United States Government Accountability Office

GAO Report to the Subcommittee on 

Readiness and Management Support, 

Committee on Armed Services, 

U.S. Senate 

DEFENSE 

ACQUISITIONS 

DOD Has Paid Billions 

in Award and 

Incentive Fees 

Regardless of 

Acquisition Outcomes 

December 2005 

 

GAO-06-66 
What GAO Found

United States Government Accountability Office

Why GAO Did This Study

Highlights

Accountability Integrity Reliability

December 2005

DEFENSE ACQUISITIONS 

DOD Has Paid Billions in Award and 

Incentive Fees Regardless of Acquisition 

Outcomes 

Highlights of GAO-06-66, a report to the 

Subcommittee on Readiness and

Management Support, Committee on 

Armed Services, U.S. Senate 

Collectively, the Department of 

Defense (DOD) gives its

contractors the opportunity to earn 

billions of dollars through 

monetary incentives—known as

award fees and incentive fees. 

These fees are intended to motivate

excellent contractor performance 

in areas deemed critical to an 

acquisition program’s success, with

award fees being appropriate when

contracting and program officials 

cannot devise objective incentive

fee targets related to cost, technical 

performance, or schedule. 

GAO was asked to determine

whether award and incentive fees 

have been used effectively as a tool

for achieving DOD’s desired 

acquisition outcomes. To do this, 

GAO selected a probability sample

of 93 contracts from the study

population of 597 DOD award- and 

incentive-fee contracts that were

active and had at least one contract

action valued at $10 million or 

more from fiscal year 1999 through 

2003. 

What GAO Recommends

GAO recommends that DOD 

improve its use of fees by

specifically tying them to 

acquisition outcomes in all new 

award- and incentive-fee contracts,

maximizing contractors’ motivation

to perform, and collecting data to

evaluate the effectiveness of fees. 

In its comments on a draft of this 

report, DOD concurred or partially 

concurred with all of the

recommendations. 

The power of monetary incentives to motivate excellent contractor 

performance and improve acquisition outcomes is diluted by the way DOD 

structures and implements incentives. While there were two examples in our 

sample in which the Missile Defense Agency attempted to link award fees

directly to desired acquisition outcomes, such as demonstrating a capability 

within an established schedule, award fees are generally not linked to 

acquisition outcomes. As a result, DOD has paid out an estimated $8 billion 

in award fees to date on the contracts in our study population, regardless of 

outcomes. The following selected programs show this disconnect. 

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 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 baseline

33 months

14.8 percent 

27 months

13.3 percent 

11 months

5.9 percent 

More than 12

months 

Percentage and total 

award fee paid to prime 

systems contractor 

(adjusted for rollover) a

85 percent 

$202.5 million 

paid through 2004

91 percent 

$848.7 million 

100 percent 

$494.0 million 

74 percent 

$160.4 million 

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

a

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. 

When DOD programs did not pay all of the available award fee, DOD gave 

contractors on an estimated 52 percent of award-fee contracts at least a 

second opportunity to earn an estimated $669 million in initially unearned or 

deferred fees. GAO believes these practices, along with paying significant 

amounts of fee for “acceptable, average, expected, good, or satisfactory” 

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

marginalize their use in holding contractors accountable for acquisition 

outcomes. They also serve to waste taxpayer funds. Incentive fees provide a 

clearer link to acquisition outcomes; however, a majority of the 27 contracts 

with cost incentives that GAO reviewed failed or are projected to fail to 

complete the acquisition at or below the target price.

Despite paying billions in fees, DOD has little evidence to support its belief 

that these fees improve contractor performance and acquisition outcomes. 

The department has not compiled data, conducted analyses, or developed 

performance measures to evaluate the effectiveness of award and incentive

fees. In addition, when contracts have utilized different fee strategies to 

focus the contractor’s attention on specific acquisition outcomes, 

contracting officials have stated that DOD has few mechanisms to share 

lessons learned and innovative practices outside the local level. 

www.gao.gov/cgi-bin/getrpt?GAO-06-66.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact 

Ann Calvaresi-Barr, (202) 512-4841, 

calvaresibarra@gao.gov. 
Contents 

Letter 1

Results in Brief 3

Background 6

Award and Incentive Fees Are Not an Effective Tool for Achieving 

DOD’s Desired Acquisition Outcomes 14 

DOD Has Little Evidence That Monetary Incentives Improve 

Results as Intended 31 

Conclusions 33

Recommendations for Executive Action 33 

Agency Comments and Our Evaluation 34 

Appendix I Scope and Methodology 37 

Appendix II Comments from the Department of Defense 42 

Appendix III Contracting Definitions 46 

Appendix IV Sample Characteristics 48 

Appendix V GAO Reports on the Weapon Systems Acquisition 

Environment 49 

Tables 

Table 1: General Process for Determining Award-Fee Amounts 8 

Table 2: General Process for Determining Incentive-Fee Amounts 9 

Table 3: Products and Services, Dollars Obligated, and Contract 

Types in GAO’s Sample, Fiscal Years 1999-2003 11 

Table 4: Award Fees as a Percentage of Contract Value 12 

Table 5: Base Fees as a Percentage of Contract Value 13 

Table 6: Program Performance and Award-Fee Payments on 

Selected DOD Development Programs 27 

Page i GAO-06-66 DOD's Use of Monetary Incentives
Figures 

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

Years 1999-2003 10 

Figure 2: Weaknesses in DOD’s Use of Award and Incentive Fees 16 

Figure 3: Percentage of Available Award Fee Paid to Date for 63 

Award-Fee Contracts in GAO’s Sample 18 

Figure 4: Percentage of Available Award Fee Earned for 572 

Evaluation Periods in GAO’s Sample 20 

Figure 5: DOD’s Use of Rollover on 32 Contracts in GAO’s Sample 22 

Figure 6: 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 24 

Abbreviations 

DOD Department of Defense 

FAR Federal Acquisition Regulation 

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

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reproduce this material separately. 

Page ii GAO-06-66 DOD's Use of Monetary Incentives
United States Government Accountability Office

Washington, DC 20548 

December 19, 2005 

The Honorable John Ensign 

Chairman 

The Honorable Daniel K. Akaka 

Ranking Minority Member 

Subcommittee on Readiness and Management Support 

Committee on Armed Services 

United States Senate 

The Department of Defense (DOD) contracts with various companies, 

institutions, and organizations to provide products and services that 

include everything from spare parts for aircraft to ship maintenance to the

development of major weapon systems. With federal discretionary 

spending, including defense spending, facing serious budget pressures in 

the coming years, fiscal realities demand that DOD maximize its return on 

investment for these acquisitions. Each of these acquisitions poses unique 

risks and challenges for DOD and its contractors. In an effort to encourage 

defense contractors to perform in an innovative, efficient, and effective 

way in areas deemed important to an acquisition’s success, DOD gives its 

contractors the opportunity to collectively earn billions of dollars through 

monetary incentives known as award fees and incentive fees. Award fees 

and incentive fees can be used alone or together in contracts, with award 

fees being appropriate when contracting and program officials cannot 

devise predetermined objective incentive-fee targets applicable to cost, 

technical performance, or schedule.

Award and incentive fees operate in an environment where actions taken

by both DOD and the contractor contribute to acquisition outcomes. Prior 

GAO work has shown how fundamental acquisition problems within DOD, 

especially a lack of key product knowledge at critical junctures, have 

contributed to such issues as cost increases, schedule delays, and 

performance shortfalls in weapons programs. See appendix V for a list of 

GAO reports on weapon systems acquisition. These overarching problems, 

along with the selection of an unqualified supplier or inadequate funding, 

among other reasons, can negatively affect acquisition outcomes. 

Page 1 GAO-06-66 DOD's Use of Monetary Incentives
In this context, DOD has looked to monetary incentives as one of the ways 

it can promote its desired acquisition outcomes. However, senior DOD and 

service acquisition officials have raised concerns about how effectively 

these fees are being used because DOD programs have paid contractors 

large amounts of fee on acquisitions that are falling behind schedule, 

overrunning costs, and experiencing significant technical problems. 

Because of these concerns, you requested that we determine whether 

award fees and incentive fees have been used effectively as a management 

tool for achieving DOD’s desired acquisition outcomes. 

To address this objective, we selected a probability sample of 93 contracts 

from the 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-plusincentive-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 report 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. 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, 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. See appendix I for more details about the 

probability sample and associated sampling error. Fifty-two contracts in 

our sample contained only award-fee provisions; 27 contracts contained 

only incentive-fee provisions; and 14 included both award- and incentivefee provisions. The types of products or services associated with contracts 

in our sample include research and development projects, aircraft and 

aircraft-related procurements, ship construction, and non-research-anddevelopment services, among others. For each of the 93 contracts in our 

sample, we interviewed contracting and program officials about the 

development, implementation, and effectiveness of the award- and 

incentive-fee structures using a standard questionnaire and analyzed their 

Page 2 GAO-06-66 DOD's Use of Monetary Incentives
responses. We also reviewed contract documentation related to these 

areas and examined fee payments in the context of program performance. 

Program performance was assessed using GAO’s body of work on DOD 

weapon systems acquisitions.1

 Finally, we interviewed acquisition policy 

officials and consulted recent policy initiatives, reports, and audits related 

to DOD’s use of award and incentive fees. See appendix I for additional 

details on scope and methodology. We performed our review from 

February 2004 to November 2005 in accordance with generally accepted 

government auditing standards. 

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

desired acquisition outcomes. DOD programs engage in practices that 

undermine efforts to motivate 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. DOD programs frequently pay most of the available award fee 

for what they describe as improved contractor performance, regardless of 

whether acquisition outcomes fell far short of DOD’s expectations, were 

satisfactory, or exceeded expectations. Based on our sample, we estimate 

that for the study population of DOD contracts, the median percentage of 

available award fee paid to date (adjusted for fees that were deferred) was 

90 percent, representing an estimated $8 billion in award fees. DOD 

programs also provided about half of its contractors multiple 

opportunities to earn fees that the contractors did not earn when the fees 

were first made available. Based on our sample, we estimate that, to date, 

contractors for DOD contracts in our study population received at least 

two chances to earn $669 million in fees that were not initially earned or 

deferred. In addition, DOD programs regularly paid contractors a 

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

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

when federal acquisition regulations and military service guidance state 

that the purpose of these fees is to motivate excellent performance. These 

practices reduce the effectiveness of award fees as motivators of 

performance and compromise the integrity of the fee process. DOD does 

Results in Brief 

 1

 GAO, Defense Acquisitions: Assessments of Selected Major Weapon Programs, 

GAO-05-301 (Washington, D.C.: Mar. 31, 2005). 

Page 3 GAO-06-66 DOD's Use of Monetary Incentives
not define contractor performance in terms of acquisition outcomes. 

Rather than focusing on acquisition outcomes, such as delivering a fielded 

capability within established cost and schedule baselines, DOD often 

places emphasis on such things as the responsiveness of contractor 

management to feedback from DOD officials, quality of contractor 

proposals, or timeliness of contract data requirements. Some programs, 

most notably the Missile Defense Agency’s Airborne Laser program, have 

structured fees to focus on acquisition outcomes, such as successfully 

demonstrating the system, which can help ensure that fee payments are 

more representative of program results. Incentive-fee contracts link 

contractor performance to acquisition outcomes more explicitly; however, 

about half of the 27 incentive-fee contracts that we reviewed failed or are 

projected to fail to meet a key measure of program success—completing 

the acquisition at or below the target price. In the one case in which 

significant savings were realized through the successful use of an incentive

fee, program officials were able to leverage the knowledge gained about 

program costs on a previous contract. However, when contracts have 

identified seemingly effective award- and incentive-fee strategies, 

contracting officials have stated that DOD has few mechanisms to share 

lessons learned and innovative practices outside the local level. 

The effectiveness of award and incentive fees as a management tool has 

also been limited by DOD’s failure to examine the basis for their use, 

assess how well they are working, and account for various factors that 

arise in the complex acquisition environment. Although DOD has paid 

billions in fees over time, the department has little evidence to support its 

contention that the use of award and incentive fees results in the intended 

effect on contractor performance and acquisition outcomes. While DOD 

officials have told us that they believe these fees improve contractor 

performance and program outcomes, DOD has not conducted overall 

evaluations or compiled data on the effectiveness of award and incentive

fees. In addition, DOD has not developed performance measures to 

evaluate whether contracts utilizing these fees actually produce better 

outcomes than other contract types. Research on incentive fees by GAO, 

Harvard University, and the RAND Corporation going back decades has 

concluded that these types of fees do not consistently motivate 

contractors to control cost. Other research by Air Force personnel has 

shown that award fees are not always implemented in a way that is 

consistent with the intent of improving contractor performance. 

Page 4 GAO-06-66 DOD's Use of Monetary Incentives
To strengthen the link between monetary incentives and acquisition 

outcomes and by extension increase the accountability of DOD programs 

for fees paid and of contractors for results achieved, we recommend that 

the Secretary of Defense direct the Undersecretary of Defense for 

Acquisition, Technology, and Logistics to take the following seven actions. 

DOD can immediately improve its use of award fees on all new contracts 

by (1) instructing the military services to move toward more outcomebased award-fee criteria that are both achievable and promote 

accountability for acquisition outcomes; (2) ensuring that award-fee 

structures are motivating excellent contractor performance by only paying 

award fees for above satisfactory performance; and (3) requiring the 

appropriate approving officials to review new contracts to make sure 

these actions are being taken. DOD can improve its use of award fees on 

all existing contracts by (4) issuing DOD guidance on when rollover is 

appropriate. In the longer term, DOD can improve its use of award and 

incentive fees by (5) developing a mechanism for capturing award- and 

incentive-fee data within existing data systems, such as the Defense 

Acquisition Management Information Retrieval system; (6) developing

performance measures to evaluate the effectiveness of award and 

incentive fees as a tool for improving contractor performance and 

achieving desired program outcomes; and (7) developing a mechanism to 

share proven incentive strategies for the acquisition of different types of 

products and services with contracting and program officials across DOD.

DOD’s Office of Defense Procurement and Acquisition Policy provided 

written comments on a draft of this report. In its comments, DOD 

concurred with three of our seven recommendations—moving toward 

more outcome-based award-fee criteria, issuing guidance on rollover, and 

developing a mechanism to share proven incentive strategies—and agreed 

to address them in a policy memorandum and communications plan that it 

indicated will be issued on March 31, 2006. DOD partially concurred with 

four of our recommendations—only paying award fees for above 

satisfactory performance, requiring the appropriate officials to make sure 

these recommendations are implemented in new contracts, collecting 

award- and incentive-fee data, and developing performance measures to 

evaluate the effectiveness of award and incentive fees in improving 

acquisition outcomes. Concerning our recommendation related to the 

payment of award fees for satisfactory performance, DOD stated that it

was both fair and reasonable to pay a portion of the award fee for this 

level of performance, but agreed that the preponderance of fee should be 

Page 5 GAO-06-66 DOD's Use of Monetary Incentives
paid for excellent performance and that it would reinforce existing 

policies in its March memorandum. We continue to believe that award fees 

should be primarily reserved for above satisfactory performance, which as

pointed out in this report is not the current practice for most contracts. On 

the remaining three recommendations, DOD indicated that it would 

conduct a study to determine the appropriate actions to address these 

recommendations. DOD plans to complete the study by June 1, 2006. While 

this study may provide additional insights, we encourage DOD to use it as

a mechanism for identifying the specific steps the department will take to 

fully address our recommendations, not to determine whether the 

department will take action. Between fiscal years 1999 through 2003, the 

department obligated $157 billion through award- and incentive-fee 

contracts and used these contracts on some of its largest weapons 

programs. Given the dollars involved, DOD needs to collect data and 

develop performance measures on the use of award and incentive fees to 

help it effectively manage these contracts and assure its resources are 

well-spent. DOD’s comments are reprinted in their entirety in appendix II

of this report. 

Federal agencies, including DOD, can choose among numerous contract 

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

varies 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

 Typically, award-fee 

contracts emphasize multiple aspects of contractor performance in a wide 

variety of areas, such as quality, timeliness, technical ingenuity, and costeffective management. Incentive-fee contracts usually focus on cost 

control, although they can also be used to motivate contractors to achieve

specific delivery targets or performance goals in areas such as missile 

range, aircraft speed, engine thrust, or vehicle maneuverability. 

Background 

 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, the contractor receives a 

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

Page 6 GAO-06-66 DOD's Use of Monetary Incentives
Regardless of differences between award- and incentive-fee contracts, 

federal acquisition regulations state that these 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. The reason or basis for selecting an award- or 

incentive-fee contract can vary, depending on the type of work a 

contractor is expected to perform. The acquisition environment, including

the knowledge DOD has prior to starting an acquisition program, the 

adequacy of resources, and the soundness of acquisition practices, can

also be a critical factor that affects how well contractor performance 

translates into acquisition outcomes. 

Award-Fee Contracts The development and administration of award-fee contracts involve 

substantially more effort over the life of a contract than incentive-fee

contracts.3

 For award-fee contracts, DOD personnel (usually members of 

an award-fee evaluation board4

) conduct periodic—typically semiannual—

evaluations of the contractor’s performance against specified criteria in an

award-fee plan and recommend the amount of fee to be paid.5

 Because 

award fees are intended to motivate contractor performance in areas that 

are susceptible to judgmental and qualitative measurement and evaluation

(e.g., technical, logistics support, cost, and schedule), these criteria and 

evaluations tend to be subjective.6

 After receiving the recommendation of 

 3

 The Federal Acquisition Regulation (FAR) requires that the expected benefits of using an

award-fee contract must exceed the additional administrative effort and cost involved 

(FAR Part 16.404(b)(1) and 16.405-2(b)(1)(iii)). 

4

 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. 

5

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

program officials to change fee criteria and the weight given to each criterion from 

evaluation period to evaluation period. 

6

 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 7 GAO-06-66 DOD's Use of Monetary Incentives
the award-fee evaluation board, a fee-determining official7

 makes the final 

decision about the amount of fee the contractor will receive. The feedetermining official can also decide to move 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—a practice called rollover. Table 1 provides a general look

at the process for evaluating and determining award fee amounts. 

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 a briefing or summary for the award-fee 

evaluation board. 

3 Award-fee evaluation board convenes meeting; contractor has the 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 the contracting officer. 

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 a final determination, including whether to rollover 

unearned fee, and notifies contracting officer. 

8 Contracting officer issues final determination to contractor and processes a contract 

modification authorizing payment. 

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

GAO (analysis). 

Incentive-Fee Contracts Incentive-fee contracts use what is considered to be an objective 

evaluation of the contractor’s performance to adjust the fee paid. DOD’s 

evaluation usually involves the application of a fee-determination formula 

that is specified in the contract. Evaluations occur at the end of the 

contract or, in the case of a performance or delivery incentive, at program 

milestones. The evaluations do not require an extensive evaluation 

 7

 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. 

Page 8 GAO-06-66 DOD's Use of Monetary Incentives
process or the participation of a large number of contracting or program 

personnel. Table 2 provides a general look at the process for evaluating 

and determining the amount of incentive fee paid for a contract with a cost 

incentive. 

Table 2: General Process for Determining Incentive-Fee Amounts 

1 At the conclusion of the contract, DOD contracting officer compares the contractor’s 

actual cost to complete the contract with the target cost specified in the contract. 

2 a. If contractor’s actual cost matches the target cost, DOD awards the contractor an 

amount called the target fee or target profit.a 

b. If contractor’s actual cost falls below the target cost, the contracting officer applies 

a formula with a share ratio that specifies how much the contractor’s target fee or 

profit is increased for every dollar the actual cost is below the target cost. 

c. If contractor’s actual cost exceeds the target cost, the contracting officer applies a 

formula with a share ratio that specifies how much the contractor’s target fee or 

profit is reduced for every dollar the actual cost is above the target cost. 

3 Contracting officer processes a contract modification authorizing payment. 

Sources: Federal Acquisition Regulation, DOD Contract Pricing Guide (data); GAO (analysis).

a

In federal contracting, the terms “profit” and “fee” refer to the amount of money paid to the contractor 

above and beyond either a fixed price or a contractor’s reimbursable costs. The term “profit” is 

associated with fixed-price contracts, and the term “fee” is associated with cost-reimbursable 

contracts. 

Contracts Discussed in 

This Report 

For this report, we examined fixed-price and cost-reimbursable awardand incentive-fee contracts, as well as contracts that combined aspects of 

both of these contract types. (See app. III for an explanation of various 

contract types.) Our probability sample of 93 contracts was drawn from a 

total of 597 DOD award- and incentive-fee contracts that were active from 

fiscal years 1999 through 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. 

Among the sample, 52 contracts contained only award-fee provisions, 

27 contracts contained only incentive-fee provisions, and 14 contracts 

included both. (App. I contains additional information on our scope and 

methodology.) 

Page 9 GAO-06-66 DOD's Use of Monetary Incentives
From fiscal year 1999 through fiscal year 2003, award- and incentive-fee 

contract actions8

 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 1.9

 Our sample of 93 contracts includes $51.6 billion, or 

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

dollars. 

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

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)

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. 

 8

 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. 

9

 These obligations include award- and incentive-fee payments as well as other contract

costs.

Page 10 GAO-06-66 DOD's Use of Monetary Incentives
Table 3 shows the dollars obligated and the types of contracts by product

and service. Appendix IV contains a breakdown of the contracts in our 

sample by contract type and military service. 

Table 3: Products and Services, Dollars Obligated, and Contract Types in GAO’s Sample, Fiscal Years 1999-2003 

Product or service 

Number of 

contracts 

according to

product or

service 

Total dollars 

in GAO’s 

sample (in

billions)

Percentage of

dollars in GAO’s 

sample

Number of 

contracts with

award fees and

no incentive 

fees

Number of 

contracts with

incentive fees

and no award

fees 

Number of 

contracts with

both award

and incentive 

fees

Research and 

development 32 $26.4 51.2% 20 7 5

Aircraft and aircraftrelated procurement 7 8.5 16.5 2 5 0

Ship construction 6 8.3 16.0 0 2 4

Non-research-anddevelopment services 36 6.0 11.6 23 9 4

Other 12 2.4 4.7 7 4 1

Total 93 $51.6 100% 52 27 14

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

Note: The sample cases include 12 contracts that were selected with certainty: 7 for research and 

development, 3 for ship construction, 1 for aircraft procurement, and 1 for non-research-anddevelopment services. Seven of the contracts selected with certainty had award-fee provisions, 2 had

incentive-fee provisions, and 3 contained both award- and incentive-fee provisions. 

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; however, based on our 

sample results, we estimate that about 60 percent of the cost-plus-awardPage 11 GAO-06-66 DOD's Use of Monetary Incentives
fee contracts in our study population included zero base fee.10 Tables 4 

and 5 show the estimated percentage of DOD award-fee contracts that had 

a particular percentage of the value of the contract available in award fees 

and base fees. 

Table 4: Award Fees as a Percentage of Contract Value 

Percentage of value of 

contract available in award fees 

Estimated percentage of award fee 

contracts with this percentage available 

1 0

2 4

3 10

4 2

5 4

6 4

7 23

8 4

9 6

10 15

11 4

12 7

13 4

14 0

15 14

20 Less than 1

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

Notes: While there is no limit on the maximum percentage of the value of the contract that can be 

made available in award fee, the 20 percent included in the Space-Based Infrared System High 

development contract was outside the norm. Percentages do not add to 100 due to rounding. 

Sampling errors for percentages in this table do not exceed plus or minus 12 percentage points. 

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

73 percent. 

Page 12 GAO-06-66 DOD's Use of Monetary Incentives
Table 5: Base Fees as a Percentage of Contract Value 

Percentage of value of 

contract available in base fees 

Estimated percentage of award fee 

contracts with this percentage available 

0 63

1 0

2 8

3 26

4 2

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

Notes: 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. Percentages do not add to 100 due to rounding. 

Sampling errors for percentages in this table do not exceed plus or minus 13 percentage points. 

Based on the results from our sample, an estimated 16 percent of the 

contracts in our study population were fixed-price incentive contracts, and 

an estimated 13 percent were cost-plus-incentive-fee contracts. In both of 

these cases, the government and the contractor share the cost risks. 

However, on fixed-price incentive contracts, the contractor usually 

assumes more risk because if the contract reaches its ceiling price, the 

contractor absorbs the loss. Under a cost-plus-incentive-fee contract, 

when costs increase to the point where the contractor will only earn the 

minimum fee, no further fee adjustments occur and the government 

continues to pay the contractor’s reimbursable costs. 

DOD Acquisition Practices 

and Program Success 

When discussing award- and incentive-fee contracts, it is important to 

acknowledge the acquisition environment in which they are used. For 

instance, based on our sample results, we estimate that most of the 

contracts and most of the dollars in our study population are related to the 

acquisition of weapon systems. Since 1990, GAO has designated DOD 

weapon system acquisition as a high-risk area.11 Although U.S. weapons 

are the best in the world, DOD’s acquisition process for weapon programs 

consistently yields undesirable consequences—cost increases, late 

deliveries to the warfighter, and performance shortfalls. These problems 

 11 GAO, High-Risk Series: An Update, GAO-05-207 (Washington, D.C.: January 2005). 

Page 13 GAO-06-66 DOD's Use of Monetary Incentives
occur because DOD’s weapon programs do not capture early on the 

requisite knowledge that is needed to efficiently and effectively manage

program risks. For example, programs move forward with unrealistic 

program cost and schedule estimates, lack clearly defined and stable 

requirements, 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, problems often surface late in the development 

process, and fixes tend to be more costly than if made earlier. When 

programs require more resources than planned, the buying power of the 

defense dollar is reduced, and funds are not available for other competing 

needs. 

The persistence of these problems reflects the fact that the design, 

development, and production of major weapon systems are extremely 

complex technical processes that must operate within equally complex 

budget and political processes. A program that is not well conceived, 

planned, managed, funded, and supported may easily be subject to such 

problems as cost growth, schedule delays, and performance shortfalls. 

Even properly run programs can experience problems that arise from 

unknowns, such as technical obstacles and changes in circumstances. In 

short, it takes a myriad of things to go right for a program to be successful

but only a few things to go wrong to cause major problems. 

DOD has not structured and implemented award-fee contracts in a way 

that effectively motivates contractors to improve performance and achieve 

acquisition outcomes. DOD practices—such as routinely paying its 

contractors nearly all of the available award fee, amounting to billions of 

dollars, regardless of whether the acquisition outcomes fell short of, met, 

or exceeded expectations; rolling an estimated $669 million in unearned or

withheld award fees to future evaluation periods; and paying a significant 

portion of the available fee for what award-fee plans describe as 

“acceptable, average, expected, good, or satisfactory” performance—all 

lessen the motivation for the contractor to strive for excellent

performance. In addition, DOD award-fee plans have not been structured 

to focus the contractor’s attention on achieving desired acquisition 

outcomes. DOD generally does not evaluate contractors on criteria that 

are directly related to acquisition outcomes, and the link between the 

Award and Incentive 

Fees Are Not an 

Effective Tool for 

Achieving DOD’s 

Desired Acquisition 

Outcomes 

Page 14 GAO-06-66 DOD's Use of Monetary Incentives
elements of contractor performance that are included in award-fee criteria

and acquisition outcomes is not always clear. While incentive-fee contracts 

are more directly linked to select acquisition outcomes, DOD has not fared 

well at using these types of contracts to improve cost control behavior or 

meet program goals. However, when contractor performance does not 

result in the desired acquisition outcome under an incentive-fee contract,

the reduction of fees is usually automatic and based on the application of a 

predetermined formula. Figure 2 summarizes our findings within the 

general framework of issues surrounding DOD’s use of award and 

incentive fees. 

Page 15 GAO-06-66 DOD's Use of Monetary Incentives
Figure 2: Weaknesses in DOD’s Use of Award and Incentive Fees 

Source: GAO.

DOD faces challenges in its acquisition environment.

Challenges include poor acquisition practices, such as selecting unqualified contractors,

insufficient funding, and proceeding with acquisitions without adequate knowledge.

DOD focuses on contractor performance ...

However, DOD engages in practices that undermine

its efforts to motivate excellent performance.

DOD frequently pays most of the available award 

fee for what it describes as improved contractor 

performance regardless of whether outcomes fell 

short of, met, or exceeded expectations.

DOD gives contractors multiple chances to earn 

award fees that they failed to earn in previous

evaluation periods.

DOD pays contractors award fees for satisfactory 

performance even though acquisition regulations

and guidance intend for such fees to be used to 

motivate excellent performance.

DOD does not effectively link award-fee criteria to 

acquisition outcomes.

DOD pays contractors award fees even if acquisition 

outcome falls short of DOD’s expectations.

DOD programs have suffered cost increases in the 

billions of dollars, have had schedules grow by many

months or years, and have not delivered promised 

capabilities to the warfighter, yet DOD has paid 

contractors billions in award fees.

... and does not focus on acquisition outcomes.

DOD lacks a strong basis for using award and incentive fees.

DOD has not examined its basis for using award and incentive fees nor assessed

whether they result in improved contractor performance and acquisition outcomes.

Page 16 GAO-06-66 DOD's Use of Monetary Incentives
DOD’s practice of routinely paying its contractors nearly all of the 

available award fee puts DOD at risk of creating an environment in which 

programs pay and contractors expect to receive most of the available fee,

regardless of acquisition outcomes. 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)12 was 90 percent, representing an

estimated $8 billion in award fees for contracts active between fiscal years 

1999 through 2003.13 The lowest percentage of available fee paid to date for

contracts in our sample was 36 percent, and the highest was 100 percent.

Figure 3 shows the percentage of available fee earned for the 63 award-fee 

contracts in our sample and the lack of variation, especially across the 

contracts in the middle of the distribution. 

Award-Fee Contracts: DOD 

Practices Do Not Maximize 

Contractors’ Motivation to 

Perform 

 12 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. 

13 Our estimate is based on award fee periods that were held from the inception of the

contracts in our sample through the data collection phase of our review. The oldest award 

fee contracts in our sample were signed in fiscal year 1991.

Page 17 GAO-06-66 DOD's Use of Monetary Incentives
Figure 3: Percentage of Available Award Fee Paid to Date for 63 Award-Fee Contracts in GAO’s Sample 

Percentage of available fee paid by DOD

0

10

20

30

40

50

60

70

80

90

100

Contracts in GAO’s sample

33 of 63 award-fee contracts in GAO’s sample paid between 83 and 96 percent of the available fee

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

Page 18 GAO-06-66 DOD's Use of Monetary Incentives
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 the level of variation across the evaluation periods in 

our sample was similar to the trend shown in figure 3. On DOD award-fee 

contracts, we estimate 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. Figure 4 

shows the percentage of available fee earned by evaluation period for the

award-fee contracts in our sample. There were 572 evaluation periods 

overall for these contracts. 

Page 19 GAO-06-66 DOD's Use of Monetary Incentives
Figure 4: Percentage of Available Award Fee Earned for 572 Evaluation Periods in 

GAO’s Sample

350

300

250

200

150

100

50

0

Number of evaluation periods

0

1-10

320

91 or 

higher

134

81-90

62

71-80

23

61-70

12

51-60

3

41-50

5

31-40

11-20

1 3

21-3

0

0

9

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

Percentage range

In addition to consistently awarding most of the available award fee on an 

evaluation period-by-evaluation period basis, the use of “rollover” is 

another indication of DOD’s reluctance to withhold fees. 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 unearned award-fee amount. DOD 

and program officials view rollover as an important mechanism for 

maintaining leverage with contractors; however, award-fee guidance 

issued by the Air Force, Army, and Navy in the last 3 years states that this

practice should rarely be used in order to avoid compromising the 

integrity of the award-fee evaluation process. We estimate that 52 percent 

of DOD award-fee contracts rolled over unearned fees into subsequent 

Page 20 GAO-06-66 DOD's Use of Monetary Incentives
evaluation periods.14 We estimate that unearned fees were rolled over in 

42 percent of evaluation periods of contracts that used this practice.

15

Further, we estimate that the mean percentage of unearned fees that were 

rolled over in these periods was 86 percent, and in 52 percent

16 of these 

periods at least 99 percent of the unearned fee was rolled over. 

Consequently, in many evaluation periods when rollover was used, the 

contractor still had the chance to earn almost all of the unearned fee, even 

in instances when the program was experiencing problems. Across all the 

evaluation periods for the 32 contracts in our sample that used this 

practice, the amount rolled over was almost $500 million, or an average of

51 percent of the total unearned fees. (See fig. 5 for a depiction of DOD’s 

use of rollover on the contracts in our sample.) Overall, for DOD award-fee 

contracts active between fiscal 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. 

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

15 The 95 percent confidence interval for this estimate ranges from 31 percent to 53 percent. 

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

Page 21 GAO-06-66 DOD's Use of Monetary Incentives
Figure 5: DOD’s Use of Rollover on 32 Contracts in GAO’s Sample 

Unearned fees

Rolled-over fees

Rolled-over fees

Rollover

Rollover

51% of 

unearned 

fees

$500M

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

Several of the contracts in our sample routinely rolled over 100 percent of

a contractor’s unearned award fee into fee pools for use later in the 

programs. For example, the Joint Strike Fighter program has rolled over 

100 percent of the unearned award fee for its development contracts into a 

reserve award-fee pool that the program uses to target areas not covered

in the award-fee plan, such as encouraging the contractor to track awards 

to small businesses and improving communications with countries that are 

partners in the development program.17 However, the program has also 

used the reserve award-fee pool to provide additional money to motivate 

cost control, even though this area is already a focus of the award-fee plan. 

If the contractor does not earn the fee in the targeted area, the program 

keeps rolling the unearned fee back into the reserve pool. The practical 

effect of this is that the Joint Strike Fighter program’s prime contractors 

still have the ability to earn the maximum award fee despite the cost and 

technical issues the program has experienced. 

 17 In its technical comments on a draft of this report, DOD stressed that while the Joint

Strike Fighter program office has rolled over unearned fee to a reserve award fee pool, it is

under no obligation to make any of this reserve award fee pool available to the contractor. 

Page 22 GAO-06-66 DOD's Use of Monetary Incentives
DOD may also be diluting the motivational effectiveness of award fees by 

paying significant amounts of fee for satisfactory performance. Although 

DOD guidance and federal acquisition regulations state that award fees 

should be used to motivate excellent contractor performance in key areas,

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

fee from one evaluation period to the next for what award-fee plans 

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

performance.18 Figure 6 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. Some plans for 

contracts in our sample did not require the contractor to meet all of the 

minimum standards or requirements of the contract to receive one of 

these ratings. Some DOD award-fee contracts in our sample also allowed 

for a portion of the available award fee to be paid for marginal 

performance—a rating lower than satisfactory. Even fixed-price-award-fee 

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

out award fees for satisfactory performance. Six of the eight fixed-price 

contracts with award fee provisions in our sample paid out 50 percent or 

more of the available award fee for satisfactory performance. 

 18 For the 53 contracts in our sample that paid at least a portion of the available fee if the

contractor received a rating of “acceptable, average, expected, good, or satisfactory,” there

were 40 different fee ranges associated with these categories. 

Page 23 GAO-06-66 DOD's Use of Monetary Incentives
Figure 6: 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 

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

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

points. 

The amount of award fee being paid for performance at or below the 

minimum standards or requirements of the contract appears to not only be

inconsistent with the intent of award fees (as explained in DOD guidance

and federal acquisition regulations19) but also is inconsistent with the 

reasons contracting and program officials cited on our questionnaire for 

their use. According to responses to our questionnaire, rewarding 

satisfactory performance was one reason that award or incentive fees 

were used on an estimated 29 percent of DOD award- and incentive-fee 

 19 According 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. 

Page 24 GAO-06-66 DOD's Use of Monetary Incentives
contracts. However, rewarding better than satisfactory performance was 

one reason that these fees were used on an estimated 77 percent of these 

contracts.20

The responses provided to our questionnaire also seem to rule out the 

administration of award fees as one of the reasons for their general lack of 

effectiveness. Several key elements related to development and 

administration of award-fee contracts were present on almost all 

contracts. Specifically, contracting and program officials’ questionnaire 

responses showed that the appropriate people were involved in the 

development and administration of award-fee contracts, and there was 

adequate guidance and training in place. We estimate that for 91 percent of 

DOD award-fee contracts, there were designated performance monitors 

responsible for evaluating specific areas described in the award-fee plan. 

On an estimated 88 percent of DOD award-fee contracts, award-fee 

evaluation board members received training on their roles and

responsibilities. We further estimate that on 85 percent of DOD award-fee 

contracts, performance monitors also received training. Evaluation boards 

were held as planned for an estimated 86 percent of DOD award-fee 

contracts, and some programs conducted interim assessments of 

contractor performance to support the end-of-period evaluations. Based 

on questionnaire responses from contracting and program officials, an 

estimated 95 percent of DOD award-fee contracts had rating category 

descriptions that provided enough detail to distinguish between 

categories. An estimated 79 percent of the contracting officers responsible 

for developing and administering award-fee contracts and an estimated 

80 percent of the contracting officers responsible for incentive-fee 

contracts believed the training was adequate. Finally, the contracting and

program officials on an estimated 94 percent of DOD award- and incentivefee contracts felt that the guidance they used to develop and administer 

the contract was adequate. 

Award-Fee Contracts: Fee 

Criteria and Payouts Not 

Routinely Linked to 

Acquisition Outcomes 

DOD programs do not structure award fees in a way that motivates 

contractors to achieve or holds contractors accountable for achieving

desired acquisition outcomes. In several contracts we evaluated, DOD 

established award-fee criteria that were focused on broad areas, such as 

 20 The sum of these estimates exceeds 100 percent because respondents to our

questionnaire were provided seven potential reasons as to why award and incentives fees 

were used in the contract and were asked to choose all that applied. 

Page 25 GAO-06-66 DOD's Use of Monetary Incentives
how well the contractor was managing the program. This can result in 

award-fee plans and criteria that seemingly have little to do with 

acquisition outcomes, such as meeting cost and schedule goals and 

delivering desired capabilities. For example, on a Navy ship construction 

contract, 50 percent of the award-fee money, or $28 million, was based on 

management criterion including how responsive the contractor was to the 

government customers, the quality and accuracy of contract proposals, 

and the timeliness of contract data requirements. Elements of the awardfee process, such as the frequency of evaluations, may also limit DOD’s 

ability to effectively evaluate the contractor’s progress toward acquisition 

outcomes. For instance, while holding award-fee evaluations every quarter 

was successful for three Pentagon Renovation Management construction 

contracts because the contractor’s short-term progress could easily be 

assessed, a similar strategy might not be effective for a long-term 

development effort because quarterly or even semiannual evaluations may 

not generate meaningful information about progress. 

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 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. 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 respectively received 85, 91, 100, 

and 74 percent of the award fee made available to date (adjusted for 

rollover), totaling $1.7 billion (see table 6). 

Page 26 GAO-06-66 DOD's Use of Monetary Incentives
Table 6: 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 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 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 available fee

100 percent N/A

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

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

Infrared 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 fees 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. 

DOD can ensure that fee payments are more representative of program 

results by developing fee criteria that focus on its desired acquisition 

outcomes. We found two notable examples in which DOD’s Missile 

Defense Agency attempted to hold contractors accountable for program 

outcomes. In the case of the Airborne Laser 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 

Page 27 GAO-06-66 DOD's Use of Monetary Incentives
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. 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.21

Similarly, the development contract for the Terminal High Altitude Area 

Defense program, a ground-based missile defense system, contains a 

portion of the award fee tied specifically to desired program outcomes—

conducting successful flight tests, including intercepts of incoming 

missiles. This $50 million special award-fee pool is separate from and in 

addition to the subjective award-fee portion of the contract, which is 

worth more than $524 million (of which $275 million has already been 

paid). If one of the first two test flights is successful, the contractor will 

receive $25 million. If the missile misses the target, the contractor 

provides DOD with a cost credit of $15 million. The first of these flight 

tests is scheduled to occur before the end of calendar year 2005. 

Other programs have utilized different fee strategies to focus the 

contractor’s attention on specific acquisition outcomes. However, 

contracting officials have stated that there are few mechanisms to share 

lessons learned and innovative practices outside the local level. These 

approaches include conditional fees and linked incentives. 

• Conditional fees stipulate that certain requirements must be met for a 

contractor to earn and keep fees. For example, we reviewed an 

Intercontinental Ballistic Missile program award-fee plan that included 

an “After Discover Performance Deficiencies” provision to ensure that 

award-fee payouts were consistent with program outcomes. This 

provision allowed the program to retrieve funds paid during prior 

award-fee periods if the program experienced overruns or if 

performance deficiencies were discovered after the award fee has been

paid. 

• Linked incentives evaluate cooperation across multiple contracts and 

contractors. For example, after initial interoperability problems, the 

Cooperative Engagement Capability program added award-fee criteria 

to evaluate how well the system integrated with the Aegis destroyer. 

 21 According 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.

Page 28 GAO-06-66 DOD's Use of Monetary Incentives
Contracts with incentive fees have also not fared well at motivating costcontrol behavior or meeting program targets; however, fee payments are 

more consistent with acquisition outcomes. According to DOD contracting 

and program officials, contractors overran or were expected to overrun 

the target price on 52 percent of the 27 incentive-fee contracts in our 

sample. In these cases, the contractor does not earn the target fee but may 

earn a minimum fee, if one is specified in the contract. For example, 

Incentive-Fee Contracts: 

Many Contracts Not 

Meeting Cost or 

Performance Targets 

• the Navy’s cost-plus-incentive-fee contract for the LPD 17, an

amphibious transport dock ship, is projected to overrun the target 

price of $644 million by at least 139 percent; 

• on the Army’s Brilliant Anti-Armor Submunition program, a fixed-price 

incentive contract for test hardware, overran the $75 million target cost 

by 27 percent ($20 million); and 

• the fixed-price incentive contract for the Navy’s P-3C Sustained

Readiness Program initially called for 50 kits to be produced, but only 

13 were delivered before contract funding was exhausted. 

Incentive-fee contracts that also included performance and delivery 

incentives similarly have not met those key objectives, as shown in the 

examples below. 

• Even though the system received approval from the Navy in June 2005 

for low-rate initial production, the contracting officer and program 

manager stated that the cost, delivery, and technical incentives in the 

Airborne Laser Mine Detection System program did not improve 

contractor performance. During the course of the effort, the contractor 

experienced several cost overruns, as well as technical performance 

shortfalls. In addition, because of government delays, program officials 

decided to eliminate the delivery incentive included in the initial 

contract. 

• According to the contracting and program officials responsible for 

administering and managing one of the Army’s chemical 

demilitarization contracts, performance milestones with incentive fees 

were an important part of the Army’s effort to accelerate the 

destruction of chemical weapons stockpiles after the events of

September 11, 2001. However, these incentives did not keep the 

contract on schedule. The contractor missed the target completion date 

for the third of its four performance incentive milestones and the 

program was delayed by over a year. According to DOD, the failure to 

meet this milestone was due to unforeseen technical difficulties, and 

could not have been ultimately influenced by any type of contractual 

language. 

Page 29 GAO-06-66 DOD's Use of Monetary Incentives
In contrast, the successful use of fee is supported by the level of product 

knowledge attained by officials and their ability to leverage this 

knowledge. For example, DOD contracting officials for the Patriot 

Advanced Capability-3 missile had a well-developed knowledge of the 

acquisition’s cost risks and were able to reduce costs by $42 million for the 

low-rate initial production contract. Contracting officials stated that the 

favorable outcome was due to the use of a cost model that was developed

and matured on the previous production contract.

Unlike award-fee contracts, incentive-fee contracts are based on formulalike mechanisms that determine the amount of fee earned. When a 

contractor misses a target in an incentive-fee contract, the reduction of

fees is usually automatic and based on the application of a predetermined

formula.22 The nature of the fee criteria in these contracts also eliminates 

most of the subjectivity in the evaluation process. Cost, schedule or 

delivery, and performance incentives are all based on targets that can be

evaluated against actual costs, actual dates, and actual performance. In 

addition, negative incentives allow for fee reductions if the contractor 

does not meet certain criteria. For example, on one of the Navy’s carrier 

refueling and overhaul contracts, the contractor’s fee could be reduced if 

its overhead rate exceeded a certain target. Since incentive fees, especially

those related to cost, are primarily evaluated at the conclusion of the 

contract, the officials applying the evaluation criteria or fee formula have a 

clear sense of the contractor’s performance. 

 22 We found one instance of DOD using the equivalent of rollover for incentive-fee 

contracts. When the contractor missed the third program milestone on the Army chemical 

demilitarization contract, the program delayed the milestone by 14 months and offered the

contractor a chance to earn 80 percent of the available fee. According to program officials, 

the performance incentive milestone was rescheduled to re-incentivize the contractor. 

Page 30 GAO-06-66 DOD's Use of Monetary Incentives
DOD’s use of monetary incentives is based on the assumption that such 

incentives can improve contractor performance and acquisition outcomes; 

however, past studies have challenged the validity of this assumption. 

Research on incentive fees going back to the 1960s has concluded these 

incentive fees are not effective in controlling cost.23 Studies conducted by 

GAO, Harvard University, and the RAND Corporation, among others, have 

concluded that these incentives do not motivate cost efficiency, in part 

because profit is not the contractor’s only motivation. Other 

considerations, such as securing future contracts with the government, 

can be stronger motivators than earning additional profit. More recently, 

research on award fees revealed that while these fees are an intuitively 

appealing way to improve contractor performance, they do not always 

operate that way in practice. Contractor respondents in one study stated 

that award fees motivate performance to some extent; however, the 

consensus was that they do not in and of themselves increase performance 

significantly. Research has also pointed to recurring disconnects between 

the intent and the administration of award-fee contracts. Award-fee 

criteria were not applied as intended; and many award-fee board members 

and fee-determining officials approached the process with the assumption 

the contractors should earn the full amount unless there were specific 

instances of poor performance that warranted deductions, instead of 

starting at zero and considering the actions the contractor had taken to 

earn the available fee. Finally, the lack of explicit rationale and 

documentation in support of performance ratings has led some 

researchers to conclude that fees were being paid without adequate 

justification.24

DOD Has Little 

Evidence That 

Monetary Incentives 

Improve Results as 

Intended 

Despite these findings and the concerns raised by senior DOD officials 

about the amounts of award fee paid to contractors on acquisitions that 

were not performing to their established baselines, 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 

for Acquisition Technology and Logistics and the Assistant Secretary of 

the Air Force for Acquisition expressed concerns that contractors 

 23 GAO, Incentive Contracts: Examination of Fixed-Price Incentive Contracts, 

GAO/NSIAD-88-36BR (Washington, D.C.: November, 1987). Frederic M. Scherer, The 

Weapons Acquisition Process: Economic Incentives (Boston: Harvard University, 1964). 

Irving N. Fisher, A Reappraisal of the Incentive Contracting Experience (Santa Monica: 

The RAND Corporation, 1968). 

24 Thomas J. Snyder, Analysis of Air Force Award Fee and Award Term Contract 

Implementation (Air Command and Staff College: Air University, 2001). 

Page 31 GAO-06-66 DOD's Use of Monetary Incentives
routinely earn high percentages of fee while programs have experienced

performance problems, schedule slips, and cost growth.25 In 1999, 

following a report by a DOD-led integrated process team addressing 

contractor incentives, the Undersecretary of Defense also issued a 

memorandum for all service secretaries specifically noting that 

contractors do not always have an incentive to focus their attention on the 

government’s desired outcomes and offered several principles for 

structuring future contract incentives. However, according to the lead of 

the integrated process team from the Office of the Secretary of Defense, 

the effort did not result in any new policy directives, changes in guidance,

or new training. In addition, DOD did not assess the results of the study. 

In contrast to the concerns expressed by DOD’s senior acquisition 

leadership, we gathered testimonial evidence that indicates DOD 

contracting and program officials believe that these monetary incentives

are effective for improving contractor performance. Based on responses to 

our questionnaire, an estimated 77 percent of DOD award- and incentivefee contracts had improved performance because of the incentive 

provisions, in the opinion of contracting and program officials. On awardfee contracts, officials pointed to increased responsiveness or attention 

from the contractor at the management level as evidence of this 

improvement, even if this increased responsiveness did not result in 

overall desired program outcomes being achieved. 

One of the potential reasons for this disconnect between statements at the 

policy level and the opinions of practitioners is the lack of a DOD-wide 

system for compiling and aggregating award- and incentive-fee 

information and for identifying resulting trends and outcomes. DOD has 

not compiled information, conducted evaluations, 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 possible. For instance, DOD is 

implementing the Defense Acquisition Management Information Retrieval 

system to collect data on acquisition costs and variances, schedules, and 

 25 In its technical comments on a draft of this report, DOD stated that the Air Force’s 

Acquisition Transformation Action Council is currently analyzing award- and incentive-fee 

contracts and aggressively pursuing solutions to the problems outlined in the draft report. 

A Transformation Initiative Group was assembled to provide recommendations back to the

Acquisition Transformation Action Council for implementation. 

Page 32 GAO-06-66 DOD's Use of Monetary Incentives
program baseline breaches on major acquisition systems. This system 

provides DOD policymakers with readily available information they can 

use to oversee program performance across the department. If DOD does 

not begin to collect similar information on award and incentive fee 

payments, it may not be able to measure progress toward meeting one of 

the goals listed in its fiscal 2004 performance and accountability report, 

that is, invigorating the fiscal well-being of the defense industry by 

rewarding good performance. 

The existence or application of a well-developed and well-implemented 

monetary incentive alone does not determine the overall success or failure 

of an acquisition. DOD acquisition programs operate in an environment 

with underlying pressures and incentives that drive both program and 

contractor behavior. Competition for funding and contracts leads to 

situations, especially in major system acquisitions, in which costs are 

underestimated and capabilities are overpromised. Resulting problems 

require additional time and money to address. At the same time, DOD 

customers are tolerant of cost overruns and delays in order to get a highperformance weapon system. DOD’s current approach toward monetary 

incentives reflects these realities and has resulted in a failure to hold 

contractors accountable for delivering and supporting fielded capabilities 

within cost and schedule baselines. While DOD and contractors share the 

responsibility for program success, award and incentive fees, to be 

effective, need to be realigned with acquisition outcomes. Awarding large 

amounts of fee for satisfactory or lesser performance and offering 

contractors multiple chances to earn previously withheld fees has fostered 

an environment in which DOD expects to pay and contractors expect to 

receive most of the available award fee regardless of outcomes. In 

addition, DOD’s lack of information on how well award and incentive fees 

are achieving their intended purpose leaves the department vulnerable to 

millions of dollars of potential waste. Successes do exist at the individual 

contract level, but DOD will need to leverage this knowledge if it hopes to 

identify proven incentive strategies across a wide variety of DOD 

acquisitions.

To strengthen the link between monetary incentives and acquisition 

outcomes and by extension increase the accountability of DOD programs 

for fees paid and of contractors for results achieved, we recommend that 

the Secretary of Defense direct the Undersecretary of Defense for 

Acquisition, Technology, and Logistics to take the following seven actions. 

DOD can immediately improve its use of award fees on all new contracts 

Conclusions 

Recommendations for 

Executive Action 

Page 33 GAO-06-66 DOD's Use of Monetary Incentives
by (1) instructing the military services to move toward more outcomebased award-fee criteria that are both achievable and promote 

accountability for acquisition outcomes; (2) ensuring that award-fee 

structures are motivating excellent contractor performance by only paying 

award fees for above satisfactory performance; and (3) requiring the 

appropriate approving officials to review new contracts to make sure 

these actions are being taken. DOD can improve its use of award fees on 

all existing contracts by (4) issuing DOD guidance on when rollover is 

appropriate. In the longer term, DOD can improve its use of award and 

incentive fees by (5) developing a mechanism for capturing award- and 

incentive-fee data within existing data systems, such as the Defense 

Acquisition Management Information Retrieval system; (6) developing

performance measures to evaluate the effectiveness of award and 

incentive fees as a tool for improving contractor performance and 

achieving desired program outcomes; and (7) developing a mechanism to 

share proven incentive strategies for the acquisition of different types of 

products and services with contracting and program officials across DOD.

DOD’s Office of Defense Procurement and Acquisition Policy provided 

written comments on a draft of this report. These comments are reprinted 

in appendix II. DOD also provided separate technical comments, which we 

have incorporated as appropriate. 

Agency Comments 

and Our Evaluation 

DOD concurred with three of our seven recommendations—moving 

toward more outcome-based award-fee criteria, issuing guidance on 

rollover, and developing a mechanism to share proven incentive strategies. 

The department indicated that it would implement these recommendations 

by issuing a policy memorandum on award fees and completing a 

communications plan for sharing incentive strategies on March 31, 2006. 

DOD partially concurred with four of our seven recommendations. 

Concerning three of the four recommendations—requiring the appropriate 

officials to make sure these recommendations are implemented in new 

contracts, collecting award and incentive fee data, and developing 

performance measures to evaluate the effectiveness of award and 

incentive fees in improving acquisition outcomes—DOD indicated that the 

Director of the Office of Defense Procurement and Acquisition Policy, in

collaboration with the military departments and defense agencies, would 

conduct a study to determine the appropriate actions to address them. The 

office plans to complete the study by June 1, 2006. While this study may 

provide additional insights, we encourage DOD to use it as a mechanism 

for identifying the specific steps the department will take to fully address 

Page 34 GAO-06-66 DOD's Use of Monetary Incentives
our recommendations, not to determine whether the department will take 

action. For instance, in its response to our recommendation on developing 

a mechanism for capturing award and incentive fee data, DOD raises the 

issue of cost. We agree that the potential cost of implementing this 

recommendation should be considered, while deciding on an appropriate 

course of action. However, given that the department paid out an 

estimated $8 billion in award fees on the contracts in our study population 

regardless of outcomes, we believe that a reasonable investment in 

ensuring that these funds are well-spent in the future is warranted. 

Collecting this data is also necessary to support the development of 

meaningful performance measures, which can be used to evaluate the 

costs and benefits of continuing to use these contract types and determine 

if they are achieving their goal of improving contractor performance and 

acquisition outcomes. Further, without data and performance measures, 

DOD will not be in a position to measure the effectiveness of any actions it

takes to address the issues identified in this report. 

DOD also partially concurred with our recommendation related to only 

paying award fees for above satisfactory performance. Specifically, the 

department stated that it is fair and reasonable to allow the contractor to 

earn a portion of the award fee for satisfactory performance. However, we 

believe that this use of award fee should be the exception, not the rule. 

Fixed-price-award-fee contracts already include a normal level of profit in

the price which is paid for satisfactory performance. In addition, the 

inclusion of base fee in a cost-plus-award-fee contract may be a more 

appropriate mechanism for providing fee for satisfactory performance. 

According to the Army Contracting Agency’s Handbook for Award Fee 

Contracts, base fee (not exceeding three percent of the estimated contract

cost) can be paid to the contractor for acceptable performance and is 

designed to compensate the contractor for factors such as risk 

assumption, investment, and the nature of the work. DOD also stated that

award fee arrangements should be structured to encourage the contractor

to earn the preponderance of fee by providing excellent performance. 

According to its comments, DOD plans to address this issue in the March 

2006 policy memorandum on award fees. While DOD may conclude that it

needs the flexibility to pay a portion of the award fee for satisfactory 

performance, especially for high risk efforts, current practice on most 

award fee contracts is to pay a significant portion of the available fee for 

“acceptable, average, expected, good, or satisfactory” performance. We 

would encourage DOD to consider limiting the maximum percentage of 

fee available for this level of performance to, consistent with its 

comments, keep the preponderance of fee available for excellent 

performance. 

Page 35 GAO-06-66 DOD's Use of Monetary Incentives
We are sending copies of this report to interested congressional 

committees; the Secretary of Defense; the Secretaries of the Air Force, 

Army, and Navy; the Commandant of the Marine Corps; and the Director, 

Office of Management and Budget. We will provide copies to others on 

request. This report will also be available at no charge on GAO’s Web site 

at http://www.gao.gov. 

If you have any questions about this report or need additional information, 

please call me at (202) 512-4841 (calvaresibarra@gao.gov). Contact points 

for our Offices of Congressional Relations and Public Affairs may be found 

on the last page of this report. Other staff making key contributions to this 

report were Thomas J. Denomme, Assistant Director; Robert Ackley; 

Heather Barker; Lily J. Chin; Aftab Hossain; Julia Kennon; John Krump; 

Jerry Sandau; Sidney Schwartz; Ron Schwenn; Najeema Davis Washington; 

and E. Chris Woodard. 

Ann M. Calvaresi-Barr 

Director 

Acquisition and Sourcing Management 

Page 36 GAO-06-66 DOD's Use of Monetary Incentives
Appendix I: Scope and Methodology Appendix I: Scope and Methodology 

Our objective was to determine whether award and incentive fees are an

effective management tool for achieving the Department of Defense’s 

(DOD) desired outcomes. To conduct our work, we selected a sample of 

93 award- and incentive-fee contracts, interviewed contracting and 

program officials, analyzed contract documentation related to incentive

provisions, collected and analyzed data on award-fee payments, reviewed 

DOD and military service guidance on award and incentive fees, and 

examined the results of initiatives related to improving the use of these 

fees. 

Our sample for this review was based on contract data from the Federal 

Procurement Data System. We extracted information from this database 

on all DOD contracts active between fiscal years 1999 through 2003 that

had at least one contract action coded as cost-plus-award-fee, cost-plusincentive-fee, fixed-price-award-fee, or fixed-price incentive valued at 

$10 million or more during that time. These criteria gave us a study 

population of 597 unique contracts, which were associated with 

2,474 award- and incentive-fee contract actions. 

To ensure the validity of the database from which we drew our sample, we 

tested the reliability of the contract type field in the Federal Procurement 

Data System.1

 We selected a sample of 30 contracts from the population of 

DOD contracts active between fiscal years 1999 through 2003 and asked 

DOD and the military services to provide data on the contract type(s) for 

each one using data sources other than the Federal Procurement Data 

System or Individual Contracting Action Reports (DD Form 350). We also 

requested that DOD and the military services verify that at least one 

contract action between fiscal years 1999 through 2003 was valued at over

$10 million. Of the 30 contracts, DOD and the military services reported 

that 10 were either incorrectly coded or omitted information on a relevant 

contract type in the Federal Procurement Data System. Of these 10 errors, 

only 3 would have caused a contract to be mistakenly included or 

excluded in the population from which our sample was selected. Based 

upon these responses and the exclusion of only one contract from our 

sample because of miscoding in the Federal Procurement Data System, we 

determined that the data were sufficiently reliable for the purposes of this 

report. 

 1

 See GAO, Reliability of Federal Procurement Data, GAO-04-295R (Washington D.C.: Dec.

30, 2003), for more information on the reliability of the data. 

Page 37 GAO-06-66 DOD's Use of Monetary Incentives
Appendix I: Scope and Methodology 

To select the sample for this review, we stratified the population of 

597 contracts based on the total dollar value of award- and incentive-fee 

contract actions associated with the contract during this period. We 

included all 12 contracts in the sample for which the total value of the 

award- and incentive-fee contract actions during this period exceeded

$2 billion. We used probability sampling techniques to select 85 contracts 

from the remaining 585 contracts in the population, ensuring that the 

number of contracts from the Navy, Army, Air Force, and all other defense 

agencies and organizations combined were proportional to their 

representation among the 585. During our work, we discovered that 2 of 

the 85 contracts we sampled from the stratum of 585 contracts were 

outside of the scope of this review. These contracts were removed from 

the sample. We also discovered that for 2 other in-scope contracts in this 

stratum, the officials involved in developing and administering the 

contract and the contract documentation were not available. We excluded 

these contracts from our analysis. We randomly selected a total of 

4 additional contracts from the same stratum to include in our analysis. 

Because we followed a probability procedure based on random selections, 

our sample is only one of a large number of samples that we might have 

drawn. Since each sample could have provided different estimates, we 

express our confidence in the precision of our particular sample’s results 

as 95 percent confidence intervals (for example, plus or minus 

7 percentage points). These are the intervals that would contain the actual 

population values for 95 percent of the samples we could have drawn. As a 

result, we are 95 percent confident that each of the confidence intervals in

this report will include the true values in the study population. All 

percentage estimates from our review have margins of error (that is, 

confidence interval widths) 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. Our 

analysis also tested the extent to which statistically significant 

relationships existed between such factors as contract type, reasons an 

incentive contract was chosen, types of officials involved in developing the 

incentive structure, use of rollover, training, and guidance; and contracts 

that contracting and program officials have cited improved contractor 

performance because of the use of incentive. 

To determine whether award and incentive fees are an effective 

management tool, we conducted structured interviews with contracting 

and program officials about the development, implementation, and 

effectiveness of the incentive structure for 92 of the 93 award- and 

Page 38 GAO-06-66 DOD's Use of Monetary Incentives
Appendix I: Scope and Methodology 

incentive-fee contracts in our sample; analyzed contract documentation 

related to incentive provisions; and collected and analyzed data on awardfee payments for 63 of the 66 contracts with award-fee provisions in our 

sample. For one contract, the office responsible for administering the 

contract could not identify any contracting or program personnel who 

could address our interview topics and all questions were coded as “no 

response.” For three contracts, the office responsible for administering the 

contract could not provide complete documentation on award-fee 

payments. 

To conduct our structured interviews on the development, 

implementation, and effectiveness of the incentive structure, we used a 

questionnaire that was a combination of open- and close-ended questions. 

When possible, these interviews were held in person. We visited the 

Defense Threat Reduction Agency Headquarters; Joint Strike Fighter 

Program Office; Los Angeles Air Force Base; Missile Defense Agency 

(Navy Annex); Patuxent Naval Air Station; Pentagon Renovation and 

Construction Program Office; Redstone Arsenal; U.S. Army Contracting 

Agency’s Information Technology, E-Commerce and Commercial 

Contracting Center; U.S. Navy’s Strategic System Program Office; Warner 

Robins Air Force Base; Washington Navy Yard; and Wright Patterson Air 

Force Base for this purpose. The remaining interviews were held by video 

teleconference or by telephone. All interviews were conducted between 

October 2004 and April 2005. 

We also reviewed contract documentation related to the development and 

implementation of the contracts’ incentives, including the basic contract,

statement of work, acquisition planning documents, modifications related 

the incentive structure, award-fee plan, documentation describing fee 

criteria for specific evaluation periods, contractor self-assessments, 

award-fee board evaluation reports, and fee-determination documents. We 

used this information to corroborate and supplement the information 

provided in the structured interviews, determine the extent to which 

linkages exist between fee criteria and the desired program outcomes 

identified by contracting and program officials, and examine fee payments 

in the context of program performance. When possible, we evaluated 

program and contract performance using GAO’s body of work on DOD 

systems acquisitions, including the annual assessment of selected major 

weapon programs and annual status report on the ballistic missile defense 

program. 

For each of the 66 award-fee contracts in our sample, we collected and 

analyzed data on the base fee and maximum award fee, expressed as a 

Page 39 GAO-06-66 DOD's Use of Monetary Incentives
Appendix I: Scope and Methodology 

percentage of the estimated cost, exclusive of the cost of money; the

award fee available and paid for each evaluation period; the amount of 

unearned fee rolled over into subsequent evaluation periods; the total 

award-fee pool; and the remaining award-fee pool, which included any 

rolled-over fee still remaining to be potentially earned. In most cases, 

contracting and program officials submitted the data on a standard 

template we provided. In cases where the program did not submit data in 

the requested format, we gathered this information from fee-determination 

letters and contract modifications. We also used these documents to verify 

the reliability of the data that were submitted by contracting and program 

officials. From this data, we calculated the percentage of the available fee 

that was awarded for individual evaluation periods, entire contracts to 

date, and the overall sample. We included rollover amounts available and 

earned in our calculations of fee awarded for individual evaluation 

periods. When calculating the percentage of fee earned for entire 

contracts, we excluded rolled-over fees from the available fee pool when 

those fees were still available to be earned in future evaluation periods. 

We also calculated the percentage of unearned fee that was made available 

to the contractor as rollover for individual evaluation periods, entire 

contracts, and the overall sample. Estimates of total award fees earned 

and total award fees that were rolled over 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. We 

did not analyze incentive fee payments because most fee determinations 

are related to cost and are not complete until the contract is closed out. 

We interviewed officials from Defense Acquisition University, Office of 

Director of Defense Procurement and Acquisition Policy, Office of the

Deputy Assistant Secretary of the Air Force for Contracting (Policy and 

Implementation), Office of Deputy Assistant Secretary of the Army (Policy 

and Procurement), Office of the Deputy Assistant Secretary of the Navy 

for Acquisition Management, Office of the Air Force Inspector General, 

and the U.S. Army Audit Agency, as well as government contracting 

experts on recent initiatives and current trends in incentive contracting. 

We reviewed previous audit and inspection reports from the Air Force, 

Army, and Navy. We analyzed current award- and incentive-fee guidance 

provided in the Federal Acquisition Regulation, Defense Federal 

Acquisition Regulation Supplement, U.S. Army Audit Agency’s report on 

Best Practices for Using Award Fees, Air Force Award Fee Guide, Air 

Force Material Command Award Fee Guide, and other service-specific 

policies, as well as the National Aeronautics and Space Administration’s 

Award Fee Guide. We identified and reviewed DOD and military service 

policy memos and initiatives including DOD’s Contractor Incentives 

Page 40 GAO-06-66 DOD's Use of Monetary Incentives
Appendix I: Scope and Methodology 

Integrated Process Team; the Assistant Secretary of the Navy for 

Research, Development, and Acquisition’s policy memo on Contract 

Incentives, Profits and Fees; the Deputy Assistant Secretary of the Army 

for Procurement’s report on Innovation in Contractual Incentives; and the 

Office of the Undersecretary of Defense for Acquisition, Technology, and 

Logistics’ “quick look” at DOD Profit Policy and Defense Industry 

Profitability. We identified innovative monetary incentives used on 

contracts within our sample and the mechanisms available to share those 

across DOD.

We performed our review from February 2004 to November 2005 in 

accordance with generally accepted government auditing standards.

Page 41 GAO-06-66 DOD's Use of Monetary Incentives
Appendix II: Comments from the Department Appendix II: Comments from the Department of Defense 

of Defense 

Page 42 GAO-06-66 DOD's Use of Monetary Incentives
Appendix II: Comments from the Department 

of Defense 

Page 43 GAO-06-66 DOD's Use of Monetary Incentives
Appendix II: Comments from the Department 

of Defense 

Page 44 GAO-06-66 DOD's Use of Monetary Incentives
Appendix II: Comments from the Department 

of Defense 

Page 45 GAO-06-66 DOD's Use of Monetary Incentives
Appendix III: Contracting Definitions Appendix III: Contracting Definitions 

Award fee: An amount of money that is added to a contract and that a 

contractor may earn in whole or in part during performance and that is 

sufficient to provide motivation for excellence in the areas such as quality,

schedule, technical performance, and cost management. 

Base fee: An award-fee contract mechanism that is an amount of money 

over the estimated costs (typically in the range of 0 to 3 percent of the 

contract value), which is fixed at the inception of the contract and paid to 

the contractor for performance in a cost-plus-award-fee contract. A base 

fee is similar to the fixed fee paid to a contractor under a cost-plus-fixedfee contract that does not vary for performance. 

Ceiling price: A prenegotiated maximum price that may be paid to the 

contractor. 

Cost contract: A cost-reimbursement contract in which the contractor 

receives no fee. A cost contract may be appropriate for research and 

development work, particularly with nonprofit educational institutions or 

other nonprofit organizations, and for facilities contracts. 

Cost-plus-award-fee contract: A cost-reimbursement contract that 

provides for a fee consisting of a base amount (which may be zero) fixed 

at inception of the contract and an award amount, based upon a 

judgmental evaluation by the government, sufficient to provide motivation 

for excellence in contract performance. 

Cost-plus-incentive-fee contract: A cost-reimbursement contract that 

provides for an initially negotiated fee to be adjusted by a formula based 

on the relationship of total allowable costs to total target costs. 

Cost-reimbursable contract: A contract that provides for payment of 

the contractor’s allowable cost to the extent prescribed in the contract not 

to exceed a ceiling. 

Delivery incentives: A monetary incentive used to motivate the 

contractor to meet a particular product or service delivery objective. 

Fixed-price contract: A contract that provides for a price that is either 

fixed or subject to adjustment obligating the contractor to complete work 

according to terms and for the government to pay the specified price 

regardless of the contractor’s cost of performance. 

Page 46 GAO-06-66 DOD's Use of Monetary Incentives
Appendix III: Contracting Definitions 

Fixed-price-award-fee contract: A variation of the fixed-price contract 

in which the contractor is paid the fixed price and may be paid a 

subjectively determined award fee based on periodic evaluation of the 

contractor’s performance. 

Fixed-price incentive contract: A fixed-price contract that provides for 

adjusting profit and establishing the final contract price by application of a 

formula based on the relationship of total final negotiated cost to total 

target cost. 

Incentive contract: A contract used to motivate a contractor to provide 

supplies or services at lower costs and, in certain instances, with improved 

delivery or technical performance, by relating the amount of fee to 

contractor performance. 

Linked incentives: Incentives tied to performance in areas across 

multiple contracts and contractors and used to motivate contractors to 

cooperate. 

Negative incentives: A method used by the government to allow for fee 

reductions if the contractor does not meet certain criteria. 

Rollover: The process of moving unearned award fee from one evaluation

period to a subsequent period or periods, thus allowing the contractor an

additional opportunity to earn that unearned award fee. 

Share ratio: A fee-adjustment formula written as a ratio of the cost risk 

between the government and the contractor. 

Target cost: The preestablished cost of the contracted goods/services 

that is a reasonable prediction of final incurred costs. 

Page 47 GAO-06-66 DOD's Use of Monetary Incentives
Appendix IV: Sample Characteristics Appendix IV: Sample Characteristics 

GAO’s sample of 93 award and incentive contracts comprises the following 

contract types: 

• 48 cost-plus-award-fee contracts, 

• 4 fixed-price-award-fee contracts, 

• 12 cost-plus-incentive-fee contracts,

• 14 fixed-price incentive contracts, 

• 1 cost-plus-incentive-fee / fixed-price incentive contract, and 

• 14 contracts that are combinations of award- and incentive-fee contract 

types. 

The sample contracts included the following breakdown by military 

service and DOD agency or organization: 

• 37 Navy contracts, 

• 30 Air Force contracts, 

• 18 Army contracts, 

• 3 Missile Defense Agency contracts,

• 3 Pentagon Renovation Management Office contracts, 

• 1 Marine Corps contract, and 

• 1 Defense Threat Reduction Agency contract. 

Page 48 GAO-06-66 DOD's Use of Monetary Incentives
Appendix V: GAO Reports on the Weapon

Appendix V Systems Acquisition Environment : GAO Reports on the Weapon 

Systems Acquisition Environment 

Defense Acquisitions: Stronger Management Practices Are Needed to 

Improve DOD’s Software-Intensive Weapon Acquisitions. GAO-04-393. 

Washington, D.C.: March 1, 2004. 

Defense Acquisitions: DOD’s Revised Policy Emphasizes Best Practices, 

but More Controls Are Needed. GAO-04-53. Washington, D.C.:

November 10, 2003. 

Best Practices: Setting Requirements Differently Could Reduce Weapon 

Systems’ Total Ownership Costs. GAO-03-57. Washington, D.C.: 

February 11, 2003. 

Best Practices: Capturing Design and Manufacturing Knowledge Early 

Improves Acquisition Outcomes. GAO-02-701. Washington, D.C.: 

July 15, 2002.

Defense Acquisitions: DOD Faces Challenges in Implementing Best 

Practices. GAO-02-469T. Washington, D.C.: February 27, 2002.

Best Practices: Better Matching of Needs and Resources Will Lead to 

Better Weapon System Outcomes. GAO-01-288. Washington, D.C.: 

March 8, 2001. 

Best Practices: A More Constructive Test Approach Is Key to Better 

Weapon System Outcomes. GAO/NSIAD-00-199. Washington, D.C.: 

July 31, 2000.

Defense Acquisition: Employing Best Practices Can Shape Better 

Weapon System Decisions. GAO/T-NSIAD-00-137. Washington, D.C.: April 

26, 2000. 

Best Practices: DOD Training Can Do More to Help Weapon System 

Program Implement Best Practices. GAO/NSIAD-99-206. Washington, 

D.C.: August 16, 1999. 

Best Practices: Better Management of Technology Development Can 

Improve Weapon System Outcomes. GAO/NSIAD-99-162. 

Washington, D.C.: July 30, 1999. 

Defense Acquisitions: Best Commercial Practices Can Improve Program 

Outcomes. GAO/T-NSIAD-99-116. Washington, D.C.: March 17, 1999. 

Page 49 GAO-06-66 DOD's Use of Monetary Incentives
Appendix V: GAO Reports on the Weapon

Systems Acquisition Environment 

Defense Acquisition: Improved Program Outcomes Are Possible. 

GAO/T-NSIAD-98-123. Washington, D.C.: March 18, 1998. 

Best Practices: Successful Application to Weapon Acquisition Requires

Changes in DOD’s Environment. GAO/NSIAD-98-56. Washington, D.C.: 

February 24, 1998. 

Major Acquisitions: Significant Changes Underway in DOD’s Earned 

Value Management Process. GAO/NSIAD-97-108. Washington, D.C.: May 5,

1997. 

Best Practices: Commercial Quality Assurance Practices Offer 

Improvements for DOD. GAO/NSIAD-96-162. Washington, D.C.: 

August 26, 1996. 

(120326) Page 50 GAO-06-66 DOD's Use of Monetary Incentives
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