Award Fees and Incentive Contracts, a Focus on Cost Savings

In light of the recent memos by the Office of Management and Budget (OMB) to improve government performance and save on contract costs, focus has turned to the use of award fees on incentive contracts. Earlier this week, the Senate Subcommittee on Federal Financial Management, Government Information, Federal Services, and International Security held hearings to investigate the issue with leaders at the Departments of Defense (DoD), Energy (DOE), Health and Human Services (HHS), and Homeland Security (DHS) and the National Aeronautics and Space Administration (NASA) who constitute the vast majority of spending on award fee contracts. Further, the Government Accountability Office (GAO) did a thorough analysis of the issue, which shows a path to follow, makes recommendations on fixing these issues, but more importantly, lays out the case through cost findings that can translate into real savings.

According to the GAO, current practices for using award fee contracts were inconsistent with the OMB guidance. However, where the revised OMB policies have been applied, the results have been hundreds of millions of dollars in cost savings and better use of government funds. GAO cites one main issue, which is the limiting of second chances for contractors to earn fees not awarded in a previous period. The report states that eliminating unearned fees in eight programs will save DoD over $450 million through fiscal year 2010. The question now becomes what needs to be done to realize savings of this magnitude?

The analysis also indicates that consistent use of award fees are not being implemented across the various agencies within DOE, HHS, and DHS, and these agencies have developed their own internal, disparate approaches to using award fees to the point that very little standardization or understanding of any accurate policy has taken hold. The DoD is the only agency that collects data on the use of award fees. However, this data collected is not being used to evaluate the effectiveness of award fees, but to create paperwork to respond to legislative requirements to Congress. As such, these agencies have stated in their testimony that they generally do not have methods to evaluate the effectiveness of award fees, and that identifying metrics to compare performance across programs would be difficult. Further, GAO found effective practices within some agencies, but the lack of a government-wide or, with the exception of DoD, agency-wide forum to share information or have standard policies remains a potential risk to acquisition programs.

The overall theme of the testimony by agency officials was that further regulations would continue to burden an already difficult situation for the acquisition workforce. As expected, mandated in the 2009 National Defense Authorization Act are these new rules to link award fees to contract outcomes, with the Federal Acquisition Regulation (FAR) Council to prepare these new rules to in late September or October. The new rules will also mandate the collection of more data on award fees and evaluating whether the awards work. I agree with the agency officials that the regulations and guidance already exist, and what is needed is to adhere to these already established parameters that will help improve performance and create real cost savings.

In regards to the regulation, FAR 16.4, Incentive Contracts, describes incentive contract types, award fee usage, and under what circumstances. However, the real key to this issue is the OMB guidance, which describes the overall parameters of using award fees. The agency officials have agreed to establish an interagency working group to determine how best to evaluate the effectiveness of award fees as a tool for improving contractor performance and achieving desired program outcomes and to develop methods for sharing information on successful strategies, in addition to standardizing the use of award fees using OMB guidance as the foundation for the consistent application of theses award fees.

Award fee contracts, when administered properly, can motivate contractor performance when certain principles are applied in the OMB guidance. These principles include linking fees to acquisition outcomes to ensure that the fee being paid is directly related to the cost, schedule, and performance metrics. Further, limiting the opportunity for contractors to have a second chance at earning previously unearned fee in a subsequent period (e.g. rollover) maximizes the incentive during an award fee period, but also is where the cost savings can have significant impact. Under very limited circumstances should rollover be allowed, because it dilutes the intent of motivating performance since the contractors will simply view the fees as a future target and perhaps not live up to expectations. These missed award fees can be used for other areas, with the subsequent cost savings that go with it. Additionally, no fee should be paid for performance that is judged to be unsatisfactory or does not meet contract requirements, or even satisfactory for that matter. I am not a proponent of providing significant award fees for meeting requirements, as the point is to motivate better than average performance which improves operations, efficiencies, and is what the government is seeking. Satisfactory performance should earn considerably less than excellent performance; otherwise the motivation to excel is negated. Of course some fees will be paid to contractors for satisfactory performance so they receive an adequate fee on contracts. Regretfully, that award fee percentage seems to be too high on current contracts. If the contractor will simply be meeting requirements, where is the motivation or justification to pay significant award fees?

Finally, it is the sharing of information that is also vital to communicating the strategy and the process for the use of incentives contracts. Agency officials have stated that the communication factor is a hindrance to improving the use of award fees, but the use of social media, also known as Web 2.0 or Gov 2.0, is a powerful tool that should be exploited to solve this issue. The main benefits to be solved would be enabling effective collaboration and teamwork, especially among disparate teams and across agencies. Further, the transfer of information will be critical to prevent the current process of different agencies, and different departments within an agency, creating their own rules since they are unaware of guidance or standardized procedures. Of course, one of the biggest issues with Web 2.0 is security, and I hope that issue is solved as simply restricting access to these tools is counterproductive and impedes progress on a powerful tool to help improve government knowledge transfer, and thus performance.

I believe the issue of award fees is a good example where further regulation can only hinder vice help. Existing regulation and guidance only need to be fully exploited and executed upon to realize change. I hope that Congress revisits this concept, and does not simply make more work and further unnecessary regulation for regulations sake.