Our probability sample of 93 contracts was drawn from a  total of 597 DOD award- and incentive-fee contracts that were active from  fiscal years 1999 through 2003 and had at least one contract action coded  as cost-plus-award-fee, cost-plus-incentive-fee, fixed-price award-fee, or  fixed-price-incentive valued at $10 million or more during that time. Award and Incentive Fees Are Not an Effective Tool for Achieving DOD’s Desired Acquisition Outcomes

DOD has not structured and implemented award-fee contracts in a way  that effectively motivates contractors to improve performance and achieve  acquisition outcomes. DOD practices—such as routinely paying its  contractors nearly all of the available award fee, amounting to billions of  dollars, regardless of whether the acquisition outcomes fell short of, met,  or exceeded expectations; rolling an estimated $669 million in unearned or  withheld award fees to future evaluation periods; and paying a significant  portion of the available fee for what award-fee plans describe as  “acceptable, average, expected, good, or satisfactory” performance—all  lessen the motivation for the contractor to strive for excellent  performance. DOD may also be diluting the motivational effectiveness of award fees by  paying significant amounts of fee for satisfactory performance. We found two notable examples in which DOD’s Missile  Defense Agency attempted to hold contractors accountable for program  outcomes. Other programs have utilized different fee strategies to focus the  contractor’s attention on specific acquisition outcomes. However,  contracting officials have stated that there are few mechanisms to share  lessons learned and innovative practices outside the local level. According to DOD contracting  and program officials, contractors overran or were expected to overrun  the target price on 52 percent of the 27 incentive-fee contracts in our  sample. In addition, DOD did not assess the results of the study. In the longer term, DOD can improve its use of award and  incentive fees by (5) developing a mechanism for capturing award- and  incentive-fee data within existing data systems, such as the Defense  Acquisition Management Information Retrieval system; (6) developing  performance measures to evaluate the effectiveness of award and  incentive fees as a tool for improving contractor performance and  achieving desired program outcomes; and (7) developing a mechanism to  share proven incentive strategies for the acquisition of different types of  products and services with contracting and program officials across DOD. However, given that the department paid out an  estimated $8 billion in award fees on the contracts in our study population  regardless of outcomes, we believe that a reasonable investment in  ensuring that these funds are well-spent in the future is warranted.
Why GAO Did This Study

Collectively, the Department of Defense (DOD) gives its contractors the opportunity to earn billions of dollars through monetary incentives--known as award fees and incentive fees. These fees are intended to motivate excellent contractor performance in areas deemed critical to an acquisition program's success, with award fees being appropriate when contracting and program officials cannot devise objective incentive fee targets related to cost, technical performance, or schedule. GAO was asked to determine whether award and incentive fees have been used effectively as a tool for achieving DOD's desired acquisition outcomes. To do this, GAO selected a probability sample of 93 contracts from the study population of 597 DOD award- and incentive-fee contracts that were active and had at least one contract action valued at $10 million or more from fiscal year 1999 through 2003.

What GAO Found

The power of monetary incentives to motivate excellent contractor performance and improve acquisition outcomes is diluted by the way DOD structures and implements incentives. While there were two examples in our sample in which the Missile Defense Agency attempted to link award fees directly to desired acquisition outcomes, such as demonstrating a capability within an established schedule, award fees are generally not linked to acquisition outcomes. As a result, DOD has paid out an estimated $8 billion in award fees to date on the contracts in our study population, regardless of outcomes. The following selected programs show this disconnect. When DOD programs did not pay all of the available award fee, DOD gave contractors on an estimated 52 percent of award-fee contracts at least a second opportunity to earn an estimated $669 million in initially unearned or deferred fees. GAO believes these practices, along with paying significant amounts of fee for "acceptable, average, expected, good, or satisfactory" performance, undermine the effectiveness of fees as a motivational tool and marginalize their use in holding contractors accountable for acquisition outcomes. They also serve to waste taxpayer funds. Incentive fees provide a clearer link to acquisition outcomes; however, a majority of the 27 contracts with cost incentives that GAO reviewed failed or are projected to fail to complete the acquisition at or below the target price. Despite paying billions in fees, DOD has little evidence to support its belief that these fees improve contractor performance and acquisition outcomes. The department has not compiled data, conducted analyses, or developed performance measures to evaluate the effectiveness of award and incentive fees. In addition, when contracts have utilized different fee strategies to focus the contractor's attention on specific acquisition outcomes, contracting officials have stated that DOD has few mechanisms to share lessons learned and innovative practices outside the local level.