Effect of Information and Decision-making on DoD Performance Incentives and Award Fees

Abstract

This analysis discuses DoD policy for the use of Performance Incentives and Award-fee Contracts during System Development and Demonstration (SDD). Both a review of the use of Performance Incentive Contracts since the 1960s, as well as the current policy required by the DoD to develop performance incentives are provided. A performance incentive should be structured such that the contractor receives a profit for improved performance equal to the value to the government of the improved performance times the cost-sharing ratio. This formula will motivate a contractor to spend no more than the government's value to enhance performance. If exactly that amount is spent, the loss in profit resulting from increased cost will just equal the profit received from enhanced performance. This project also shows how a similar logic can be extended to Award-fee Contracts. The analysis examines alternative decision-making and informational structures to determine the effect on contract outcome when the performance incentives are structured in accordance with policy. In certain situations, more complex incentive structures may be required. However, the informational requirements to properly develop these more complex Incentive Contracts may be substantial.