OMB spells out best practices for incentive contracts

The government's chief procurement official has directed agency acquisition heads to review and update their use of incentive fee contracts to guarantee that the contracts are tied to well-defined and measurable performance results.

In a memorandum issued Tuesday, Paul A. Denett, administrator of the Office of Federal Procurement Policy at the Office of Management and Budget, spelled out a number of best practices for agencies to follow before signing incentive contracts.

Among the items on Denett's Incentive Contract Checklist:

• Ensure that the acquisition plan and market research state desired outcomes, performance requirements and milestones associated with the contract-type choice;
• Conduct a risk assessment and cost-benefit analysis to support the use of an incentive fee contract;
• Determine whether the administrative costs associated with managing such a contract are outweighed by the expected benefits;
• Demonstrate that enough staff and personnel are available to properly structure and monitor the contract.

Incentive fee arrangements have been heavily scrutinized in recent years by the Government Accountability Office, which found that some contracts and payment procedures did not result in better performance by the contractor.

A 2005 GAO report (GAO-06-66), which examined a sample of 93 Defense Department incentive-based contracts, found that most were not linked to an acquisition outcome, resulting in roughly $8 billion in award fees that were distributed regardless of the results. A subsequent report (GAO-06-409t) found that problems with the Pentagon's incentive structure in its weapons system procurement were particularly pronounced.

But the issues with cost-plus, award-fee contracts are not limited to Defense.

A GAO report (GAO-07-58) issued in January 2007 found that NASA often failed to follow its own guidelines on the use of incentive contracts. In one case, the agency paid the contractor working on the Earth Observing System Data and Information System core program 97 percent of its available award fee despite a delay of more than two years and an increase in the cost of the contract of more than 50 percent.

The Federal Acquisition Regulation states that incentive fee contracts can be used to motivate contractors when an agency wants to achieve specific objectives, such as delivering products or services on time, within cost estimates and with promised performance outcomes. The award fee, the FAR states, must be tied to demonstrated results, rather than only effort, in meeting or exceeding the established goals.

The OFPP memorandum encourages chief acquisition officers and senior procurement executives to establish, in writing, the processes by which a contractor can earn an incentive fee.

Such a plan should include metrics for measuring performance -- distinguishing a firm that does an excellent job from one that simply performs adequately -- and would include standards for agencies to use in evaluating the proper fee amount. The plan should establish a base fee that the contractor would be paid for completing the job in at least a satisfactory manner, and then define the percentage of the award fee that the firm could earn based on the agency's performance rating.

Agencies also were directed to develop guidance to show when it is appropriate to roll over unearned incentive fees to a subsequent evaluation period. "Rolling over fees is not the preferred method for incentivizing the contractor to perform above satisfactorily, and should be permitted on a limited basis and require prior approval of the appropriate agency official," Denett wrote.

OMB also has requested that agencies classify by Jan. 7, 2008, an incentive and award fee point of contact within the agency who could contribute lessons learned and best practices to an upcoming interagency working group.