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Testimony: 

Before the Subcommittee on Federal Financial Management, Government 
Information, Federal Services, and International Security, Committee on 
Homeland Security and Governmental Affairs, U.S. Senate: 

United States Government Accountability Office: 
GAO: 

For Release on Delivery: 
Expected at 3:00 p.m. EDT:
Monday, August 3, 2009: 

Federal Contracting: 

Application of OMB Guidance Can Improve Use of Award Fee Contracts: 

Statement of John Hutton, Director:
Acquisition and Sourcing Management: 

GAO-09-839T: 

[End of section] 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss our recent work for this 
subcommittee on the use of award fee contracts. An award fee is an 
amount of money that a contractor may earn in whole or in part by 
meeting or exceeding subjective criteria stated in an award fee plan. 
Typically the criteria are related to quality, technical ingenuity, 
cost-effective management, program management, and other unquantifiable 
areas. From fiscal year 2004 through fiscal year 2008, agencies spent 
over $300 billion on contracts which include award fees. While many 
agencies use award fee contracts, over 95 percent of the government's 
spending using this contract type in fiscal year 2008 occurred at five: 
the departments of Defense (DOD), Energy (DOE), Health and Human 
Services (HHS), and Homeland Security (DHS) and the National 
Aeronautics and Space Administration (NASA). In December 2007, the 
Office of Management and Budget's (OMB) Office of Federal Procurement 
Policy issued guidance to chief acquisition officers and procurement 
executives across the government that echoed several recommendations we 
made in 2005 on the use of award fees and emphasized positive practices 
to be implemented by all agencies.[Footnote 1] 

My statement today is based on our May 29, 2009, report, Federal 
Contracting: Guidance on Award Fees Has Led to Better Practices But is 
Not Consistently Applied (GAO-09-630). Like the report, this statement 
addresses how agencies are implementing OMB's guidance. Specifically, 
we (1) identified the actions agencies have taken to revise or develop 
policies and guidance to reflect OMB guidance on using award fees, (2) 
determined the extent to which current practices for using award fee 
contracts are consistent with the new guidance, and (3) identified the 
extent to which agencies collect and analyze information on award fees 
to evaluate their use and share that information within their agencies. 

To identify the actions that these five agencies have taken to revise 
or develop guidance on the use of award fees, we assessed procurement 
policies and discussed planned and implemented policy changes with 
procurement officials at each agency. To determine the extent to which 
current practices for using award fee contracts are consistent with OMB 
guidance, we reviewed data from 645 evaluation periods for 100 
contracts at the five agencies. For DOD and NASA, our scope included 
contracts examined in prior GAO work and DOD contracts awarded after 
policies were changed that had held at least one award fee period. 
Where applicable, we identified the programmatic and monetary effect of 
implementing policy changes. For DOE, HHS, and DHS, we selected all 
award fee contracts with over $50 million obligated against them from 
fiscal year 2004 through fiscal year 2008 as identified in the Federal 
Procurement Data System (FPDS). We collected data on the amount of the 
award fee available compared to the amount awarded as well as the 
criteria used to evaluate contractor performance. We reviewed contract 
documents including award fee plans to determine the extent to which 
the contracts reflected positive award fee practices identified in our 
prior work and OMB guidance. We also interviewed procurement officials 
at each agency on efforts to collect data on award fees, evaluate their 
effectiveness, and share information on successful strategies. 

Our work for our May 29, 2009, report was conducted from August 2008 
through May 2009 in accordance with generally accepted government 
auditing standards. Those standards require that we plan and perform 
the audit to obtain sufficient and appropriate evidence to provide a 
reasonable basis for our findings and conclusions based on our audit 
objectives. We believe that the evidence obtained provides a reasonable 
basis for our findings and conclusions based on our audit objectives. 
More detailed information on our scope and methodology appears in our 
2009 report. 

OMB's Guidance Is Not Consistently Addressed at All Agencies: 

In December 2007, the OMB Office of Federal Procurement Policy issued 
guidance to chief acquisition officers and senior procurement 
executives to review and update their acquisition policies on the 
appropriate use of incentive fee contracts, which include award fee 
contracts. The guidance highlighted preferred practices including: (1) 
linking award fees to acquisition outcomes, such as cost, schedule, and 
performance results; (2) limiting the use of rollover[Footnote 2] to 
exceptional circumstances defined by agency policies; (3) designing 
evaluation factors that motivate excellent contractor performance by 
making clear distinctions between satisfactory and excellent 
performance; and (4) prohibiting payments for contractor performance 
that is judged to be unsatisfactory or does not meet the basic 
requirements of the contract.[Footnote 3] Further, OMB asked agencies 
to obtain and share practices in using award fees through an existing 
Web-based resource. The OMB guidance was developed based on award fee 
problems that had been identified by GAO and which DOD and NASA had 
begun to address. The following shows how OMB's guidance is reflected 
in guidance provided by each agency: 

* In response to GAO recommendations in 2005[Footnote 4] and subsequent 
legislation,[Footnote 5] DOD issued guidance in 2006 and 2007 that 
states it is imperative that award fees are linked to desired outcomes, 
that the practice of rolling over unearned award fees should be limited 
to exceptional circumstances, that award fees must be commensurate with 
contractor performance, and that performance that is unsatisfactory is 
not entitled to any award fee. It also states that satisfactory 
performance should earn considerably less than excellent performance; 
otherwise, the motivation to achieve excellence is negated. 

* While NASA's Award Fee Guide already addressed the four issues, our 
previous work found that NASA did not consistently implement key 
aspects of its guidance on major award fee contracts.[Footnote 6] In 
response to our findings, a June 2007 NASA policy update reemphasized 
these policies to contracting staff and added a requirement that 
contracting officers include documented cost-benefit analysis when 
using an award fee contract. 

* DOE has supplemental guidance to the Federal Acquisition Regulation 
(FAR) that outlines how award fees should be considered and in 
September 2008 created implementing guidance specific to management and 
operations contracts that links award fees to acquisition outcomes and 
limits the use of rollover. However, DOE's departmental guidance does 
not clearly define the standards of performance for each rating 
category or prevent payment of fees for unsatisfactory performance. 
Divisions of DOE have developed their own standards and methods of 
evaluation which vary in their consistency with the OMB guidance. 

* DHS provides guidance on award fees in its acquisition manual, but 
does not fully address the issues in the OMB guidance. The DHS guidance 
requires award fee plans to include criteria related (at a minimum) to 
cost, schedule, and performance and establishes that award fees are to 
be earned for successful outcomes and that no award fee may be earned 
against criteria that are ranked below "successful" or "satisfactory." 
However, the manual does not describe standards or definitions for 
determining various levels of performance or include any limitation on 
the use of rollover. 

* HHS officials did not have guidance specific to the use of award fees 
and were not aware of any such guidance at their operational divisions. 
Officials told us that they relied on the FAR for guidance on using 
award fees. However, contracting officials at HHS operational divisions 
noted a need for better guidance and told us that the FAR did not 
provide the level of detail needed to execute an award fee contract. As 
a result, contracting officers at these operational divisions have 
developed approaches to award fee contracts which vary in their degree 
of consistency with OMB's guidance. 

The National Defense Authorization Act for Fiscal Year 2009[Footnote 7] 
directed that the FAR be amended by the middle of October 2009 to 
expand the requirements placed on DOD in 2007 to all executive 
agencies.[Footnote 8] A working group including representatives from 
these agencies is reviewing and updating the FAR. DOD officials also 
told us that they are developing supplemental guidance on award fees, 
but will wait until the FAR working group completes its work before 
finalizing the guidance. 

Agency Practices Are Not Always Consistent with OMB Guidance: 

By implementing the revised guidance, some DOD components reduced costs 
and improved management of award fee contracts. Potential changes at 
NASA --such as documented cost-benefit analyses--are too recent for 
their full effects to be judged. At DOE, DHS, and HHS, individual 
contracting offices have developed their own approaches to executing 
award fee contracts which are not always consistent with the principles 
in the OMB guidance or between offices within these departments. 

* Use of Rollover: Guidance from DOD, DOE, and OMB states that allowing 
contractors a second chance at unearned fees should be limited to 
exceptional circumstances and should require high-level approval. NASA 
guidance does not allow rollover. Allowing contractors an opportunity 
to obtain previously unearned fees reduces the motivation of the 
incentive in the original award fee period. In almost all of the 50 DOD 
contracts we reviewed, rollover is now the exception and not the rule. 
While in 2005 we found that 52 percent of all DOD programs rolled over 
fee, only 4 percent of the programs in our sample continue this 
practice. We reviewed active contracts from our 2005 sample and found 
that eliminating rollover will save DOD more than an estimated $450 
million on 8 programs from April 2006 through October 2010. However, 
with the exception of NASA where rollover is not allowed, we found 
instances at each agency, where rollover was allowed, at times, for 100 
percent of the unearned fee. 

* Linking Fees to Outcomes: OMB's guidance indicates that award fees 
should be used to achieve specific performance objectives established 
prior to contract award, such as delivering products and services on 
time, within cost, and with promised performance; and must be tied to 
demonstrated results, as opposed to effort. Contracting officers and 
program managers across all five agencies said award fee contracts 
could benefit from objective targets that equate to a specific amount 
of the fee. While the combination of award fee contracts which evaluate 
subjective criteria and incentive contracts which evaluate objective 
targets was the preferred approach of several officials, there is no 
guidance on how to balance or combine these contract types. The 
effective use of subjective criteria requires that they be accompanied 
by definitions and measurements of their own to ensure they are linked 
to outcomes rather than processes or efforts. DOD's Joint Strike 
Fighter is one program that has incorporated more discrete criteria. In 
comparing periods before and after the application of these criteria, 
the contractor has consistently scored lower in the performance areas 
than in previous periods where less defined criteria were applied. We 
estimate that the more accurate assessment of contractor performance 
has saved almost $29 million in less than 2 years of the policy change. 
However, contracts do not always use criteria that are linked to 
outcomes. For example, an HHS contract for call center services awarded 
a portion of the fees based on results, such as response times, but 
also included criteria based more on efforts, such as requiring the 
contractor to ensure that staffing levels were appropriate for 
forecasted volumes during hours of operation, rather than measuring 
results. 

* Using Evaluation Factors to Motivate Excellent Performance: The 
amount of the fee established for satisfactory performance or meeting 
contract requirements generally awards the contractor for providing the 
minimum effort acceptable to the government. Programs used a broad 
range in setting the amount of the fee available for satisfactory 
performance, but many left little to motivate excellent performance. 
For example, DOE's Office of Science uses a model that sets the amount 
of the fee able to be earned for meeting expectations at 91 percent, 
thus leaving 9 percent to motivate performance that exceeds 
expectations. In contrast, in an HHS contract for management, 
operation, professional, technical, and support services, the 
contractor earns 35 percent of the award fee for satisfactory 
performance, leaving 65 percent of the fee to motivate excellent 
performance. DOD and NASA are the only agencies we reviewed that 
provide guidance on the amount of the fee to be paid for satisfactory 
performance, up to 50 percent and 70 percent respectively. However, not 
all DOD programs have followed this guidance. For example, a DOD 
Missile Defense Agency (MDA) contract signed in December 2007 awards 
the contractor up to 84 percent of the award fee pool for satisfactory 
performance, which the agency defines as meeting most of the 
requirements of the contract. This leaves only 16 percent of the award 
fee pool to motivate performance that fully meets contract requirements 
or is considered above satisfactory. 

* Payments for Unsatisfactory Performance: DOD, NASA, and OMB have 
stated that performance not meeting contract requirements or judged to 
be unsatisfactory merits no award fee. However, while the median award 
fee scores indicate satisfaction with the results of the contract, 
programs we reviewed continue to use evaluation tools that could allow 
for contractors to earn award fees without performing at a level that 
is acceptable to the government under the terms of the contract. For 
example, an HHS contract for Medicare claims processing rates 
contractor performance on a point scale, from 0 to 100, where the 
contractor can receive up to 49 percent of the fee for unsatisfactory 
performance and up to 79 percent for satisfactory performance (defined 
as meeting contract requirements). The National Nuclear Safety 
Administration, a separate agency within DOE, uses a tool that 
prohibits payments for unsatisfactory performance while the evaluation 
method used by DOE's Office of Science allows a contractor to earn up 
to 84 percent of the award fee for performance that is defined as not 
meeting expectations. Further, current award fee plans for some 
programs using the Office of Science lab appraisal process allow for an 
award fee to be earned at the "C" level, which guidance defines as 
performance in which "a number of expectations...are not met and/or a 
number of other deficiencies are identified" with potentially negative 
impacts to the lab and mission. According to Office of Science 
guidance, as much as 38 percent of the fee can be earned for objectives 
that fall in this category. 

Agencies Do Not Have Methods for Evaluating Award Fee Effectiveness in 
Improving Contractor Performance: 

While programs have paid more than $6 billion in award fees for the 100 
contracts we reviewed, none of the five agencies has developed methods 
for evaluating the effectiveness of an award fee as a tool for 
improving contractor performance. Instead, program officials noted that 
the effectiveness of a contract is evident in the contractor's ability 
to meet the overall goals of the program and respond to the priorities 
established for a particular award fee period. However, officials were 
not able to identify the extent to which successful outcomes were 
attributable to incentives provided by award fees versus external 
factors such as a contractor's interest in maintaining a good 
reputation. When asked how they would respond to a requirement to 
evaluate the effectiveness of an award fee, officials told us that they 
would have difficulty developing performance measures that would be 
comparable across programs. 

Of the five agencies we reviewed, only DOD collects data on award fee 
contracts. In 2006, legislation required DOD to develop guidance on the 
use of award fees that included ensuring that the department collects 
relevant data on award and incentive fees paid to contractors and that 
it has mechanisms in place to evaluate such data on a regular basis. 
[Footnote 9] DOD has collected and analyzed data and provided that 
analysis to Congress and the Senior Procurement Executives of the 
military services and other DOD agencies. However, DOD does not have 
performance measures to evaluate the effectiveness of award fees as a 
tool for improving contractor performance and achieving desired program 
outcomes. DOD's data collected on objective efficiencies include cost 
and schedule measures but do not reflect any consideration of the 
circumstances that affected performance, a critical element in 
determining award fees. 

While DOD has established an award fee community of practice through 
its Defense Acquisition University, most information regarding 
successful strategies for using award fees is shared through informal 
networks. Contracting officers at DOD, DOE, DHS, and HHS were unaware 
of any formal networks or resources for sharing best practices, lessons 
learned, or other strategies for using award fee contracts, and said 
they rely on informal networks or existing guidance from other 
agencies. However, within agencies, procurement executives are 
beginning to review award fee criteria across programs for consistency 
and successful strategies. 

Concluding Observations and Prior Recommendations for Executive Action: 

Award fee contracts can motivate contractor performance when certain 
principles are applied. Linking fees to acquisition outcomes ensures 
that the fee being paid is directly related to the quality, timeliness, 
and cost of what the government is receiving. Limiting the opportunity 
for contractors to have a second chance at earning a previously 
unearned fee maximizes the incentive during an award fee period. 
Additionally, the amount of the fee earned should be commensurate with 
contractor performance based on evaluation factors designed to motivate 
excellent performance. Further, no fee should be paid for performance 
that is judged to be unsatisfactory or does not meet contract 
requirements. While DOD has realized benefits from applying these 
principles to some contracts, these principles have not been 
established fully in guidance at DOE, DHS, and HHS. Having guidance is 
not enough, however, unless it is consistently implemented. Further, 
the lack of methods to evaluate effectiveness and promote information 
sharing among and within agencies has created an atmosphere in which 
agencies are unaware of whether these contracts are being used 
effectively and one in which poor practices can go unnoticed and 
positive practices can be isolated. 

In our report, we recommended that DOE, HHS, and DHS update or develop 
implementing guidance on using award fees. This guidance should provide 
instructions and definitions on developing criteria to link award fees 
to acquisition outcomes, using an award fee in combination with 
incentive fees, rolling over unearned fees, establishing evaluation 
factors to motivate contractors toward excellent performance, and 
prohibiting payments of award fees for unsatisfactory performance. To 
expand upon improvements made, we recommended that DOD promote 
consistent application of existing guidance, including reviewing 
contracts awarded before the guidance was in effect for opportunities 
to apply it, and provide guidance on using an award fee in combination 
with incentive fees to maximize the effectiveness of subjective and 
objective criteria. We also recommended that the five agencies 
establish an interagency working group to (1) identify how best to 
evaluate the effectiveness of award fees as a tool for improving 
contractor performance and achieving desired program outcomes and (2) 
develop methods for sharing information on successful strategies. The 
agencies concurred with our recommendations and noted that both the FAR 
working group and an interagency working group could be potential 
mechanisms for implementing our recommendations. 

Mr. Chairman, this concludes my statement. I would be pleased to 
respond to any questions you or other Members of the Subcommittee may 
have. 

For questions regarding this statement, please contact John P. Hutton 
at (202) 512-4841 or at huttonj@gao.gov. Individuals making 
contributions to this testimony include Thomas Denomme, Assistant 
Director, Kevin Heinz, John Krump, and Robert Swierczek. 

[End of section] 

Footnotes: 

[1] GAO, Defense Acquisitions: DOD Has Paid Billions in Award and 
Incentive Fees Regardless of Acquisition Outcomes, [hyperlink, 
http://www.gao.gov/products/GAO-06-66] (Washington, D.C.: 2005). 

[2] Rollover is a practice in which unearned award fee is moved from 
one evaluation period to a subsequent evaluation period or periods, 
thus providing the contractor an additional opportunity to earn 
previously unearned fee. 

[3] Other guidance in OMB's guidance memo included performing a cost- 
benefit analysis before using incentive fees and ensuring that plans 
had clear definitions on how contractors would be evaluated, the levels 
of performance used to judge them, and specific criteria on how to 
achieve those levels. 

[4] [hyperlink, http://www.gao.gov/products/GAO-06-66]. 

[5] The John Warner National Defense Authorization Act for Fiscal Year 
2007. Pub. L. No. 109-364, § 814 (2006). 

[6] [hyperlink, http://www.gao.gov/products/GAO-07-58], NASA 
Procurement: Use of Award Fees for Achieving Program Outcomes Should Be 
Improved, GAO-07-58 (Washington, D.C.: 2007). 

[7] The Duncan Hunter National Defense Authorization for Fiscal Year 
2009, Pub. L. No. 110-417 §. 867 (2008). 

[8] Pub. L. No. 109-364, § 814 (2006). 

[9] Pub. L. No. 109-364, § 814 (2006). 

[End of section] 

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