Federal Contracting: Application of OMB Guidance Can Improve Use of Award Fee Contracts
Published: 2009-08-03T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: From fiscal year 2004 through fiscal year 2008, agencies spent over $300 billion on contracts which include award fees. While many agencies use award fee contracts, over 95 percent of the government's spending using this contract type in fiscal year 2008 occurred at five: the departments of Defense (DOD), Energy (DOE), Health and Human Services (HHS), and Homeland Security (DHS) and the National Aeronautics and Space Administration (NASA). In December 2007, the Office of Management and Budget's (OMB) Office of Federal Procurement Policy issued guidance to chief acquisition officers and procurement executives across the government that echoed several recommendations we made in 2005 on the use of award fees and emphasized positive practices to be implemented by all agencies. GAO's statement today is based on our May 29, 2009, report, Federal Contracting: Guidance on Award Fees Has Led to Better Practices But is Not Consistently Applied (GAO-09-630). Like the report, this statement addresses how agencies are implementing OMB's guidance. Specifically, we (1) identified the actions agencies have taken to revise or develop policies and guidance to reflect OMB guidance on using award fees, (2) determined the extent to which current practices for using award fee contracts are consistent with the new guidance, and (3) identified the extent to which agencies collect and analyze information on award fees to evaluate their use and share that information within their agencies.
section_title: What GAO Found
paragraphs: Award fee contracts can motivate contractor performance when certain principles are applied. Linking fees to acquisition outcomes ensures that the fee being paid is directly related to the quality, timeliness, and cost of what the government is receiving. Limiting the opportunity for contractors to have a second chance at earning a previously unearned fee maximizes the incentive during an award fee period. Additionally, the amount of the fee earned should be commensurate with contractor performance based on evaluation factors designed to motivate excellent performance. Further, no fee should be paid for performance that is judged to be unsatisfactory or does not meet contract requirements. While DOD has realized benefits from applying these principles to some contracts, these principles have not been established fully in guidance at DOE, DHS, and HHS. Having guidance is not enough, however, unless it is consistently implemented. Further, the lack of methods to evaluate effectiveness and promote information sharing among and within agencies has created an atmosphere in which agencies are unaware of whether these contracts are being used effectively and one in which poor practices can go unnoticed and positive practices can be isolated.

section_title: Letter
paragraphs: I am pleased to be here today to discuss our recent work for this  subcommittee on the use of award fee contracts. An award fee is an  amount of money that a contractor may earn in whole or in part by  meeting or exceeding subjective criteria stated in an award fee plan.  Typically the criteria are related to quality, technical ingenuity, cost- effective management, program management, and other unquantifiable  areas. From fiscal year 2004 through fiscal year 2008, agencies spent over  $300 billion on contracts which include award fees. While many agencies  use award fee contracts, over 95 percent of the government’s spending  using this contract type in fiscal year 2008 occurred at five: the  departments of Defense (DOD), Energy (DOE), Health and Human  Services (HHS), and Homeland Security (DHS) and the National  Aeronautics and Space Administration (NASA). In December 2007, the  Office of Management and Budget’s (OMB) Office of Federal Procurement  Policy issued guidance to chief acquisition officers and procurement  executives across the government that echoed several recommendations  we made in 2005 on the use of award fees and emphasized positive  practices to be implemented by all agencies.
My statement today is based on our May 29, 2009, report, Federal  Contracting: Guidance on Award Fees Has Led to Better Practices But is  Not Consistently Applied (GAO-09-630). Like the report, this statement  addresses how agencies are implementing OMB’s guidance. Specifically,  we (1) identified the actions agencies have taken to revise or develop  policies and guidance to reflect OMB guidance on using award fees,   (2) determined the extent to which current practices for using award fee  contracts are consistent with the new guidance, and (3) identified the  extent to which agencies collect and analyze information on award fees to  evaluate their use and share that information within their agencies.
To identify the actions that these five agencies have taken to revise or  develop guidance on the use of award fees, we assessed procurement  policies and discussed planned and implemented policy changes with  procurement officials at each agency. To determine the extent to which  current practices for using award fee contracts are consistent with OMB  guidance, we reviewed data from 645 evaluation periods for 100 contracts  at the five agencies. For DOD and NASA, our scope included contracts  examined in prior GAO work and DOD contracts awarded after policies  were changed that had held at least one award fee period. Where  applicable, we identified the programmatic and monetary effect of  implementing policy changes. For DOE, HHS, and DHS, we selected all  award fee contracts with over $50 million obligated against them from  fiscal year 2004 through fiscal year 2008 as identified in the Federal  Procurement Data System (FPDS). We collected data on the amount of   the award fee available compared to the amount awarded as well as the  criteria used to evaluate contractor performance. We reviewed contract  documents including award fee plans to determine the extent to which the  contracts reflected positive award fee practices identified in our prior  work and OMB guidance. We also interviewed procurement officials at  each agency on efforts to collect data on award fees, evaluate their  effectiveness, and share information on successful strategies.
Our work for our May 29, 2009, report was conducted from August 2008  through May 2009 in accordance with generally accepted government  auditing standards. Those standards require that we plan and perform the  audit to obtain sufficient and appropriate evidence to provide a reasonable  basis for our findings and conclusions based on our audit objectives. We  believe that the evidence obtained provides a reasonable basis for our  findings and conclusions based on our audit objectives. More detailed  information on our scope and methodology appears in our 2009 report.
subsections: section_title: OMB’s Guidance Is Not Consistently Addressed at All Agencies
paragraphs: In December 2007, the OMB Office of Federal Procurement Policy issued  guidance to chief acquisition officers and senior procurement executives  to review and update their acquisition policies on the appropriate use of  incentive fee contracts, which include award fee contracts. The guidance  highlighted preferred practices including: (1) linking award fees to  acquisition outcomes, such as cost, schedule, and performance results;   (2) limiting the use of rollover to exceptional circumstances defined by  agency policies; (3) designing evaluation factors that motivate excellent  contractor performance by making clear distinctions between satisfactory  and excellent performance; and (4) prohibiting payments for contractor  performance that is judged to be unsatisfactory or does not meet the basic  requirements of the contract. Further, OMB asked agencies to obtain and  share practices in using award fees through an existing Web-based  resource. The OMB guidance was developed based on award fee problems  that had been identified by GAO and which DOD and NASA had begun to  address.  The following shows how OMB’s guidance is reflected in  guidance provided by each agency:  In response to GAO recommendations in 2005 and subsequent legislation,  DOD issued guidance in 2006 and 2007 that states it is imperative that  award fees are linked to desired outcomes, that the practice of rolling over  unearned award fees should be limited to exceptional circumstances, that  award fees must be commensurate with contractor performance, and that  performance that is unsatisfactory is not entitled to any award fee. It also  states that satisfactory performance should earn considerably less than  excellent performance; otherwise, the motivation to achieve excellence is  negated.
While NASA’s Award Fee Guide already addressed the four issues, our  previous work found that NASA did not consistently implement key  aspects of its guidance on major award fee contracts. In response to our  findings, a June 2007 NASA policy update reemphasized these policies to  contracting staff and added a requirement that contracting officers include  documented cost-benefit analysis when using an award fee contract.
DOE has supplemental guidance to the Federal Acquisition Regulation  (FAR) that outlines how award fees should be considered and in  September 2008 created implementing guidance specific to management  and operations contracts that links award fees to acquisition outcomes  and limits the use of rollover. However, DOE’s departmental guidance  does not clearly define the standards of performance for each rating  category or prevent payment of fees for unsatisfactory performance.  Divisions of DOE have developed their own standards and methods of  evaluation which vary in their consistency with the OMB guidance.
DHS provides guidance on award fees in its acquisition manual, but does  not fully address the issues in the OMB guidance. The DHS guidance  requires award fee plans to include criteria related (at a minimum) to cost,  schedule, and performance and establishes that award fees are to be  earned for successful outcomes and that no award fee may be earned  against criteria that are ranked below “successful” or “satisfactory.”  However, the manual does not describe standards or definitions for  determining various levels of performance or include any limitation on the  use of rollover.
HHS officials did not have guidance specific to the use of award fees and  were not aware of any such guidance at their operational divisions.  Officials told us that they relied on the FAR for guidance on using award  fees. However, contracting officials at HHS operational divisions noted a  need for better guidance and told us that the FAR did not provide the level  of detail needed to execute an award fee contract. As a result, contracting  officers at these operational divisions have developed approaches to  award fee contracts which vary in their degree of consistency with OMB’s  guidance.
The National Defense Authorization Act for Fiscal Year 2009 directed that  the FAR be amended by the middle of October 2009 to expand the  requirements placed on DOD in 2007 to all executive agencies. A working  group including representatives from these agencies is reviewing and  updating the FAR. DOD officials also told us that they are developing  supplemental guidance on award fees, but will wait until the FAR working  group completes its work before finalizing the guidance.
section_title: Agency Practices Are Not Always Consistent with OMB Guidance
paragraphs: By implementing the revised guidance, some DOD components reduced  costs and improved management of award fee contracts. Potential changes  at NASA —such as documented cost-benefit analyses—are too recent for  their full effects to be judged. At DOE, DHS, and HHS, individual  contracting offices have developed their own approaches to executing  award fee contracts which are not always consistent with the principles in  the OMB guidance or between offices within these departments.
Use of Rollover: Guidance from DOD, DOE, and OMB states that  allowing contractors a second chance at unearned fees should be limited  to exceptional circumstances and should require high-level approval.  NASA guidance does not allow rollover. Allowing contractors an  opportunity to obtain previously unearned fees reduces the motivation of  the incentive in the original award fee period. In almost all of the 50 DOD  contracts we reviewed, rollover is now the exception and not the rule.  While in 2005 we found that 52 percent of all DOD programs rolled over  fee, only 4 percent of the programs in our sample continue this practice.  We reviewed active contracts from our 2005 sample and found that  eliminating rollover will save DOD more than an estimated $450 million on  8 programs from April 2006 through October 2010. However, with the  exception of NASA where rollover is not allowed, we found instances at  each agency, where rollover was allowed, at times, for 100 percent of the  unearned fee.
Linking Fees to Outcomes: OMB’s guidance indicates that award fees  should be used to achieve specific performance objectives established  prior to contract award, such as delivering products and services on time,  within cost, and with promised performance; and must be tied to  demonstrated results, as opposed to effort. Contracting officers and  program managers across all five agencies said award fee contracts could  benefit from objective targets that equate to a specific amount of the fee.  While the combination of award fee contracts which evaluate subjective  criteria and incentive contracts which evaluate objective targets was the  preferred approach of several officials, there is no guidance on how to  balance or combine these contract types. The effective use of subjective  criteria requires that they be accompanied by definitions and  measurements of their own to ensure they are linked to outcomes rather  than processes or efforts. DOD’s Joint Strike Fighter is one program that  has incorporated more discrete criteria. In comparing periods before and  after the application of these criteria, the contractor has consistently  scored lower in the performance areas than in previous periods where less  defined criteria were applied. We estimate that the more accurate  assessment of contractor performance has saved almost $29 million in less  than 2 years of the policy change. However, contracts do not always use  criteria that are linked to outcomes. For example, an HHS contract for call  center services awarded a portion of the fees based on results, such as  response times, but also included criteria based more on efforts, such as  requiring the contractor to ensure that staffing levels were appropriate for  forecasted volumes during hours of operation, rather than measuring  results.
Using Evaluation Factors to Motivate Excellent Performance: The  amount of the fee established for satisfactory performance or meeting  contract requirements generally awards the contractor for providing the  minimum effort acceptable to the government. Programs used a broad  range in setting the amount of the fee available for satisfactory  performance, but many left little to motivate excellent performance. For  example, DOE’s Office of Science uses a model that sets the amount of the  fee able to be earned for meeting expectations at 91 percent, thus leaving 9  percent to motivate performance that exceeds expectations. In contrast, in  an HHS contract for management, operation, professional, technical, and  support services, the contractor earns 35 percent of the award fee for  satisfactory performance, leaving 65 percent of the fee to motivate  excellent performance. DOD and NASA are the only agencies we reviewed  that provide guidance on the amount of the fee to be paid for satisfactory  performance, up to 50 percent and 70 percent respectively. However, not  all DOD programs have followed this guidance. For example, a DOD  Missile Defense Agency (MDA) contract signed in December 2007 awards  the contractor up to 84 percent of the award fee pool for satisfactory  performance, which the agency defines as meeting most of the  requirements of the contract. This leaves only 16 percent of the award fee  pool to motivate performance that fully meets contract requirements or is  considered above satisfactory.
Payments for Unsatisfactory Performance: DOD, NASA, and OMB  have stated that performance not meeting contract requirements or judged  to be unsatisfactory merits no award fee. However, while the median  award fee scores indicate satisfaction with the results of the contract,  programs we reviewed continue to use evaluation tools that could allow  for contractors to earn award fees without performing at a level that is  acceptable to the government under the terms of the contract. For  example, an HHS contract for Medicare claims processing rates contractor  performance on a point scale, from 0 to 100, where the contractor can  receive up to 49 percent of the fee for unsatisfactory performance and up  to 79 percent for satisfactory performance (defined as meeting contract  requirements). The National Nuclear Safety Administration, a separate  agency within DOE, uses a tool that prohibits payments for unsatisfactory  performance while the evaluation method used by DOE’s Office of Science  allows a contractor to earn up to 84 percent of the award fee for  performance that is defined as not meeting expectations. Further, current  award fee plans for some programs using the Office of Science lab  appraisal process allow for an award fee to be earned at the “C” level,  which guidance defines as performance in which “a number of  expectations ... are not met and/or a number of other deficiencies are  identified” with potentially negative impacts to the lab and mission.  According to Office of Science guidance, as much as 38 percent of the fee  can be earned for objectives that fall in this category.
section_title: Agencies Do Not Have Methods for Evaluating Award Fee Effectiveness in Improving Contractor Performance
paragraphs: While programs have paid more than $6 billion in award fees for the 100  contracts we reviewed, none of the five agencies has developed methods  for evaluating the effectiveness of an award fee as a tool for improving  contractor performance. Instead, program officials noted that the  effectiveness of a contract is evident in the contractor’s ability to meet the  overall goals of the program and respond to the priorities established for a  particular award fee period. However, officials were not able to identify  the extent to which successful outcomes were attributable to incentives  provided by award fees versus external factors such as a contractor’s  interest in maintaining a good reputation. When asked how they would  respond to a requirement to evaluate the effectiveness of an award fee,  officials told us that they would have difficulty developing performance  measures that would be comparable across programs.
Of the five agencies we reviewed, only DOD collects data on award fee  contracts. In 2006, legislation required DOD to develop guidance on the  use of award fees that included ensuring that the department collects  relevant data on award and incentive fees paid to contractors and that it  has mechanisms in place to evaluate such data on a regular basis. DOD  has collected and analyzed data and provided that analysis to Congress  and the Senior Procurement Executives of the military services and other  DOD agencies. However, DOD does not have performance measures to  evaluate the effectiveness of award fees as a tool for improving contractor  performance and achieving desired program outcomes. DOD’s data  collected on objective efficiencies include cost and schedule measures but  do not reflect any consideration of the circumstances that affected  performance, a critical element in determining award fees.
While DOD has established an award fee community of practice through  its Defense Acquisition University, most information regarding successful  strategies for using award fees is shared through informal networks.  Contracting officers at DOD, DOE, DHS, and HHS were unaware of any  formal networks or resources for sharing best practices, lessons learned,  or other strategies for using award fee contracts, and said they rely on  informal networks or existing guidance from other agencies. However,  within agencies, procurement executives are beginning to review award  fee criteria across programs for consistency and successful strategies.
section_title: Concluding Observations and Prior Recommendations for Executive Action
paragraphs: Award fee contracts can motivate contractor performance when certain  principles are applied. Linking fees to acquisition outcomes ensures that  the fee being paid is directly related to the quality, timeliness, and cost of  what the government is receiving. Limiting the opportunity for contractors  to have a second chance at earning a previously unearned fee maximizes  the incentive during an award fee period. Additionally, the amount of the  fee earned should be commensurate with contractor performance based  on evaluation factors designed to motivate excellent performance.  Further, no fee should be paid for performance that is judged to be  unsatisfactory or does not meet contract requirements. While DOD has  realized benefits from applying these principles to some contracts, these  principles have not been established fully in guidance at DOE, DHS, and  HHS. Having guidance is not enough, however, unless it is consistently  implemented. Further, the lack of methods to evaluate effectiveness and  promote information sharing among and within agencies has created an  atmosphere in which agencies are unaware of whether these contracts are  being used effectively and one in which poor practices can go unnoticed  and positive practices can be isolated.
In our report, we recommended that DOE, HHS, and DHS update or  develop implementing guidance on using award fees. This guidance should  provide instructions and definitions on developing criteria to link award  fees to acquisition outcomes, using an award fee in combination with  incentive fees, rolling over unearned fees, establishing evaluation factors  to motivate contractors toward excellent performance, and prohibiting  payments of award fees for unsatisfactory performance. To expand upon  improvements made, we recommended that DOD promote consistent  application of existing guidance, including reviewing contracts awarded  before the guidance was in effect for opportunities to apply it, and provide  guidance on using an award fee in combination with incentive fees to  maximize the effectiveness of subjective and objective criteria. We also  recommended that the five agencies establish an interagency working  group to (1) identify how best to evaluate the effectiveness of award fees  as a tool for improving contractor performance and achieving desired  program outcomes and (2) develop methods for sharing information on  successful strategies. The agencies concurred with our recommendations  and noted that both the FAR working group and an interagency working  group could be potential mechanisms for implementing our  recommendations.
Mr. Chairman, this concludes my statement. I would be pleased to respond  to any questions you or other Members of the Subcommittee may have.
For questions regarding this statement, please contact John P. Hutton at  (202) 512-4841 or at huttonj@gao.gov. Individuals making contributions to  this testimony include Thomas Denomme, Assistant Director, Kevin Heinz,  John Krump, and Robert Swierczek.
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