	Background

Federal agencies, including DOD, can choose among numerous contract  types to acquire products and services. Further, we estimate that most of the contracts and most of the dollars in  our study population are related to the acquisition of weapon systems. A System in Need of Reform

DOD’s use of award and incentive fees is symptomatic of an acquisition  system in need of fundamental reform. Award fees have generally not been effective at helping DOD achieve its  desired acquisition outcomes, in large part, because award-fee criteria are  not linked to desired acquisition outcomes, such as meeting cost and  schedule goals and delivering desired capabilities. As  a result of all these factors, DOD programs frequently paid most of the  available award fee for what they described as improved contractor  performance, regardless of whether acquisition outcomes fell short of,  met, or exceeded DOD’s expectations. A Case for Change: Motivating Excellent Contractor Performance and Promoting Accountability

While DOD stated that award fee  motivating excellent contractor  performance by only paying award fees  for above satisfactory performance  arrangements should be structured to  encourage the contractor to earn the  preponderance of fee by providing  excellent performance, it maintains that  paying a portion of the fee for  satisfactory performance is appropriate  to ensure that contractors receive an  adequate fee on contracts. DOD programs routinely engage in award-fee practices that are  inconsistent with the intent of award fees, reduce the effectiveness of  these fees as motivators of performance, compromise the integrity of the  fee process, and waste billions in taxpayer money. Two practices, in  particular, paying significant amounts of fee for “acceptable, average,  expected, good, or satisfactory” performance and providing contractors  multiple opportunities to earn fees that were not earned when first made  available, undermine the effectiveness of fees as a motivational tool and  marginalize their use in holding contractors accountable for acquisition  outcomes. The inconsistent application of DOD’s existing policies on award fees and  weapon system development reinforce the need for increased  transparency and accountability in DOD’s management of award fees. Very little effort has gone into determining whether DOD’s current use of  monetary incentives is effective. However, DOD has not compiled information,  conducted evaluations, shared lessons learned, or used performance  measures to judge how well award and incentive fees are improving or can  improve contractor performance and acquisition outcomes. DOD uses these fees in an attempt to mitigate  the risks that it creates through a flawed approach to major weapon  system development. As a result, DOD  has to date not been willing to hold its programs or its contractors  accountable for achieving its specified acquisition outcomes. Implementing our recommendations on award and incentive fees will not  fix the broader problems DOD faces with its management of major  weapons or service acquisitions. However, by implementing our  recommendations, DOD can improve incentives, increase transparency,  and enhance accountability for the fees it pays. Working in concert, these  steps can help DOD set the right conditions for more successful  acquisition outcomes and make more efficient use of its resources in what  is sure to be a more fiscally constrained environment as the nation  approaches the retirement of the “baby boom” generation. Finally, we encourage the department to  fully implement our remaining recommendations including developing a  mechanism to capture award- and incentive-fee data and developing  performance measures to evaluate the effectiveness of these fees.
Why GAO Did This Study

With DOD spending over $200 billion annually to acquire products and services that include everything from spare parts to the development of major weapon systems, our numerous, large, and mounting fiscal challenges demand that DOD maximize its return on investment and provide the warfighter with needed capabilities at the best value for the taxpayer. In an effort to encourage defense contractors to perform in an innovative, efficient, and effective way, DOD gives its contractors the opportunity to collectively earn billions of dollars through monetary incentives known as award and incentive fees. Using these incentives properly--in concert with good acquisition practices--is a key to minimizing waste, maximizing value, and getting our military personnel what they need, when and where they need it. Congress asked GAO to testify on DOD's use of award and incentive fees and the role they play in the acquisition system. This statement highlights the risks of conducting business as usual and identifies the actions DOD needs to take to use these fees more effectively. DOD concurred or partially concurred with the seven recommendations GAO made in a previously issued report on award and incentive fees. GAO looks forward to seeing DOD turn these promised steps into actual policy and practice.

What GAO Found

DOD's use of award and incentive fees is an issue at the nexus of two areas that GAO has designated "high risk" for DOD--contract management and weapon system acquisition. Contract management has been a long-standing business management challenge for DOD because it often cannot assure that it is using sound business practices to acquire the goods and services the warfighter needs. For weapon system acquisitions, the persistent and long-standing nature of acquisition problems has perhaps made a range of key decision makers complacent about cost growth, schedule delays, quantity reductions, and performance shortfalls. DOD's strategies for incentivizing its contractors, especially for weapon system development programs, reflect the challenges in these areas. DOD programs routinely engage in award-fee practices that do not hold contractors accountable for achieving desired outcomes and undermine efforts to motivate contractor performance, such as evaluating contractors on award-fee criteria that are not directly related to key acquisition outcomes (e.g., meeting cost and schedule goals and delivering desired capabilities to the warfighter); paying contractors a significant portion of the available fee for what award-fee plans describe as "acceptable, average, expected, good, or satisfactory" performance; and giving contractors at least a second opportunity to earn initially unearned or deferred fees. As a result, DOD has paid out an estimated $8 billion in award fees on contracts in GAO's study population, regardless of whether acquisition outcomes fell short of, met, or exceeded DOD's expectations. Despite paying billions of dollars, DOD has not compiled data or developed performance measures to evaluate the validity of its belief that award and incentive fees improve contractor performance and acquisition outcomes. These issues, along with those GAO has identified in DOD's acquisition and business management processes, present a compelling case for change. By implementing the recommendations GAO has made on award and incentive fees, DOD can improve incentives, increase transparency, and enhance accountability for the fees it pays. At the same time, by working more broadly to improve its acquisition practices, DOD can set the right conditions for getting better acquisition outcomes and making more efficient use of its resources in what is sure to be a more fiscally constrained environment.