Let Contractors Take the Risks

here's a new beast stalking the contracting world, and it's shaking the very ground on which deals are made. The share-in-savings contract is a souped-up version of fixed-price, performance-based pacts now being used to shift cost and performance risks off the government and onto contractors. Shared savings deals outperform even performance-based contracts in putting pressure on contractors to deliver results.

Performance contracts carefully describe work in terms of the results an agency seeks, set performance standards based on those results and measure contractor performance against those standards. The idea is to let contractors apply ingenuity and innovation to get the work done quickly and well instead of dictating to them the government's preferred approach. Fixing the prices of these contracts turns up the heat on contractors to shave time and costs in order to increase profits. Often, agencies add performance incentives to really rev up contractor interest in hitting challenging performance targets for critical elements of service.

Former Office of Federal Procurement Policy Administrator Steven Kelman calls share-in-savings contracts turbocharged performance basing. These deals guarantee bidders not a penny, instead promising payment only if and when benefits result from the contractor's work on a government project. The vendor, not the government, assumes the upfront project costs so the government doesn't pay for solutions that fail.

The concept started getting attention in government after California struck a $6 million shared-savings deal in late 1993 to collect back taxes from businesses and corporations. Winning bidder American Management Systems Inc. of Fairfax, Va., collected enough to pay for its system seven times over in the first year. The tax board expected a return of $7.4 million a year and pulled in $42.6 million during year one. AMS completed its system in 11 months, compared with the six years it took the tax board to build its last collection system.

Share-in-savings contracts bring unique challenges for government agencies. In order to persuade vendors to take the huge risks involved in devising and building solutions without any fee guarantees, agencies are obliged to drop the customary adversarial relationship with the firms in favor of partnership with them. Government contracting and program people define the problem to be solved rather than the work to be done, and solicit conceptual proposals from potential business partners.

'Kick the Tires'

Qualified bidders get unprecedented access to agency programs and people, as well as a role in managing the project. Kelman says programs that want vendors to make large investments in solving problems must give them plenty of time and leeway to come into the program and "kick the tires," thereby changing the arms-length solicitation process.

The Energy Department is using the shared-savings approach to help federal agencies reduce their energy consumption as required by the 1992 Energy Policy Act and an executive order requiring a 30 percent reduction in energy consumption in federal buildings between 1985 and 2005. The federal government is the nation's largest energy consumer, using $4 billion worth of energy to heat, light and operate its 500,000 buildings each year. To achieve the 30 percent reduction by 2005 would require energy savings worth $1 billion a year, but that would require an estimated investment of $5 billion in energy savings equipment. To come up with that investment without beggaring agencies, Energy's Federal Energy Management Program (FEMP) has crafted energy savings performance contracts (ESPCs).

Under these contracts, energy service companies pick up all the upfront costs of identifying a facility's energy needs and then buying, installing, operating and maintaining energy-efficient equipment to cut energy costs. During the contract, the firm owns the equipment. When the contract ends, the government owns it. In payment, the companies get a share of energy savings generated by the improvements during the contracts, which can last as long as 25 years.

FEMP is cutting a series of deals worth about $5 billion modeled on multiple-award, indefinite delivery/indefinite quantity contracts with firms in six regions across the country. Under these contracts, agencies use delivery orders to contract with firms that already have competed and won slots on a regional Super ESPC roster. An agency can select a single company or request proposals from more than one without advertising the procurement. The first Super ESPC, covering the Western Region of the United States, was awarded in May 1997 to five firms. A second, covering the Southeast, was let in January. The contracts provide for $750 million in delivery orders.

Among the early users of the Southeast Region Super ESPC is the Coast Guard Center, Elizabeth City, N.C., which plans to save $300,000 a year at 11 buildings, more than half the space at the site. NASA's Kennedy Space Center in Cape Canaveral, Fla., is using the contract for energy upgrades in eight buildings on which it hopes to save $500,000 a year. The Energy Department crafted its own ESPC in 1993 with EUA Cogenex of Lowell, Mass., to cut electricity use 62 percent in its headquarters. The Naval Surface Warfare Center, Crane Division, in Indiana signed a $15 million ESPC late last year with ERI Services Inc. of Bridgeport, Conn. The Crane delivery order, worth $2 million, involved upgrades at 46 buildings slated to cut energy consumption 7.4 percent a year.

A Beauty of a Beast

Tanya Sadler, FEMP's ESPC program manager, says the contracts aren't appropriate for all agency facilities. "We recommend, because the contracts are long-term, that you need to consider [carefully]. If you will be closing in five years and the equipment is amortized in 15, an ESPC is not the way to go," she advises. FEMP provides training for agencies interested in using the contracts. FEMP has won permission to collect administrative fees from agencies using the contracts. Among other things, FEMP has set guidelines for calculating the energy savings from which contractors are paid.

Certainly, kinks will need to be worked out with ESPCs and other deals on the bleeding edge of shared-savings contracting. We've entered an era in which the Defense Department has vowed to "manage suppliers, not supplies," contracting offices are shrinking governmentwide and discretionary budget pressure won't let up. Just in time, shared-savings pacts offer a promising new way for agencies to fund needed projects while placing more pressure on contractors to get results. These deals also offer contractors maximum latitude to innovate to beef up profits. So far, it looks like shared-savings deals may be a real beauty of a beast.

For more information about energy savings performance contracts contact the FEMP Help Desk at (800) DOE-EREC (363-3732) or try their Web site.