Contract Incentives – A Perspective

2. Contract Incentives – A Perspective Pamela Schwenke Associate Deputy Assistant Secretary - Contracting United States Air Force Patricia Olsen Vice President - Contracts, Pricing, Estimating & Procurement Financial Analysis The Boeing Company – Integrated Defense Systems July 9, 2009

3. Agenda • Historical Perspective • Current State • Government / Industry Perspectives - Discussion • Multiple Incentive Contracts • Non Standard Incentive Arrangements • Fixed price Development • Questions

4. 1960’s NASA: Uses CPAF contracts to ensure Safety and Mission Success DoD: Major problems with Fixed Price Development Programs (C-5A, F14, Ship Building). 1970’s DoD return to traditional incentive structures Award Fee (AF) used as a bonus for performance beyond objective incentives 1980’s Decline in use of traditional incentive structures. FP Development returns with a vengeance. Industrial base harmed by unbalanced risk DoD major problems (C-17, A-12, P-7, AMRAAM) Historical Perspective

5. 1990’s Return to CPAF/IF. 80% earned AF expected/customary. FP development largely abandoned. 2000’s GAO Report 06-66 “DoD has paid billions in Award and Incentive fees regardless of acquisition outcomes”. Resultant media/Congressional portrayal of IF/AF as “Contractor Bonuses”. Historical Perspective (cont’d)

6. Current State GAO Report 06-66 Recommendations Payment for above-satisfactory performance Limited use of rollover Develop metrics on use/effectiveness of award fees and share proven strategies Various AT&L Memos/Policies issued in response to GAO findings (2006-2007) Endorsed most GAO recommendations . Did not endorse limiting award fees to “Above satisfactory performance”. FY07 National Defense Authorization Act - SECDEF to issue guidance: Link award fees to acquisition outcomes (e.g. cost, schedule, and performance) Provide guidance for judging performance and % fee to be earned No award fee for below satisfactory (failure to meet minimum requirements) Provide direction on use of “rollover

7. OUSD (AT&L/DPAP) Memorandum (April 07) “It is the policy of the Department that objective criteria will be utilized, wherever possible, to measure contract performance” Preference is multiple incentive type contracts If objective criteria exist and want to also use subjective elements - use IF/AF If objective criteria does not exist, HCA must sign D&F to use CPAF For CPAF, defines and sets % ranges of award fee pool to be earned in terms of: Minimum essential contract requirements; and Award fee criteria as established in award fee plan Current State (cont.)

8. Dec. -08 Update to DoD Instruction 5000.02 Contract Type selected at M/S B Fixed Price presumed Cost type permitted if supported by: Written determination that complexity and Technical Challenges pose too much risk for FP (Consistent with FY07 NDAA and DFARS 234.004) Issues under OMB review based on Presidential Contracting Policy Memo (March 09) Includes Policy Statement consistent with current FAR preference for Fixed Price contracts Current State (cont.)

9. Government / Industry Perspectives

10. Matching Contract Type to Risk User Needs Technology Opportunities & Resources Pre-Systems Systems Acquisition Sustainment Acquisition B A C CPFF FFP (LOE) FPI FFP FPI FFP CPFF/CPAF CPAF/CPIF FOC IOC LRIP Material Solution Analysis Engineering & Manufacturing Development Technology Development Production and Deployment Operations & Support FRP Decision Review Material Development Decision Post PDR Assessment Post-CDR Assessment PDR PDR ILL DEFINED RQMT …………………………... WELL DEFINED RQMT or Contract Type Risk Technical Risk

11. Agree CPAF should not be automatically used When used: Make part of multiple incentive structure Be reflective of “Bonus Concept” for superior performance Award Fee Plan should be bilateral: Agreement on evaluation criteria Allocation of pool consistent with expenditure profile over contract period of performance Multiple Incentive Contracts-Contractor Perspective

12. Multiple Incentive Contracts-Contractor Perspective(cont) Implement use of Objective Criteria via CPIF, FPI or Multiple Incentive Contracts arrangements. Cost, schedule and performance incentives to be encouraged Contract Type/Incentives and Risk/Rewards should be consistent with program phase. Include Partners and Subcontractors within overall fee arrangement. Avoid Overly complicated incentive structures.

13. Multiple Incentive Contracts-Government Perspective Moving away from subjective criteria (award fee) to objective criteria (incentive fee) Award Fee: Must be backloaded and linked to performance outcomes with evaluation factors to motivate contractors toward excellent performance Incentive Fee: Set appropriate base on program and maintain Key is articulating desired outcomes in simple language For complex integration efforts initiate with CPI and move to FPI as soon as possible Adopt “pay-for-performance” philosophy

14. Multiple Incentive Contracts-Government Perspective (cont) Reinforce that the government will pay incentive fees only for satisfactory performance Not just acceptable performance in one area, but overall satisfactory performance Force the contractor and government to build realistic, high-confidence cost and schedule estimates into the contract Greater emphasis on high-confidence program estimates and program transparency up front

15. Non Standard Incentive Arrangements- Contractor Perspective FAR Guidance must be maintained Performance Criteria capable of objective targets and measures – Use Incentive Fee (objective) Performance Criteria not capable of objective targets and measures Use award Fee (subjective) Misapplying Objective Criteria to work that can only be reasonably measured subjectively will not achieve desired results Interdependent Incentives can over-constrain needed trade space between cost/schedule/performance

16. Non Standard Incentive Arrangements- Government Perspective FAR Guidance must be maintained and clear Objective criteria tied to objective incentives Subjective criteria should be minimized When necessary if award fee is required due to circumstances Should consider shorter duration efforts in competitive environment until Technology Readiness Level 7/8 Could alleviate conflicting incentive structures Each effort should have objective criteria if at all possible Stress continuation of competition into EMD where possible Performance Incentive is potential for production award

17. Fixed Price Development – Contractor Perspective Fixed price contracts proven unsuccessful for complex, high-risk system development. Historically, cost growth on FP development contracts is equivalent to that on cost reimbursable contracts. Significant performance disruption due to REAs, claims and terminations. Heavily unbalanced risk provides no customer incentive to accept trade-offs. Current policy is appropriate: Use FP contracts only if program risk permits realistic pricing and an equitable allocation of program risk between Government and the contractor. Current Rhetoric is of Great Concern

18. Fixed Price Development – Contractor Perspective

19. Fixed Price Development – Government Perspective Current policy may be appropriate but is changing DOD plans to explore greater use of fixed price development Key to FPI development is technology maturity and marketplace readiness Technical Readiness Assessments PDR prior to MS B Competitive prototypes of systems or key components when possible Will probably force Government to stay in technology development longer and massage market during that phase to ensure “true readiness” for EMD and production Government will not longer chase cutting edge or exotic technologies in EMD

20. Multiple Incentive Contracts – Government Perspective Matching Contract Type to Risk User Needs Technology Opportunities & Resources Pre-Systems Systems Acquisition Sustainment Acquisition A B C CPFF FFP (LOE) FPI FFP FPI FFP CPFF/CPAF CPAF/CPIF/FPIF FOC IOC LRIP Material Solution Analysis Engineering & Manufacturing Development Technology Development Production and Deployment Operations & Support FRP Decision Review Material Development Decision Post PDR Assessment Post-CDR Assessment PDR ILL DEFINED RQMT…………………WELL DEFINED RQMT Contract Type Risk Technical Risk

21. Questions?