Presenter: James Gill Technical Advisor Space & Missile Systems Center

1. Presenter: James Gill Technical Advisor Space & Missile Systems Center

2. Breakout Session #704 - Incentives Today Name: James Gill Date: 21 Jul 2010 Time: 10:00 – 11:15 2

3. OUTLINE What are Incentives? How can they help improve Contract Performance? Historical Use of Incentives at SMC Incentive Reform Way Ahead

4. What We Do Wide array of Space Systems Navy SMC SMC SMC ESC SMC SMC

5. WHAT ARE INCENTIVES? • GAO defines Incentive Contracts as: • “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”* • Incentives, for the purpose of this briefing, may be defined as the approach by which the customer motivates performance by the use of positive and negative provisions to a Kt for a product or service *GAO Report 06-66, DOD’s use of Monetary Incentives

6. DO INCENTIVES WORK? Fundamental Question – Still Being Debated GAO Suggests that there is no evidence that Incentives alter behavior Most Contractors want to do good work – Do Incentives help set priorities? All Contractors Consider Fee when evaluating Business Opportunities, some cases fee not primary concern

7. DO INCENTIVES WORK? How Can the Government Make Performance a Condition of Receiving Fee? Should It? Negative or Positive – Which work better? For Service Effort, What Incentive Arrangements Motivate Performance Especially in today’s harsh economic times – future Business is High on contractor’s list of importance Appropriately applied Incentives transfer reasonable risk to Contractors

8. How Do Incentives Help? Achievable Incentives stimulate productivity Belt Tightening can mean doing smarter acquisitions Shared Responsibility means having to say NO Over-promising and Under-Performing is not acceptable Accountability is top-down direction

9. HISTORICAL USE OF INCENTIVES AT SMC? • 1970’s – 80’s Incentives included CPIF R&D contracts, orbital incentives, cost incentives, warrantees, EPA’s DTUPC, VECP • Adversarial relationship with Industry • 80’s – 90’s Druyun Era rise of the use of Award Fee, Fixed Price development contracts • 90’s – 00’s Era of Acquisition Reform – TSPR, commerciality, Lightning Bolts, Insight, IPT’s • Non-adversary relationship (teammates) • 05 – present - Back to Basics, verify performance, CPIF and AF, Block Development, Shared responsibilities, Incentives tied to acquisition outcomes • Future – More oversight, harsher consequences for “failure”

10. INCENTIVE REFORM • GAO Report, Defense Acquisitions, Dec 2005 • Recommended reform of current incentive practices • Recommended fee tied to acquisition outcomes • USD (AT&L) and SAF Policy Letters, Mar-Apr 2006 • Linked fees to performance outcomes • Rollover to be used only on an exception basis • DPAP Policy dated 24 Apr 2007 • SAF/AQ Policy 15 Jun 2007 • SMC/CC Policy dated Dec 2008 • New Report commissioned by Congress in 2008 to Review impact of DoD policy changes • President issues Policy Memo on Contracting -2009 • Weapon Systems Acquisition Reform Act – 2009 • AT&L Policy Initiative – Jun 2010

11. WAY AHEAD? - GET “BACK TO BASICS” Emphasize deliberate risk apportionment Utilize four-staged acquisition approach Develop rhythm of research, design, build Improve collaboration on requirements Cost at and fund to 80% confidence Emphasize Systems Engineering and Integration

12. The foundation of any incentive is the contract type. Contract Type establishes appropriate responsibility, accountability, and risk and reward on the contractor to motivate outstanding performance . Contract Types TYPES OF INCENTIVES

13. COST/FINANCIAL INCENTIVES • Cost incentives relate profit or fee directly to results achieved by Ktr • Are normally based on a share formula • (i.e., fixed-price incentive (FPI) or cost plus incentive fee (CPIF) contracts) or the payment of a fee from an award fee pool • To be effective they must be: • Quantitative • Clearly related to the desired outcome • Achievable • Must offer rewards commensurate with risks the contractor assumes • Cost to the Government must not be overemphasized orunderemphasized relative to other program objectives

14. COST/FINANCIAL INCENTIVES • Cash flow is important to contractors in any incentive plan • Some arrangements that aid cash flow are: • Provisional payments for award fee • Award fee with a base fee • Progress Payments • Performance based payments for FFP contracts

15. PERFORMANCE INCENTIVES • Are designed to relate profit to the contractor’s achieved results • Based on specified targets • Should be used when they will induce better quality performance • May be positive, negative, or a combination of both • Performance Based SOW’s are mandatory for Service Contracts

16. PERFORMANCE INCENTIVES • Should be applied selectively to motivate efforts that may not otherwise be emphasized & to discourage inefficiency • Incentives should apply to the most important aspects of the work, rather than to each individual task • Incentivizing too many requirements: • Dilutes the monetary importance of each requirement • Creates an administrative burden for the government

17. SCHEDULE/DELIVERY INCENTIVES • Schedule Incentivesfocus on getting a contractor to meet or exceed minimum delivery requirements • They can be defined in terms of: • Early delivery • Attaining or exceeding milestones • On-time criticality • Meeting rapid-response or urgent requirements • Reward to the contractor for accepting schedule risks must be consistent with the level of risk it assumes • I.E. pre-production schedule objectives and risks would differ significantly from production schedule objectives and risks

18. AWARD-TERM CONTRACT INCENTIVES • Award-term contracts reward exceptional contractor performance by extending the period of the contract for a prescribed period of time • Must comply with the Competition in Contracting Act (CICA) • To comply with CICA, ensure the maximum potential term and price/cost for that effort was part of the competition or the J& A Documentation

19. NEGATIVE/POSTIVE INCENTIVES Incentives can either be negative or positive A negative incentive is any requirement that causes a contractor to take action in order to avoid an undesirable result Negative incentives are not to be punitive, or treated as penalties

20. PAST PERFORMANCE “INCENTIVE” • Not a formal incentive written into contract • However, it is a tool to motivate improved performance or to reinforce exceptional performance because contractors realize: • Can have an effect on decisions to exercise options & future awards • Information often used as a factor in source selections • Assessments must be supportable with performance documentation • Should not conflict with any other positive or negative incentives

21. EXTENT OF COMPETITION “INCENTIVE” Note: It’s important to set the stage for an incentive program early during competitive stages • Competition is the most powerful incentive for superior contractor performance • When it exists, the central relationship is between the competing firms • When it is absent, the inherent competitive relationship is between the Ktr and the Gov’t

22. QUESTION Is competition always a positive incentive?

23. KEY INCENTIVE CONSIDERATIONS • Incentives Must Correlate To Desired Results • Make sure performance incentives are based on measurable standards that clearly relate to desired performance goals • Incentive provisions must clearly communicate the government’s objectives to be a useful guide for the contractor’s performance • Remember the GAO Report – tie Incentives to Expected Acquisition Outcomes

24. KEY INCENTIVE CONSIDERATIONS Remember the “Law of Unintended Consequences”! • Incentives Must Balance Competing Needs • The Government must: • Carefully assess the total effect of all incentives • Verify that they will all work together to achieve the desired result • Without proper controls, a schedule incentive could drive the contractor to speed up delivery while putting quality in jeopardy • Similarly, an incentive to reduce cost could do so at the expense of reaching technical objectives

25. KEY INCENTIVE CONSIDERATIONS • Make Incentives Challenging but Attainable • Incentives should: • Be realistic • Do not expect the contractor to spend a dime to earn a nickel or to expend extra effort when the objective is not attainable • Be consistent with the effort and the contract value • Not pay extra for performance that merely meets minimum Kt requirements • Not penalize the contractor for work that is fully satisfactory • Balance “Gold-Plating” vs. exceeding objective capabilities

26. KEY INCENTIVE CONSIDERATIONS • - Labor or material cost - Terms and conditions • - The schedule - Individuals or groups of individuals • - Quality requirements - Subcontractors • Incentives can be Based on: • Financial (cost or price) or non-financial considerations • Achievement of quantitative targets • Subjective performance evaluations by government officials • May be positive or negative • The incentive may be targeted to a portion or aspect of the contract, such as:

27. KEY INCENTIVE CONSIDERATIONS • Industry Perspective • Profit, earnings per share, cash flow & return on investment are important • Govt tends to focus solely on fee, how much and how it is to be earned • Fee, while important - not sole issue that motivates contractor performance • Contractors may have many concerns that are independent of profit • These factors should be considered when formulating acquisition strategies

28. KEY INCENTIVE CONSIDERATIONS • To Incentivize Subcontractors: • Develop key subcontractor milestones that will drive both prime and subcontractor fee allocation • Have critical events for the subcontractor flow into the performance and schedule criteria • Be aware of the prime’s incentive arrangements with their suppliers and subcontractors • The method should be compatible with the manner in which the government is evaluating their performance • This will help in avoiding disconnects in which the prime is receiving performance fee, while the sub is being penalized

29. Cost Incentive • Settlement cost position used as basis for the 12.9% Award Fee Pool • Contractor keeps 50% of under-run between settlement cost position and Gov’tcost position • If the contractor meets the settlement cost position, total incentives under the Award Fee would be 12.9% of the settlement cost position • If contractor under-runs to the Gov’tposition, total incentives (award fee + cost incentive) would be 17.3% of the Gov’tcost position 50/50 Share Of Underrun to Settlement Cost Position Fee 17.3% of Govt Cost Positon 12.9% of Settlement Cost Position Cost Gov’tCost Position Settlement Cost Position Contractor Cost Position

30. INCENTIVES TODAY • Senior DoD Leadership is averse to award and fixed fee contract types – See limited opportunity for use • New SMC contracts/restructures are using more objective incentives • GPS III, AEHF,DMSG, WGS, SBIRS • Payback provisions have become popular • Senior leadership is encouraging “inclusive” approach to incentives • Multiple incentives • DCMA participation recommended

31. INDUSTRY FEEDBACK • Wants base fee and provisional payments of award and incentive fees • Disagrees with no fee for mission failure (high risk business) • Wants proportionate fee for partial successes • Rollover seen as effective tool • Takes exception to withholding of cost • Wants higher award fee pool in light of objective criteria • Wants negative incentives offset with positive or higher pools

32. SUMMARY OF KEY POINTS Correlate incentives to desired program results Make incentives challenging, but achievable Recognize contractor motivations as well as Govt. Establish milestones associated with subcontract performance if critical Ensure to not overburden the Government and Ktr with administration Consult with legal on funding of incentives Remember the stage of the acquisition when establishing incentives In a time of limited resources incentives can fuel improved efficiencies and savings – reduce the impact of “belt tightening”

33. RECENT INITIATIVE • 28 Jun 2010 Policy Memo AT&L (Ashton Carter) • Better Buying Power • Mandate for Restoring Affordability & Productivity in Defense Spending • Two approaches • Eliminate unneeded Programs (TSAT, SR,FIA etc.) • Savings through efficiencies in Existing Programs

34. Recent Initiative (cont.) • Objectives • Deliver the warfighting capability we need for the dollars we have • Get better buying power for warfighter and taxpayer • Restore affordability to defense goods and services • Improve defense industry productivity • Remove government impediments to leanness • Avoid program turbulence • Maintain a vibrant and financially healthy defense industry • Obtain 2-3% net annual growth in warfighting capabilities without commensurate budget increase by identifying and eliminating unproductive or low-value-added overhead and transfer savings to warfighting capabilities. Do more without more

35. Recent Initiative (cont.) • Providing Incentives for Greater Efficiency in Industry • Leveraging Real Competition – Avoid Directed Buys • Using Proper Contract Type For Development and Procurement • Phase out award fee contracts and favor fixed price or cost type incentive contracts that share equally in under runs and overruns • Using Proper Contract Type For Services • Phase out T&M and sole source ID/IQ contracts where possible • Utilize FP LOE and CPFF when requirements are still being defined • Maximize the use of multiple-source continuously competitive contracts • Aligning Policy on Profit and Fee to Circumstance • Align opportunity to earn profits/fees to both value to the taxpayer and risk to the contractor • Reward higher productivity with higher profits • Incentivize investment in innovation • Sharing the Benefits of Cash Flow • Consideration (price reductions) for improved cash flows

36. WHAT TO EXPECT • WHERE ARE WE HEADED? • More Oversight – DCAA, GAO, IG, Auditors • More HQ involvement in Acquisition Decisions (Clearances, Acquisition Planning etc.) • Do more with less or More without more • FIXED-PRICE CONTRACTS – control costs • Harsher Penalties for Failure (Schedule & Cost) • Less Team Orientation – Possibly More Adversarial • More Competition • Need for a Paradigm Shift • More Help from our friends in Congress • Regulatory and Statutory • Back to the 80’s?

37. QUESTIONS?