Testimony

Before the Subcommittee on Readiness 

and Management Support, Committee on 

Armed Services, U.S. Senate 

United States Government Accountability Office

GAO 

For Release on Delivery 

Expected at 3:00 p.m. EDT 

Wednesday April 5, 2006 DEFENSE ACQUISITIONS

DOD Wastes Billions of 

Dollars through Poorly 

Structured Incentives 

Statement of David M. Walker 

Comptroller General of the United States 

GAO-06-409T 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

www.gao.gov/cgi-bin/getrpt?GAO-06-409T.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Katherine 

Schinasi at (202) 512-4841 or 

schinasik@gao.gov. 

Highlights of GAO-06-409T, a testimony 

before the Subcommittee on Readiness 

and Management Support, Committee on 

Armed Services, U.S. Senate 

April 5, 2006

DEFENSE ACQUISITIONS 

DOD Wastes Billions of Dollars through 

Poorly Structured Incentives 

DOD’s use of award and incentive fees is an issue at the nexus of two areas 

that GAO has designated “high risk” for DOD—contract management and 

weapon system acquisition. Contract management has been a long-standing 

business management challenge for DOD because it often cannot assure that 

it is using sound business practices to acquire the goods and services the 

warfighter needs. For weapon system acquisitions, the persistent and 

long-standing nature of acquisition problems has perhaps made a range of 

key decision makers complacent about cost growth, schedule delays, 

quantity reductions, and performance shortfalls. DOD’s strategies for 

incentivizing its contractors, especially for weapon system development 

programs, reflect the challenges in these areas. 

DOD programs routinely engage in award-fee practices that do not hold 

contractors accountable for achieving desired outcomes and undermine 

efforts to motivate contractor performance, such as 

• evaluating contractors on award-fee criteria that are not directly related 

to key acquisition outcomes (e.g., meeting cost and schedule goals and 

delivering desired capabilities to the warfighter); 

• paying contractors a significant portion of the available fee for what 

award-fee plans describe as “acceptable, average, expected, good, or 

satisfactory” performance; and 

• giving contractors at least a second opportunity to earn initially 

unearned or deferred fees. 

As a result, DOD has paid out an estimated $8 billion in award fees on 

contracts in GAO’s study population, regardless of whether acquisition 

outcomes fell short of, met, or exceeded DOD’s expectations. Despite paying 

billions of dollars, DOD has not compiled data or developed performance 

measures to evaluate the validity of its belief that award and incentive fees 

improve contractor performance and acquisition outcomes. 

These issues, along with those GAO has identified in DOD’s acquisition and 

business management processes, present a compelling case for change. By 

implementing the recommendations GAO has made on award and incentive 

fees, DOD can improve incentives, increase transparency, and enhance 

accountability for the fees it pays. At the same time, by working more 

broadly to improve its acquisition practices, DOD can set the right 

conditions for getting better acquisition outcomes and making more efficient 

use of its resources in what is sure to be a more fiscally constrained 

environment. 

With DOD spending over 

$200 billion annually to acquire 

products and services that include 

everything from spare parts to the 

development of major weapon 

systems, our numerous, large, and 

mounting fiscal challenges demand 

that DOD maximize its return on 

investment and provide the 

warfighter with needed capabilities 

at the best value for the taxpayer. 

In an effort to encourage defense 

contractors to perform in an 

innovative, efficient, and effective 

way, DOD gives its contractors the 

opportunity to collectively earn 

billions of dollars through 

monetary incentives known as 

award and incentive fees. Using 

these incentives properly—in 

concert with good acquisition 

practices—is a key to minimizing 

waste, maximizing value, and 

getting our military personnel what 

they need, when and where they 

need it. 

The subcommittee asked GAO to 

testify on DOD’s use of award and 

incentive fees and the role they 

play in the acquisition system. This 

statement highlights the risks of 

conducting business as usual and 

identifies the actions DOD needs to 

take to use these fees more 

effectively. DOD concurred or 

partially concurred with the seven 

recommendations GAO made in a 

previously issued report on award 

and incentive fees. GAO looks 

forward to seeing DOD turn these 

promised steps into actual policy 

and practice. 
Page 1 GAO-06-409T DOD's Use of Award Fees 

Mr. Chairman and Members of the Subcommittee: 

I am pleased to be here today to discuss the Department of Defense’s 

(DOD) use of monetary incentives known as award and incentive fees. 

With DOD spending over $200 billion annually to acquire products and 

services that include everything from spare parts to the development of 

major weapon systems, our numerous, large, and mounting fiscal 

challenges demand that DOD maximize its return on investment and 

provide the warfighter with needed capabilities at the best value for the 

taxpayer. In an effort to encourage defense contractors to perform in an 

innovative, efficient, and effective way, DOD gives its contractors the 

opportunity to collectively earn billions of dollars through monetary 

incentives known as award and incentive fees. Using these incentives 

properly, in concert with sound acquisition practices, is a key to 

minimizing waste, maximizing value, and getting our military personnel 

what they need, when and where they need it. Unfortunately, DOD has not 

used these incentives effectively. How they have been used and how we 

believe they should be used is the focus of my statement today. 

To put the issues related to DOD’s use of award and incentive fees in 

context, I want to step back and look at some of the broader management 

challenges that confront DOD. The department is facing a significant 

number of recurring problems in managing its major weapon acquisitions. 

Although U.S. weapons are the best in the world, DOD’s acquisition 

process for weapons programs consistently yields undesirable 

consequences—dramatic cost increases, late deliveries to the warfighter, 

and performance shortfalls. These problems occur, in part, because DOD 

tends to consistently overpromise and underdeliver in connection with 

major acquisition efforts. In addition, DOD’s weapons programs do not 

capture, early on, the requisite knowledge that is needed to efficiently and 

effectively manage program risks. For example, programs lack clearly 

defined and stable requirements, move forward with unrealistic program 

cost and schedule estimates, use immature technologies in launching 

product development, and fail to solidify design and manufacturing 

processes at appropriate junctures in development. As a result, wants are 

not always distinguished from needs; expectation gaps are the norm; 

problems often surface late in the development process; and fixes tend to 

be much more costly than if they were caught earlier. 

Cost increases incurred while developing new weapon systems typically 

mean that DOD cannot produce as many of those weapons as intended nor 

can it be relied on to deliver them to the warfighter when promised and 

with the initially advertised capabilities. In addition, military operations in 
Page 2 GAO-06-409T DOD's Use of Award Fees 

Afghanistan and Iraq are consuming a large share of DOD resources and 

causing the department to invest more money sooner than expected to 

replace or fix existing weapons. Meanwhile, DOD is intent on transforming 

military operations and currently has its eye on multiple megasystems that 

are expected to be the most expensive and complex ever. These new 

desires and long-standing acquisition and contract management challenges 

are running head-on into the nation’s current imprudent and unsustainable 

fiscal path. At the same time, DOD’s numerous business management 

weaknesses continue to result in reduced efficiencies and effectiveness 

that waste billions of dollars every year. These business management 

weaknesses touch on all of DOD’s major business operations, ranging 

from the department’s inadequate management of its overall business 

transformation effort to decades-old financial management and 

information technology problems to various contracting and selected 

supply chain challenges. In fact, all these areas and more are on GAO’s 

2005 “high-risk” list of programs and activities that need urgent attention 

and fundamental transformation to ensure that our national government 

functions in the most economical, efficient, and effective manner possible. 

DOD’s use of award and incentive fees is an issue at the nexus of two of 

these high-risk areas—DOD contract management and DOD weapon 

system acquisition. Contract management has been a long-standing 

business management challenge for the department. DOD is the 

government’s largest purchaser, yet it is often unable to assure that it is 

using sound business practices to acquire the goods and services needed 

to meet the warfighter’s needs. For example, we have found that DOD has 

not used various contracting tools and techniques effectively—such as 

performance-based service contracting, multiple-award task order 

contracts, purchase cards, and, most recently, award and incentive fees. 

For DOD weapon system acquisitions, we have found the persistent and 

long-standing nature of acquisition problems has perhaps made a range of 

key players both in the Pentagon and the Congress complacent about cost 

growth, schedule delays, quantity reductions, and performance shortfalls 

in weapon system programs. DOD’s strategies for incentivizing its 

contractors, especially on weapon system development programs, reflect 

this complacency and are symptomatic of the lack of discipline, oversight, 

transparency, and accountability in DOD’s acquisition process. As a result, 

DOD programs routinely engage in practices that undermine efforts to 

motivate positive contractor performance and that do not hold contractors 

accountable for achieving desired acquisition outcomes, such as meeting 

cost and schedule goals and delivering desired capabilities to the 

warfighter. 
Page 3 GAO-06-409T DOD's Use of Award Fees 

Specifics follow: 

• DOD generally does not evaluate contractors based on award-fee 

criteria that are directly related to key acquisition outcomes. In 

addition, the link between the elements of contractor performance that 

are included in the criteria and these outcomes is not always clear. As a 

result, DOD paid out an estimated $8 billion in award fees over the life 

of the contracts in our study population (from their inception through 

our data collection phase),1

 regardless of whether acquisition outcomes 

fell short of, met, or exceeded DOD’s expectations. 

• DOD programs engage in practices that undermine efforts to motivate 

excellent contractor performance by regularly paying contractors a 

significant portion of the available fee for what award-fee plans 

describe as “acceptable, average, expected, good, or satisfactory” 

performance. Although the definition of this level of performance 

varies by contract, these definitions are generally not related to 

outcomes. About half of the contracts in our sample, allowed 

70 percent or more of the available fee to be paid for this level of 

performance. 

• DOD award fee practices do not promote accountability. DOD 

programs gave contractors on about half of the award-fee contracts in 

our study population at least a second opportunity to earn an estimated 

$669 million in initially unearned or deferred fees. 

Taken together, DOD’s acquisition, business, and contract management 

practices are contrary to the purpose of performance-based contracting 

concepts and have resulted and, if not corrected in both form and practice, 

will continue to result in wasting billions of dollars in taxpayer funds. My 

statement today will focus on what steps DOD must take to strengthen the 

link between monetary incentives and acquisition outcomes and by 

extension increase the transparency and accountability of DOD programs 

for fees paid and of contractors for results achieved. This testimony draws 

upon our recently issued report on DOD’s use of award and incentive fees 

as well as the GAO High-Risk series and our body of work on weapon 

system acquisitions. 

 1

Estimates of total award fees earned are based on all evaluation periods held from the 

inception of our sample contracts through our data collection phase, not just those from 

fiscal years 1999 through 2003. The oldest award fee contracts in our sample were signed in 

fiscal year 1991. For some contracts, the data collection phase ended as early as November 

2004. For at least one contract, data collection was not complete until April 2005. 
Page 4 GAO-06-409T DOD's Use of Award Fees 

GAO’s many acquisition-related reports over the years raise serious 

questions about the reasonableness, appropriateness, and affordability of 

DOD’s current investment plans; the soundness of the acquisition process 

which implements those plans; and the effectiveness of the practices DOD 

uses to manage its contractors, including the use of award and incentive 

fees. These reports collectively present a compelling case for change. 

Appendix I contains information about the scope and methodology for 

GAO-06-66, Defense Acquisitions: DOD Has Paid Billions in Award and 

Incentive Fees Regardless of Acquisition Outcomes. The work was 

conducted in accordance with generally accepted government auditing 

standards. 

Federal agencies, including DOD, can choose among numerous contract 

types to acquire products and services. One of the characteristics that vary 

across contract types is the amount and nature of the fee that agencies 

offer to the contractor for achieving or exceeding specified objectives or 

goals. Of all the contract types available, only award- and incentive-fee 

contracts allow an agency to adjust the amount of fee paid to contractors 

based on the contractor’s performance.2

Federal acquisition regulations state that award- and incentive-fee 

contracts should be used to achieve specific acquisition objectives, such 

as delivering products and services on time or within cost goals and with 

the promised capabilities. For award-fee contracts, the assumption 

underlying the regulation is that the likelihood of meeting these 

acquisition objectives will be enhanced by using a contract that effectively 

motivates the contractor toward exceptional performance. Typically, 

award-fee contracts emphasize multiple aspects of contractor 

performance in a wide variety of areas, such as quality, timeliness, 

technical ingenuity, and cost-effective management.3

 These areas are 

 2

Other contract types do not provide this same level of control over fees and profits. The 

two most prevalent DOD contract types (based on the number of contract actions) are 

firm-fixed-price and cost-plus-fixed-fee. Under firm-fixed-price contracts, DOD and the 

contractor agree on a price and the contractor assumes full responsibility for all costs and 

the resulting profit or loss. Under cost-plus-fixed-fee contracts, DOD provides payment for 

the contractor’s allowable incurred costs, to the extent prescribed in the contract, and the 

contractor receives a fee that was negotiated and fixed at the inception of the contract. 

3

Award-fee contracts are intended to be flexible, so award-fee plans allow contracting and 

program officials to change the fee criteria in these areas and the weight given to each 

criterion from evaluation period to evaluation period. 

Background 
Page 5 GAO-06-409T DOD's Use of Award Fees 

susceptible to judgmental and qualitative measurement and evaluation, 

and as a result, award-fee criteria and evaluations tend to be subjective.4

Table 1 provides a description of the general process for evaluating the 

contractor and determining the amount of award fee earned. 

Table 1: General Process for Determining Award-Fee Amounts 

1 DOD officials provide input on the contractor’s performance for an evaluation 

period that just ended. 

2 Program officials compile data and prepare briefing or summary for award-fee 

evaluation board.a

3 Award-fee evaluation board convenes meeting; contractor has option to submit a 

self-assessment and brief the board. 

4 Award-fee evaluation board considers all the input and recommends a fee rating 

for the contractor. 

5 Fee-determining official (usually outside the program) makes an initial fee 

determination and notifies contracting officer.b

6 Contracting officer notifies contractor of initial determination; contractor has the 

option to appeal the decision to the fee-determining official. 

7 Fee-determining official makes final determination, including whether to roll over 

unearned fee, and notifies contracting officer.c

8 Contracting officer issues final determination to contractor and processes a 

contract modification authorizing payment. 

Sources: Army Contracting Agency Award Fee Handbook, Air Force Award Fee Guide, Navy/Marine Corps Award Fee Guide (data); 

GAO (analysis). 

a Award-fee evaluation board members may include personnel from key organizations knowledgeable 

about the award-fee evaluation areas, such as: engineering, logistics, program management, 

contracting quality assurance, legal, and financial management; personnel from user organizations 

and cognizant contract administration offices; and the local small business office in cases where 

subcontracting goals are important. On major weapons programs, the boards are generally made up 

of personnel from the program office. 

b The fee-determining official is generally at a higher level organizationally than those directly involved 

in the evaluation of the contractor (e.g. award-fee board members). For instance, this official can be 

the program executive officer for a weapons system acquisition contract or a garrison commander on 

a base support services contract. 

c Rollover is the practice of moving unearned award fee from one evaluation period to a subsequent 

evaluation period or periods, thus providing the contractor an additional opportunity to earn previously 

unearned fee. 

 4

The Navy Award Fee Guide suggests that objective measures also be utilized, to the 

maximum extent possible, to support the subjective evaluation of the contractor’s 

performance. 
Page 6 GAO-06-409T DOD's Use of Award Fees 

From fiscal year 1999 through fiscal year 2003, award- and incentive-fee 

contract actions5

 accounted for 4.6 percent of all DOD contract actions 

over $25,000. However, when taking into account the dollars obligated—

award- and incentive-fee contract actions accounted for 20.6 percent of 

the dollars obligated on actions over $25,000, or over $157 billion, as 

shown in figure 1. Our sample of 93 contracts includes $51.6 billion, or 

almost one-third, of those obligated award- and incentive-fee contract 

dollars.6

 These obligations include award- and incentive-fee payments as 

well as other contract costs. 

Figure 1: Prevalence of Award- and Incentive-Fee Contracts, Fiscal Years 1999-2003 

 5

Contract actions include any action related to the purchasing, renting, or leasing of 

supplies, services, or construction. Contract actions include definitive contracts; letter 

contracts; purchase orders; orders made under existing contracts or agreements; and 

contract modifications, which would include the payment of award and incentive fees. 

6

These contracts were selected as part of a probability sample of 93 contracts from a study 

population of 597 DOD award-fee and incentive-fee contracts that were active between 

fiscal years 1999 and 2003 and had at least one contract action coded as cost-plus-awardfee, cost-plus-incentive-fee, fixed-price-award-fee, or fixed-price incentive valued at 

$10 million or more during that time. 

Prevalence and Use of 

Award and Incentive Fees 

Sources: Federal Procurement Data System (data); GAO (analysis and presentation).

Other DOD contracts

DOD award- and incentive-fee contracts

95.4% $607.1

billion

(79.4%)

4.6% DOD award- and 

incentive-fee contracts

Cost-plus award fee: 3.4%

Fixed-price incentive: 0.8%

Cost-plus incentive fee: 0.4%

Other DOD contracts

Firm-fixed price: 73.2%

Cost-plus fixed-fee: 9.3%

Other: 12.9%

$157.2 billion (20.6%)

DOD award- and 

incentive-fee contracts

Cost-plus award fee: 13.0%

Fixed-price incentive: 5.1%

Cost-plus incentive fee: 2.5%

Other DOD contracts

Firm-fixed price: 51.4%

Cost-plus fixed-fee: 11.9%

Other: 16.1%

DOD contract actions over $25,000 

(fiscal years 1999-2003)

DOD contract dollars obligated on actions over $25,000

(fiscal years 1999-2003)
Page 7 GAO-06-409T DOD's Use of Award Fees 

DOD utilized the contracts in our sample for a number of purposes. For 

example, research and development contracts accounted for 51 percent 

(or $26.4 billion) of the dollars obligated against contracts in our sample 

from fiscal years 1999 through 2003; while non-research-and-development 

services accounted for the highest number of contracts in our sample. 

Further, we estimate that most of the contracts and most of the dollars in 

our study population are related to the acquisition of weapon systems. 

DOD has the flexibility to mix and match characteristics from different 

contract types. The risks for both DOD and the contractor vary depending 

on the exact combination chosen, which, according to the Federal 

Acquisition Regulation, should reflect the uncertainties involved in 

contract performance. Based on the results from our sample, about half of 

the contracts in our study population were cost-plus-award-fee contracts. 

The theory behind these contracts is that although the government 

assumes most of the cost risk, it retains control over most or all of the 

contractor’s potential fee as leverage. On cost-plus-award-fee contracts, 

the award fee is often the only source of potential fee for the contractor. 

According to defense acquisition regulations, these contracts can include a 

base fee—a fixed fee for performance paid to the contractor—of anywhere 

from 0 to 3 percent of the value of the contract;7

 however, based on our 

sample results, we estimate that about 60 percent of the cost-plus-awardfee contracts in our study population included zero base fee.8

 There is no 

limit on the maximum percentage of the value of the contract that can be 

made available in award fee, although the 20 percent included in the 

Space-Based Infrared Radar System High development contract we 

examined was outside the norm. The available award fees on all the 

award-fee contracts in our study population typically ranged from 

7 to 15 percent of the estimated value of the contract. 

DOD’s use of award and incentive fees is symptomatic of an acquisition 

system in need of fundamental reform. DOD’s historical practice of 

routinely paying its contractors nearly all of the available award fee 

creates an environment in which programs pay and contractors expect to 

 7

The two F/A-22 development contracts in our sample included a 4 percent base fee. The 

program office received a deviation from the Defense Federal Acquisition Regulation 

Supplement, which allows for a maximum of 3 percent base fee. 

8

The 95 percent confidence interval surrounding this estimate ranges from 46 percent to 

73 percent. 

A System in Need of 

Reform 
Page 8 GAO-06-409T DOD's Use of Award Fees 

receive most of the available fee, regardless of acquisition outcomes. This 

is occurring at a time when DOD is giving contractors increased program 

management responsibilities to develop requirements, design products, 

and select major system and subsystem contractors. Based on our sample, 

we estimate that for DOD award-fee contracts, the median percentage of 

available award fee paid to date (adjusted for rollover)9

 was 90 percent, 

representing an estimated $8 billion in award fees for contracts active 

between fiscal years 1999 and 2003. Estimates of total award fees earned 

are based on all evaluation periods held from the inception of our sample 

contracts through our data collection phase, not just those from fiscal 

years 1999 through 2003.10 Figure 2 shows the percentage of available fee 

earned for the 63 award-fee contracts in our sample. 

 9

When calculating the percentage of award fee paid (i.e. percentage of award fee paid = 

total fee paid to date / (total fee pool – remaining fee pool)), we included rolled-over fees in 

the remaining fee pool when those fees were still available to be earned in future 

evaluation periods. 

10The oldest award fee contracts in our sample were signed in fiscal year 1991. For some 

contracts, the data collection phase ended as early as November 2004. For at least one 

contract, data collection was not complete until April 2005. 
Page 9 GAO-06-409T DOD's Use of Award Fees 

Figure 2: Percentage of Available Fee Paid to Date for 63 Award-Fee Contracts in GAO’s Sample 

Sources: DOD submissions to GAO and contract documentation (data); GAO (analysis and presentation). 

The pattern of consistently high award-fee payouts is also present in 

DOD’s fee decisions from evaluation period to evaluation period. This 

pattern is evidence of reluctance among DOD programs to deny 

contractors significant amounts of fee, even in the short term. We estimate 

that the median percentage of award fee earned for each evaluation period 

was 93 percent and that the contractor received 70 percent or less of the 

available fee in only 9 percent of the evaluation periods and none of the 

available fee in only 1 percent of the evaluation periods. 

Recommendations made DOD response 

• Move toward more outcome-based 

award-fee criteria that are both 

achievable and promote accountability 

for positive acquisition outcomes

• DOD issued a policy memo on 

March 29, 2006, emphasizing the need 

to link award fees to desired program 

outcomes. 

Award fees have generally not been effective at helping DOD achieve its 

desired acquisition outcomes, in large part, because award-fee criteria are 

not linked to desired acquisition outcomes, such as meeting cost and 

A Case for Change: 

Moving Toward 

Outcome-Based 

Award-Fee Criteria 

100

80

60

40

20

0

Percentage of available fee paid by DOD

Contracts in GAO’s sample
Page 10 GAO-06-409T DOD's Use of Award Fees 

schedule goals and delivering desired capabilities. Instead, DOD programs 

structure award fees to focus on the broad aspects of contractor 

performance, such as technical and management performance and cost 

control, that they view as keys to a successful program. In addition, 

elements of the award-fee process, such as the frequency of evaluations 

and the composition of award-fee boards, may also limit DOD’s ability to 

effectively and impartially evaluate the contractor’s progress toward 

acquisition outcomes. Most award-fee evaluations are time-based, 

generally every six months, rather than event-based; and award-fee boards 

are made up primarily of individuals directly connected to the program. As 

a result of all these factors, DOD programs frequently paid most of the 

available award fee for what they described as improved contractor 

performance, regardless of whether acquisition outcomes fell short of, 

met, or exceeded DOD’s expectations. 

High award-fee payouts on programs that have fallen or are falling well 

short of meeting their stated goals are also indicative of DOD’s failure to 

implement award fees in a way that promotes positive performance and 

adequate accountability. Several major development programs—

accounting for 52 percent of the available award-fee dollars in our sample 

and 46 percent of the award-fee dollars paid to date—are not achieving or 

have not achieved their desired acquisition outcomes, yet contractors 

received most of the available award fee. These programs—the Comanche 

helicopter, F/A-22 and Joint Strike Fighter aircraft, and the Space-Based 

Infrared System High satellite system—have experienced significant cost 

increases, technical problems, and development delays, but the prime 

systems contractors have received 85, 91, 100, and 74 percent of the award 

fee, respectively to date (adjusted for rollover), totaling $1.7 billion (see 

table 2). 
Page 11 GAO-06-409T DOD's Use of Award Fees 

Table 2: Program Performance and Award-Fee Payments on Selected DOD Development Programs 

Acquisition 

outcomes 

Comanche

reconnaissance

attack helicopter

F/A-22 Raptor 

tactical fighter 

aircraft

Joint Strike Fighter 

tactical fighter 

aircraft 

Space-Based

Infrared System

High

Research and development 

cost increase over original 

baseline 

$3.7 billion

41.2 percent

$10.2 billion

47.3 percent

$10.1 billion 

30.1 percent 

$3.7 billion

99.5 percent

Acquisition cycle time increase 

over original baseline 

33 months

14.8 percent

27 months

13.3 percent

11 months 

5.9 percent 

More than

12 monthsa

Number of program 

rebaselines 

1b14 1 3

Total award fee paid to prime 

systems contractor 

$202.5 million

paid through 2004

$848.7 million $494.0 million $160.4 millionc

Percentage of award fee paid 

to prime systems contractor 

(adjusted for rollover)d

85 percent

of available fee

91 percent 100 percent 74 percent

Total award fee paid to prime 

engine contractor 

No engine contractor $115 million

paid through 2004

$35.8 million No engine contractor

Percentage of award fee paid 

to prime engine contractor 

(adjusted for rollover)d

N/A 89 percent

of the available fee

100 percent N/A

Sources: DOD submissions to GAO, contract documentation, and GAO-05-301 (data); GAO (analysis and presentation). 

a The Air Force Space Command has not specified the acquisition cycle time for the Space-Based 

Infrared Radar System High program; however, the delivery of the first two satellites has been 

delayed by more than a year. 

b Overall, there were five rebaselines for the Comanche program; however, only one occurred after 

development start. The Comanche program was canceled in 2004. 

c The program also utilizes incentive fees tied to cost and mission successes. The award fee paid 

does not include fee earned through mission success incentives. To date, the contractor has earned 

$3 million in these fees and could earn over $70 million over the life of the contract. 

d When calculating the percentage of award fee paid to date (i.e., percentage of award fee paid to 

date = total fee paid to date / (total fee pool – remaining fee pool)), we included rolled-over fees in the 

remaining fee pool when those fees were still available to be earned in future evaluation periods. For 

instance, even though the Joint Strike Fighter prime contractor has not been paid 100 percent of the 

award fee that was made available for each evaluation period, it retains the ability to potentially earn 

all of this unearned fee at a later date. By reflecting the continued availability of this unearned fee in 

the percentage calculation, it becomes clear that the contractor has, in essence, earned 100 percent 

of the total award fee to date. 
Page 12 GAO-06-409T DOD's Use of Award Fees 

DOD can ensure that fee payments are more representative of program 

results by developing fee criteria that focus on its desired acquisition 

outcomes. For instance, DOD’s Missile Defense Agency attempted to hold 

contractors accountable for program outcomes on the Airborne Laser 

program. On this program, DOD revised the award-fee plan in June 2002 as 

part of a program and contract restructuring. The award-fee plan was 

changed to focus on achieving a successful system demonstration by 

December 2004. Prior to the restructuring, the contractor had received 95 

percent of the available award fee, even though the program had 

experienced a series of cost increases and schedule delays. Importantly, 

the contractor did not receive any of the $73.6 million award fee available 

under the revised plan because it did not achieve the key program 

outcome—successful system demonstration.11

Recommendations made DOD response 

• Ensure that award-fee structures are 

motivating excellent contractor 

performance by only paying award fees 

for above satisfactory performance 

• While DOD stated that award fee 

arrangements should be structured to 

encourage the contractor to earn the 

preponderance of fee by providing 

excellent performance, it maintains that 

paying a portion of the fee for 

satisfactory performance is appropriate 

to ensure that contractors receive an 

adequate fee on contracts. In its 

March 29, 2006 policy memo, DOD 

reiterated this position and emphasized 

that less than satisfactory performance 

is not entitled to any award fee. 

• Issue DOD guidance on when rollover is 

appropriate 

• In its March 29, 2006 policy memo, 

DOD provided guidance and placed 

several limitations on the use of rollover. 

DOD programs routinely engage in award-fee practices that are 

inconsistent with the intent of award fees, reduce the effectiveness of 

these fees as motivators of performance, compromise the integrity of the 

fee process, and waste billions in taxpayer money. Two practices, in 

particular, paying significant amounts of fee for “acceptable, average, 

expected, good, or satisfactory” performance and providing contractors 

multiple opportunities to earn fees that were not earned when first made 

 11According to DOD, the contract was restructured again in May 2004 and the cost ceiling 

was increased from about $2 billion to $3.6 billion and the period of performance of the 

contract was extended more than 3 years, from June 2005 to December 2008. 

A Case for Change: 

Motivating Excellent 

Contractor Performance 

and Promoting 

Accountability 
Page 13 GAO-06-409T DOD's Use of Award Fees 

available, undermine the effectiveness of fees as a motivational tool and 

marginalize their use in holding contractors accountable for acquisition 

outcomes. 

Although DOD guidance and federal acquisition regulations state that 

award fees should be used to motivate excellent contractor performance, 

most DOD award-fee contracts pay a significant portion of the available 

fee for what award-fee plans describe as “acceptable, average, expected, 

good, or satisfactory” performance. Although the definition of this level of 

performance varies by contract, these definitions are generally not related 

to outcomes. Some plans for contracts in our sample did not even require 

the contractor to meet all of the minimum standards or requirements of 

the contract to receive one of these ratings. Some plans also allowed for 

fee to be paid for marginal performance. Even fixed-price-award-fee 

contracts, which already include a normal level of profit in the price, paid 

out award fees for satisfactory performance. Figure 3 shows the maximum 

percentage of award fee paid for “acceptable, average, expected, good, or 

satisfactory” performance and the estimated percentage of DOD award-fee 

contracts active between fiscal years 1999 through 2003 that paid these 

percentages. 
Page 14 GAO-06-409T DOD's Use of Award Fees 

Figure 3: Maximum Percentage of Award Fee Available for “Acceptable, Average, 

Expected, Good, or Satisfactory” Performance and the Estimated Percentage of 

DOD Contracts That Paid These Percentages 

Note: Sampling errors for percentages in this figure do not exceed plus or minus 13 percentage 

points. 

The use of rollover is another indication that DOD’s management of 

award-fees lacks the appropriate incentives, transparency, and 

accountability necessary for an effective pay-for-performance system. 

Rollover is the process of moving unearned available award fee from one 

evaluation period to a subsequent evaluation period, thereby providing the 

contractor an additional opportunity to earn that previously unearned 

award-fee. We estimate that 52 percent of DOD award-fee contracts rolled 

over unearned fees into subsequent evaluation periods,12 and in 

52 percent13 of these periods, at least 99 percent of the unearned fee was 

rolled over. Overall, for DOD award-fee contracts active between fiscal 

 12The 95 percent confidence interval for this estimate ranges from 40 percent to 64 percent. 

13The 95 percent confidence interval for this estimate ranges from 34 percent to 69 percent. 

0

5

10

15

20

25

30

40-49

50-59

60-69

70-79

80-89

90-100

0

Estimated percentage of DOD award-fee contracts

Maximum percentage of award fee made available for “acceptable, 

average, expected, good, or satisfactory” performance

Sources: Award-fee plans and contract documentation (data); GAO (analysis and presentation).

6

12

8

22

26

22

4
Page 15 GAO-06-409T DOD's Use of Award Fees 

years 1999 through 2003, we estimate that the total dollars rolled over 

across all evaluation periods that had been conducted by the time of our 

review was $669 million. 

Recommendations made DOD response 

• Requiring appropriate approving officials 

to review new contracts to make sure 

award-fee criteria reflect desired 

acquisition outcomes and award-fee 

structures motivate excellent contractor 

performance by only providing fees for 

above satisfactory performance 

• DOD plans to conduct an analysis to 

determine what the appropriate 

approving official level should be for new 

contracts utilizing award fees and issue 

additional guidance if needed by 

June 1, 2006. 

The inconsistent application of DOD’s existing policies on award fees and 

weapon system development reinforce the need for increased 

transparency and accountability in DOD’s management of award fees. 

Although DOD award-fee guidance and federal acquisition regulations 

state that award fees should be used to motivate excellent contractor 

performance, most DOD award-fee contracts still pay a significant portion 

of the available fee for what award-fee plans describe as “acceptable, 

average, expected, good, or satisfactory” performance.14 Air Force, Army, 

and Navy guidance that states rollover should rarely be used in order to 

avoid compromising the integrity of the award-fee evaluation process; 

however, about half of the contracts in our study population used rollover. 

 14According to FAR 16.404(a)(1), in a fixed-price-award-fee contract, the fixed price 

(including normal profit) will be paid for satisfactory contract performance. Award fee 

earned (if any) will be paid in addition to that fixed price. According to FAR 16.405-2(a)(2), 

a cost-plus-award-fee contract should include an award amount that is sufficient to provide 

motivation for excellence in such areas as quality, timeliness, technical ingenuity, and costeffective management. 

A Case for Change: 

Ensuring Practice Is 

Consistent with Policy 
Page 16 GAO-06-409T DOD's Use of Award Fees 

Recommendations made DOD response 

• Develop a mechanism for capturing 

award- and incentive-fee data within 

existing data systems, such as the 

Defense Acquisition Management 

Information Retrieval system 

• DOD will conduct an analysis of existing 

systems and determine which, if any, is 

best suited, to capture this type of data 

and at what cost. DOD expects to 

complete the study by June 1, 2006. 

• Develop performance measures to 

evaluate the effectiveness of award and 

incentive fees as a tool for improving 

contractor performance and achieving 

desired program outcomes 

• DOD will review and identify possible 

performance measures and determine 

the appropriate actions by June 1, 2006. 

• Develop a mechanism to share proven 

incentive strategies for the acquisition of 

different types of products and services 

with contracting and program officials 

across DOD 

• In its March 29, 2006 policy memo, 

DOD tasked Defense Acquisition 

University to develop an online 

repository for award- and incentive-fee 

policy information, related training 

courses, and examples of good award 

fee arrangements. 

Very little effort has gone into determining whether DOD’s current use of 

monetary incentives is effective. Over the past few years, officials 

including the Undersecretary of Defense for Acquisition Technology and 

Logistics and the Assistant Secretary of the Air Force for Acquisition 

expressed concerns that contractors routinely earn high percentages of 

fee while programs have experienced performance problems, schedule 

slips, and cost growth. However, DOD has not compiled information, 

conducted evaluations, shared lessons learned, or used performance 

measures to judge how well award and incentive fees are improving or can 

improve contractor performance and acquisition outcomes. The lack of 

data is exemplified by the fact that DOD does not track such basic 

information as how much it pays in award and incentive fees. Such 

information collection across DOD is both necessary and appropriate. 

DOD’s use of award-fee contracts, especially for weapon system 

development, reflects the fundamental lack of knowledge and program 

instability that we have consistently cited as the main reasons for DOD’s 

poor acquisition outcomes. DOD uses these fees in an attempt to mitigate 

the risks that it creates through a flawed approach to major weapon 

system development. The DOD requirements, acquisition, budgeting, and 

investment processes are broken and need to be fixed. DOD’s 

requirements process generates much more demand for new programs 

than fiscal resources can reasonably support. The acquisition environment 

encourages launching product developments that promise the best 

capability, but embody too many technical unknowns and too little 

A Case for Change: 

Developing and Sharing 

Proven Incentive 

Strategies 

Conclusions 
Page 17 GAO-06-409T DOD's Use of Award Fees 

knowledge about the performance and production risks they entail. 

However, a new program will not be approved unless its costs fall within 

forecasts of available funds and, therefore, looks affordable. Further, 

because programs are funded annually and departmentwide, 

cross-portfolio priorities have not been established, competition for 

funding continues over time, forcing programs to view success as the 

ability to secure the next funding increment rather than delivering 

capabilities when expected and as promised. 

The business cases to support weapon system programs that result from 

these processes are in many cases not executable because the incentives 

inherent in the current defense acquisition system are not conducive to 

establishing realistic cost, schedule, and technical goals. As a result, DOD 

has to date not been willing to hold its programs or its contractors 

accountable for achieving its specified acquisition outcomes. Instead, 

faced with a lack of knowledge and the lack of a sound business case, 

DOD programs use award-fee contracts, which by their very nature allow 

DOD to evaluate its contractors on a subjective basis. This results in 

billions of dollars in wasteful payments because these evaluations are 

based on contractors’ ability to guide programs through a broken 

acquisition system, not on achieving desired acquisition outcomes. 

Implementing our recommendations on award and incentive fees will not 

fix the broader problems DOD faces with its management of major 

weapons or service acquisitions. However, by implementing our 

recommendations, DOD can improve incentives, increase transparency, 

and enhance accountability for the fees it pays. In particular, moving 

toward more outcome-based award-fee criteria would give contractors an 

increased stake in helping DOD to develop more realistic targets upfront 

or risk receiving less fee when unrealistic cost, schedule, and performance 

targets are not met. To make this new approach to incentives function as 

intended, DOD would also need to address the more fundamental issues 

related to its management approach, such as the lack of a sound business 

case, lack of well-defined requirements, lack of product knowledge at key 

junctions in development, and program instability caused by changing 

requirements and across-the-board budget cuts. Working in concert, these 

steps can help DOD set the right conditions for more successful 

acquisition outcomes and make more efficient use of its resources in what 

is sure to be a more fiscally constrained environment as the nation 

approaches the retirement of the “baby boom” generation. 
Page 18 GAO-06-409T DOD's Use of Award Fees 

Last week, DOD issued a policy memorandum on award-fee contracts that 

takes steps towards addressing several of the recommendations made in 

our report, and the department has indicated that further actions are 

planned to address the remaining recommendations. This guidance is a 

positive first step, but, like so many prior DOD concurrences, its 

effectiveness will ultimately be determined by how well it is implemented. 

Identifying who will be responsible for ensuring it is carried out and how 

progress will be monitored and measured are key ingredients that are 

missing in the new guidance. We continue to believe that DOD must 

designate appropriate approving officials to review new contracts to 

ensure that award-fee criteria are tied to desired acquisition outcomes; 

fees are used to promote excellent performance; and the use of rollover 

provisions in contracts is the exception not the rule. Changing DOD 

award-fee practices will also require a change in culture and attitude. The 

policy memorandum’s position that it is appropriate to pay a portion of the 

available award fee for satisfactory performance to ensure that 

contractors receive an “adequate fee on contracts” is indicative of DOD’s 

resistance to cultural change. Finally, we encourage the department to 

fully implement our remaining recommendations including developing a 

mechanism to capture award- and incentive-fee data and developing 

performance measures to evaluate the effectiveness of these fees. 

Mr. Chairman and Members of the Committee, this concludes my prepared 

statement. I would be happy to answer any questions you may have at this 

time. 

Recent DOD Actions 
Page 19 GAO-06-409T DOD's Use of Award Fees 

In this statement, we examine fixed-price and cost-reimbursable awardand incentive-fee contracts, as well as contracts that featured 

combinations of these contract types. These contracts were selected as 

part of a probability sample of 93 contracts from a study population of 

597 DOD award-fee and incentive-fee contracts that were active between 

fiscal years 1999 and 2003 and had at least one contract action coded as 

cost-plus-award-fee, cost-plus-incentive-fee, fixed-price-award-fee, or 

fixed-price incentive valued at $10 million or more during that time. Unless 

otherwise noted, the estimates in this statement pertain to (1) this 

population of award- and incentive-fee contracts, (2) the subpopulation of 

award-fee contracts, or (3) the evaluation periods associated with 

contracts described in (1) or (2) that had been completed at the time of 

our review. In the sample, 52 contracts contained only award-fee 

provisions; 27 contracts contained only incentive-fee provisions; and 

14 contracts included both. Estimates of total award fees earned and total 

award fees that contractors received at least two chances to earn are 

based on all evaluation periods held from the inception of our sample 

contracts through our data collection phase,1

 not just those from fiscal 

years 1999 through 2003. Because the estimates in this report are derived 

from a probability sample, they are subject to sampling error. All 

percentage estimates from our review have margins of error not exceeding 

plus or minus 10 percentage points unless otherwise noted. All numerical 

estimates other than percentages (such as totals and ratios) have margins 

of error not exceeding plus or minus 25 percent of the value of those 

estimates. 

 1

For some contracts, the data collection phase ended as early as November 2004. For at 

least one contract, data collection was not complete until April 2005. 

Appendix I: Scope and Methodology 

(120517) 
This is a work of the U.S. government and is not subject to copyright protection in the 

United States. It may be reproduced and distributed in its entirety without further 

permission from GAO. However, because this work may contain copyrighted images or 

other material, permission from the copyright holder may be necessary if you wish to 

reproduce this material separately. 
The Government Accountability Office, the audit, evaluation and 

investigative arm of Congress, exists to support Congress in meeting its 

constitutional responsibilities and to help improve the performance and 

accountability of the federal government for the American people. GAO 

examines the use of public funds; evaluates federal programs and policies; 

and provides analyses, recommendations, and other assistance to help 

Congress make informed oversight, policy, and funding decisions. GAO’s 

commitment to good government is reflected in its core values of 

accountability, integrity, and reliability. 

The fastest and easiest way to obtain copies of GAO documents at no cost 

is through GAO’s Web site (www.gao.gov). Each weekday, GAO posts 

newly released reports, testimony, and correspondence on its Web site. To 

have GAO e-mail you a list of newly posted products every afternoon, go 

to www.gao.gov and select “Subscribe to Updates.” 

The first copy of each printed report is free. Additional copies are $2 each. 

A check or money order should be made out to the Superintendent of 

Documents. GAO also accepts VISA and Mastercard. Orders for 100 or 

more copies mailed to a single address are discounted 25 percent. Orders 

should be sent to: 

U.S. Government Accountability Office 

441 G Street NW, Room LM 

Washington, D.C. 20548 

To order by Phone: Voice: (202) 512-6000 

TDD: (202) 512-2537 

Fax: (202) 512-6061 

Contact: 

Web site: www.gao.gov/fraudnet/fraudnet.htm 

E-mail: fraudnet@gao.gov

Automated answering system: (800) 424-5454 or (202) 512-7470 

Gloria Jarmon, Managing Director, JarmonG@gao.gov (202) 512-4400 

U.S. Government Accountability Office, 441 G Street NW, Room 7125 

Washington, D.C. 20548 

Paul Anderson, Managing Director, AndersonP1@gao.gov (202) 512-4800 

U.S. Government Accountability Office, 441 G Street NW, Room 7149 

Washington, D.C. 20548 

GAO’s Mission 

Obtaining Copies of 

GAO Reports and 

Testimony 

Order by Mail or Phone 

To Report Fraud, 

Waste, and Abuse in 

Federal Programs 

Congressional 

Relations 

Public Affairs 

PRINTED ON RECYCLED PAPER