Innovative Incentives

ew people don't want to succeed when given a job to do. How many offices have you seen where performance or Hammer awards are not proudly displayed?

Some money may come with those awards, but as any civil servant knows, Uncle Sam is frugal in that department. That doesn't stop people, though, from displaying their awards and appreciating the recognition. But what about the corporate world? What motivates the private sector?

The simple answer is profits, but even elementary economics reveals that companies can have many different goals. Maintaining a stable workforce and holding on to market position translate into money and also serve as ends in themselves.

Here, then, is the question: Are there innovative ways to reward a company's successful performance that go beyond the traditional incentives based on profit or fee? At a July National Contract Management Association conference in Los Angeles, the answer was a resounding "yes" from at least two prominent government procurement officials. Kenneth Oscar, new deputy administrator of the Office of Management and Budget's Office of Federal Procurement Policy, and Thomas Luedtke, NASA's associate administrator for procurement, both said they have come up with new performance-based ways to create practical incentives for government and industry alike.

"Award-term contracting is the most innovative approach in use today," Luedtke said at the conference. Oscar also cited this technique as one of the key methods identified by a team he had set up in the spring of 1999, when he was deputy assistant secretary of the Army for procurement, to study incentives. As is the case with so many of today's acquisition reforms, award-term contracting is derived from commercial best business practices. Private firms seek long-term business relations with the vendors they choose. That relationship depends on the contractors' ability to perform. Award-term contracting provides a similar approach in government contracting. If a contractor's performance is continually rated excellent by its evaluators, the firm stands to add as much as five years to an existing five-year contract, all without competition.

Here's how it works. A five-year core contract period is established, but the terms could be scaled back to a minimum of three and a half years or expanded to a maximum of 10. For each annual rating of "excellent," nine months would be added to the contractor's performance period, and nine months would be subtracted for each "poor" rating. Seven years of excellent ratings could stretch the contract to 10 years.

NASA's approach is to assess not only a contractor's technical performance but also its ability to reduce costs. It's too early, however, to tell how the approach is working: NASA's award term pilot project at the Glenn Research Center at Plum Brook just started in March 1999. But NASA sees high potential for creating a solid win-win situation for government and contractors. Award-term contracting topped a list of new incentives that Oscar's study team of government and industry representatives recommended for the Army to consider. (see http://acq.net.sarda.army.mil/library/final/final299.htm) The team's approach paralleled that of NASA in emphasizing that productivity gains, not just technical performance, should be part of the equation. A number of Army pilot projects have resulted from this effort.

One way to visualize this concept is to map efficiencies over time with a line leading down a staircase reflecting continually lowered costs. By following that line, the government continues to see productivity gains from the contractor and continues to lengthen the contract. However, if the slope flattens out, a new competition would be set up to promote cost savings that are no longer accruing through the existing contract.

"Every contract we write creates incentives. We just have to see that they're the right ones," Oscar says, citing the Defense Department's purchase of missiles as an example. What is the incentive for contractors to do better in the current contract scheme, which calls for a specific number of missiles at a set price? If a contract is restructured so that if the contractor produced more missiles, it gets increased profits, then a true incentive is created. Under this approach, the contractor would be hired to produce at least "x" missiles for that total price, with additional missiles resulting in higher profits. As long as quantities don't exceed the government's needs, the agreement is a clear win for both sides.

Other study recommendations included allowing companies higher profits for plant-wide efficiencies, letting contractors retain intellectual property rights, and structuring payments to encourage performance through milestone billings. Under milestone billings. Under milestone billings, a contractor is paid when it has accomplished a major task that allows the program to move forward.

Oscar plans to carry this incentive message across government, making clear that agencies should focus on promoting incentives as opposed to negotiating lower fees. "If we can get performance specifications, good incentives and well-trained people, it will go a long way toward getting the kind of contracting support the government needs," he says.