Innovation in Contracting Using Contract Incentives to Improve Vendor Performance–a Junior Officer’s Perspective


lisowski articleOver time, there have been numerous acquisition strategies and subsequent Federal Acquisition Regulation clauses implemented to introduce new methods of contract financing and innovation incentives (e.g., award fees and special incentive clauses) to improve vendor performance. Additionally, the Government Accountability Office reports have shown that in some cases award fees for average or satisfactory performance undermine the effectiveness of the fees as a motivational tool to reduce vendor costs. Knowing a vendor’s operations well enough to set a firm fixed price or incentive cost target that energizes vendor innovation is more cost effective than special incentives or capital expenditure structures alone.

In five years as an acquisition manager at Naval Reactors, I’ve been fortunate enough to tour the shop floor of many nuclear industrial base contractors. In my opinion, witnessing specialized machinery operations and talking with the engineers and manufacturing personnel that produce the nuclear components are as important as analyzing audit reports and reviewing historical contractor performance. In doing so, the government is better able to identify areas where operational efficiency can be increased, learn what management is doing in these areas, understand contractor incentives, and estimate the appropriate target cost that will drive efficiency and cost reductions. Without increased knowledge of vendor operations, it is difficult to introduce cost incentives, such as the right capital expenditure cost sharing arrangements. For example, agreeing to share in the cost of a new machine or accept a vendor’s estimate of overtime provides little value to the government if the vendor’s production bottleneck occurs in a different part of the factory than where the new machine will be added or where the overtime will occur. While continuous improvement and innovation is occurring on our factory floors, it is regularly happening at a pace that best serves the vendor base. Vendor contracting officials often support negotiations with operational data from today, while they plan for tomorrow’s operations and thus benefit from efficiencies after the price is set. In factory tours, I have learned that reading the writing on the wall (literally: almost every vendor now has efficiency metrics posted for all employees to see) is instrumental. In doing so, we start to learn what is important to management and the continuous improvement they are planning and tracking. We can take this knowledge to the negotiation table and change the negotiation from historical performance to the opportunities and risks of the vendor’s future operations.

Setting the discussion on the vendor’s future and how it aligns with government needs changes the purpose of the discussion. Often, government backlog is the valued resource that supports vendor needs. However, a combination of target cost and incentive packages can support government needs for reduced cost and incentivize the vendor towards continuous and sometimes drastic operational improvements with commensurate reward. The fixed price incentive package should not put the government in a position of paying excessively, should balance the vendor reward for taking risk to reach an aggressive cost target with innovation, and should provide protection should the vendor fall short. Applying appropriate (often times uneven) sharelines (e.g., 60 percent government / 40 percent contractor for over-run, 25 percent government / 75 percent contractor for under-run) may properly incentivize the vendor to work to under-run the contract, and it introduces shared government risk of the over-run. Arriving at this point comes down to having an increased knowledge of the vendor factory floor operations and setting an aggressive cost target.

By entering negotiations with a holistic mindset on vendor business operations, cash flow features, and risk-sharing incentives, procurement personnel set themselves up for success by allowing for more flexible, creative contracting. Negotiating in a piecemeal fashion by looking at specific award fees or special incentive clauses is less preferred, as more mutually beneficial outcomes occur when the contractor’s problems and interests are fully understood.

*Lt. Lisowski currently serves as acquisition program manager at the Navy’s Division of Naval Reactors in Washington D.C. and is enrolled as a master of business administration candidate at the Georgetown University McDonough School of Business.

November/December 2015