C**ontract Types**

+---+---------------+---------------+---------------+---------------+
|   | **FIXED-PRICE |               |               |               |
|   | FAMILY**      |               |               |               |
+===+===============+===============+===============+===============+
|   | **FIRM**      | **            | **            | **PRICE**     |
|   |               | FIXED-PRICE** | FIXED-PRICE** |               |
|   | **            |               |               | **REDE        |
|   | FIXED-PRICE** | **WITH        | **INCENTIVE** | TERMINATION** |
|   |               | ECONOMIC**    |               |               |
|   | **(FFP)**     |               | **(FPI)**     |               |
|   |               | **PRICE       |               |               |
|   |               | ADJUSTMENT**  |               |               |
|   |               |               |               |               |
|   |               | **(FP-EPA)**  |               |               |
+---+---------------+---------------+---------------+---------------+
|   | Government    | The price     | **Firm        | **P           |
|   | pays price    | paid by the   | Target**:     | rospective**: |
|   | which is not  |               |               | Government    |
|   | subject to    | government    | Government    | pays fixed    |
|   | any           | may be        | pays price    | price for     |
|   | adjustment    | revised       | that is the   | goods or      |
|   |               | upward or     | sum of final  | services for  |
|   | regardless of | downward if   | negotiated    | a given       |
|   |               | certain       | cost and      | period, but   |
|   | contractor's  | contingencies | final profit. | price is      |
|   | cost          | exist.        | Final profit  | subject to    |
|   | experience.   |               | determined by | revision at   |
|   |               | Provides for  |               | stated times  |
|   | Place maximum | price         | comparing     | during        |
|   | risk on       | adjustment to | final         | performance   |
|   | con-tractor.  | protect       | negotiated    | of contract.  |
|   |               | parties       |               |               |
|   | Contractor    | against       | cost to       | **R           |
|   | has greatest  |               | target cost   | etroactive**: |
|   | incentive to  | significant   | and           | Government    |
|   | control       | economic      |               | pays price    |
|   | costs.        |               | adjusting     | (subject to   |
|   |               | fluctuation   | target profit | ceiling),     |
|   | Minimum       | or changes in | IAW formula   | that is       |
|   | a             |               | (             | negotiated    |
|   | dministrative | contractor's  | share-ratio). | after         |
|   | bur-den on    | established   | Final price   | contract      |
|   | parties.      |               | cannot exceed |               |
|   |               | prices.       | ceiling       | performance.  |
|   | Preferred     |               | price.        |               |
|   | contract      | EPA           |               |               |
|   | type.         | provisions    | **Successive  |               |
|   |               | can be based  | Targets**:    |               |
|   | **Level of    | on            |               |               |
|   | Effort**:     | established   | At            |               |
|   | Payment is    | (published)   | predetermined |               |
|   | based on      | prices,       | production    |               |
|   | effort        | actual costs, | point, firm   |               |
|   | expended      | or cost       | target cost   |               |
|   | rather than   | index.        | is negotiated |               |
|   | results       |               | and firm      |               |
|   | achieved.     | Adjustments   | target profit |               |
|   | Contractor    | based on      | is determined |               |
|   | provides      |               | IAW           |               |
|   | specified     | established   | adjustment    |               |
|   | effort over a | prices        | formula;      |               |
|   | stated period | restricted to | either an FFP |               |
|   | for fixed     | Industry-wide | or FPI(F) can |               |
|   | price.        | c             | be            |               |
|   |               | ontingencies. | negotiated.   |               |
|   |               |               |               |               |
|   |               | Adjustment    |               |               |
|   |               | based on      |               |               |
|   |               | labor or      |               |               |
|   |               |               |               |               |
|   |               | material      |               |               |
|   |               | costs limited |               |               |
|   |               | to            |               |               |
|   |               |               |               |               |
|   |               | contingencies |               |               |
|   |               | beyond the    |               |               |
|   |               |               |               |               |
|   |               | contractor's  |               |               |
|   |               | control.      |               |               |
+---+---------------+---------------+---------------+---------------+
|   | Price         | Price         | **Firm        | **P           |
|   |               |               | Target**:     | rospective**: |
|   |               | EPA Clause    |               |               |
|   |               |               | Target Cost   | Price         |
|   |               |               |               |               |
|   |               |               | Target Profit | Ceiling       |
|   |               |               |               | (Optional)    |
|   |               |               | Ceiling Price |               |
|   |               |               |               | **R           |
|   |               |               | Sharing       | etroactive**: |
|   |               |               | Formula       |               |
|   |               |               |               | Ceiling Price |
|   |               |               | **Successive  |               |
|   |               |               | Targets**:    |               |
|   |               |               |               |               |
|   |               |               | Initial       |               |
|   |               |               | Target Cost   |               |
|   |               |               |               |               |
|   |               |               | Initial       |               |
|   |               |               | Target Profit |               |
|   |               |               |               |               |
|   |               |               | Ceiling Price |               |
|   |               |               |               |               |
|   |               |               | Target Profit |               |
|   |               |               | Adjustment    |               |
|   |               |               |               |               |
|   |               |               | Formula       |               |
+---+---------------+---------------+---------------+---------------+
|   | When fair and | When          | Where         | **P           |
|   | reasonable    | contingencies | assumption of | rospective**: |
|   | prices can be | resulting     | a degree of   | Quantity      |
|   | established   | from unstable | cost          | production or |
|   | at outset.    | market or     | r             | services when |
|   |               | labor         | esponsibility | a fair and    |
|   | Particularly  | conditions    | by            | reasonable    |
|   | suitable for  | can be        | con-tractors  | price can be  |
|   | standard or   | identified    | will provide  | negotiated    |
|   | modified      | and covered   | incentive for | for initial   |
|   | commercial    | by a separate | effective     | period but    |
|   | items or      | price         | cost control. | not entire    |
|   | military      | adjustment    |               | contract      |
|   | items for     | clause.       | Can combine   | period.       |
|   | which sound   |               | with          |               |
|   | prices can be |               | incentives on | **R           |
|   | developed.    |               | performance   | etroactive**: |
|   |               |               | and schedule. | When fair and |
|   | **Level of    |               |               | reasonable    |
|   | effort**: R&D |               |               | FFP cannot be |
|   | investigation |               |               | negotiated    |
|   | or study.     |               |               | and low value |
|   |               |               |               | or short      |
|   |               |               |               | period of     |
|   |               |               |               | performance   |
|   |               |               |               | renders other |
|   |               |               |               | types         |
|   |               |               |               | i             |
|   |               |               |               | mpracticable. |
+---+---------------+---------------+---------------+---------------+
|   | **Level of    |               | Sole purpose  | **P           |
|   | effort**:     |               | cannot be to  | rospective**: |
|   | Used only     |               | shift         | FFP not       |
|   | when work     |               |               | feasible;     |
|   | cannot be     |               | cost          | pricing       |
|   | clearly       |               | r             | periods       |
|   | defined but   |               | esponsibility | conform to    |
|   | effort        |               | to            |               |
|   | desired can   |               |               | contracto     |
|   | be agreed     |               | government;   | r'saccounting |
|   | upon.         |               | requires      | system;       |
|   |               |               |               |               |
|   |               |               | simultaneous  | assurance     |
|   |               |               | agreement on  | that price    |
|   |               |               | all elements  |               |
|   |               |               | of pricing    | pred          |
|   |               |               | structure.    | etermina-tion |
|   |               |               |               | will be taken |
|   |               |               |               | promptly.     |
|   |               |               |               |               |
|   |               |               |               | **Retroactive |
|   |               |               |               | **:Reasonable |
|   |               |               |               | assurance     |
|   |               |               |               | that price    |
|   |               |               |               |               |
|   |               |               |               | Re            |
|   |               |               |               | determination |
|   |               |               |               | will be taken |
|   |               |               |               | promptly;     |
|   |               |               |               | requires HCA  |
|   |               |               |               |               |
|   |               |               |               | Approval      |
+---+---------------+---------------+---------------+---------------+
|   |               | **Not for use |               |               |
|   |               | with sealed   |               |               |
|   |               | bid method**  |               |               |
|   |               |               |               |               |
|   |               | Adequate      |               |               |
|   |               | Contractor    |               |               |
|   |               | Cost          |               |               |
|   |               | Accounting    |               |               |
|   |               | System        |               |               |
+---+---------------+---------------+---------------+---------------+

**\
Contract Types**

+---+---------------+---------------+---------------+---------------+
|   | **COST-       |               |               |               |
|   | REIMBURSEMENT |               |               |               |
|   | FAMILY**      |               |               |               |
+===+===============+===============+===============+===============+
|   | *             | **COST-PLUS** | *             | **COST**      |
|   | *COST-PLUS-** |               | *COST-PLUS-** |               |
|   |               | **AWARD-FEE** |               | **AND COST**  |
|   | **IN          |               | **FIXED-FEE** |               |
|   | CENTIVE-FEE** | **(CPAF)**    |               | **SHARING**   |
|   |               |               | **(CPFF)**    |               |
|   | **(CPIF)**    |               |               |               |
+---+---------------+---------------+---------------+---------------+
|   | Government    | Government    | Government    | **Cost**:     |
|   | pays          | pays          | pays          | Government    |
|   | allowable     | allowable     | allowable     | pays          |
|   | cost and      | cost, base    | cost and      | allowable     |
|   | incentive     | fee, and      | fixed fee.    | cost, no fee. |
|   | fee.          | award fee.    |               |               |
|   |               |               | Fixed fee     | **Cost        |
|   | Incentive fee | Contractor    | does not vary | Sharing**:    |
|   | determined by | earns a base  | with actual   | Government    |
|   | comparing     | fee which     | costs.        | pays only a   |
|   | actual cost   | does not vary |               | portion of    |
|   | to target     | with          | Fixed fee may | allowable     |
|   | cost and      | performance   | be adjusted   | cost as       |
|   | adjusting     | and all or    | for changes   | agreed to by  |
|   | target fee    | part of an    | in work to be | both parties. |
|   | IAW fee       | award fee     | performed.    | Contractor    |
|   | adjustment    | based on      |               | absorbs       |
|   | formula       | subjective    | Minimum       | portion of    |
|   | (share        | evaluation by | incentive for | the cost with |
|   | ratio).       | government of | contractors   | expectation   |
|   |               | contractor's  | to control    | of gaining    |
|   | Performance   | performance.  | costs.        | other         |
|   | incentives    |               |               | benefits from |
|   | should be     | Amount of the | **Completion  | the effort.   |
|   | incorporated  | award fee is  | Form**:       |               |
|   | if            | unilaterally  | Requires      |               |
|   | development   | determined by | contractor to |               |
|   | is feasible   | the           | deliver end   |               |
|   | and           | government    | product       |               |
|   | government    | and generally | (preferred    |               |
|   | performance   | is not        | form).        |               |
|   | objectives    | subject to    |               |               |
|   | have been     | Disputes      | **Term        |               |
|   | determined.   | Clause.       | Form**:       |               |
|   |               |               | Requires      |               |
|   |               | Evaluation of | specified     |               |
|   |               | performance   | level of      |               |
|   |               | and           | effort over   |               |
|   |               | corresponding | stated period |               |
|   |               | partial       | of time.      |               |
|   |               | payment of    |               |               |
|   |               | fee made at   |               |               |
|   |               | stated        |               |               |
|   |               | intervals.    |               |               |
+---+---------------+---------------+---------------+---------------+
|   | Target Cost   | Estimated     | Estimated     | Estimated     |
|   |               | Cost          | Cost          | Cost          |
|   | Target Fee    |               |               |               |
|   |               | Base Fee      | Fixed Fee     |               |
|   | Sharing       |               |               |               |
|   | Formula       | Award Fee     |               |               |
|   |               |               |               |               |
|   | Minimum Fee   |               |               |               |
|   |               |               |               |               |
|   | Maximum Fee   |               |               |               |
+---+---------------+---------------+---------------+---------------+
|   | Development   | Level of      | Research      | **Cost**:     |
|   | and test      | effort (R&D   |               | Non-profit    |
|   | where a       | or            | Preliminary   | institutions/ |
|   | profit        | Production)   | exploration   | organizations |
|   | incentive is  |               | or study.     | and           |
|   | likely to     | Method of     |               | facilities    |
|   | provide       | proving fee   | Development   | contracts.    |
|   | motivation    | which         | and test      |               |
|   | for more      | motivates     | where CPIF    | **Cost        |
|   | effective     | excellence in | not           | Sharing**:    |
|   | management.   | such areas as | practical.    | R&D efforts   |
|   |               | quality,      |               | with either   |
|   |               | timelines,    |               | profit or     |
|   |               | technical     |               | non-profit    |
|   |               | ingenuity,    |               | contractors.  |
|   |               | and           |               |               |
|   |               | c             |               |               |
|   |               | ost-effective |               |               |
|   |               | management.   |               |               |
|   |               |               |               |               |
|   |               | **Award fee   |               |               |
|   |               | may be used   |               |               |
|   |               | in            |               |               |
|   |               | conjunction   |               |               |
|   |               | with other    |               |               |
|   |               | types of      |               |               |
|   |               | contracts.**  |               |               |
+---+---------------+---------------+---------------+---------------+
|   | Adjustment in | Base Fee      | Fee shall not | **Cost        |
|   | fee is        | shall not     | exceed 15     | Sharing**:    |
|   | limited by    | exceed 3      | percent of    | Not           |
|   | minimum and   | percent of    | estimated     | applicable    |
|   | maximum fees  | estimated     | cost for R&D  | for effort    |
|   | negotiated.   | cost.         | or 10 percent | specified by  |
|   |               |               | of estimated  | government or |
|   |               | Weighted      | cost for      | that has only |
|   |               | guidelines    | other         | minor         |
|   |               | (for          |               | relevance to  |
|   |               | determining   | contracts.    | commercial    |
|   |               | profit        |               | activities of |
|   |               | objective)    | Price of A/E  | the           |
|   |               | shall not be  | contract      | contractor.   |
|   |               | applied.      | shall not     |               |
|   |               |               | exceed 6      |               |
|   |               | Shall not be  | percent of    |               |
|   |               | used in lieu  | estimated     |               |
|   |               | of CPFF or    | cost of the   |               |
|   |               | CPIF when     | public work   |               |
|   |               | objective     | or utility    |               |
|   |               | measurement   | project.      |               |
|   |               | is feasible.  |               |               |
+---+---------------+---------------+---------------+---------------+
|   | **Not for use | **Not for use |               |               |
|   | with sealed   | with sealed   |               |               |
|   | bid method**  | bid method**  |               |               |
|   |               |               |               |               |
|   | Adequate      | Adequate      |               |               |
|   | Contractor    | Contractor    |               |               |
|   | Cost          | Cost          |               |               |
|   | Accounting    | Accounting    |               |               |
|   | System        | System        |               |               |
+---+---------------+---------------+---------------+---------------+

**Contract Types**

+---+-------------------+-------------------+-------------------+---+
|   | **OTHER TYPES**   |                   |                   |   |
|   |                   |                   |                   |   |
|   | **SPECIAL USES**  |                   |                   |   |
+===+===================+===================+===================+===+
|   | **Time and**      | **Letter**        | **INDEFINITE**    |   |
|   |                   |                   |                   |   |
|   | **Materials**     | **CONTRACT**      | **DELIVERY**      |   |
|   |                   |                   |                   |   |
|   | **Labor Hours**   |                   |                   |   |
+---+-------------------+-------------------+-------------------+---+
|   | Government pays   | Preliminary       | **Definite        |   |
|   | fixed hourly rate | contractual       | Quantity**:       |   |
|   | for supplies or   | instrument that   |                   |   |
|   | services.         | authorizes        | Provides for      |   |
|   |                   | immediate         | definite quantity |   |
|   | With contractor   | commencement of   | of specified      |   |
|   | furnished         | effort.           | supplies or       |   |
|   | material.         |                   | services for a    |   |
|   | Provided at cost. | Method of payment | fixed period with |   |
|   |                   | corresponds to    | deliveries at     |   |
|   | **Labor Hours**   | type of contract  | designated        |   |
|   | differs only in   | contemplated when | locations upon    |   |
|   | that no material  | definitized       | order             |   |
|   | is supplied by    |                   |                   |   |
|   | contractor.       |                   | **Requirements**: |   |
|   |                   |                   | Provides for      |   |
|   |                   |                   | furnishing all    |   |
|   |                   |                   | actual            |   |
|   |                   |                   | requirements of   |   |
|   |                   |                   | specified         |   |
|   |                   |                   | supplies or       |   |
|   |                   |                   | services during a |   |
|   |                   |                   | specified period  |   |
|   |                   |                   | as ordered by     |   |
|   |                   |                   | designated        |   |
|   |                   |                   | activities        |   |
|   |                   |                   |                   |   |
|   |                   |                   | **Indefinite      |   |
|   |                   |                   | Quantity**:       |   |
|   |                   |                   | Provides for      |   |
|   |                   |                   | furnishing        |   |
|   |                   |                   | indefinite        |   |
|   |                   |                   | quantifies of     |   |
|   |                   |                   | specified         |   |
|   |                   |                   | supplies or       |   |
|   |                   |                   | services during a |   |
|   |                   |                   | specified time    |   |
|   |                   |                   | but government    |   |
|   |                   |                   | must order a      |   |
|   |                   |                   | stated minimum    |   |
|   |                   |                   | quantity.         |   |
+---+-------------------+-------------------+-------------------+---+
|   | Hourly labor rate |                   | Firm Fixed Price, |   |
|   |                   |                   | Fixed Price with  |   |
|   | Ceiling Price     |                   | EPA, or Price     |   |
|   |                   |                   | Redetermination   |   |
+---+-------------------+-------------------+-------------------+---+
|   | Engineering and   | When interests of | **Definite        |   |
|   | design services,  | national defense  | Quantity**: Where |   |
|   | repair,           | demand that work  | definite quantity |   |
|   | maintenance, or   | commence          | of supplies or    |   |
|   | overhaul,         | immediately and   | services required |   |
|   | emergency         | insufficient time | during a          |   |
|   | situations        | available to      | specified period  |   |
|   |                   | negotiate a       | are readily       |   |
|   |                   | definitive        | available         |   |
|   |                   | contract          |                   |   |
|   |                   |                   | **Requirements:** |   |
|   |                   |                   | When impossible   |   |
|   |                   |                   | to determine in   |   |
|   |                   |                   | advance the       |   |
|   |                   |                   | precise           |   |
|   |                   |                   | quantities needed |   |
|   |                   |                   | during a definite |   |
|   |                   |                   | period of time    |   |
|   |                   |                   |                   |   |
|   |                   |                   | **Indefinite      |   |
|   |                   |                   | Quantity:** Same  |   |
|   |                   |                   | as requirements   |   |
|   |                   |                   | but government is |   |
|   |                   |                   | only committed to |   |
|   |                   |                   | minimum quantity  |   |
+---+-------------------+-------------------+-------------------+---+
|   | Determination     | Written           |                   | . |
|   | that no other     | determination     |                   |   |
|   | type of contract  | that no other     |                   |   |
|   | is suitable       | type suitable     |                   |   |
|   |                   |                   |                   |   |
|   |                   | Price ceiling     |                   |   |
|   |                   | required if award |                   |   |
|   |                   | based on price    |                   |   |
|   |                   | competition       |                   |   |
|   |                   |                   |                   |   |
|   |                   | Must be defined   |                   |   |
|   |                   | within 180 days   |                   |   |
|   |                   | or prior to       |                   |   |
|   |                   | completion of 40% |                   |   |
|   |                   | of work           |                   |   |
|   |                   |                   |                   |   |
|   |                   | Maximum           |                   |   |
|   |                   | government        |                   |   |
|   |                   | liability cannot  |                   |   |
|   |                   | exceed 50% of     |                   |   |
|   |                   | estimated cost at |                   |   |
|   |                   | outset            |                   |   |
+---+-------------------+-------------------+-------------------+---+
|   | **Not for use     | **Not for use     |                   |   |
|   | with sealed bid   | with sealed bid   |                   |   |
|   | method**          | method**          |                   |   |
+---+-------------------+-------------------+-------------------+---+

**Another Look at Award Fee Contracting**

*When coupled with recent procurement reform initiatives, award fee
contracts may no longer be the most advantageous incentive to offer
contractors.*

BY MARGARET BRANDIS

About the Author

MARGARET BRANDIS is the director of contracts at Applied Resources, Inc.
She is a member of the NOVA chapter of NCMA

Award Fee contracting first appeared in the 1960s when NASA developed it
as a variation on incentive fee arrangements.^1^ The government, wanting
to provide incentives in certain areas of contract performance that did
not lend themselves to objective measurement, created the award fee
contract. Under an award fee arrangement, contractor performance is
evaluated on a regular basis, and a portion of the award fee is
allocated to the contractor ac. The purpose of award fee contracting is
to motivate the contractor to obtain (or exceed) specific acquisition
objectives. This article examines the use of award fee contracts in
federal procurements.

**Contract Types**

The *Federal Acquisition Regulations* classify award fee contracts as
one type of incentive contract that is distinguished primarily by the
qualitative nature of the award fee criteria versus the more
straightforward quantitative assessment of performance under incentive
fee arrangements.^2^ Incentive fee contracts contain formulas based on
objective, measurable standards to calculate cost, delivery, or
performance incentives. Award fee contracts entail regular assessments
of contractor performance by the government---a feature that adds to the
administration of an award fee contract but that also is cited as a
major benefit. In the days before "past performance" entered the
acquisition reform vernacular, regular performance evaluations were one
way to improve communications between contractors and the government. By
requiring periodic evaluations and supplying award fee determinations
that were based on the results, the government gave contractors specific
feedback and monetary incentives that were based on the quality of their
performance.

Award fee contracts may be used with either fixed price or cost plus
contract vehicles. In fixed price award fee (FPAF) contracts, the fixed
price is paid when the contract is satisfactorily completed regardless
of the actual cost to the contractor.^3^ The award fee (if any) is
allocated to the contractor above and beyond the fixed price. A cost
plus award fee (CPAF) contract provides a base fee (which may be zero),
reimbursement of allowable contractor costs, and an award fee.^4^ In
both FPAF and CPAF contracts, the award fee determination is made
unilaterally by the government according to award fee criteria that are
stated in the contract. These criteria may be unilaterally adjusted by
the government over the course of contract performance.

The award fee contract represents a sort of middle ground between full
contractor cost risk at the fixed price end of the continuum and minimal
contractor cost risk under cost plus fixed fee arrangements. By pegging
all or some of the contractor's profit or fee to performance, the
outcome of the contract cost ceases to be the only measure of success or
failure. The desirability of this more moderate contract mechanism and
its concomitant motivational thrust are shown by the award fee
contract's increasing popularity. CPAF contracts are now the most
commonly used contract vehicle at NASA.^5^ In other agencies, award fee
contracting is increasingly used, particularly with service contracts in
which it may not be feasible to quantify measurable performance
standards.^6^

**Components of an Award Fee Contract**

An award fee contract consists of the following components:

-   an estimated cost;

-   a base fee, paid on a regular basis and not tied to any evaluation
    of service;

-   an award fee, which is the difference between the maximum fee and
    the base fee;

-   a payment plan indicating how often contractor performance will be
    evaluated; and

-   award criteria that describe the general areas in which the
    contractor will be evaluated.

The base fee can range from zero to three percent; it is comparable to
the minimum fee on an incentive contract in that it is paid as long as
satisfactory performance occurs. A number of agencies do not allow any
base fee amount in certain situations. For example, NASA now prohibits
base fee on service contracts and discourages it in any circumstances
where the evaluations are considered interim in nature.^7^ (Presumably,
this restriction guards against paying fees throughout the contract and
then discovering at the end that the final product fails.) The Air Force
Materiel Command does not allow base fee in fixed price award fee
arrangements^8^ (perhaps, because it assumes the contractor has already
received some level of profit that was built into the fixed price).
Contractors, particularly small businesses, prefer base fees because the
regular receipt of money helps improve the organization's cash flow.

The maximum fee a contractor can earn is the sum of the base fee (if
any) and the award fee. The award fee portion of the maximum fee must be
large enough to motivate the contractor and must be distributed
appropriately across the key performance areas so one facet of
performance does not overshadow the others. For example, if meeting
accelerated schedules is emphasized too much in the award fee criteria,
then quality, costs, ,or both may suffer. A balance in the criteria must
be achieved to ensure a balance in performance.

The timing of award fee evaluations should be spelled out in the
contract. Typically, award fee boards meet every four or six months. If
the award periods are too close together, the contractor does not have
time to improve between evaluations, and the government does not have
adequate time to conduct the evaluations. For many agencies, three or
four evaluations per year may be too burdensome; a twice-a-year or
once-a-year schedule may be more manageable. Often, the contractor
provides substantial input to the award fee deliberations (e.g.,
amassing performance data, preparing materials, delivering
presentations, etc.), so award periods that are too frequent also create
a burden for the contractor. In contrast, when award fee determinations
are not made frequently enough, the contractor loses the use of the
award fee money to which he or she would have been entitled. Infrequent
award fee determinations also pose a greater risk that important
milestones or extenuating circumstances that occurred in the distant
past will be overlooked. The Air Force Materiel Command does not permit
award periods of more than six months for small businesses; large
businesses must be evaluated at least once a year.^9^ However, even with
good intentions and guidelines that express clear evaluation periods,
many contractors experience considerable delays in being evaluated and
in receiving their results.

Award fee criteria will vary depending on the nature of the contract and
the areas that would benefit from additional motivation. Note that award
fee criteria are completely different from the evaluation factors used
to decide who will get the contract. The latter are contained in Section
M of any Request for Proposals (RFP) and are used by source selection
officials to evaluate proposals and determine the winner. Typically, the
award fee criteria are based on the scope of work and the deliverables
contained in the original RFP. The most common areas evaluated in award
fee contracts are cost, schedule, quality, and management. Similar to
incentive fee arrangements---where measurable performance and delivery
criteria may be added to cost incentives---NASA requires cost to be one
of the factors in the evaluation of the award fee portion of contracts.
This proviso is included to ensure that contractors do not focus on one
area of performance (e.g., quality) to the detriment of another (e.g.,
increased costs).

Over the course of a long-term contract, it is not uncommon for the
original scope of work to resemble less and less the actual work being
done. This transformation is particularly true in the information
technology field where rapid change is the norm. When the award fee
criteria do not evolve to reflect the current nature of the work being
done, contractors may lose award fee dollars even though they are
performing as the agency desires.

An example of actual award fee criteria, taken from the award fee plan
of an RFP for systems engineering and technical assistance services, is
shown in Table 1. In this Plan, Financial Management is one of the main
categories to be evaluated; cost-related considerations also appear
secondarily under the Management Performance category which includes
Hour Management, Management of Hours, Other Direct Costs, and
Subcontract Management. The award fee plan from this RFP also indicates
that the contractor will be informed at the beginning of the evaluation
period of the relative order of importance of the criteria and specific
factors that may be considered in the evaluation. See Table 1 for sample
award fee criteria.

Once the criteria are defined, the contractor's performance is rated
against the criteria. A sample rating scale from the same RFP is shown
in Table 2. Although these particular examples came from a service
contract, they are written broadly enough that they could apply to
almost any aspect of almost any type of contract.

An overall score for the performance period is calculated and the amount
of award fee is determined by the government, using some mechanism to
translate the contractor's performance score (points, colors, grades,
adjectives) into a dollar amount of award fee. Some plans may use a
one-to-one correspondence: If the contractor has an overall score of 91,
for example, then 91 percent of the award fee for that period would be
allocated to the contractor. Other conversion methods exclude
performance at the low end of the scale (e.g., the "Inadequate" rating
in Table 2) from any award fee and distribute the award fee linearly
over the remaining rating levels (e.g., "Adequate" to "Excellent"). In
Table 2, anything below a 50 rating might receive a \$0 award fee;
performance ratings from 50 to 100 points would be calculated at 2
percent of the potential award fee amount per rating point. A rating of
91 percent would result in a fee amount of 82 percent (91 − 50 × 0.2).

From the government's perspective, this approach is logical because the
government does not want to reward unsatisfactory performance by
allowing an award fee to be paid for substandard work. However, from the
contractor's perspective, the decks are stacked against the contractor
because only a perfect score of 100 on all evaluation items will result
in full fee. For every point below 100, the award fee percentage drops
disproportionately (two to one in this example).

In a recent decision by the U.S. Court of Appeals for the Federal
Circuit, the conversion method used by the fee determining official was
at issue.^10^ This case involved a CPAF contract that was awarded to
Burnside-Ott Aviation Training Center by the Navy for aircraft
maintenance and repair. Burnside-Ott earned an overall performance
rating of 93.65 but received an award fee of only 84.15 percent because
the conversion method used by the government did not include an award
fee for ratings below 60 (labeled "Submarginal"). Thus, instead of a
one-to-one correspondence between the performance rating (93.65) and the
amount of the award fee (93.65 percent) that Burnside-Ott argued for,
the government used a conversion method of 2.5 percent per rating point
for evaluation ratings of 60 and above.

This sort of disconnect between a very good performance evaluation and a
mediocre award fee amount is a common problem for contractors. The issue
is not confined to short-term monetary rewards, however. It can also
extend to future business potential when past performance data that is
required by RFPs include total award fee pools versus the actual award
fee received. Unless the contractor annotates the requested award fee
data with an explanation, the contractor's past performance may be
misinterpreted.

Although Burnside-Ott lost the case (the court declared that the
conversion method was left to the government's discretion and that the
decision was not arbitrary or capricious), they won a much bigger battle
because the court also found that contract language that removes
contractual matters from the Contracts Disputes Act is illegal and
unenforceable. Before Burnside-Ott, language in the *FAR* that flowed to
award fee contracts was always clear: Award fee decisions were not
subject to the "Disputes" clause of the contract. Contractually,
contractors had no right to protest award fee decisions, a limitation
that, when coupled with the unilateral authority of the government to
establish evaluation criteria, change evaluation criteria, and apply
evaluation criteria, put contractors at a distinct disadvantage. The
court sought to restore the balance between the government and its
contractors when it found that the government could not put language in
its RFPs and contracts that refused contractors the protections of the
Contract Disputes Act. As a consequence of the Burnside-Ott decision,
Federal Acquisition Circular (FAC) 97-15 (December 27, 1999) has now
deleted the phrasing "not subject to the Disputes clause of the
contract" from the *FAR* references to award fee contracts.
Parenthetically, the Burnside-Ott decision may have even wider
repercussions if this same reasoning is applied to protests of
task-delivery order awards that the *FAR* currently does not allow
except for a few limited grounds. This repercussion may have been what
Robert D. Witte was alluding to when he referred to the "far-reaching
consequences" of the Burnside-Ott case.^11^

Although the general areas covered by the government's performance
evaluation should be stated in the contract, the specific award fee plan
may not be a part of the contract. The award fee plan documents the
methodology the government will use: the criteria, the weightings, and
the way in which the contractor's evaluation scores are converted to an
amount of fee awarded. The plan is often kept outside the contract so
the government has maximum flexibility to change the award criteria as
program needs change.

This flexibility to adjust criteria and their weightings over time is
another difference between incentive fee contracts and award fee
contracts. Generally, all methods of performance assessment are laid
out---by formula---in incentive fee contracts and remain in force over
the course of the contract. If mission objectives change midway through
an award fee contract, however, the government may unilaterally alter
the award fee criteria as long as the contractor is given sufficient
notice prior to the next evaluation period.^12^ Thus, contractors may
discover that the assumptions on which their risk was originally
calculated could be changed without recourse on their part.

Although problems stemming from this loophole do not appear common,
contractors could conceivably find themselves caught in this bind.
Suppose, for example, that a contractor bids and wins an award fee
contract containing award fee incentives for cost and schedule. The
government has emphasized timeliness in its award fee criteria because
delays have been a chronic problem in the past. The contractor accepts
the schedule risks because the contractor has innovative techniques for
improving delivery times. A year into the contract, the contractor has
performed better than the standards set for schedules without increasing
costs. Now that delays are no longer an issue, the government shifts its
focus to improving the quality of the product and changes the evaluation
criteria accordingly. The contractor, however, has no methods for
improving quality without affecting cost or schedule. In fact, the
contractor was able to speed up delivery precisely because the product
was not expected to change. Suddenly, the performance requirements are
different, and the contractor could lose substantial award fee amounts
through no fault of its own.

**Selection Criteria**

Given the different contract types and variations among types, when is
an award fee contract appropriate? As mentioned earlier, award fee
contracts are used when the government wishes to motivate contractor
performance but cannot use incentive fee arrangements because objective
(quantifiable) measures are not feasible. The government expends more
resources to administer award fee contracts; thus, the benefits to be
gained (in terms of improved product, reduced costs, or timely delivery)
must outweigh the administrative costs. Because of this extra
administrative burden, award fee contracts should be reserved for large
contracts, contracts that are critical to the agency's goals, or both.

CPAF contracts are subject to the same *FAR* limitations (adequate
accounting system, government surveillance to ensure cost controls) as
all cost reimbursement contracts.^13^ The *FAR* requires FPAF contracts
to have award fee procedures already established, including designated
award fee board members. The *FAR* also requires approval at the level
above the contracting officer for FPAF contracts.^14^ The limitations
placed on award fee contracting in the *FAR* are indicative of some of
the potential pitfalls the government is trying to avoid: inappropriate
use of the contract type as well as lack of planning and preparation.

A number of different "hybrid" contract types have sprung up in recent
years, combining elements of several contract types into one. One form
has an objective, formula-based incentive for cost and a subjective
award fee provision for qualitative measures such as technical
excellence or customer satisfaction. Although not specifically
identified in the *FAR*, these types of contracts are referred to as
cost plus incentive fee/award fee (CPIF/AF) or fixed price
incentive/award fee (FPI/AF). They are possible only when enough
certainty in estimating costs exists to allow establishment of a target
cost and, therefore, measurement of the cost incentive by formula. At
the same time, subjective appraisal of other aspects of performance is
considered an important incentive.

Hybrid contracts such as CPIF/AF and FPI/AF are administratively
burdensome both for the government and the contractor. Not only must the
procedures for both award fee and incentive fee be followed but also
payment from the different fee pools must be billed and tracked
separately. Because of these constraints, CPIF/AF and FPI/AF contracts
should be used only if the dollar value and mission importance warrant
them.

The Department of Energy uses performance-based incentives in
combination with award fees on its management and operating
contracts.^15^ These contracts have a base fee and an award fee, a
portion of which applies to performance-based incentives. These
objective measures are evaluated on a regular basis by subject matter
experts, and achievement of the specific measures is confirmed before
release of the fee. The remainder of the award fee pool is applied to
subjective evaluations. Hybrid contracts often evolve when objective
cost incentives are desired but insufficient information is available at
the time of award to specify those targets precisely. For example, an
award fee contract might be combined with Value Engineering provisions
that allow the contractor to share in cost savings initiatives without
first establishing a target cost and share ratio at contract
inception.^16^

The *FAR* also authorizes FPI (successive targets) contracts that
provide some flexibility in determining the target cost.^17^ This
contract type allows cost experience under the contract (and other
contracts) to be taken into account during contract performance in
negotiating a realistic, firm target cost and profit at some point other
than prior to contract award. As Indefinite Delivery/Indefinite Quantity
(ID/IQ) contracts have become more popular, award fee provisions are
finding their way into these contractual vehicles. It is not uncommon to
see CPAF, FPAF, and fixed price task-delivery orders all possible under
the same ID/IQ contract.

**Procedures and Personnel**

A number of different government personnel become involved in an award
fee contract.^18^ A fee determining official (FDO) is typically a high
ranking government official who may head the contracting activity or may
be the head's designee. The FDO makes the final award fee decisions with
input from an award fee board (sometimes called a performance evaluation
board). The board usually ranges from three to six or more people who
are appointed by the FDO. These people tend to be senior level managers
who will approach the fee determination from a broader perspective. The
board includes the contracting officer and others with knowledge in the
broad areas being performed. These people are charged with reviewing
performance evaluation data collected by specialists in their areas
(e.g., quality control, cost analysts). The board must synthesize the
evaluation information from performance monitors and come up with a
fully justified and documented recommendation concerning the award fee.
Performance monitors are those people who have frequent contact with the
contractor and the contractor's work. They must apply the standards by
which the contractor's performance is to be evaluated.

Sometimes board members are selected from outside the agency or even
outside of the government. Depending on the knowledge and background of
the members, the award fee board may help, hinder, or be neutral with
respect to contract performance. The relationship between the
contracting officer and the rest of the board is also a factor in the
fair administration of an award fee contract. The contracting officer
should apprise the board of changes in the direction of the contract and
other factors beyond the contractor's control. Contracts commonly evolve
over the course of several years, either through the government's
direction or by natural progression. The award fee board, however, will
keep going back to the original criteria that was established prior to
or shortly after the contract award to evaluate performance. Even though
the evaluation criteria could be updated unilaterally, this updating
does not often happen. Unless the contracting officer ensures that the
board is aware of changes in the contract, the contractor may be judged
by criteria that are no longer applicable.

**Time and Money**

A very real cost is associated with award fee contracting. The regular
performance evaluation aspects are an ongoing resource drain. NASA
estimates an average cost to the government of \$38,700 per evaluation
period for an award fee contract.^19^ This estimate includes the time of
five monitors, six board members, one recorder, and one contracting
officer. Although no mention of contractor cost is made, one can fairly
assume that contractor costs could meet or exceed this estimate in cases
where the contractor must gather and report extensive data on
performance. Sometimes, the contractor and staff are present at the
board meetings (which can last several days) to answer questions and
present material. When board members are not familiar with the work
area, it is in the contractor's best interest to expend additional
effort to brief the members so they understand the circumstances and
constraints of the work. As monetary and personnel resources in the
government dwindle, award fee contracts may become harder and harder to
justify.

Time lines for the process are stated on the optimistic side. Some
guidelines indicate that the FDO's decision should be made within 45
days of the end of the award fee period with payment to the contractor
authorized within 60 days.^20^ A sample of actual contract documents
suggests an even shorter period: 30 days for the FDO determination and 5
days after to modify the contract adding the award fee amount.

In practice, many contractors experience extensive delays. A natural
time lag occurs while cost and other performance data is gathered.
Additional time may be needed to analyze the data and write up findings.
Sometimes, assembling the award fee board is difficult because of
conflicting schedules and competing demands. The board's deliberations
can be lengthy as can the final determination and documentation of the
decision. Finally, the award fee amount for the evaluation period cannot
be billed until it is added to the contract through issuance of a
modification. Then the contractor must wait to be paid.

**Conclusion**

From the government's perspective, award fee contracts offer several
benefits. First, many government personnel believe that the monetary
incentive is a strong one; it focuses the contractor's attention on the
areas that are most important to the government. Second, the government
often touts award fee contracts because of their flexibility. Specific
formula-based criteria do not have to be determined before the contract
starts as in CPIF or FPIF arrangements. Furthermore, award fee criteria
may be changed unilaterally by the government to reflect changing
circumstances and priorities. A third advantage cited for award fee
contracts is enhanced communication between the government and the
contractor. Finally, the argument is often proffered that, generally,
higher fees are seen in award fee contracts and that these higher fees
add to the contractor's motivation.

The use of award fees as incentives to the contractor may occur in
theory, but not always in practice. First, the amount of the fee has to
be large enough to make a difference.^21^ The government should not
expect to negotiate award fees on the same terms as the fee amounts in
CPFF contracts, for example. Second, when the base fee is removed from
the equation, the award fee ceases to be the carrot that will induce
better performance but, instead, becomes a stick with which to dictate
to the contractor. When some amount of base fee is guaranteed, the
contractor has a choice regarding extra or creative effort. When an
entire fee is tied to the award fee criteria, this freedom does not
exist. Additional problems occur over time as the contract evolves or
when the project officer gives direction in one way and the award fee
board cleaves to the old criteria. The contractor is forced to make a
choice: follow the project officer or work to the original criteria for
maximum award fee.

The flexibility of award fee contracts may simply disguise a lack of
planning. Award fee contracts should not be used to avoid the effort of
specifying before the contract award exactly what the government needs
and how it will determine the extent to which those needs were
fulfilled. As we have seen, changing criteria midstream may penalize the
contractor; however, not making such a change may cause serious issues
with respect to fulfilling the contract. If the government cannot
articulate what its requirements are because of technical uncertainties
or because of the developmental nature of the work, then a CPFF contract
may be more appropriate than an award fee contract.

Improved communications between government and contractor was a
legitimate goal in the 1960s when award fee contracts first originated.
However, the requirements of past performance information make that
advantage seem redundant. When the annual performance reviews of
contracts are finally fully carried out, the more burdensome and
time-consuming evaluation for award fee may no longer be necessary.
Although past performance reviews are not directly tied to a monetary
value, the importance of good reports is taken very seriously by
contractors interested in obtaining new contracts. Past performance
reviews have further advantages because they are done by someone close
to the contract and they allow the contractor to comment or rebut. With
the advent of Burnside-Ott, the government may find their award fee
decisions being challenged more often, further consuming scarce
resources.

The extra administrative burden imposed on both the government and the
contractor makes an award fee contract a much less desirable contract
type in this era of procurement personnel downsizing. When coupled with
recent procurement reform initiatives such as past performance
information, award fee contracts may no longer be the best solution to
current acquisition issues.

Printed by permission: "Contract Management", February 2001.\
**Table 1. Sample Award Fee Criteria**

A. Technical Performance

1\. Quality of Work

2\. Timeliness of Performance

B. Management Performance

1\. Program Management

2\. Hour Management

3\. Customer Services

4\. Other Direct Costs

5\. Management of Hours

6\. Subcontract Management

7\. Property Management

8\. Configuration Management

9\. Planning

C. Financial Management

1\. Cost Management of ODC

2\. Budget Forecasting

3\. Funds Requirements are Projected Correctly and Accurately on
Contract Funds Status Reports (CFSR), if required

D. Security

**Table 2. Sample Rating Standards**

+---------------------+-------+--------------------------------------+
| Adjectival Rating   | Grade | Definition                           |
+=====================+=======+======================================+
| Excellent (86--100) | A     | • Contractor has exceeded adequate   |
|                     |       | performance by a substantial margin  |
|                     |       | in all elements of the evaluation.   |
|                     |       |                                      |
|                     |       | • Deficiencies are minimal or        |
|                     |       | nonexistent.                         |
+---------------------+-------+--------------------------------------+
| Good (70--85)       | B     | • Contractor has exceeded adequate   |
|                     |       | performance by a substantial margin  |
|                     |       | in most elements of the evaluation.  |
|                     |       |                                      |
|                     |       | • Deficiencies are minor, relatively |
|                     |       | unimportant, and easily cured.       |
+---------------------+-------+--------------------------------------+
| Adequate (50--69)   | C     | • Contractor's performance in the    |
|                     |       | aggregate meets the minimal          |
|                     |       | acceptable standards of performance  |
|                     |       | over the elements of evaluation.     |
|                     |       |                                      |
|                     |       | • Any deficiencies are offset by     |
|                     |       | exceptional performance in other     |
|                     |       | areas.                               |
+---------------------+-------+--------------------------------------+
| Inadequate (0--49)  | F     | • Contractor performance is less     |
|                     |       | than adequate over the elements of   |
|                     |       | evaluation.                          |
|                     |       |                                      |
|                     |       | • Deficiencies are pervasive         |
|                     |       | throughout evaluation areas and not  |
|                     |       | offset by areas of exceptional       |
|                     |       | performance.                         |
+---------------------+-------+--------------------------------------+

**\
Endnotes**

1\. John Cibinic, Jr. and Ralph C. Nash, *Formation of Government
Contracts*, 3rd ed. (Washington, D.C.: The George Washington University
Press, 1988), 1148.

2\. FAR 16.4, Incentive Contracts.

3\. FAR, 16.404(a)(1), Fixed-price contracts with award fees.

4\. FAR, 16.405-2, Cost-plus-award-fee contracts.

5\. National Aeronautics and Space Administration (NASA), *National
Aeronautics and Space Administration Award Fee Contracting Guide*,
December 2, 1997), 1. Retrieved February 6, 2000, from the World Wide
Web: **http://www.hq.nasa.gov/office/procurement/regs/afguide.html**

6\. Cibinic and Nash, *Formation of Government Contracts*, 1148; Air
Force Materiel Command (AFMC), *Air Force Materiel Command Award Fee
Guide* revision 2, March 1997), 3; and *NASA Award Fee Contracting
Guide*, 6.

7\. NASA, *NASA Award Fee Contracting Guide*, 9.

8\. AFMC, *AFMC Award Fee Guide*, 8.

9\. Ibid., 25.

10\. *Burnside-Ott Aviation Training Center v. John H. Dalton, Secretary
of the Navy*, U.S. Court of Appeals for the Federal Circuit No. 96-1227,
February 25, 1997.

11\. Robert D. Witte, "Award Fees and Discretion," *Contract
Management*, July 1999, 43.

12\. AFMC, *AFMC Award Fee Guide*, 31.

13\. FAR 16.405-2(c)(1), Cost-plus-award-fee contracts.

14\. FAR 16.404(b), Fixed-price contracts with award fees.

15\. Acquisition Reform Net Electronic Forum: Water Cooler. October 29,
1998 from Charlie Dan, Subject: Performance based contracting. Retrieved
March 2, 2000 from The World Wide Web:
**http://www.arnet.gov/Discussions/Water-Cooler.html**.

16\. Acquisition Reform Net Electronic Forum: Water Cooler. August 17,
1998 from Chuck Solloway, Subject: Guidance sought on negotiated
contract type. Retrieved March 2, 2000 from The World Wide Web:
**http://www.arnet.gov/Discussions/Water-Cooler.html**.

17\. FAR 16.403-2, Fixed-price incentive (successive targets) contracts.

18\. NASA, *NASA Award Fee Contracting Guide*, 11--14; and AFMC, *AFMC
Award Fee Guide*, 17--22.

19\. NASA, *NASA Award Fee Contracting Guide*, 7.

20\. AFMC, *AFMC Award Fee Guide*, 36.

21\. AFMC, *AFMC Award Fee Guide*, 8; and NASA, *NASA Award Fee
Contracting Guide*, 9.

Award-term: The Newest Incentive

BY VERNON J. EDWARDS

About the Author

Vernon J. Edwards writes and teaches about Federal contracting. He may
be reached at

<Vernon.edwards@worldnet.att.net>. Send comments on this article to
cm\@ncmahq.org

The award-term incentive is a relatively new development in government
contracting, one that was first used in 1997 and that is not yet
described in the *Federal Acquisition Regulation* (*FAR*). It is modeled
after the award fee incentive described in FAR § 16.405-2, but instead
of rewarding a contractor for excellent performance with additional fee,
it rewards the contractor by extending the contract without competition.
Under an award-term incentive, a government team monitors and evaluates
the contractor's performance on the basis of contractually stipulated
criteria and reports their findings to a government term determining
official. The term determining official decides whether the contractor's
performance was good enough to merit an extension. The extension is (or
should be) conditioned upon the government's continuing need for the
service and the availability of funds.

The award-term incentive was the inspiration of Thomas Jordan, a senior
U.S. Air Force civilian employee at Kelly Air Force Base. Its first use
was on a task order contract that the Air Force's Aeronautical Systems
Center awarded to the McDonnell Douglas Corporation in October of 1997,
for simulation services for the F-15C aircraft. The contract has a
seven-year base period, which the contractor can extend to 15 years by
providing excellent service. Since that first use, at least 25
acquisitions have included or plan to include award-term incentives.

**Not an Option**

A true award-term incentive rewards the contractor with legal
entitlement to a contract extension, not an additional option. An option
is a unilateral right of the government; a contractor is not entitled to
the exercise of an option. But under a true award-term incentive, if the
contractor's performance meets the award-term criteria stipulated in the
contract, and if any stipulated conditions such as continuing need and
availability of funds are met, then the government must either extend
the contract or terminate it for convenience or default. Several
contracts have included incentives that have been labeled award-term,
but that should be called award option or incentive option because the
contractor's reward is not an actual extension but merely a government
option to extend.

Agencies have used award-term incentives when acquiring a variety of
services, including technical and logistics support, laundry and
dry-cleaning, depot-level maintenance, aircraft maintenance, grounds
maintenance, janitorial services, real property maintenance and repair,
and training. The incentive has been used with several different pricing
and delivery arrangements such as fixed-price, cost-reimbursement,
indefinite-delivery-indefinite-quantity, and requirements. Award-term
has also been used in combination with other incentives such as
cost-plus-incentive-fee and cost-plus-award-fee.

The U.S. Air Force, the National Aeronautics and Space Administration,
the Naval Facilities Engineering Command, the Naval Sea Systems Command,
the Army's Ft. Drum in New York, and the General Services Administration
have all conducted or announced plans to conduct acquisitions that
include award-term incentives. Those acquisitions include or plan to
include provisions that will enable the contractor to extend its
performance for periods ranging from seven years to 20 years.

**A More All-Encompassing Incentive**

The award-term incentive may provide a solution to one of the most
vexing shortcomings of contractual incentives---that they do not work as
advertised. The contractual incentives described in FAR Part 16 are all
profit incentives; they reward excellent performance by paying more
money. But since the early 1960s, researchers have concluded that such
profit incentives do not produce the results predicted by incentive
theory. Studies conducted by Harvard University, the Rand Corporation,
the Logistics Management Institute (LMI), the U.S. General Accounting
Office, and a number of independent researchers have concluded that
there is little evidence that profit incentives have been effective.^1^

Why don't the standard contractual incentives work? In a 1968 study, J.
Ronald Fox of LMI reported that

Extra-contractual considerations dominate over profit or fee. A
contractor rarely seeks to maximize profit during the short run of a
single contract. He is more interested in taking actions that will
expand company operations, lead to increased future business, enhance
company image and reputation, benefit his nondefense business, or
relieve such immediate problems as loss of skilled personnel and a
narrow base for fixed costs.^2^

If the researchers are right and contractual incentives have had little
effect on contract performance outcomes, then the award-term incentive
is a promising development. The award-term incentive rewards a
contractor with additional *business*, which satisfies four of the
long-term goals identified by LMI in its 1968 study: 1) enhanced company
image and reputation, 2) increased future business, 3) retention of
skilled personnel, and 4) the maintenance of an allocation base for
fixed costs. The award-term incentive gives a contractor a chance to
earn a more all-encompassing reward than short term profit dollars: a
long-term business relationship.

**Advantages of Long-Term Business Relationships**

Aside from the potential for motivating contractors to perform
excellently, there are at least three other advantages to using
award-term incentives to establish long-term business relationships:

-   increased operational efficiency and effectiveness,

-   increased contractor investment, and

-   reduced acquisition transaction costs.

Government service contracts are becoming more complex as government
agencies outsource more of their internal functions. As service
requirements more complex and require performance over an extended
period of time, it becomes exceedingly difficult to write statements of
work and contract clauses that fully describe all of the government's
requirements and that cover all of the contingencies that may affect
performance. Legal scholars and economists refer to such complex,
long-term contracts as *relational contracts* and *incomplete
contracts*, and have produced a large body of scholarly writing about
them.^3^

Complex, long-term contracts have gaps in their terms, and wise business
managers know this. During the course of a cooperative long-term
relationship, the parties will fill in the gaps by adapting their
expectations to prevailing contingencies and making cooperative, ad hoc
adjustments. They will do so through formal contract modifications, to
be sure, but also through informal, undocumented daily cooperation. As
the parties work together, they develop a shared body of knowledge about
the contract work and an informal protocol of cooperation that will
enable them to respond to new conditions and to solve new problems as
they arise. Their shared knowledge and cooperative protocol become a
part of the culture of their relationship. By consciously recognizing
the fact that their contract is incomplete, being willing to adapt their
expectations to new conditions, and adopting a cooperative approach to
ad hoc decision-making, the parties can satisfy their needs and increase
the efficiency and effectiveness of their joint endeavor. In short, a
long-term, cooperative relationship facilitates team development and
effectiveness. If the relationship works poorly, then a change in
contractors may be necessary. But if it works well, a change in
contractors may degrade performance, at least temporarily.

Advocates of the award-term incentive also believe that long-term
business relationships will motivate contractors to invest in
performance-enhancing technologies, to take steps to attract and retain
the best workers, and to stay abreast of the latest developments in
their fields. Re-competitions of on-going requirements are costly to
contractors and entail considerable business risk. The government source
selection process requires firms to compete against one another without
full knowledge about who their competitors are and what their
competitors are offering. Incumbent contractors have lost competitions
despite good performance records and good relationships with their
government customer because their written technical essay was not as
impressive as a competitor's, or because a competitor that did not know
about all of the costs of performance offered a lower price. Competitive
uncertainty arising from these conditions may discourage contractors
from making long-term capital or workforce investments. Award-term
incentives may have the potential to significantly reduce that
uncertainty.

A third benefit of a long-term relationship is a reduction in
acquisition transaction costs. Government contract formation is often a
long and expensive process for both the government and competing
offerors. New awards are expensive to plan, proposals are expensive to
solicit, prepare, and evaluate, and contract award may be delayed by a
protest. Agencies can reduce their transaction costs by reducing the
frequency with which they conduct new competitions for continuing
service requirements. That is one reason why agencies use options. The
Competition in Contracting Act does not prohibit the use of award-term
incentives, any more than it prohibits the use of options. However,
reducing the frequency of competitions for continuing service
requirements can be justified on business grounds only if there is an
overall net savings to the government.

Disadvantages of Long-Term Relationships
========================================

A potential disadvantage of a long-term relationship is the possibility
that the agents of the contracting parties will begin to conduct
business on a personal basis instead of a proper professional basis.
Contractual relationships are, after all, human relationships. People
who have come to know and like one another in the course of time may
relax their standards and overlook performance deficiencies for the sake
of their personal relations. They may become reluctant to criticize or
to take an action that could hurt the other person. On the other hand, a
change in personnel may bring conflict as the parties try to adapt to
new personalities and changes in long-standing ways of seeing,
understanding, and doing. These sorts of developments are probably a
natural and unavoidable byproduct of long-term business relationships.

Another potential disadvantage of long-term business relationships is
the possibility that they will reduce the number of business
opportunities in the government marketplace, making it less attractive
or even untenable to firms that lose competitions. Such firms may be
forced to leave the government marketplace, making it less competitive.
A less competitive marketplace could make government agencies too
dependent upon a few contractors, which could lead to increased costs
and poor quality.

Commercial Idea, Government Rules
=================================

The award-term incentive is an attempt to use a commercial idea within a
framework of government rules. The commercial idea is to use the
prospect of a long-term business relationship and the sales to motivate
the contractor to provide excellent service. This is something that
commercial organizations generally do implicitly and informally, usually
without writing it into a contract. It goes without saying in the
commercial sector that a customer will stick with a contractor that
performs well and charges reasonable prices.

But to comply with the Competition in Contracting Act (CICA) when using
an award-term incentive to extend a contract, a government agency must
ensure that prospective award-term extensions are included within the
scope of the original competition. In ruling on the use of options to
extend the term of a contract, the General Accounting Office (GAO) has
long insisted that agencies meet three conditions:

-   The solicitation must state that the contract will include options
    and the maximum length of the contract as extended by the options;

-   The government must solicit prices for each option; and

-   The government must evaluate the option prices during the source
    selection for the original contract.

The GAO will not go along with the use of unpriced options.^4^

It is likely that the GAO will insist upon the same conditions for the
use of award-term incentives. Thus, to comply with CICA as interpreted
by the GAO, government agencies must do something that commercial
organizations need not do---they must make the award-term incentive
express and formal by writing it into their solicitations and resulting
contracts.

Problems Arising from Contractual Formality
===========================================

The need to make the award-term incentive express and formal gives rise
to contract writing problems that commercial firms do not have to face,
since no sensible business person would make an *irrevocable* legal
commitment---enforceable in court---to a long-term business
relationship. Markets and organizations can change rapidly in today's
highly dynamic global market; it is very difficult to predict conditions
even two years from now, and almost impossible to predict the state of a
market or organization 10 to 15 years in the future. A deal that is
highly advantageous today can be utterly worthless or bad business two
years from now. Consequently, government agencies using an award-term
incentive must simultaneously write the contract to meet the demands of
CICA and the GAO, provide a real incentive, and include provisions for
exiting the deal so that the parties do not become locked in a legal
death grip. Failing to provide enough exit opportunities would be a
serious mistake, but providing too many might undermine the incentive.

First and foremost, the contract must condition any award-terms upon a
continuing need for the service and the availability of funds. The
contract must enable the government to cancel any or all award-terms
that the contractor has earned if the government no longer needs the
service or Congress does not appropriate funds to pay for it. Aside from
those conditions, there may be other reasons why the government would
want to renege on an award-term; inconsistent performance is one such
example.

Some award-term contracts provide for a base year and four option years.
with the contractor to earn a one-year award-term extension in each of
those first five years as a reward for excellent performance. Suppose
that a contractor renders excellent performance during the first year
and earns an award-term extension, but renders only acceptable
performance during the second year. Such inconsistent performance then
continues throughout the first five years, so that by the end of that
time the contractor has earned only two of the five available
award-terms. Should the government remain in a relationship with such an
inconsistent performer? What provision if any should the contract make
for inconsistent performance?

Government agencies also face the possibility that the contractor may be
deemed no longer responsible as defined by FAR 9.101 when an award-term
is scheduled to begin. What if the contractor was debarred or suspended
for reasons that have nothing to do with the contract? Should the
government be contractually obligated to continue to do business with
such a firm? If the contract allows the government to get out of the
award-term in the event that the contractor is no longer responsible for
some reason, and if the contractor is a small business, would the Small
Business Administration's Certificate of Competency Program apply?

Contract pricing poses another challenge. Should an award-term extension
be contingent upon the continuing reasonableness of the award-term
prices? What if a price that was fair and reasonable at the time of the
original source selection is no longer fair and reasonable 10 years
later? What provision should the contract make for this possibility? In
the commercial sector, firms aren't required to negotiate prices far in
advance. They can agree to negotiate them later, or they can agree on
baseline prices and then renegotiate them as the need arises. But in
light of the GAO's position that agencies must obtain and evaluate
prices for option periods, and evaluate those prices during source
selection, it is likely that the GAO will insist upon the same
conditions for prospective award-term extensions. Moreover, the GAO is
also likely to object to any contract provision that would allow the
parties to renegotiate the award-term extension prices, since it has
objected to the renegotiation of option prices. It has insisted that
such renegotiations are sole source contract actions for which
justification and approval are required in accordance with CICA.^5^

Because most agencies that have used or that plan to use award-term
incentives have provided for as many as 10 to 15 years of performance,
the GAO's requirement to price those years at the time of initial
contract award and its objection to renegotiating those prices poses a
daunting problem to agencies and contractors. It is hard to imagine any
business person making a firm commitment to prices 10 to 15 years in
advance without some provision for price adjustment or escape from the
deal. Economic price adjustment clauses (as described in FAR § 16.203)
can help, but they usually do not cover all exigencies that could affect
prices significantly. Thus, agencies that are contemplating the use of
award-term incentives must develop another solution, one that will meet
with the approval of the GAO. One such solution may be for the parties
to agree on ceiling prices that are subject to downward adjustment based
on clearly stipulated terms and conditions. Upward adjustments of such
ceilings could be based on economic price adjustment provisions or some
other reasonable basis.

The government can always get out of a contract by terminating it for
convenience. But it would seem that fairness demands that the contractor
should have a way out, too. Contract law aside, is it good business to
compel a contractor to perform an award-term even though the contract no
longer serves its interests or is harmful to its interests? What about
the government's notoriously long acquisition administrative lead times?
If the contract allows the contractor to opt out of an award-term, how
much notice should it require the contractor to give the government? Six
months? A year? Two years? These considerations pose two significant
challenges to persons writing contracts that contain award-term
incentives.

Conclusion
==========

It is too soon to say whether the award-term incentive is a good idea
and will receive widespread acceptance within the acquisition community.
One thing is clear: The effective use of an award-term incentive demands
a high level of contracting knowledge and skill. It requires that
acquisition planners effectively solve many complex incentive design
problems. It requires that the contracting parties communicate clearly
and work together effectively when negotiating contract terms and
drafting contract language to ensure a common understanding of the
nature of their undertaking. They must remember that they are thinking
and writing for people who will not have been a part of the original
negotiation. It requires a new approach to contract management, one in
which the parties openly acknowledge that they cannot see or plan far
into the future, and that their contract is incomplete. It is a process
in which they agree to learn together, adjust their expectations when
necessary, and engage in cooperative, ad hoc decision making during the
course of performance.

The need to make award-term incentives express and formal and subject to
contract enforcement, as well as the speed with which technology and the
modern global economy change demands that we consider the prudence of
entering into formal 10-, 15-, or 20-year contracts. Does it make good
business sense to do so? The answer ultimately depends on how
effectively award-term incentives actually work to motivate contractors
to provide and maintain a high level of service performance at fair and
reasonable prices and to reduce acquisition transaction costs. The
effectiveness of award-term incentives will undoubtedly depend on the
wisdom and skill with which agencies and their contractors plan, design,
and manage them. All we can say for certain at present is that the
award-term incentive is an interesting experiment.

**Endnotes**

1.  See Scherer, F. M., *The Weapons Acquisition Process: Economic
    Incentives* (Boston: Harvard University, 1964); Fisher, I. N., *A
    Reappraisal of Incentive Contracting Experience*, Memorandum
    RM-5700-PR (Santa Monica: The Rand Corporation, 1968); Logistics
    Management Institute, *An Examination of the Foundations of
    Incentive Contracts*, LMI Task 66-67, May 1968; Fox, J. R. *Arming
    America: How the U.S. Buys Weapons* (Boston: Harvard University,
    1974); and, U.S. General Accounting Office, *Incentive Contracts:
    Examination of Fixed-Price Incentive Contracts*, GAO/NSIAD-88
    (Washington, DC: 1987).

2.  Logistics Management Institute, *An Examination of the Foundations
    of Incentive Contracts*, LMI Task 66-67, May 1968, cited by Fox, J.
    R. op. cit., p. 241. Frederic Scherer had reached similar
    conclusions in 1964. Scherer, F. M., op. cit., pp. 159-162, 268-269,
    and 321-323.

3.  For an overview of the legal analyses of relational contracts see:
    Speidel, R. E., "The Characteristics and Challenges of Relational
    Contracts," *Northwestern University Law Review*, Spring 2000, p.
    823.

4.  For GAO's own analysis of these issues, see: *The Honorable
    Caspar W. Weinberger, The Secretary of Defense*, GAO file number
    B-217655, April 23, 1986.

5.  See *Magnavox Electronic Systems Co.*, Comp. Gen. Dec. B-231795,
    88-2 CPD ¶ 431: "An agency is not permitted to negotiate with the
    awardee to reduce the option prices stated in the contract price if
    price competition for the option quantity is available." Also see:
    *Varian Associates, Inc*., Comp. Gen. Dec. B-208281, February 16,
    1983, 83-1 CPD ¶ 160; request for reconsideration denied, 83-2 CPD
    ¶ 78. The GAO's position on the renegotiation of option prices is
    reflected in FAR 17.207(f), which requires that options must be
    exercisable at prices that are "reasonably determinable" from the
    terms of the basic contract.

cording to the government's (subjective) assessment of the contractor's
performance that period

Printed by permission: "Contract Management", February 2001.