DoD Issues Final Rule to Increase the Use of Fixed-Price Incentive (Firm Target) Contracts

September 16, 2011

DoD is issuing a final rule amending the DFARS to increase the use of fixed-price incentive (firm target) contracts, with particular attention to share lines and ceiling prices. Effective date: September 16, 2011. Reference Federal Register Volume 76, Number 180 (Friday, September 16, 2011).

Background
This DFARS case was initiated to implement an initiative to incentivize productivity and innovation in industry, as set forth in a memorandum from the Under Secretary of Defense for Acquisition, Technology, & Logistics (USD(AT&L)), dated November 3, 2010. The memorandum provided guidance to the secretaries of the military departments and directors of defense
agencies on obtaining greater efficiency and productivity in defense spending. In support of this initiative, DoD published a proposed rule in the Federal Register on March 2, 2011 (76 FR 11410). The proposed rule required that contracting officers must--
(1) Give particular consideration to the use of fixed-price incentive (firm target) contracts, especially for acquisitions moving from development to production; and
(2) Pay particular attention to share line and ceiling prices for fixed-price incentive (firm target) contracts, with 120 percent ceiling and a 50/50 share ratio as the default arrangement.

The comment period closed on May 2, 2011. DoD received comments from one respondent.

Discussion/Analysis
The respondent considered that the incorporation of a broad preference to use a 50/50 share line with a ceiling of 120 percent is a mistake for Government acquisitions for the reasons discussed in the following comments.

Comment: The respondent provided anecdotal evidence that currently acquisition leadership translates this preference as a mandatory requirement.
Response: All of the documentation for this case, and all of the presentations by senior acquisition leaders within DoD, have emphasized that this initiative is to be implemented in a way that makes sense for each individual acquisition. The guidance in the DFARS companion Procedures, Guidance, and Information (PGI) reiterates that each situation must be evaluated in terms of the degree and nature of the risk presented in order to select the proper contract type. The PGI also provides additional guidance on establishing the target cost, share lines, and ceiling price. This regulation is not a ''one-size-fits-all'' mandate. However, to make the final rule more consistent with the terminology of the USD(AT&L) memo of November 3, 2010, and to clarify that each contract must be considered on a case-by-case basis, DoD has revised the description of the use of a fixed-price incentive (firm target) contract with a 50/50 share ratio and a 120 percent ceiling from ''the default arrangement'' to ''the point of departure for establishing the incentive arrangement.''

Comment: According to the respondent, the Institute for Defense Analyses (IDA) study, Can Profit Policy and Contract Incentives Improve Defense Contract Outcomes?, makes a strong case for the ineffectiveness of incentive contracts.
Response: The majority of incentive contracts covered by the IDA study were award-fee contracts, not fixed-price incentive (firm target) contracts. Furthermore, DoD is actively taking steps to ensure that incentives are linked to acquisition outcomes and the profits are tied to performance in achieving those outcomes.

Comment: The respondent stated that in order to correct the use of incentives, DoD should mandate that contracting officers use a true pessimistic/optimistic weighted average and ensure that their cost curves do not mirror cost-plus-fixed-fee cost curves.
Response: DoD endorses the respondent's concept that contracting officers should carefully develop a realistic target cost and that an incentive contract should provide adequate incentives. The reason for specifying the 120 percent ceiling and the 50/50 cost sharing arrangement as the point of departure for establishing the incentive arrangement is to promote cost realism and discourage an incentive arrangement that does not provide adequate incentive to the contractor to control costs. An excessively flat share line approaches a cost-plus-fixed-fee arrangement (100/0), thereby providing almost no incentive to the contractor to control costs. A 50/50 share line suggests that the Government and the contractor have a common view of the likely contract execution cost. A 50/50 share line should represent a point where the estimate is deemed equally likely to be too high or too low. However, as already stated, rather than issuing mandates, DoD encourages the evaluation of each situation in terms of the degree and nature of the risk presented in order to select the proper contract type and, if an incentive contract type is selected, the appropriate incentive arrangement.

FOR FURTHER INFORMATION CONTACT:  Ms. Amy Williams, telephone 703-602-0328.

PART 216--TYPES OF CONTRACTS
1. The authority citation for 48 CFR part 216 continues to read as follows: Authority:  41 U.S.C. 1303 and 48 CFR chapter 1.
2. Add section 216.403-1 to read as follows:

216.403-1  Fixed-price incentive (firm target) contracts.
(b) Application.
(1) The contracting officer shall give particular consideration to the use of fixed-price incentive (firm target) contracts, especially for acquisitions moving from development to production.
(2) The contracting officer shall pay particular attention to share lines and ceiling prices for fixed-price incentive (firm target) contracts, with a 120 percent ceiling and a 50/50 share ratio as the point of departure for establishing the incentive arrangement.
(3) See PGI 216.403-1 for guidance on the use of fixed-price incentive (firm target) contracts. 






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