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~fCIJll[ ll - DEPARTMENT OF THE AIR FORCE 

DIRECTORATE OF SPECIAL PROJECTS (OSAF) 

AF UNIT POST OFFICE, LOS ANGELES, CALIFORNIA 90045 

19 April 1969 

B YE-16745-69 

REPLY TO 

ATTN OF: SP-1 

11111111111111~1111111111111111111111111111111m11111111111111 14 00078298D 

SUBJECT: Incentive Contracting 

DNRO {Dr. McLucas) 

1. This letter is in response to your request of 11 March, as 

forwarded by Mr. Davis, for a paper on my incentive contracting 

philosophy. I have completed the revision of the basic unclassified 

paper on this subject and am forwarding a copy with this letter. 

This third and final revision of my original April 1966 paper represents 

my current views as a result of these several years of work in applying 

this approach to SAFSP programs. At the present time some, if not all, 

of the major aspects of most SAFSP programs are included in a version 

of this incentive structure. 

2. The paper first describes the application to a satellite vehicle 

(such as the Program 110 vehicle), and then describes the variations 

with which this basic structure is applied to other system elements 

such as payloads, command systems, etc. The paper then describes 

the application of this incentive approach to other types of satellite 

projects such as those with relatively long individual lifetimes 

Pro ram 770 

The incentive structure for the 

Program 467 mission software is included and illustrates the adaptation 

of this basic incentive philosophy to a non-flying end item. The essential 

contingency arrangements are also described. These are important 

elements of a practical incentive structure. It must be possible for the 

government to have full and complete flexibility in the use of the resulting satellite system without the contractor's fee possibilities becoming 

an entangling or limiting consideration of such use. At the same time, 

each vehicle represents a significant portion of the contractor Is chance 

to earn, so the contingency must be handled in a way which is fair and 

reasonable, while providing the essential flexibility of operation in a 

manner which maintains the integrity of the incentive structure. 

3. The first five major paragraphs of the paper describe this incentive 

approacp as applied to a satellite vehicle, but the remaining paragraphs 

are necessary to show how the approach is adapted to other satellite 

system tasks. I realize that this paper is muc:\1: longer than the eight 

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to ten pages suggested by Mr. Davis, but I cannot fully explain the 

essential features of this rationale in a paper of that length. If one 

is contemplating the possible adaptation of this outlook to other types 

of programs, as Mr. Davis indicated, it is particularly important 

that the way this incentive structure is adapted within these satellite 

programs be understood in all its major variations. 

4. With respect to the question of the degree of success achieved on the 

contracts which employ this approach, I must point out that none of this 

experience is suitable for any unclassified or even non-Bye~classified 

reference. Although a number of "white" contracts are involved in the 

group of about thirty eight currently active SAFSP contracts which employ 

this general incentive structure, there is some associated involvement 

with "black" contracts in every instance, and in~ instance can the full 

effect be seen from consideration of the "white" contract data alone. 

Any specific reference to any of these contracts therefore must be 

carried out on a full Byeman clearance basis appropriate to the individual 

program involved, and cannot be used at all in unclassified or DOD 

classified discussions or material. 

5. The major effect of this structure has been a definite and sustained 

improvement in the orbital performance of the end items. This improvement has been realized in some cases with improved financial control, 

that is, with generally 1 ower overruns than those experienced by the 

same contractor in similar type of work. This is not an easy area to 

compare in many instances, however, since in some cases of new work 

we have no good reference of similar work with similar technical 

difficulty (as, for example ~~~~-~~---~---~------~ 

which is difficult to compare fairly with any of our other project experience). On balance, our results show that performance is improved, in 

regard to both quality and reliability, that financial management is every 

bit as good and in some cases better than our previous experience even 

when we used cost incentives for underruns. (Prior to my introduction of 

this present incentive structure, SAFSP had used some CPIF structure 

with+ cost incentives. However, I concluded that the typical effect of 

the cost incentive on underru.ns was only to reduce the fee available 

for positive incentive on performance, since no contractor ever had 

underruns on major satellite vehicles and payloads anyway.) 

6. The nearest example of reasonably comparable effort is the satellite 

vehicle experience in Program 206 (GE), and Program 110 (LMSC) which 

replaced 206. In both programs the initial development buy was six 

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vehicles. The 206 vehicles had cost incentive but no performance 

incentive, while the 110 vehicles had the full incentive structure 

described in my paper. Of the six 206 vehicles, only one lasted three 

days in orbit; four were two-day missions, three of which involved 

failures, and the other one failed in the first day on orbit. In contrast, 

all five of the 110 vehicles that reached orbit were 100% successful 

(the Titan booster second stage failed on one flight so the satellite 

vehicle did not have an opportunity to perform). The 110 vehicle is 

much more complex than was the 206 vehicle, but the initial orbital 

life of these first vehicles was significantly longer, in addition to being 

trouble free: 5 days primary plus 2 for the first one, 7 days primary 

plus 2 solo for the second, 8 days primary plus 2 solo for the third and 

fourth, and 10 days primary for the last. If the later aspects of these 

programs are compared, the performance difference is even more 

drastic. In the fall of 1965, I injected this basic incentive approach 

into the GE effort on 206. Although the contract was already in a major 

overrun condition, the effect of the new incentive was obvious in the 

results achieved during the last year of Program 206, (i. e. , one major 

failure (due to use of the wrong squib in the camera hatch opening 

mechanism) in the last fifteen flights). 

7. Another case in which the performance has been improved after 

introducing this incentive structure is Program 770. The orbital lifetime achieved in the last few flights substantially exceeds the original 

design lifetime. If the remaining STRAWMAN vehicles continue to 

operate as well as the earlier flights, the total operational time on orbit 

for the five flights of this series could exceed by 18 months to two years 

the original expectation when procurement of these flights was approved 

by the DNRO. 

8. Turning now to the question of satisfaction with this incentive approach, 

I will say first that I am well satisfied with it. I am convinced that it not 

only works but that it is a significant factor in getting and keeping responsible managerial attention throughout all phases of the contractor's effort. 

As to the contractor 1 s satisfaction, I have had many expressions of such 

satisfaction and no instance of dissatisfaction with this structure from 

anyone who has worked under it. After the success of the developmental 

110 vehicles, which I have described above in paragraph 6, Dr. Flax 

asked the Lockheed management for their view of the major factors which 

contributed to this early success. The contractor's response cited three 

major factors, one of which was this incentive structure. The following 

is a verbatim quote of this response; 

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listed factor: 

11 A carefully devised incentive contract biased 

toward technical performance which resulted in 

a powerful management tool for motivation of all 

employees associated with the program to promote early and continued success. 11 

discussion: 

11 The incentive contract which featured vehicle 

performance had the desired result. It was of 

particular importance that all performance 

was to be measured as a negative from optimum. 

In other words, any performance less than perfection represented a loss to the company rather 

than a more classic approach which provided a 

potential gain. The contract will experience a 

cost overrun of 5% or less. This did not result 

from irresponsible fiscal management, but 

rather many program decisions which were believed to contribute to better reliability. These 

actions were broadly within the scope of the contract but not foreseen. They did not represent 

difficult trade-off decisions, since it was believed 

that vehicle performance would offset the penalty 

to the company. 11 

9. With respect to other attitudes toward this incentive structure, I 

must say that not everyone in the procurement field has instantly 

accepted it, although it has been completely validated as both legal and 

within the intent of DOD incentive contracting policy. I had many long 

sessions with some of my own people in the beginning before getting 

them oriented in the same direction. I think that some of the people in 

the procurement field, such as some in plant representative work, 

question paying the contractor more for, in effect, supervising his own 

efforts better, and possibly see in this approach a tendency toward reduction of their own role. I think that some of the Aerospace personnel 

see the continued use of this approach as a potential inroad on their 

traditional GSE/ TD role, as the contractor is much less inclined to 

lightly take all sorts of direction after his work is put under this type 

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of incentive. I should note also that there is a fundamental difference 

in the attitude which leads to this incentive structure and that which 

seems to underlie many more conventional incentive structures. Even 

though, in a legalistic sense, the various applicable documents contain 

words and phrases here and there which purport to keep things in proper 

perspective, in actual practice it has seemed to me that much of the 

conventional incentive attitude reflects a desire to get something for 

nothing -- to get more than the contract requires at a cost less than the 

agreed contract price. The real problem is just the opposite - - to get 

as much as was contracted for without having to pay much more than 

the original contracted price. 

10. One of the major factors which has motivated me to develop this 

approach is the problem of keeping the satellite reconnaissance program 

at a sustained level of operational effectiveness under very difficult 

circumstances which normally and constantly threaten to erode it. This 

capability rests on an industrial base of contractor facilities and personnel, 

many separate contracts, with people constantly changing and a.ffecting the 

knowledge, experience, and competency on which this capability depends 

for its very existence. Such changes must be watched closely by responsible management and controlled through selection and training of replacements in order to prevent serious reduction of the existing capability. 

The other aspect of the problem is that the continued production of ongoing systems requires continued top quality engineering support, yet 

top quality engineers normally want to move on into the initial design 

of newer work rather than continuing to watch and guide on-going 

production. Their employers also tend toward this same end in order 

to take advantage of their knowledge and experience to get new business. 

Yet the continued production of the most stabilized satellite projects involves constant changes for various reasons. A myriad of components 

which are initially selected because they are available in production 

either go out of production or undergo changes for other work, forcing 

changes in all systems which use them. The choice is often to either 

change to accommodate the new production version of this component, 

change to accommodate a different component, or else to continue as 

a sole user of very small production lots of the old component, which 

course, if available at all, is usually more expensive and involves 

greater degradation in reliability than accepting the forced change. 

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The only solution to these problems is constant, meticulous attention 

of competent management at every echelon of the contractor's efforts. 

This incentive contract structure is certainly not a panacea, but it is the 

best way I have been able to find to cope with this task. 

1 Atch (Unclassified} 

Major General, USAF "A Specialized Incentive Contract 

Director Structure for Satellite Projects, 11 

Ref No: SP142866 

6 

Revised 4/ 18/ 69 

cc: Gen Berg (SAFSS) 

Harry Davis 

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