Subject: Award Fee Contracts (FAR 16, DFARS 215, DFARS 216).

OFFICE OF THE UNDER SECRETARY OF DEFENSE

3000 DEFENSE PENTAGON 

WASHINGTON, DC 20301-3000

MAR 29 2006

[ILLUSTRATION OMITTED]

MEMORANDUM FOR SECRETARIES OF THE MILITARY DEPARTMENTS ATTN: ACQUISITION EXECUTIVES DIRECTORS OF THE DEFENSE AGENCIES

SUBJECT: Award Fee Contracts (FAR 16, DFARS 215, DFARS 216)

Award fee contracts must be structured in ways that will focus the government's and contractor's efforts on meeting or exceeding cost, schedule, and performance requirements. The ability to earn award fees needs to be directly linked to achieving desired program outcomes. In December 2005, the Government Accountability Office (GAO) issued a report entitled "DEFENSE ACQUISITIONS: DoD Has Paid Billions in Award and Incentive Fees Regardless of Acquisition Outcomes" <http://www.gao.gov/new.items/d0666.pdf>, which made a number of recommendations on how to improve the use of award fees.

In the DoD response dated December 12, 2005, the Department generally concurred with the recommendations in the report and agreed to issue a policy memo by March 31,2006, to (1) address desired outcomes and the role the award fee should play in the overall acquisition strategy; (2) remind the acquisition workforce to follow existing policies; (3) provide guidance to the acquisition workforce on "rollover"; and (4) develop a communication plan to share proven incentive strategies across the entire DoD acquisition workforce. These actions correspond to Recommendations 1, 2, 4 and 7, respectively, in the GAO report. Separately, the Department will respond to Recommendations 3, 5 and 6 of the report at a later time. While award fee contracts are intended to be flexible, this memorandum provides additional guidance on the proper use of award fees.

Link Award Fees to Desired Outcomes (GAO Recommendation 1)

While award fee contracts are used when it is neither feasible nor effective to devise predetermined objective performance targets, it is imperative that award fees be tied to identifiable interim outcomes, discrete events or milestones, as much as possible. Examples of such interim milestones include timely completion of preliminary design review, critical design review, and successful system demonstration. In situations where there may be no identifiable milestone for a year or more, consideration should be given to apportioning some of the award fee pool for a predetermined interim period of time based on assessing progress toward milestones. In any case, award fee provisions must clearly explain how a contractor's performance will be evaluated.

Award Fees Must Be Commensurate with Contractor Performance (GAO Recommendation 2)

While award fee arrangements should be structured to motivate excellent contractor performance, award fees must be commensurate with contractor performance over a range from satisfactory to excellent performance. Clearly, satisfactory performance should earn considerably less than excellent performance, otherwise the motivation to achieve excellence is negated. However, because base fees are typically limited to no more than three percent of target cost (DFARS 216.405-2), it is appropriate to award a portion of the award fee pool for satisfactory performance to ensure that contractors receive an adequate fee on our contracts. Performance that is less than satisfactory is not entitled to any award fee.

Rollover of Award Fees (GAO Recommendation 4)

An element of many award fee plans is the ability to "roll over" unearned award fee money from one period to another. The following limitations on the use of "rollover" are established:

* Use of a "rollover" provision should be the exception rather than the rule.

* Use of an award fee rollover provision is a business decision and should be addressed in the acquisition strategy, including the rationale as to why a rollover provision is appropriate.

* If "rollover" is used, the contractor may only earn a portion of the fee that was rolled over, even for subsequent excellent performance. Factors to consider in determining how much to reduce the available rollover fee include how close the contractor came to meeting the scheduled milestone in terms of cost, schedule, and performance. For example, the reduction in rollover fees for missing a milestone by a year should be significantly greater than for missing a milestone by 30 days.

* If the Fee Determining Official approves the use of "rollover," the official contract file must be documented accordingly and the contractor must be notified.

Communication Plan (GAO Recommendation 7)

In order to facilitate discussion and to share proven incentive strategies across the entire acquisition workforce, the Department has established the "Award and Incentive Fees" Community of Practice (CoP) under the leadership of the Defense Acquisition University (DAU). The CoP will serve as the repository for all related materials including policy information, related training courses, examples of good award fee arrangements, and other supporting resources related to this policy memorandum. The CoP is available on the DAU Acquisition Community Connection at <https://acc.dau.mil/awardandincentivefees>.

This policy memorandum is effective immediately. The DFARS and/or its PGI supplement will be revised to reflect the policy contents of this memorandum. Please direct any questions to Michael Canales at 703-695-8571 or e-mail [e-mail].

James I. Finley 

Deputy Under Secretary of Defense (Acquisition and Technology)