According to the FAR, a wide selection of contract types is available to the government and contractors to allow flexibility in acquiring a variety of products and services. Contract types vary according to the degree and timing of the contractor’s responsibility for the costs of performance and by the amount and nature of the profit incentive offered to the contractor for meeting or exceeding specified goals. Contract types are grouped into two broad categories: fixed-price or cost-reimbursement contracts. Within these categories, the specific types range from firm-fixed-price (FFP), in which the contractor has full responsibility for the costs of performance and the resulting profit or loss, to cost-plus-fixed-fee (CPFF), in which the contractor has minimal responsibility for the costs of performance and the fee is a fixed dollar amount, established as a percentage of the estimated target cost at the start of the contract. In between these are incentive contracts, in which the contractor’s responsibility for costs and the profit or fee incentives offered are tailored to performance uncertainties. The FAR also notes that incentive contracts are appropriate when a firm- fixed-price contract is not, and the required items can be acquired at lower costs and possibly with improved delivery or technical performance by tying fee or profit to the contractor’s performance. Incentive and award fee provisions can be used together in the same contract, but each uses a different approach with respect to how performance is assessed and how fees or profits are determined. Incentive fees—For contracts with incentive fees or profits, the amount of fee or profit payable is related to the contractor’s performance. Incentive fees or profits generally focus on cost control, though they may be used to motivate performance toward specific delivery (e.g., schedule) targets or technical goals. Incentive fees or profits involve an objective evaluation by the government through a process that is generally less administratively burdensome than award fee evaluations. The government usually applies a fee- or profit- determination formula that is specified in the contract to evaluate performance at the end of the contract or at program milestones. The formula may include a target cost, a target profit or fee, a ceiling price, and a profit- or fee-adjustment formula, sometimes referred to as a share ratio for fixed-price incentive (FPI) contracts (see figure 1). In the hypothetical example above, if the contractor incurred $100 in costs, the contractor would receive $10 in profit, and the government would pay the target price of $110. If the contractor kept costs under the $100 target cost, it would split cost savings equally with the government and receive a larger profit; if the contractor exceeded the cost target, it would share the additional costs with the government up to the ceiling price but earn a smaller profit. At ceiling, the contractor earns no profit, and the contractor is responsible for any costs incurred above the ceiling price. A cost-plus-incentive-fee (CPIF) contract reimburses the contractor for its allowable costs, but still uses a formula of total allowable costs to target costs to determine fee and includes a target fee instead of a target profit. A CPIF contract also has a minimum fee—the lowest fee the contractor may receive when total allowable costs exceed target costs—and maximum fee—the highest fee the contractor may earn when total allowable costs are less than target costs, and, unlike an FPI contract, there is no ceiling price. Award fees—Award fees typically emphasize multiple aspects of contractor performance in areas that are more subjectively assessed, such as the contractor’s responsiveness, technical ingenuity, or cost management. From the government’s perspective, development and administration of award fee contracts often involve substantially more effort over the life of a contract than incentive fee contracts, requiring government officials, through an award fee evaluation board, to conduct periodic evaluations of the contractor’s performance against specified criteria and to make recommendations on the amount of fee to be paid. Criteria are specified in an award fee plan, which contracting officials may revise from one evaluation period to another to redirect contractor emphasis. Following the award fee evaluation, a fee-determining official makes the final decision about the amount of fee paid to the contractor. Table 2 identifies the range of incentive contract types and their appropriate use based on acquisition regulations. We have previously identified issues with the use of incentive and award fees that called into question whether they were used effectively to achieve their intended purpose. In our December 2005 review of incentive and award fee contracts, we found that award fees were generally not linked to acquisition outcomes, and that DOD had paid an estimated $8 billion in award fees regardless of outcomes. In addition, we estimated that in 52 percent of the award fee contracts, DOD moved unearned award fees from one evaluation period to a subsequent period—a practice referred to as “rollover”—which provides contractors at least a second chance to earn fees after failing to perform well enough to earn them initially. We also found that DOD had not compiled data, conducted analyses, or developed performance measures to evaluate the effectiveness of incentive and award fees. We recommended that DOD apply more outcome-based award fee criteria, pay award fees only for above satisfactory performance, issue guidance on the appropriate use of rollover, develop a mechanism for capturing incentive and award fee data within existing data systems, and develop performance measures to evaluate the effectiveness of incentive and award fees at improving contractor performance and achieving desired outcomes. DOD concurred with two of these recommendations, and partially concurred with our recommendations to only pay award fees for above satisfactory performance, collect incentive and award fee data, and develop performance measures to evaluate the effectiveness of incentive and award fees. DOD implemented all but one of these recommendations— paying award fees only for above satisfactory performance—though a provision was later added to the FAR prohibiting payment of award fees for below satisfactory performance. In our May 2009 review of 50 DOD contracts containing award fees, we found that DOD had made progress toward minimizing payments of award fees for unsatisfactory performance, limiting overpayment for satisfactory performance, and reducing the number of programs that used rollover. DOD, however, still struggled to use data collected on award fee contracts to evaluate their effectiveness. We did not make new recommendations in these areas. Most recently, in a March 2017 report on selected FPI contracts awarded by the Navy for new ship construction, we found the Navy often structured the contracts such that it absorbed more cost risk than DOD’s regulation suggests, indicating it may not achieve the expected benefits of using the FPI contract type. For example, we found that 8 of 11 ships delivered under the contracts reviewed experienced cost growth. We recommended that DOD conduct a portfolio-wide assessment of the Navy’s use of additional incentives on FPI contracts across shipbuilding programs. DOD concurred with our recommendation. In 2007, OMB issued government-wide guidance highlighting preferred practices for incentive contracting and directing agencies to review and update their acquisition policies. In 2009, the FAR was revised to implement legislative provisions and OMB’s guidance on the appropriate use of incentive contracts. These changes addressed some of the issues that we identified in 2005 and 2009 relative to the use of award fees. The FAR now prohibits rollover of unearned award fees from one evaluation period requires award fees to be linked to cost, schedule, and technical performance acquisition objectives; restricts payment of award fees in instances of unsatisfactory contractor performance; and requires agencies to collect relevant data on incentive and award fee payments and evaluate the effectiveness of these contract types in achieving desired outcomes. Since 2010, DOD has taken steps to improve its use of incentive contracts—often beyond what is required by the FAR—by revising the Defense Federal Acquisition Regulation Supplement (DFARS), instituting its Better Buying Power initiative, and developing new guidance and training courses. In particular, DOD has emphasized the use of objective incentives through FPI and CPIF contracts rather than award fees whenever possible, in part to better motivate contractors to control costs. These efforts are reflected in DOD’s reported use of incentive contracts since 2010, which indicate a substantial growth in obligations for incentive fee contracts and a corresponding decrease in obligations for award fee contracts. DOD made changes to the DFARS and its accompanying Procedures, Guidance, and Information in recent years intended to support appropriate use of incentive contracts. For example, DOD made the following updates to the DFARS in 2011: Directed contracting officers to utilize objective criteria—associated with incentive fee contracts—to the maximum extent possible for measuring contract performance. DOD noted concerns that award fee contracts have a limited ability to motivate contractors to control costs, and that there had been instances in which award fee payments were not consistent with outcomes. Directed contracting officers to give particular consideration to FPI contracts, especially for acquisitions moving from development to production or in contracts for which previous FFP contract costs had varied by more than 4 percent from negotiated costs. By looking at historical pricing and contract performance data, DOD officials stated they determined that in some FFP contracts, actual costs have come in noticeably lower than negotiated costs (e.g., at 4 percent or more), indicating that costs are not stable or that the government may not have negotiated a good deal when it awarded the contract. Directed contracting officers to include a contract clause prohibiting the payment of award fees when a contractor’s performance is rated below satisfactory, as required by the FAR, which emphasizes that the amount of award fee paid should correspond with the contractor’s performance. DOD released memoranda between 2010 and 2015 through its Better Buying Power initiative, which focused, in part, on the use of incentive contracts. The Better Buying Power memoranda established a preference for FPI contracts and advised contracting officers to increase the use of this contract type, when appropriate, such as early in production and in single-source production where year-over-year price improvement can be rewarded.