2011-23779. Defense Federal Acquisition Regulation Supplement; Increase the Use of Fixed-Price Incentive (Firm Target) Contracts

AGENCY:

Defense Acquisition Regulations System, Department of Defense (DoD).

ACTION:

Final rule.

SUMMARY:

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.

DATES:

Effective date: September 16, 2011.

FOR FURTHER INFORMATION CONTACT:

Ms. Amy Williams, telephone [phone].

SUPPLEMENTARY INFORMATION:

I. 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.

II. 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.

III. Executive Orders 12866 and 13563

Executive Orders (E.O.s) 12866 and 13563 direct agencies to assess all costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). E.O. 13563 emphasizes the importance of quantifying both costs and benefits, of reducing costs, of harmonizing rules, and of promoting flexibility. This is not a significant regulatory action and, therefore, was not subject to review under section 6(b) of E.O. 12866, Regulatory Planning and Review, dated September 30, 1993. This rule is not a major rule under 5 U.S.C. 804.

IV. Regulatory Flexibility Act

DoD has prepared a final regulatory flexibility analysis (FRFA) consistent with the Regulatory Flexibility Act, 5 U.S.C. 601, et seq. The FRFA is summarized as follows:

This rule amends the Defense Federal Acquisition Regulation Supplement to implement the initiative on incentivizing productivity and innovation in industry, as presented by the Under Secretary of Defense for Acquisition, Technology, & Logistics in a memorandum dated November 3, 2010. The objective of the rule is to incentivize contractors to control costs. The legal basis is 41 U.S.C. 1303 and 48 CFR chapter 1.

There were no public comments in response to the initial regulatory flexibility analysis.

The final rule will not have much impact on small entities, because the focus of the rule is on development efforts that are moving into early production. Small entities are more likely to receive awards for commercial products, including commercially available off-the-shelf products, for which firm-fixed-price contracts are appropriate. In Fiscal Year 2010, 93 percent of awards to small businesses were firm-fixed-price contracts, and 99.99 percent of awards to small businesses were other than fixed-price incentive contracts.

The final rule imposes no reporting, recordkeeping, or other information collection requirements.

There are no known alternatives to the rule that would adequately implement the DoD policy. There is no significant economic impact on small entities.

There are no other alternatives that will accomplish the objectives of the rule.

V. Paperwork Reduction Act

The final rule does not contain any information collection requirements that require approval of the Office of Management and Budget under the Paperwork Reduction Act (44 U.S.C. chapter 35).

List of Subjects in 48 CFR Part 216

• Government procurement

Ynette R. Shelkin,

Editor, Defense Acquisition Regulations System.

Therefore, 48 CFR part 216 is amended as follows:

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.