The Award Fee has been the staple of Air Force incentive arrangements for the past 25 years or more. It offers the opportunity to leverage performance through the use of subjective criteria and gives power to the Fee Determining Official (FDO) unlike almost any other contract type.

The Space & Missile Systems Center is reviewing the use of Award Fee Incentives in light of a December 2005 GAO report that was highly critical of the way fees have been awarded on programs that have not performed as well as predicted. The GAO report, “Defense Acquisitions: DOD Has Paid Billions in Award and Incentive Fees Regardless of Acquisition Outcomes,” contends that ” despite paying billions in fees, [the Defense Department] has little evidence to support its belief that these fees improve contractor performance and acquisition outcomes.” Some of the criticism stems from the lack of discrete data to support the contention of effectiveness; some is due to the perceived generosity of FDOs across the board (throughout the Defense Department ).

It is true that some FDO s have been willing to accept the contractor’s contention of successful performance, evidenced by the average fee award of higher than 90 percent for the past several years. It is less clear that the fees earned to date were not consistent with the criteria contained in the Award Fee Plan that was on contract. This may be due to the difficulty in developing criteria that capture the way to a successful “outcome-based” conclusion of the contract. This points to the need to write criteria better, i.e. capture the essential elements of the outcomes that are desired.

Defining success

The disconnect can be explained in part by the different perception as to successful performance. To the government FDO, the willingness of the contractor to perform in an environment in which funding is turbulent, where requirements growth is a daily occurrence and where the technical complexity of the system being designed often pushes state-of-the-art advances in what only can be defined as “rocket science.”

Many of the space systems under development today truly push the envelope on intelligence, communications, infrared and radar technology. The advances are of a grand leap forward and should be expected to cost substantial amounts to support the warfighter. The classified and unclassified systems in work today will be a model of technology for future acquisition professionals. In some cases, it is apparent that a more credible job of estimating the cost for these systems might have been accomplished before awarding contracts to industry.

This perception is shared by some members of House and Senate committees, and the cost of these capabilities is truly staggering to them. The discussion/debate as to the appropriate need for the systems and the need for such expensive technological capabilities has gone on for decades and will continue to do so in the foreseeable future. It is often a political issue that transcends the acquisition community, but which impacts it nonetheless.

This different perspective contributes in part to the different attitude toward the effectiveness of the Award Fee Incentive arrangements in Air Force major space systems acquisition. There is a certain amount of truth to both sides of this discussion. Government FDO s recognize the contractors’ contributions to the development of program capabilities and often are more concerned with technical than cost considerations (often with the support of the customer — the warfighter). How to get critical technology incorporated into newly fielded systems is a concern where major systems often take a decade or more to develop from concept to deployment.

Unrealistic expectations

It should be — but sometimes is not — recognized that cost growth is attributable to both parties involved in the acquisition process, and that the government is to blame as often as the contractor (lack of timely funding, technology upgrades, etc.). This concentrates the focus on the willingness of the contractor to accept challenge and respond in an effective and timely manner to government concerns. Not only technology, but national security considerations, such as the war on terror, may impact the configuration and capabilities that a new system may be required to accommodate.

One aspect of the perceived failure of Award Fee Incentive arrangements lies in the need to have access to information that is both accurate and timely in nature. Under the banner of acquisition reform, many program offices were downsized and given few of the tools to measure contractor performance over time. Predictive tools were missing, and the only information available through Total System Program Responsibility was often filtered through a contractor’s management information system. This often skewed data toward a contractor’s overly optimistic perception of performance.

The nature of the work (major systems development) also protects the contractor against negative cost, technical or schedule projections. As long as the product is paper (i.e. drawings, design packages, Preliminary Design Review and Critical Design Review ) and not hardware, many program managers are unaware of major problems. The true indicators typically come with the need to provide a prototype or system hardware. Early indicators may come from subsystems, but these often are also years in the making.

Lack of accountability

Why didn’t the Award Fee Incentives work to foster successful program execution? In the eyes of the GAO, it was due in part to the lack of accountability for not defining contractor performance in terms of acquisition outcomes. “Rather than focusing on acquisition outcomes such as delivering a fielded capability within established cost and schedule baselines, [the Defense Department] often places emphasis on such things as the responsiveness of contractor management to feedback from [Defense Department] officials, quality of contractor proposals, or timeliness of contract data requirements.”

The report made a number of recommendations that have been incorporated into the policy memos issued recently by James I. Finley, deputy undersecretary for defense, acquisition, technology and logistics, and by Air Force Secretary Michael W. Wynn.

The GAO report stated that: ” [The Defense Department] can immediately improve its use of award fees on all new contracts by (1) instructing the military services to move toward more outcome-based award-fee criteria that are both achievable and promote accountability for acquisition outcomes; (2) ensuring that award-fee structures are motivating excellent contractor performance by only paying award fees for above satisfactory performance; and (3) requiring the appropriate approving officials to review new contracts to make sure these actions are being taken.

” [The Defense Department] can improve its use of award fees on all existing contracts by (4) issuing [Defense Department] guidance on when rollover is appropriate.

“In the longer term, [The Defense Department] can improve its use of award and incentive fees by (5) developing a mechanism for capturing award- and incentive-fee data within existing data systems, such as the Defense Acquisition Management Information Retrieval system; (6) developing performance measures to evaluate the effectiveness of award and incentive fees as a tool for improving contractor performance and achieving desired program outcomes; and (7) developing a mechanism to share proven incentive strategies for the acquisition of different types of products and services with contracting and program officials across [The Defense Department] .”

Do these recommendations make sense?

To some degree they do — in that they have an intuitive sense to them, much like motherhood and apple pie. Of course the award fee should be outcome based ; the question is to what degree the contractor affects the outcome, and to what degree the problems are attributable to the government (late or reduced funding, requirements creep, defective government furnished property, etc.). It is not reasonable to hold the contractors accountable for these impacts that are beyond their control. As a matter of fact, in many cases, the contractor s’ flexibility and willingness to accommodate government-driven problems can, and do, contribute to the amount of award fee that they earn.

It is my experience that FDO s exhibit integrity over their determinations, and the discussions on reasonableness of fee contained in the GAO report are often held within the government Award Fee Review Board. I have provided training to contractor personnel on the workings of the award fee process and it is difficult to explain the often-contradictory input that must be factored and accounted by the FDO when making his/her decision. It is not an exact science and it requires a significant amount of judicial temperament on the part o f the FDO.

The second recommendation in the GAO report is just flat-out wrong. The government does not gold-plate requirements, nor does it encourage contractors to go to the excellent level to earn their fee.

Satisfactory performance means that the product is delivered on schedule, it works , and we pay a fair and reasonable price. If the award fee is the sole fee that is available to the contractors, it is absurd to state that the only way they can earn fee is by doing more than satisfactory performance.

Award Fee plans are very specific that the fee can be earned by meeting the criteria for satisfactory performance. If an FDO were to use this arbitrary approach, there would be a rash of lawsuits, and most would likely be upheld. Satisfactory means exactly what it says : The government is satisfied with the effort/product that is being delivered.

Slightly ambiguous

The fourth recommendation on rollover is slightly ambiguous. The discussion contained in the report seems to imply that rollover is being arbitrarily applied as a bonus pool for contractors to recoup fee previously lost. The reality in my experience is that FDO s recognize that rollover represents additional fee opportunity for the contractor, and the FDOs utilize it to provide incentive for performance in the same manner that the fee is put on contract initially — to motivate contractors to give the government what it wants.

The additional recommendations contained in the report are sensible, practical management techniques and will be incorporated to varying degrees based upon resource and data availability.

The changes that the Space & Missile Systems Center is implementing go to the fundamental effectiveness of the award fee incentive in major systems research and development programs. We are complying with the Federal Acquisition Rules (FAR) guidelines that note the use of objective criteria should be preferred over the subjective criteria contained in award fee contracts. We are recognizing that once our evolutionary/incremental block approach to new systems becomes institutionalized, it will be more practical to incentivize cost and schedule rather than technical criteria, and objective criteria will be more easily developed and utilized. This is consistent with the recommendations of the Defense Acquisition Performance Assessment Project led by former Air Force Lt. Gen. Ronald Kadish and facilitates a more stable short-term developmental approach.

We must decide whether we want to incentivize state-of-the-art, revolutionary systems development, or modest, evolutionary development. The Soviet Union used the evolutionary approach, modifying or upgrading systems with small improvements. They could field a system more rapidly, but it was limited in terms of its capabilities. Most American warfighters preferred the American approach, which incorporated large leaps in technology, but was longer and more subject to cost overruns. Once the systems are fielded, they give the warfighter the most advanced capabilities to use in battle.

This is a fundamental acquisition decision. We are capable of doing either of the two models. We have to be judicious in how we approach new systems and ensure that our strategy is logical and sensible. We will use an evolutionary approach where practicable, but we also want to maintain the capability to make revolutionary changes.

The incentive arrangement will either encourage contractors to take risks, or not. We have opportunities to facilitate contractor s’ decisions as to whether they want to invest their limited resources in the acquisition of major systems. We must avoid the “law of unintended consequences” as much as possible and focus on our “desired outcomes” in the arena of risk and reward.

The end product of this shift will put the award fee back into a secondary fee incentive arrangement. The primary focus will be to provide a reasonable outcome-based set of incentives that have been developed to accommodate the individual circumstances of each new program.

James Gill is a graduate of the University of Southern California’s Defense & Strategic Studies Program, a former professor in the CSSB National Security Studies Program and is currently employed at the Space and Missile Systems Center, Los Angeles Air Force Base. These views are solely those of the author and do not represent those of the U.S. Air Force.