Defense Acquisitions:

DOD Has Paid Billions in Award and Incentive Fees Regardless of Acquisition Outcomes

GAO-06-66: Published: Dec 19, 2005. Publicly Released: Dec 19, 2005.

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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.

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.

Recommendations for Executive Action

  1. Status: Closed - Implemented

    Comments: In response to a congressional inquiry, DOD collected data on contract actions for which fee or incentive determinations were made during calendar year 2007. DOD submitted a report that included an analysis of the data to Congress in October 2008. While the analysis was able to compare cost and schedule data to award fees paid, DOD has begun to establish metrics to evaluate the effectiveness of award fees in terms of performance. Moreover, they have built a process through which this information will be collected and analyzed over many years. Officials with the Defense Procurement and Policy group stated that analyzing the impact of award and incentive fees will be more feasible once they have collected about 5 years worth of data. Lastly, in October 2008, the National Defense Authorization Act for 2009 spurred the amendment of Federal Acquisition Regulation (FAR) to ensure that each executive agency collect relevant data on award and incentive fees and have a mechanism in place to evaluate the effectiveness of award and incentive fees as a tool for improving contractor performance and achieving desired program outcomes. It is too soon to determine the success of such effort, but we are closing the recommendation because of the implementation of the FAR rule and the evidence that DOD is working to measure the effectiveness of award fees and is discussing their results with other agencies.

    Recommendation: 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, the Secretary of Defense should direct the Undersecretary of Defense for Acquisition, Technology, and Logistics to immediately improve its use of award and incentive fees by developing performance measures to evaluate the effectiveness of award and incentive fees as a tool for improving contractor performance and achieving desired program outcomes.

    Agency Affected: Department of Defense

  2. Status: Closed - Implemented

    Comments: In our report, we recommended that DOD develop a mechanism for capturing award- and incentive-fee data. On April 24, 2007, the Director of Defense Procurement and Acquisition Policy issued a memo on collecting this type data. Specifically, the memo requires each military department and defense agency to collect data on the award and incentive fees that were available and paid for each contract with an estimated value of over $50 million. The data must be reported to the Director of Defense Procurement and Acquisition Policy on a semi-annual basis starting September 30, 2007.

    Recommendation: 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, the Secretary of Defense should direct the Undersecretary of Defense for Acquisition, Technology, and Logistics to immediately improve its use of award and incentive fees by developing a mechanism for capturing award- and incentive-fee data within existing data systems, such as the Defense Acquisition Management Information Retrieval system.

    Agency Affected: Department of Defense

  3. Status: Closed - Implemented

    Comments: On March 29, 2006, the Deputy Under Secretary of Defense (Acquisition and Technology) issued a new policy on award-fee contracts that addressed this recommendation. The policy provides guidance and sets limits on the use of rollover, which involves moving unearned fee money from one evaluation to another. Specifically, the policy states that rolling-over fee should be the exception rather than the rule on DOD programs and contractors should only be eligible to earn a portion of the unearned fee that was rolled-over. This policy is effective immediately.

    Recommendation: 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, the Secretary of Defense should direct the Undersecretary of Defense for Acquisition, Technology, and Logistics to immediately improve its use of award fees on all existing contracts by issuing DOD guidance on when rollover is appropriate.

    Agency Affected: Department of Defense

  4. Status: Closed - Implemented

    Comments: On April 24, 2007, the Director of Defense Procurement and Acquisition Policy issued a memo on the proper use of award fee contracts and award fee provisions. Among other actions, this memo requires the head of the contracting activity to sign a written justification stating that it is neither feasible nor effective to devise predetermined objective incentive targets related to cost, schedule, or technical performance before a cost-plus-award fee contract is used. Copies of these justifications will be provided to the Director of Defense Procurement and Acquisition Policy for all acquisition category one program. In our report, we recommended that DOD require appropriate approving officials to review new contracts to make sure that the military services are moving towards more outcomes-based award-fee criteria. The April 2007 memo addresses the intent of that recommendation by encouraging the use of incentive fees based on objective criteria and requiring that the head of the contracting activity justify and approve the use of award-fee contracts in writing. Providing a copy of these justifications to the Director of Defense Procurement and Acquisition Policy for major defense programs also increases the level of oversight and accountability over how award-fee contracts are being used.

    Recommendation: 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, the Secretary of Defense should direct the Undersecretary of Defense for Acquisition, Technology, and Logistics to immediately improve its use of award fees on all new contracts by requiring the appropriate approving officials to review new contracts to make sure these actions are being taken.

    Agency Affected: Department of Defense

  5. Status: Closed - Not Implemented

    Comments: On April 24, 2007, the Director of Defense Procurement and Acquisition Policy issued a memo on the proper use of award fee contracts and award fee provisions. This memo standardized the rating categories to be used in award fee plans (unsatisfactory, satisfactory, good, excellent, outstanding), the definitions of those ratings, and the percentage of the award fee pool paid for each category. While our report recommended that DOD only pay award fees for above satisfactory performance, the DOD memo still allows for up to 50% of the available award fee to be paid for satisfactory performance.

    Recommendation: 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, the Secretary of Defense should direct the Undersecretary of Defense for Acquisition, Technology, and Logistics to immediately improve its use of award fees on all new contracts by ensuring that award-fee structures are motivating excellent contractor performance by only paying award fees for above satisfactory performance.

    Agency Affected: Department of Defense

  6. Status: Closed - Implemented

    Comments: On March 29, 2006, the Deputy Under Secretary of Defense (Acquisition and Technology) issued a new policy on award-fee contracts that addressed this recommendation. Specifically, the policy states that the ability to earn award fees needs to be directly linked to desired program outcomes. To do this, it mentions the need to tie award fees to identifiable interim outcomes or discrete events or milestones, such as timely completion of preliminary design reviews, critical design reviews, and successful system demonstrations. This policy is effective immediately.

    Recommendation: 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, the Secretary of Defense should direct the Undersecretary of Defense for Acquisition, Technology, and Logistics to immediately improve its use of award fees on all new contracts by instructing the military services to move toward more outcome-based award-fee criteria that are both achievable and promote accountability for acquisition outcomes.

    Agency Affected: Department of Defense

  7. Status: Closed - Implemented

    Comments: On March 29, 2006, the Deputy Under Secretary of Defense (Acquisition and Technology) issued a new policy on award-fee contracts that addressed this recommendation. Specifically, in order to facilitate discussion and to share proven incentive strategies across the entire acquisition workforce, the policy established the "Award and Incentive Fees" Community of Practice under the leadership of the Defense Acquisition University. This online tool is supposed to serve as a repository for all related materials including policy information, related training courses, examples of good award fee arrangements, and other supporting resources related to this policy memorandum. This policy is effective immediately.

    Recommendation: 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, the Secretary of Defense should direct the Undersecretary of Defense for Acquisition, Technology, and Logistics to immediately improve its use of award and incentive fees by 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 Affected: Department of Defense

 

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