Defense Acquisitions: DOD Has Paid Billions in Award and Incentive Fees Regardless of Acquisition Outcomes
Published: 2005-12-19T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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. 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.

section_title: Letter
paragraphs: 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.
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-plus- incentive-fee, fixed-price-award-fee, or fixed-price incentive valued at $10  million or more during that time. Unless otherwise noted, the estimates in  this 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 incentive- fee 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-and- development 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   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. 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.
subsections: section_title: Background
paragraphs: 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. Typically, award-fee  contracts emphasize multiple aspects of contractor performance in a wide  variety of areas, such as quality, timeliness, technical ingenuity, and cost- effective management. 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.
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.
subsections: section_title: Award-Fee Contracts
paragraphs: The development and administration of award-fee contracts involve  substantially more effort over the life of a contract than incentive-fee  contracts. For award-fee contracts, DOD personnel (usually members of  an award-fee evaluation board) 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. 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. After receiving the recommendation of  the award-fee evaluation board, a fee-determining official makes the final  decision about the amount of fee the contractor will receive. The fee- determining 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.
section_title: Incentive-Fee Contracts
paragraphs: 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   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.
section_title: Contracts Discussed in This Report
paragraphs: For this report, we examined fixed-price and cost-reimbursable award-  and 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.)
From fiscal year 1999 through fiscal year 2003, award- and incentive-fee  contract actions accounted for 4.6 percent of all DOD contract actions  over $25,000. However, when taking into account the dollars obligated— award- and incentive-fee contract actions accounted for 20.6 percent of  the dollars obligated on actions over $25,000, or over $157 billion, as  shown in figure 1. Our sample of 93 contracts includes $51.6 billion, or  almost one-third, of those obligated award- and incentive-fee contract  dollars.
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.
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.
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.
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-award- fee contracts in our study population included zero base fee. 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.
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.
section_title: DOD Acquisition Practices and Program Success
paragraphs: 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. 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   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.
section_title: Award and Incentive Fees Are Not an Effective Tool for Achieving DOD’s Desired Acquisition Outcomes
paragraphs: 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   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.
subsections: section_title: Award-Fee Contracts: DOD Practices Do Not Maximize Contractors’ Motivation to Perform
paragraphs: 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) was 90 percent, representing an  estimated $8 billion in award fees for contracts active between fiscal years  1999 through 2003. 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.
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.
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  evaluation periods. We estimate that unearned fees were rolled over in  42 percent of evaluation periods of contracts that used this practice.  Further, we estimate that the mean percentage of unearned fees that were  rolled over in these periods was 86 percent, and in 52 percent 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.
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. 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.
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. 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.
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 regulations) 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  contracts. However, rewarding better than satisfactory performance was  one reason that these fees were used on an estimated 77 percent of these  contracts.
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 incentive- fee contracts felt that the guidance they used to develop and administer  the contract was adequate.
section_title: Award-Fee Contracts: Fee Criteria and Payouts Not Routinely Linked to Acquisition Outcomes
paragraphs: 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  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 award- fee 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).
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  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.  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.
section_title: Incentive-Fee Contracts: Many Contracts Not Meeting Cost or Performance Targets
paragraphs: Contracts with incentive fees have also not fared well at motivating cost- control 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,  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.
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 formula- like 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. 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.
section_title: DOD Has Little Evidence That Monetary Incentives Improve Results as Intended
paragraphs: 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. 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.
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  routinely earn high percentages of fee while programs have experienced  performance problems, schedule slips, and cost growth. 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 incentive- fee contracts had improved performance because of the incentive  provisions, in the opinion of contracting and program officials. On award- fee 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  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.
section_title: Conclusions
paragraphs: 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 high- performance 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.
section_title: Recommendations for Executive Action
paragraphs: 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 outcome- based 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.
section_title: Agency Comments and Our Evaluation
paragraphs: 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.
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  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.
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.
section_title: Appendix I: Scope and Methodology
paragraphs: 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-plus- incentive-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. 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.
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  incentive-fee contracts in our sample; analyzed contract documentation  related to incentive provisions; and collected and analyzed data on award- fee 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  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  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.
section_title: Appendix II: Comments from the Department of Defense
section_title: Appendix III: Contracting Definitions
paragraphs: 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-fixed-  fee 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.
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.
section_title: Appendix IV: Sample Characteristics
paragraphs: 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.
section_title: Appendix V: GAO Reports on the Weapon Systems Acquisition Environment
paragraphs: 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.
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.