The latest GAO Report on the F-35 Program has several headline-worthy findings. The one that caught my eye was the lengthy quote that follows ... which leads me to ask "Are incentive fees worth the time and effort of administering them?" I'll add that, in my experience, it can take years for the contracting parties to finalize program incentives (often because of the indirect rate finalization process, but also for other reasons). Do the seasoned professionals here think contract incentives are effective and, if so, are they worth the effort involved?

Contract Incentives Are Not Improving Production Outcomes

The F-35 program office uses various contract incentives aimed at improving program outcomes, including on-time deliveries. In the case of the F-35, engine and aircraft contractors can be compensated in multiple ways. First, contractors earn a base profit, which is calculated as a certain percentage of the cost of the engine or aircraft. Second, on top of the base profit, the contract can include the payment of additional fees to incentivize the contractors to identify opportunities to reduce the cost of developing and producing the engine or aircraft. Third, the contract may also include fees or penalties to incentivize the contractors to achieve various performance objectives, such as reducing the overall time it takes to build an engine or aircraft, or deliver them on time.

The F-35 program office compensated Lockheed Martin with hundreds of millions of dollars of performance incentive fees while the percentage of aircraft delivered late and the average days late grew.[33] For aircraft produced in lots 13 and 14, which were delivered between 2021 and 2024, the program included performance incentive fees to drive Lockheed Martin’s performance in certain areas, including delivering aircraft on time.[34] The lot 12-14 contract allows Lockheed Martin to earn a portion of the fees for aircraft delivered up to 60 days late, with the fee decreasing every day the aircraft is late.[35] Lockheed Martin earned a large percentage of the on-time delivery performance incentive fee for lots 13 and 14 although it delivered aircraft late, as shown in figure 6.

Figure 6: Lockheed Martin Earned Millions for On-Time Delivery of U.S. Aircraft, Even Though It Delivered Aircraft Late

Note: Percentage of incentive fee earned reflects the total on-time delivery incentive fee earned out of total on-time delivery incentive fee available for the entire production lot of aircraft delivered on time and late.

While the program originally targeted lot 15 incentives to on-time delivery, once officials knew the contractor would not be able to earn those incentives, the program repurposed the incentive fees. A portion of the lots 15-17 contract incentive fee was designed to incentivize on-time delivery. Defense Contract Management Agency officials projected that under the lots 15-17 contract incentive fee structure, Lockheed Martin would not earn the vast majority of the fee because of the TR-3 delays we described above. Withholding this fee altogether would have saved taxpayers millions of dollars; however, the program modified the contract, which allowed Lockheed Martin to earn some of the incentive fee that it would have otherwise not earned. The program repurposed the unearned on-time delivery incentive fee to target some of the issues that it believed were driving the late deliveries of aircraft in lots 15-17. For example:

·       The program redirected over a hundred million dollars of unearned incentive fees to Lockheed Martin to pay for improved software lab capacity, and

·       The program repurposed over a hundred million dollars of unearned incentive fees to pay Lockheed Martin to address repairs and hardware of TR-3, Next Generation Distributed Aperture System, and to fund TR-3 test stands—special tooling to improve production processes.

Pratt & Whitney also earned tens of millions of dollars in incentive fees even though it was partially penalized for delivering engines increasingly late.[36] The F-35 program negotiated an incentive fee structure for the engine that allowed the contractor to earn more money if engines passed specific quality tests and if it kept total assembly time down. This incentive fee structure is intended to encourage the contractor to improve engine quality while also reducing the hours its takes to build engines, keeping engine costs down and increasing the likelihood that engines are delivered on time. The incentive structure also included penalties that reduced the total amount of fee Pratt & Whitney could earn based on how late it delivered engines. Pratt & Whitney earned between 37 and 78 percent of the total incentive fee available for production lots 14 through 16, equating to tens of millions of dollars, because it performed well on both the quality tests and assembly time metrics. The total amount of incentive fee earned for engines delivered across those production lots was reduced by over $10 million because it delivered nearly all engines late. However, Pratt & Whitney earned tens of millions of dollars in incentive fees because the value of the fees it earned for keeping total assembly time down more than offset the penalties levied on it for delivering engines late. This incentive structure and late delivery penalty was not effective at improving on-time deliveries (see figure 7).

I think we can ignore GAO's findings, don't you? After all, GAO shouldn't exist.

Russ Vought says Government Accountability Office ‘shouldn’t exist’

2 hours ago, here_2_help said:

Are incentive fees worth the time and effort of administering them?

I'll answer that this way: I think it depends on (1) the purpose of the incentive, (2) the design of the incentive, (3) the conditions of contract performance, and (4) the relationship between the parties.

Generally, I don't believe that government contract incentives have been widely successful. As a CO, I would not willingly use any of the standard incentives described in the FAR. In my experience, the government's use of incentives has largely been based on politics and habit rather than sincere belief in their effectiveness. The historical record is not good.

I'm currently reading a book titled, Contract Strategies for Major Projects, by Edward Merrow. Mr. Merrow is the CEO of Independent Project Analysis and has decades of experience in assessing major projects. Here's what he says about contract incentives: "Years of research into the application of incentives in contracts has taught us that incentives rarely work in the way owners think they will." That's from the introduction and he's got an entire chapter on the question that I have not yet gotten to.

I have tried to use incentives in my Federal contracting work over the years. They never worked. I think they are best avoided.