribed in the contract, and the contractor
receives a fee that was negotiated and fixed at the inception of the
contract.
[3] Award-fee contracts are intended to be flexible, so award-fee plans
allow contracting and program officials to change the fee criteria in
these areas and the weight given to each criterion from evaluation
period to evaluation period.
[4] 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.
[5] 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.
[6] These contracts were selected as part of a probability sample of 93
contracts from a 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.
[7] 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.
[8] The 95 percent confidence interval surrounding this estimate ranges
from 46 percent to 73 percent.
[9] 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.
[10] The oldest award fee contracts in our sample were signed in fiscal
year 1991. For some contracts, the data collection phase ended as early
as November 2004. For at least one contract, data collection was not
complete until April 2005.
[11] 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.
[12] The 95 percent confidence interval for this estimate ranges from
40 percent to 64 percent.
[13] The 95 percent confidence interval for this estimate ranges from
34 percent to 69 percent.
[14] 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.
[15] For some contracts, the data collection phase ended as early as
November 2004. For at least one contract, data collection was not
complete until April 2005.
