Analysis of Air Force Contract Implementation

Major Thomas J. Snyder

The use of incentive contracts by federal agencies, including the Air Force, has increased significantly in the last 20 years. Incentives (in time or money) are given to contractors for specific results or quality standards. As the use of incentive contracts increases in both the public and private sectors, debate over their use has also increased among the professional acquisition community. Recent professional discourse includes anecdotal experiences centered on whether or not incentive contracts are implemented properly in the Air Force. Specifically, there are concerns that award-fee incentives or the newest hybrid award terms are not being implemented in a manner consistent with their original intent. Also, it is possible that the application of these instruments to motivate contractors could give incentive to the wrong behavior and be detrimental to acquisition initiatives.

The Air Force uses numerous types of incentives to motivate contractors to either save money or perform at a level considered above satisfactory. Award-fee contracts, through which contractors are evaluated and granted additional money for excellent performance, are popular within the Air Force acquisition community. Its popularity has spawned a new award term, in which contractors are granted contract extensions in lieu of money.

Award fees can be used in cost contracts in which contractors are reimbursed actual costs or in fixed-price contracts in which the contractor is guaranteed a fixed price no matter what costs are. Additionally, award fees can be used in conjunction with fixed fees. For example, a contractor can be granted costs plus a fixed fee for just meeting standards and an award fee on top of that depending on how far those standards are exceeded. For purposes of this article, the term award fee will refer to fixed-price contracts only, without a fixed fee. These award-fee contracts have a fixed price and an available pool of dollars, which the contractor may earn in any percentage from 0-100, based on performance level.

History of Award-Fee Incentives

This type of contract gives a company a definite incentive to cut its costs. In fact, the heart of the contract is the conviction that American business can perform miracles of low-cost production given a profit incentive for doing so.

Under Secretary of the Navy Forrestal

Attempts by federal agencies to motivate contractors using incentives reach back to the American Civil War. The Monitor, the Navy's ironclad ship, was bought using a contract that included a performance incentive. [1] Another famous use of contract incentives involved the country's first aircraft buy. The Army Signal Corps' contract with the Wright Brothers included a performance incentive based on flight speed. A $25K flat price was established for a 40 mile-per-hour flight, but the contract also included positive and negative incentives for actual speed obtained. The aircraft flew 42 miles per hour, and the brothers received a $5K incentive payment. [2]

Incentives were also common during both world wars. Navy contracts with Bethlehem Steel for shipbuilding in World War I included incentive fees for performance and capital investment. [3] During mobilization for World War II, competitive bidding was overcome by the urgency of the times. War Production Board Directive No 2, 3 March 1942, stated that formally advertised bid procedures were not to be used in war contracts; negotiation was to be used (as it was in other mobilizations). The directive also established three criteria for contracts: speed of delivery, conservation of superior facilities for the more difficult items of production, and placing contracts with firms needing the least amount of additional machinery and equipment. [4] This need for speed encouraged the Army and Navy to break new ground in contract terms. The War Department developed an evaluated-fee contract similar to the cost-plus-fixed fee construction contracts of World War I, except part of the fee varied depending on the contractor's performance. The Navy's Bureau of Ships also modified the cost-plus-fixed-fee contract so a portion of the fee was firm and the rest was paid as a bonus for achieving cost savings. This contract appeared in 1943 in large shipbuilding programs and some ordnance items. [5] These innovations were the precursors of the award-fee contract that is so popular today. Under Secretary of the Navy James V. Forrestal was a grand proponent of incentive contracts, and in 1943, the Navy tried to convert as many of its contracts as possible to incentive contracts. However, industry gave lackluster support to the initiative because of its lack of experience with contracts and frequent government contract changes. Production experience was low, so contractors had difficulty estimating costs, and government changes and interference often interrupted delivery schedules. Consequently, contractors were cool to incentives because they did not want their profit tied to changing goals. The lesson learned was that incentive contracts can be powerful but must be used at the right time and place and under the right conditions to be truly effective. The National Aeronautics and Space Administration (NASA) would successfully reintroduce this incentive 20 years later.

Award Fee Comes of Age

A convergence of government forces in the 1960s led to the development of the award-fee process currently used in government contracting. Secretary of Defense Robert S. McNamara, who served under Presidents Kennedy and Johnson, had a tremendous effect on defense procurement. McNamara, a graduate of Harvard's Graduate School of Business Administration and a statistician for the Army Air Corps in World War II, was determined to upgrade procurement practices with modern management techniques. He put a halt to cost-based contracts, believing they encouraged waste by not linking profits to how well the job was done. During McNamara's term as Secretary of Defense, the percentage of military procurement dollars awarded by cost-plus-fixed-fee contracts fell from 39 percent in 1960 to 14 percent in 1964. Conversely, fixed-price contracts and fixed-price incentive dollars awarded rose from 45 to 55 percent in the same period. [6]

Although NASA is largely credited with creating the award-fee contract common today, both NASA and the Navy issued contracts with award-fee provisions in 1962. The Navy issued a contract for logistics operations support at Kwajalein Island that year, which included provisions for award fees. NASA issued a contract in October 1962 that provided for the research and development of a nuclear-powered rocket engine. A second NASA contract, issued in January 1963, covered the operation, maintenance, and engineering services for the Mercury Manned Space Flight Network. [7] NASA went from one incentive contract in 1962 to 34 by 1964 and by the beginning of 1967 was managing some 200 contracts with incentives. [8]

The Air Force was reluctant to jump into the award-fee game and did not issue its first contract until 1964. After the Electronic Systems Division issued the contract, no more were accomplished until late 1969, due to an unwritten policy against subjective incentives. [9]

Throughout the 1960s, NASA and the Navy used award-fee contracts extensively while the Air Force and Army shunned them. However, the Air Force expanded their use in the 1970s, as then Secretary of the Air Force Robert C. Seamans, Jr, mandated their use on major programs like the B-l and F-15. [10]

Growth of Use

Throughout the 1980s and 1990s, the use of award-fee contracts increased exponentially throughout the DoD and Air Force. Historically reserved for large program contracts, award-fee contracts expanded into the smaller dollar arenas, and their use grew widely among installation-level service and maintenance contracts. In fact, one of the largest users of award-fee contracts on a consistent basis is the Air Education and Training Command (AETC). This command contracts out to private industry almost all the aircraft maintenance and many base support services conducted at its bases. With the rapid increase in use of award-fee contracts for base-level activities, the Air Force tasked the Air Force Logistics Management Center (now the Air Force Logistics Management Agency [AFLMA]) to author a guide on award-fee contracts, which was published in 1988. [11] The promulgation of this contract type among base-level offices and program offices caused AFLMA and Air Force audit agencies to do repeated reviews of implementa tion throughout the last 10 years. It is clear that award-fee use has grown substantially among Air Force contracting agencies.

The Next Step in Evolution--Award Term

The award-term incentive is a genuine innovation and one with great potential to forever alter the landscape of Government service contracting.

--Vernon J. Edwards

The award-term contract is the newest incentive in government contracting. It was first used in 1997 but is not yet covered in the Federal Acquisition Regulation (FAR). Modeled after the award-fee incentive, it rewards the contractor by extending the contract term without competition. Under an award-term incentive, a government team monitors and evaluates the contractor's performance and reports their findings to a government term-determining official (TDO), who decides whether the contractor's performance is good enough to merit an extension. The award-term incentive was the inspiration of Tommy Jordan, a senior Air Force civilian employee at Kelly AFB, and was first used on a contract that the Air Force Aeronautical Systems Center awarded to the McDonnell Douglas Corporation in October 1997 for F-15C aircraft simulation services. The contract has a 7-year base period, which can extend to 15 years with excellent service. [12] Since that first use, at least 25 programs have included award-term incentives, inc luding the $10.2B public/private competition at Kelly AFB for aircraft engine maintenance.

In the last 3 years, agencies have used award-term incentives to acquire a variety of services, including technical and logistics support, laundry and dry cleaning, depot-level maintenance, aircraft maintenance, grounds maintenance, janitorial services, real property maintenance and repair, and training. [13] The incentive is being used with several contractual configurations such as fixed price, cost reimbursement, indefinite delivery/quantity, and requirements. The Air Force, NASA, Naval Facilities Engineering Command, Naval Sea Systems Command, Fort Drum in New York, and the General Services Administration have all conducted or plan to conduct acquisitions with award-term incentives.

Future Application

As of March 1990, the Air Force had identified 114 active, installation-level, award-fee contracts with a total contract value of about $2.6B (including multiyear options) and potential award fees totaling $145M. Between fiscal years 1993 and 1998, the Air Force awarded commercial activity contracts totaling $5.8B, with award-fee pools totaling $230M. [15]

Although no one can speak with certainty regarding the future, it appears the use of award-fee and award-term contracts will continue to increase. The most likely category of acquisition for these incentives to grow in is competitive sourcing contracts and public/private competitions. There are two reasons for this. First, these types of contracts lend themselves to qualitative review since they are service oriented and not well suited to objective (versus subjective) evaluation criteria. Quality is inherently a subjective determination in performance of services. Award-fee and award-term incentives best suit these kinds of situations. Second, these competitive sourcing or public/private competitions are excruciatingly painful for the acquisition community. They take enormous time and effort to complete (frequently 1 to 2 years). Therefore, award-term contracts should flourish because the benefits are great if they extend the time between competitions. If the contractor is performing well, the agency can use its manpower more efficiently on other acquisitions rather than relet the contracts because the minimum time is up. This more closely mirrors the private sector where long-term relationships with satisfactory performers are preferred. It is also quite likely that DoD competitive sourcing and public/ private competition efforts will continue to grow or at least remain status quo as agencies search for the most efficient way to use available resources. These efforts will continue to be pursued where efficiencies and cost savings can be gained without impacting mission effectiveness.

Finally, it is the objective of DoD acquisition agencies to use incentives as much as possible. In 1997, the government iterated a policy encouraging agencies to use incentives "to the maximum extent practicable when contracting for services." [16]

Official Reviews and Findings

Audit Reports

Despite the encouragement of senior acquisition officials throughout government to make use of incentives, particularly award fees, the challenge lies in using them correctly. Numerous studies and audits have been accomplished by Air Force agencies to review how well the acquisition community has done in implementing the award-fee concept. Occasionally, the decision to use award fees is questioned, but in most cases, the manner in which the contracts were implemented is the focus of the review.

Titan IV Audit

In 1995, the Air Force Audit Agency (AFAA) conducted an audit of the Titan IV production contract incentive and award-fee program to determine if program office personnel effectively structured and administered the multiple incentive contracts to motivate the contractor to achieve all program objectives. Though the audit covered numerous areas, this article highlights just the award-fee portion.

The general conclusion was that Titan IV program office personnel did not effectively structure the incentive and award-fee program or develop adequate procedures for evaluating and administering contractor incentive payments. Specifically, with respect to award fees, personnel did not adequately evaluate contractor performance based on the award-fee plan criteria. As a result, contractor performance ratings were not supported, and fees awarded were not commensurate with actual performance. [7]

The Titan IV production contract included an $85M award-fee provision (pool) to motivate the contractor to achieve increased management, schedule, technical, and launch performance. The audit team determined that the contractor's performance was not adequately evaluated in accordance with the award-fee plan. Therefore, performance ratings recommended to the Award Fee Review Board (ARB) were not supported, and ARB award-fee percentages recommended to the fee determining official (FDO) were not commensurate with actual contractor performance. The following are summaries of specific findings:

* Evaluation monitor performance ratings did not provide comments with respect to key evaluation criteria or include specific examples that indicated the criteria were not satisfied. Further, monitor comments were too general to demonstrate whether the contractor complied with the criteria.

These problems occurred because award-fee evaluation monitors were not adequately trained in evaluation and documentation requirements, evaluation criteria were ambiguous and difficult to apply, and the ARB used the award-fee process to place more emphasis on technical performance than permitted under the award-fee plan.

* Between January 1990 and January 1995, the prime contractor experienced significant cost increases due primarily to subcontractor cost overruns in the solid-rocket motor effort and schedule delay of 5 years and 2 years in the motor upgrade and other programs. However, the ARB recommended management effectiveness and schedule performance ratings during this time period did not appear to consider contractor schedule performance in these areas. Moreover, the ARB recommended ratings for management and schedule performance that were higher than previous reviews. The audit team believed these should have been rated marginal at best, and the contractor should have received less award fee. [18]

Experts from the Air Force Acquisitions Office concurred with the comments and instituted efforts to correct deficiencies noted by the audit. To prevent future questionable fee awards, the program office implemented new training and documentation requirements.

Management of Award-Fee Provisions in Installation-Level Supply and Services Contracts

In February 1991, the AFAA released Project 0046411, which evaluated award-fee contracts at installations throughout the Air Force. The overall objective of the audit was to determine whether the Air Force effectively used and administered award-fee provisions in installation-level supply and services contracts. Specifically, the agency determined whether use of the award-fee provisions was adequately justified, the contract provisions included appropriate award-fee criteria, the evaluation and payment process was effective, and award-fee funds were effectively managed. The team found that Air Force management of installation-level, award fee contracts required significant improvements. Specifically the report found:

* Contracting officers (CO) included award-fee provisions in contracts without determining that anticipated award-fee benefits would exceed the cost of the fees and associated effort to administer the special contract provisions. As a result, the Air Force incurred at least $1.7M over the contractual life of the 17 contracts without determining and documenting whether commensurate monetary and nonmonetary benefits would result. The audit team determined the costs far outweighed the benefits in many cases. At Maxwell AFB, a $4.6m contract included a $40K per year award-fee pool as an incentive. The calculated administrative costs to administer the contract amounted to $152K annually, far above the $40K in possible incentives.

* Contracting personnel did not apply an appropriate methodology to establish the award-fee pool for 13 of the 17 contracts. In most cases, no formula or standards were used to establish the award-fee amount. As a result, 4 of the 13 contracts examined included about $830K in potential excess profits.

* At least one award-fee contract provision was missing from 15 of the 17 contracts reviewed. Without these contract provisions, COs were not adequately protecting the government's interests, and contractors were not certain what was required to earn the award fees. The Air Force paid award fees when contractor performance did not warrant the fees and was more susceptible to litigation because its legal rights were not contractually established.

* For 13 of the 17 contracts reviewed, COs did not monitor the process for selecting performance evaluation team members to ensure only appropriate personnel were selected. In four instances, performance monitors had potential conflicts of interest, including actually working part time for the contractor they were evaluating. In 12 instances, people working for the organizations being served were excluded from the team.

* The process for evaluating contractor performance was not effective for 15 of 17 contracts. The Air Force paid award fees for 11 contracts without adequate evidence the contractor earned the fees. This included $94K paid for 6 of the 11 contracts even though the contractor did not meet minimum acceptable performance requirements. At four locations, contractors were paid award fees for performing voluntary work that was not contractually required or included in the award-fee criteria. At one location, fees were paid when a janitorial contractor worked on days not required and performed services in buildings not covered in the contract. The fee-determining official did not adequately justify the award fee paid and used criteria that were deemed unacceptable.

* Installation officials did not provide timely award-fee payments to contractors, requiring an average of 60 days after the end of the evaluation period to issue payment. This delay in providing award-fee payment was a potential demotivator for contractors.

* Accounting and finance personnel did not properly record award-fee funds as a contingent liability in accounting records for 15 of the 17 contracts. These officials prematurely recorded more than $2.9M as obligations before the government had any legal liability to pay the contractor.

Analysis of Operational-Level, Fixed-Price, Award-Fee Contracts

In January 1992, AFLMA began a project to help acquisition offices overcome findings in the 1991 AFAA audit report. The agency was chosen because it published a base-level, award-fee guide in 1988 to assist offices in implementing the new tool known as award-fee contracts.

AFLMA reviewed the audit report and performed an independent analysis of the entire award-fee process from contract solicitation through administration of award-fee provisions. AFLMA also conducted interviews with using agency officials and contracting professionals to develop a professional consensus.

They concluded that many of the award-fee processes were broken and, in order to fix the system, a fundamental change in how base officials view award-fee decision making is necessary.

Contractors should have to earn award-fee money through above-and-beyond performance during each evaluation period instead of base officials looking for reasons not to pay the contractor the entire award fee amount. [19]

This finding indicates that AFLMA determined FDOs were committing a common error by starting the contractor's fee entitlement at 100 percent and making reductions based on performance rather than starting at zero and working up (as the FAR requires). The agency also concluded that bases needed structured guidance to standardize award-fee procedures and that, under current processes, it is likely government is improperly spending money through unwarranted and unjustified award-fee decisions.

Award-Fee Management of Commercial Activity Contracts

In March 2000, AFAA released an audit on award-fee contracts that highlighted continuing problems and a few new ones. Interestingly, the audit team was apparently unaware of the similar audit 10 years before, as they did not reference it in the prior audits section or in the body of the report. Therefore, the findings were certainly independent and show no bias toward confirming earlier findings.

The audit was conducted because of the increased use and associated cost of award-fee contracts, with the overall objective to determine whether Air Force personnel adequately managed award fees for commercial activity contracts. Specifically, the agency determined whether award-fee officials established award-fee provisions consistent with overall contract strategy, supported fees awarded, and managed award-fee funds.

The team concluded that award-fee officials could improve award-fee management for commercial activity contracts. Although officials established provisions consistent with the overall contract strategy, five of ten locations did not maintain adequate documentation supporting award-fee determinations. [20]

Specifically, performance monitors did not maintain adequate records supporting award-fee recommendations, award-fee review board members did not always document the results of award discussions, and FDOs did not adequately document the rationale for award-fee amounts that varied from review board recommendations. In at least two cases, the FDO significantly increased the fee amounts without rationale. Supporting documentation is important to help ensure the government pays appropriate award fees and is also critical if the contractor disputes the award-fee determination.

Award-fee officials at six of ten locations did not accurately account for award-fee funds. Specifically, they did not commit funds to establish contingent liabilities for award-fee amounts. Instead, they recorded the entire award-fee amounts as obligations or actual liabilities when evaluation periods began. As a result, for fiscal years 1996 through 1998, award-fee officials overstated funding obligations by $1.9M.

The auditors recommended that the Air Force establish award-fee guidance incorporating best practices and procedures and rescind inaccurate award-fee obligation guidance. They also recommended the issuance of a policy letter instructing award-fee officials to commit funds as contingent liabilities when evaluation periods begin. The Air Force Acquisitions office concurred with the findings and tasked AFLMA to develop an Air Force guide. It also issued a finance policy with coordination on obligation of award-fee funds.

Problems Resolved?

Analysis of these four audits indicates recurring problems with award-fee contracts. In every instance, the reviewers found that performance monitors were not documenting or justifying their recommended award-fee amounts to the FDO. Therefore, there was no legitimate rationale for paying the award fees. While the fees may be justified, lack of explicit rationale leads inquiring investigators to conclude fees are being paid for no good reason. Similarly, in three of the four audits, the FDOs were not explaining their rationale for granting the fees. In some cases, they even overruled recommendations from the monitors and board members. Again, lack of documented rationale could lead one to conclude contractors did not earn the fee but were granted it anyway. This conclusion is further supported by the AFLMA study, which indicated that FDOs commonly begin deliberations at an inflated fee amount (100 percent) and deduct for shortfalls. While the FDOs may have good rationale for the fees provided, the rationale is usually not clear.

Additionally, all three audits reported some sort of discrepancy in financial calculations with respect to the fee pool amount. Both the 1991 and 2000 audits, specifically highlighted that funds should be tracked as contingent liabilities, not up-front obligations. At the time of this article, it is clear the Air Force has adopted such a policy.

Award Fee in Application

Concept

The purpose of an award-fee incentive is to obtain better performance from the contractor than could logically be expected from a contractual arrangements. It provides a means of applying incentives in contracts where performance objectives cannot be expressed in advance by definite milestones, targets, or goals susceptible to actual measurement of performance. [21]

For contracts with an award-fee incentive, the buying office establishes an award-fee plan that defines formal evaluation periods throughout the life of the contract. For each evaluation period, fee pools, which may be earned in part or whole by the contractor, are identified, as are the criteria, techniques, and data that will be used in the evaluation of the contractor's performance. During an evaluation period, technical and business monitors collect data and provide them to an award review board for further evaluation. Additionally, the contractor is invited and encouraged to submit self-assessments of performance for consideration by the review board during the formal evaluation process that occurs at the end of each evaluation period. The evaluation results and recommendations are documented by the board and given to the FDO.

Based on all inputs and personal judgment, the FDO determines the portion of the available fee to be awarded. The FDO then advises the contractor, in writing, of the fee decision and performance evaluation within 30 days of the end of the evaluation period. The fee decision and performance evaluation are subjective, unilateral, and until recently, not subject to the disputes clause of the contract. [22]

From the process just described, it can be seen that the nature of the award-fee concept allows the government to provide formalized periodic feedback to the contractor. It also provides the government with an opportunity to make periodic, thorough evaluations of progress and cause corrective action in areas under evaluation if performance is not as expected. The subjective after-the-fact nature of the performance evaluation and fee-determination process provides unique flexibility for its users.

Regulations

Early coverage of the award-fee type contract was included in the Armed Services Procurement Regulation in the 1960s at the behest of senior government officials such as McNamara. In 1962, DoD promulgated new policies for the use of incentive contracts in the ASPR and published its first incentive contracting guide. [23] In 1969, DoD and NASA jointly published a second edition, the DoD/NASA Incentive Contracting Guide, and NASA has published several editions of award-fee guides since then. The Air Force published an award-fee guide in 1988 through AFLMA, and in 1997, the Air Force Materiel Command (AFMC) published its own version of the award-fee guide for use throughout its own command.

There is general guidance in the FAR but little prescriptive guidance. FAR Subpart 16.4, Incentive Contracts, states the government's policy about contratual incentives, describes five standard contractual incentives, and provides guidance for their use. It describes two classes of incentives: predetermined, formula-type and award-fee. However, most of the actual guidance has been published in unofficial guides or handbooks.

Although common in the Air Force for years, the award-fee incentives were not included in the FAR until publication of Federal Acquisition Circular 90-46 in May 1997. FAR 16.404 (a) explains the fixed-price, award-fee (FPAF) incentive as follows:

Award-fee provisions may be used in fixed-price contracts when the government wishes to motivate a contractor and other incentives cannot be used because contractor performance cannot be measured objectively.

FAR 16.404 (a) requires that, in FPAF incentive contracts, the parties negotiate a fixed price that includes profit. The government will pay the fixed price if the contractor performs satisfactorily. The parties must also negotiate an award (bonus) and an award-fee plan. FAR does not, however, prescribe the contents of the award-fee plan.

Although the FAR contains many passages about incentives in general, there is little award-fee guidance and no award-term guidance in the regulations. The organizational structure and procedures associated with these incentives, fee-determining official, award-fee board, and award-fee plan are not prescribed in the Federal regulation. Therefore, acquisition offices must turn to agency-specific guidance such as the award-fee guides published by NASA, AFMC, and AFLMA.

Fee Determination in Practice

To determine exactly how award-fee contracts are being implemented and used in the Air Force, a telephone survey was conducted with government COs and FDOs, as well as representatives from industry, to collect their perspectives on award-fee contracts and their impact. Eleven COs with award-fee experience in AETC and AFMC were interviewed. These two commands represent the bulk of experience in Air Force award-fee contracts. AETC uses them for contracted base support and/or aircraft maintenance at virtually all their bases, and AFMC supervises most of the major systems acquisition efforts in the Air Force. FDOs from four bases were interviewed. These officials were usually the senior officer on the base or in the wing and held at least the rank of colonel. Eight members of industry who frequently bid on and currently hold award-fee contracts were also interviewed. These individuals were either in charge of or closely aligned with the proposal writing teams and very involved in actual performance of the contrac ts for which they competed. They also represented some of the largest companies in the defense industry, as well as some moderate-sized companies competing for government contracts.

To collect completely open, honest, and useful data, all participants were interviewed under the guarantee of nonattribution to themselves and their organization. This guarantee was necessary to ensure the most candid and descriptive answers possible. The analysis that follows represents the consensus of the consolidated answers.

Industry Strategy Perspective

The industry respondents indicated that, on average in the last 3 years, they had bid on five separate programs that contained award fees. Additionally, average number of award-fee contracts the respondents were currently being performed was three. These averages indicate credibility, showing they have extensive experience in both bidding and performing contracts with award-fee provisions. The average earned award-fee percentage for the companies varied by agency and command. One respondent clearly indicated that NASA typically gave higher fees on average but the Air Force was not far behind. The average for the Air Force was between 88 and 90 percent. The respondents did note that they track this data pretty carefully and know what the historical average is for each organization, major command, or agency. That information is used extensively in the proposal process.

Most respondents agreed award fees really do give incentive to performance, to some extent. However, the consensus was that the mere granting of a bonus does not in and of itself increase performance significantly. Notable improvement is usually not seen unless the award fee is somehow shared with the employees. In other words, in those companies that share award-fee sums (or some other inducement) with employees for increased performance, a marked improvement is seen. If the award fee is not shared among the employees, the incentive is only marginally effective, if at all.

The consensus was that award fees do not constrain contractors but they shift resources. The proposals are manpower intensive for both bidders and the award-fee boards. Typically, the companies expend significant effort making their case to the board that they deserve the fee. This show adds cost in both manpower and money to the contractor's bottom line. This, in effect, increases the cost of performance (which they account for in the original proposal) and takes manpower away from performing the actual work.

When asked if award fees cause a contractor to alter proposal strategy, every respondent unequivocally answered yes. It is inherent in proposal writing to account for the fee at least partially in structuring the proposal. When asked the followup question, "Do you plan on 100 percent of the fee," all answered no. However, they all said they count on a portion of the fee based on their assumptions, detailed analysis, and calculations from historical records. Rarely did history show they could count on 100 percent of the fee. However, all respondents confirmed that this lowered their profit margins in the initial proposal and increased their risk somewhat in the early stages of the contract. However, most believed the risk was no greater than moderate because they had never been denied a substantial portion of the fee. All agreed that if the FDO granted them little r no fee they would then be in a high-risk position but, again, stated that this almost never happens.

And finally, when asked if they found themselves performing work under award-fee contracts that they would not normally perform if the contract were structured differently, a majority of the respondents answered yes. The consensus was that they were more likely to do extra things to keep the board members and FDO happy. This could include tasks that, if performed under a fixed-price contract, would result in a claim.

Government Perspective

Government COs are currently working on an average of two contracts with award fees (responses varied from one to five). None of the respondents indicated this vas their first award-fee contract. Therefore, like industry representatives, he COs were seemingly well experienced in award-fee execution and administration. Therefore, the FDOs were not. Two of the four FDOs were on their first award-fee contract, and none were serving as an FDO on more than two. Despite little experience, all felt comfortable in the role and competent to perform as an FDO.

COs and FDOs agreed the average percentage of fee earned by their contractors was 85 to 90 percent.

COS and FDOs agreed that award-fee provisions in contracts improve contractor performance. The consensus was that award-fee incentives create a partnership-like environment and inspire innovation in contractors, which leads to more efficiency. Additionally, they believed employees genuinely work harder to gain the incentive. As a corollary to this question, the respondents believed the great improvement in performance was worth the extra effort and administrative burden on the government's part.

All respondents were asked if they knew or believed that the contractor's profit in the original proposal is considered when determining award-fee amounts. The two groups differed. FDOs indicated it was not a factor in their decision and, in most cases, they are unaware of the profit on the original proposal. The COs, however, had a perception that it was, in fact, a consideration, with the board and the FDO. The consensus among COs was that, even if it was not directly addressed, the FDOs were certainly aware of the original profit margin proposed either by direct personal evaluation or by fee lobbying by the contractors. They believe FDOs want to ensure contractors remain healthy and perform.

Both groups of government officials were asked if, during fee determination, the board and FDO tend to start from 0 percent and work up or start from 100 percent and work down. The typical CO response to this question was, "Are you asking what we should do or what we actually do?" That response summarizes the common view among the contracting community in general and certainly among the respondents that fees are usually worked from 100 percent down. COs believe the FDO starts out wanting to give the maximum fee and then finds reasons to deduct for things not done well instead of justifying why the contractor should get any increment of the fee at all. Interestingly enough, the FDO responses did not fully support this but did not refute it either. The FDO consensus was that they usually start from the board recommendation and work from there. However, one FDO did indicate a bias toward higher amounts by focusing on the negative performance indicators rather than the positive ones. Given that this FDO's award a mounts fell into the same range as the others, it can be reasoned that this FDO sets an amount and subtracts for performance rather than trying to justifying any fee at all.

All COs believed the contractor's risk of lower profit margins was increased with award fees due to contractors shaving initial profits in proposals. COs believe contractors have begun to count on the award fees as part of their total profit and, therefore, are bidding tremendously low profit margins to stay competitive and win the business. They believed (like the contractors) this translates into a moderate risk for the contractors. However, none of the COs could provide data showing the increased risk is detrimental. None of their award-fee contracts had failed, indicating the increased risk did not result in any casualties.

Conclusion and Recommendations

Review of the data collected during this research has illuminated numerous problems with award-fee contracts. The conclusions associated with research are mixed, however, when compared with the research question. Indeed, it appears there are genuine disconnects in the implementation and administration of award-fee contracts, and those disconnects prevent the contracts from working as originally intended. However, the deleterious effects of the broken process are not as grave as one might imagine. The question of whether changes are necessary to improve the effectiveness of this contract tool is the difficult one. The research clearly indicates changes are necessary. However, in most cases, it appears changes would improve efficiency but not necessarily effectiveness.

Principal Conclusions

The findings clearly show that award-fee contracts are not implemented as intended, since the same problems are being experienced now as 10 years ago. These problems, however, are procedural in nature and can be fixed easily.

Improvements are needed, but they will not impact effectiveness, only efficiency. As the audits and studies show, guidance is needed for the Air Force community on how to implement award-fee contracts properly. However, based on the nature of the findings, it appears the Air Force has been directing its guidance to the wrong audience. The guidance is usually produced by the contracting community for the contracting community. However, the recurring problems identified rest with the performance monitors and FDOs. Therefore, any guidance produced to help the process should be directed toward them.

Finally, it is clear from the data gathered from industry and government sources that we indeed are giving incentives to contractors to bid near zero profit and, therefore, increase their risk. However, the effects of that issue are not detrimental, as might be expected, for two reasons. First, the process to award this type of contract is usually complex and uses best-value approaches, enabling the government to consider lots of quality indicators. Therefore, the contractors typically selected are quite solid and less prone to failure in the first place. The increase in risk is mitigated by the quality of the company. Second, the award-fee process, by its nature, allows the contractor to gain additional funds throughout the contract, and the government evaluation team is likely to help a contractor in order to maintain consistency of service. This built-in dynamic also mitigates the risk to contractors by providing a mechanism to lessen the contractor's exposure to risk throughout the contract.

The research supported the contention that the Air Force is not implementing award-fee contracts as intended and is, in fact, giving incentive to the wrong behavior in industry. However, the result is not extraordinarily detrimental to Air Force goals because of the inherent ability of the award-fee board to overcome additional risk. It is clear that improvements are necessary, but the gains will be in efficiency, not in effectiveness.

Recommendations

* The Air Force should develop and distribute a standardized format and template for performance monitors and FDOs to use when documenting their support of the fees awarded.

* Training initiatives should be redirected, and training and assistance for noncontracting personnel (performance monitors and FDOs) is needed. The next product (guide or training course) developed should target them specifically and cover topics outlined above.

* COs should seek feedback from industry before including fee or term incentives in future contracts. The value of incentives can be overestimated by government personnel, causing great administrative burden with little return.

Notes

(1.) R. F. DcMong, "The Effectiveness of Incentive Contracts: What Research Tells Us," National Contract Management Quarterly Journal, 1978, Vol 12, No 4, 12.

(2.) Ibid.

(3.) Robert I. Nash, Incentive Contracting, Washington DC: The George Washington University Government Contracts Program, 1963, 3.

(4.) James F. Nagle, A History of Government Contracting, Washington DC: George Washington University, 432.

(5.) John Perry Miller, Pricing of Military Procurements, New Haven: Yale University Press, 1949, 144.

(6.) Nagle, 494.

(7.) NASA, Cost Plus Award Fee Contracting Guide, NHG 5104.4, Washington: US Government Printing Office, Aug 67, 6.

(8.) Vernon Edwards, Award Term:: the Newest Incentive, Contract Management, National Contract Management Association, Feb 01, 44.

(9.) Jerry V. Brown, The Award Fee Incentive: Management Considerations Regarding Its Application to Research and Development Contracts, Program Management Course Study Report, Defense Systems Management College, 1976, 5.

(10.) Brown, 7.

(11.) AFLMC, Base-Level Award Fee Guide, Project Number LC850705, Maxwell AFB, Gunter Annex, Alabama, 1988.

(12.) Edwards, Award Term: the Newest Incentive, Contract Management, 44.

(13.) Edwards, Award Term: the Newest Incentive, Contract Management, 45.

(14.) AFAA, Management of Award-Fee Provision in Installation-Level Supply and Services Contracts, Project 0046411, Washington DC, Feb 91.

(15.) AFAA, Award-Fee Management on Commercial Activity Contracts, Project 98064024, Washington DC, 27 Mar 00.

(16.) FAR 37.602-4.

(17.) AFAA, Management of the Titan IV Contract Incentive and Award-Fee Program, Project 95064005, Washington DC, 1996.

(18.) Management of the Titan IV Contract Incentive and Award-Fee Program, 8.

(19.) Tom Robinson and Randy Ayers, "Analysis of Operational Level Fixed-Price Award-Fee Contracts," Project Number LC922155, AFLMA Letter Report, Jan 93.

(20.) AFAA, Award-Fee Management on Commercial Activity Contracts, Report 98064024, Washington DC, ii.

(21.) DoD, Armed Services Procurement Regulation 3-405.5. Washington: Government Printing Office, 1 Oct 75.

(22.) Prior to 1997, award-fee provisions stated that determinations were at the unilateral discretion of the government and were excluded from the process governed by the Contract Disputes Act. However, on 25 Feb 97, the US Court of Appeals, in Burnside-Ott versus Dalton, ruled that award-fee determinations could not be excluded from normal dispute procedures.

(23.) Vernon Edwards, Award-Term Contracting A New Approach for Incentivizing Performance, National Contract Management Agency, Fast Response Course Book, Vienna, Virginia.

Major Snyder is commander, 62d Contracting Squadron at McChord AFB, Washington. At the time of the writing of this article, he was a student at the Air Command and Staff College.

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