Performance Based Logistics (PBL) Incentives - Motivating Achievement of Desired Support Outcomes

General Information

The Basics

One of the ten tenets of a PBL Product Support Arrangements (PSA) outlined in the DoD PBL Guidebook is to “provide significant incentives to support providers that are tied to the achievement of outcomes (for aspects of performance that are within their control).” This article provides ideas for Defense Acquisition Workforce (DAW) members to consider when crafting outcome-based PSAs -- specifically ideas for motivating, encouraging, or incentivizing both commercial sector industry and organic government organizations serving as either PBL Product Support Integrator and/or Product Support Provider (PSI and/or PSP)-- to achieve affordable readiness product support outcomes.

A PBL arrangement can leverage various types of incentives. Contracts with commercial sector/industry PSIs/PSPs can be incentivized based on award and/or incentive fees or extended contract terms. Award term extensions when the contract will be extended if desired outcomes are being achieved. Cost-cutting targets are inherent if a fixed price model is used; the more the supplier cuts costs the more margin they make; contract price adjustments are made at pre-defined timeframes to review costs and re-price the work. (See also separate PBL Contracting Strategies ACQuipedia article for additional details related to information about PBL Contracts as either Supply or Services Contracts, as well as additional insights into contract incentives and disincentives for PBL contracts with commercial sector/industry PSIs/PSPs.)

Regulation and Policy

The Federal Acquistion Regulation (FAR) is replete with information related to incentives, clearly stating that “contractors should be offered the fullest possible range of motivation…” (FAR 48.105). While not all PBL product support arrangements are considered services contracts or are even with industry, FAR 16.402-2(b) explicitly states that “the maximum extent practicable, positive and negative performance incentives shall be considered in connection with service contracts for performance of objectively measurable tasks when quality of performance is critical and incentives are likely to motivate the contractor.” The FAR goes on to also state that “performance-based contracts for services shall include performance incentives where appropriate. When used, the performance incentives shall correspond to the performance standards set forth in the contract.” FAR Subpart 16.4 also provides detailed information on incentive contracts in particular.

DoD Directive (DoDD) 5000.01, The Defense Acquisition System, para 1.2.m, states that "The Program Manager [PM] is accountable for achieving program life-cycle management objectives throughout the program life cycle. Planning for operations and support will begin at program inception, and supportability requirements will be balanced with other requirements that impact program cost, schedule, and performance. Performance based life-cycle product support implements life-cycle systems management."

DoD Instruction (DoDI) 5000.91, Product Support Management for the Adaptive Acquisition Framework, Section 4.7.a., includes the following, and more: "The PM, with the support of the PSM, will develop and implement an effective performance-based life cycle PSS (synonymous with performance-based logistics strategy) that will deliver an integrated and affordable product support solution designed to optimize system readiness for the warfighter. The performance-based life cycle PSS [Product Support Strategy] will be the basis for all product support efforts and lead to a product support package to sustain warfighter requirements."

DoDI 5000.74, Defense Acquisition of Services, para 3.j. states “It is DoD policy that…The acquisition strategy for contracted services should provide incentives to industry to improve productivity and performance consistent with DoD objectives.” It goes on to state in para 3.n that “Where competition is determined not to be feasible or practical, acquisition strategies and plans will incorporate processes to generate improved performance or cost savings with the sole source vendor, such as incentives and performance metrics.”

Additional Guidance

When it comes to incentive contracts, April 2016 Defense Procurement and Acquisition Policy (DPAP) “Guidance on Using Incentive and Other Contract Types” provides detailed information on the subject, including the fact “an incentive, which is a stimulus to a desired action, exists in every business arrangement. The effective application of incentives remains essential to building successful business arrangements that maximize value for all parties. DoD is committed to adopting incentive strategies that attract, motivate, and reward traditional and nontraditional contractors to ensure high performance…The profit motive is the essence of incentive contracting. Incentive contracts provide the opportunity for the contractor to realize increased profit for attaining cost, performance and/or schedule criteria. At the same time, negative incentives may be employed to motivate contractors to avoid reduced profitability when outcomes fall short of the Department’s desired levels. Incentive contracts should be structured to achieve desired objectives through reasonable and attainable targets that are clearly communicated to the contractor. When developing an incentive type contract, the team should consider factors other than profit/fee that will motivate a contractor to perform. Examples of these factors include follow-on business, growth, maintaining or retaining a production capability, and positive past performance information (collected via Contractor Performance Assessment Reports). Negative incentives are the counterpart of reward. The traditional method of applying positive (reward) incentives for cost under target and negative (penalty) incentives for cost over target in a cost-incentive-only contract has been the most widely applied incentive arrangement. The practical effect is the same where the fee ranges and the range of incentive effectiveness are the same.”

And, according to the Commander, Naval Air Systems Command (COMNAVAIRSYSCOM) in a 3 Dec 2012 memo entitled “Performance Based Logistics Guidance and Best Practices Memorandum”, “PBL IPTs [Integrated Product Teams] should have a good understanding of a Provider’s business model to understand incentives. Incentives can include increased contract term, awarding of option periods, additional funding, and gain sharing. Gain sharing has become a popular path to encourage significant improvements and passing additional savings back to the Government. Another option is negative incentives which are generally monetary (reductions in payments). There may be competing factors that drive contractor behavior differently from the team’s expectation. A properly structured FFP [Firm Fixed Price] PBL will inherently incentivize the provider to improve reliability and supply chain efficiency while controlling cost to the government, by taking on risk and the opportunity to increase profits with the improved products and/or processes. Disincentives for performance below the contractual metric are also generally included. The IPT may consider additional incentives on a case by case basis. When considering the use of incentives in PBL contracts, it should be noted that both positive and negative incentives should be used to prevent any imbalance in over or under incentivizing contract performance.”

From a June 17, 2016 Washington Post article: “In his quest to transform the way the Pentagon wages war, Defense Secretary Ashton B. Carter has turned to Silicon Valley, hoping its experimentation culture, innovation, and sense of urgency will rub off on the rigid bureaucracy he runs….And recently he sat down at the Pentagon with Elon Musk to see what suggestions the billionaire founder of Tesla and SpaceX might have to make the military more efficient and daring. Musk’s answer? ‘Having an incentive structure that rewards innovation is extremely important,’ he said in an interview after the meeting. ‘It’s economics 101. Whatever you reward will happen.'" (emphasis added)

Indeed, Mr Frank Kendall, the former Undersecretary of Defense for Acquisition, Technology and Logistics (USD(AT&L)) was clear about the importance of incentivizing industry stating “industry is easy to motivate. Corporations exist for the purpose of making money for their shareholders, so the motivation tool is obvious and effective. The trick for the DoD is to align this self-interest with the DoD’s interests, and to do it in a way that will be effective at improving outcomes. We’re making progress on this, but I still see some unevenness in how our managers structure incentives. It takes good critical thinking to get incentives “right” because we deal with so many different business situations. Incentives need to “thread the needle” between being easily achieved and impossible so that they do influence behavior. They also need to be meaningful financially both as carrots and sticks, without asking corporations to assume an unreasonable amount of risk. I’ll continue to focus on this aspect of our acquisition strategies as programs come in for review, and I’ll expect managers at all levels to do the same.” Moreover, the October 2016 USD(AT&L) Performance of the DAS - 2016 Annual Report emphasizes incentives throughout, including the top-level ten “Principles for Improving Defense Acquisition” identified, not one, but two principles discussed relate to incentives; specifically stating: “Incentives work – we get what we reward” and “competition and the threat of competition are the most effective incentives.”

Specific Considerations

A few important things to consider when evaluating, identifying and applying potential incentives:

Incentives can be positive (“rewards”), negative (“penalties/remedies") or a mix
Incentives can be monetary, non-monetary, or a mix
Incentives can be based on cost, on schedule, or on quality of performance
Incentives should motivate and facilitate a contractor or organic PSI/PSP to achieve desired performance and/or cost savings outcomes
Incentives should be consistent with the effort and contract value (for industry PSIs/PSPs)
Incentives should be built upon realistic, measurable and attainable performance objectives and standards
Incentives should be carefully structured to consider their overall impact and to avoid any unintended consequences while providing value for achieving the mission and/or the specified outcomes
Incentives should motivate a contractor or organic organization serving as a PSI/PSP, to achieve performance levels of the highest quality consistent with economic efficiency
Incentives should be effective and reflect value both to the government and to the contractor
There is no “one-size fits all” universally applicable contract or incentive template
Be clear about exactly what you are trying to incentivize, as more often than not, you will likely get it (and may not be able to afford it – or may not have actually needed or wanted it)
Successful PBL product support arrangements use incentive strategies that are tightly aligned, promoting behaviors and outcomes that benefit both the customer and supplier
The government has wide discretion in assembling and blending contract award and/or incentive fee types and strategies, tailored to fit the needs, requirements, and unique circumstances of an individual program
Government organizations and personnel are expected to comply with statutory, regulatory, and policy requirements including (but not limited to):

Key Questions to Ask

A few important questions keep in mind when assessing incentives include:

Will the incentives identified support achievement of a best-value product support outcome that meets required program cost, and/or performance targets?
Does the contractor or organic PSI/PSP have control over the performance area and have the ability to impact (or ensure) its outcome?
Is the incentive affordable? Will it affect timelines or schedules in a positive way? Adversely?
Will enhanced performance provide additional value to the mission?
Which areas of the requirement would benefit most from enhanced performance?
Are incentives required or even necessary to motivate the desired outcomes?
Which areas do not need added incentives? Does an additional unit of performance merit or even need additional incentives to achieve?
How much is your organization willing to pay to achieve a level of performance beyond the performance standard? Is there a potential for using cost-sharing?
Does industry PSI and/or PSP prefer additional performance periods (award terms, option years) in lieu of monetary incentives?

Potential PBL Incentives for Commercial Sector PSIs/PSPs

Foundational Tenet - Reward specified metrics-driven performance and outcome requirements, not transactions (e.g., spare parts, repairs), which in turn encourages the PSI and/or PSP to improve performance while reducing costs

Potential Positive Incentives/Motivators for Commercial Sector PSIs/PSPs (“Rewards”)

There are a broad spectrum of potential positive incentives/motivators that can be used to encourage and/or facilitate achievement of desired product support outcomes by commercial sector PSIs and/or PSPs, including:

Monetary/Financial

FFP) contract type to incentivize industry PSI to reduce internal costs in order to increase their contract profit, as well as to make investments in product (e.g., Reliability and Maintainability (R&M), reduce demand and/or consumption of parts), infrastructure (e.g., plant, equipment, tooling, personnel), and process (e.g., supply chain, Diminishing Manufacturing Sources and Material Shortages (DMSMS)/obsolescence management, Repair Turnaround Time RTAT), Logistics Response Time (LRT))
Profits (measured either in real dollar terms or in profit margin). When commercial providers are paid for performance (vice per transaction), profits directly affected by any additional costs incurred in meeting contractual requirements.

Cost Incentives (FAR 16.402)

“Cost Share (e.g., Fixed Price Incentive Firm [FPIF] or Cost Plus Incentive Fee [CPIF] contracts where government and contractor(s) share overrun costs
Establish incentive pools on an annual basis under a multi-year contract for each performance measure/metric in the PBL PSA, with the ability to award a full incentive amount from the pool or a prorated share depending on how well the outcome was achieved
Long-Term Stable Revenue Stream(s)
Incentive Fees (objective measures). Targeted financial incentives (e.g., Incentive Fees) tied to specific, achievable performance outcomes; can be earned when actual costs are lower than target costs. (See also Incentive Contracting - Incentives, Award Fee, Award Term ACQuipedia article.)
Award Fees (subjective measures). Requires an award fee plan describing the performance areas to be incentives.
Progress Payments and/or Performance Based Payments
Gain Share. According to a Naval Postgraduate School MBA Professional Report “PBL for the FA-18/S-3/P-3/C-2 Auxiliary Power Unit (APU) at Honeywell; An Applied Analysis (December 2005) “gain sharing recognizes both the government’s and contractor’s self-interests by providing incentives versus penalties, empowerment versus oversight, Profits as incentives versus capped profits” Both parties win because the contractor is profitable and the government gets better performance."
Shared Cost and/or Performance Risk with Government (contractor retains all savings below a forecasted level, or government and contractor split the savings)
Cash Flow. According to a March-April 16 article entitled “Something for Nothing— “Cash Flow” as a Contract Incentive” contracting experts expand on fact “the government completely controls cash flow of funds already budgeted or obligated, and this can be used to provide a powerful contract incentive…. Our proposed incentive concept is to directly tie the progress payment and liquidation rates of a contract to a contractor’s performance. The difference between the limits on customary rates and what could conceivably be used as unusual rates provide the government an additional opportunity for incentivizing contractors. Under such an arrangement, the Program Manager (PM) and Contracting Officer (KO), with proper approvals in accordance with agency procedures, could establish objective (measurable) levels of contractor performance (e.g., cost or performance, including schedule) above minimum contract requirements, for which the government would be willing to provide unusual progress payments. Using objective performance criteria, the government could directly link liquidation rates to performance”. In addition to incentivizing contractors using progress payments at other than customary rates tied to performance, Performance-based payments provide an increased rate of cash flow and payment of any amount is directly tied to completion of events. Both have merit. (For additional insights, see CLC 057 Understanding Performance Based Payments and the Value of Cash Flow.)
Return on Invested Capital (ROIC) (a key measure of a commercial firm’s success is the efficiency with which it converts shareholder assets into profit)
The fewer capital assets required to generate a given level of profit, the better the ROIC
Return on financial investments in product improvements (reliability, maintainability) and process improvements (repair, supply chain, DMSMS/obsolescence mitigation) that lead to desired performance outcomes (improved maintainability, reliability, availability, mean down time, reduced Operating & Support (O&S) cost)

Time/Period of Performance

Contract Length (longer contract lengths that provide sufficient time for the PSI and/or PSP to recoup investments in product, process and/or infrastructure improvements)
- A potential example could be a 10-year PBL contract structured as a one-year arrangement with 9 one-year options risks making it difficult for a contractor to make an internal business case for justifying making R&M improvements once they amortize the costs and benefits over the time period that is on contract. A longer period of performance (e.g., a 5-year base) potentially better incentivizes a contractor to amortize the costs and benefits over the 5-years (or what is left) and invest in desired reliability and maintainability improvements.
Multiyear contracting
- FAR 17.103 defines a “multiyear contract” (as) a contract for the purchase of supplies or services for more than one, but not more than five, program years. A multi-year contract may provide that performance under the contract during the second and subsequent years of the contract is contingent upon the appropriation of funds, and (if it does so provide) may provide for a cancellation payment to be made to the contractor if appropriations are not made.”
- FAR 17.105-2 states “use of multiyear contracting is encouraged to take advantage of one or more of the following:
  - Lower costs
  - Enhancement of standardization
  - Reduction of administrative burden in the placement and administration of contracts
  - Substantial continuity of production or performance, thus avoiding annual startup costs, preproduction testing costs, make-ready expenses, and phase-out costs
  - Stabilization of contractor work forces
  - Avoidance of the need for establishing quality control techniques and procedures for a new contractor each year
  - Broadening the competitive base with opportunity for participation by firms not otherwise willing or able to compete for lesser quantities, particularly in cases involving high startup costs
  - Providing incentives to contractors to improve productivity through investment in capital facilities, equipment, and advanced technology.”
- Additional reporting, restrictions and Congressional notifications apply to DoD's use of multiyear procurement. For additional information, see Defense Acquisition Regulations (DARS) 217.1 Multiyear Contracting, which provides detailed information on the definition, application, and limitations on the use of multiyear contracting
- DPAP defines a multiyear contract as “a type of contract where the Government buys the entire multiyear quantity at the outset, unlike what we do when we use options. The multiyear contract includes requirements covering 2-5 fiscal years
- DoDI 5000.73, para 3.4d covers Multi-Year Procurement – Cost Analysis Requirements. In accordance with 10 USC 3501 (formerly 2306b) a multi-year procurement contract is a contract for the purchase of property for more than 1, but not more than 5, program years. Multi-year contracts in an amount equal to or greater than $500 million may not be entered into unless the contract is specifically authorized by law in an Act other than an appropriations Act…” Note that 10 USC 3531 (formerly 2306c) also addresses multi-year contracts as they relate to the acquisition of services.
Multiple Year Contracts
- According to FAR 17.103 “the key distinguishing difference between multi-year contracts and multiple year contracts is that multi-year contracts, defined in the statutes cited at FAR 17.101, buy more than 1 year’s requirement (of a product or service) without establishing and having to exercise an option for each program year after the first.”
- Multiple year contracts have many of the same incentive benefits as multiyear contracts, such as;
  - Working Capital Funds (WCF) can be used to fund multiple year (vice multi-year) contracts.
  - Since WCFs aren't appropriated funds, the termination liability and minimum funding of out-year requirements aren't applicable.
  - Since WCFs aren't appropriated funds, multiple year contracts don't require Congressional approvals associated with multi-year contractual arrangements.
  - Exercising Contract Options. Defense Federal Acquisition Regulation Supplement (DFARS) 217.2 Options provides additional information on the use and exercise of options.
  - Award Term arrangements/ periods linked to performance (ability to receive extensions to the duration of the contract without competition for excellent performance) (see the Guidebook for Acquisition of Services)

Other

Reputation and Past Performance Assessments (e.g., Past Performance Information Retrieval System [PPIRS] or Contractor Performance Assessment Reporting System [CPARS] ). The government must collect, maintain, and uses information on past performance. An exceptional track record gives a contractor a greater competitive edge in future source selections and in a stronger position for future work.
Recognition as a top performing industry partner by the Services and DLA as part of the DoD's annual Superior Supplier Incentive Program (SSIP)
Organizational recognition programs (in conjunction with government program team) such as the annual system, sub-system, and component level Secretary of Defense (SECDEF) “Gerald R. Beck PBL Awards”
Potential for Additional Depot Level Maintenance Workload, including Non-Core/Above-Core workload
Potential for work previously performed in a commercial activity continuing to be performed by the commercial provider
Potential opportunities for reductions in government oversight and/or contractor reporting requirements

Potential Negative Incentives, Motivators, and/or Remedies for Private Sector Industry PSIs/PSPs Not Achieving Required Outcomes (“Penalties”)

Contractual/Monetary/Financial

Reduced fee or profit under incentive contracts when performance standards are not met
Reduce, Withhold or Stop Performance-based or Progress Payments
Liquidated Damages (While contract clauses such as liquidated damages provide a negative incentive, if the contractor causes harm or damage to the government as a result of failure to perform, the contractor must compensate the government in accordance with the contract clause, according to FAR 11.501 keep in mind that “liquidated damages are used to compensate the Government for probably damages” they “are not punitive and are not negative performance incentives.”)
Remediation Plans
Triggers for Future Considerations
Requiring PSI and/or PSP to perform the services at no additional cost until the performance metrics are met

Time/Period of Performance

Not Exercising Contract Options
Not exercising award term agreement extension if performance goals fail to be attained
Contract Termination for Cause or Default if performance goals fail to be attained
Contract Termination for Convenience

Requirement for/Potential of Competition

Qualify Alternative Sources
External competition (Competing future contracts with capable organic and industry providers)
Internal competition (Although not technically a remedy/negative incentive, internal competition in sole source environment can be used as a strategy where industry ‘competes’ within their own organization in order to cut costs and increase profit, and will typically do so by a) optimizing processes, thereby reducing inefficiency and the associated costs to satisfy a logistics demand, and b) improving the quality of the product (e.g., reliability), thereby reducing overall demand and the cost to deliver the desired performance)

Other

Negative Past Performance Assessment
Show Cause / Cure Notice
Work previously performed in a commercial activity transitions to a Government activity
Potential for increased government surveillance or contractor reporting requirements
Risk of diminished reputation

Potential PBL Incentives for Organic Sector PSIs/PSPs

Foundational Tenet - While monetary/financial incentives focusing on profit may not be appropriate for public sector organizations, increased opportunities for available workload, long-term organizational viability, and potential for personal and organizational recognition (e.g., promotions, bonuses, and awards) are all possible incentives, along with an inherent desire to positively impact Warfighter outcomes and enhance national security.

Potential Positive Incentives/Motivators for Organic Sector PSIs/PSPs (“Rewards”)

There are a somewhat narrower spectrum of potential positive incentives/motivators that can be used to encourage and/or facilitate achievement of desired product support outcomes by government/organic sector PSIs and/or PSPs, including:

Workload

Long-term stable workload, with opportunities for future increases
Capitalize on the use of existing Government infrastructure
Future Depot Source of Repair (DSOR) opportunities
Future Public-Private Partnering (PPP) opportunities
Retaining existing work (work currently performed at a Government activity continues to be performed organically)

Workforce

Individual recognition programs such as:
- The annual Under Secretary of Defense for Acquisition & Sustainment (USD(A&S)) Workforce Individual Achievement Award which are given for excellence in 18 categories, including life cycle, logistics, contracting & procurement, engineering, program management and others.
- Major Command level awards such as the annual AF Materiel Command (AFMC) Depot Maintenance Management of the Year Awards for the individual categories outlined in AFMC Instruction 36-2817. Others include but are not limited to -
  - The Air Force (AF) Logistics Awards Program (AFI 36-2818)
  - The Department of Navy (DON) Admiral Stan Arthur Awards for Logistics Excellence (OPNAV Instruction 5305.8E)
  - The DoD Packaging Awards
  - The SECDEF Maintenance Awards (DoDI 1348.30)
- Individual performance appraisals/annual performance reviews
  - Utilize and build upon resident expertise of workforce
  - Monetary incentives, workforce performance bonuses, on-the-spot awards
  - Promotions
  - Awards programs, individual and team recognition
  - Professional development opportunities
  - Investments in continuous process improvements
  - Intangible (e.g., workforce commitment to the mission, morale, teambuilding, pride in craftsmanship, quality, contribution to national security, support of the warfighter, sense of making a difference)

Organizational

Organizational and team recognition award programs such as:
- The David Packard Excellence in Acquisition Award, DoD’s highest acquisition team award. Awarded annually since 1997, it emphasizes superior program management or successful execution of one or more initiatives to reduce life-cycle costs, including Performance Based Logistics.
- Major Command level awards such as the annual AF Materiel Command (AFMC) Depot Maintenance Management of the Year Awards for teams as outlined in AFMC Instruction 36-2817
- the AF Logistics Awards Program (AFI 36-2818)
- The DON Admiral Stan Arthur Awards for Logistics Excellence - Logistics Team of the Year category (OPNAV Instruction 5305.8E)
- The DoD Packaging Awards
- The SECDEF Maintenance Awards (DoDI 1348.30)
- The annual system, sub-system, and component level SECDEF “Gerald R. Beck PBL Awards”
- The annual SECDEF Robert T. Mason Award for Depot Maintenance Excellence ” as the outstanding program from a major organic depot-level maintenance facility that exemplifies responsive, transformed, depot-level maintenance support to DoD operating units
- Capital investment in infrastructure modernization and workforce improvements (plant, equipment, data system, supply chain, personnel and/or Process Improvements)
- Enhanced capability and capacity
- Minimize risk of future/potential base realignment/closure (BRAC)
- Intangible (e.g., Enhanced organizational reputation, customer satisfaction, warfighter confidence)

Potential Negative Incentives, Motivators, and/or Remedies for Organic Sector PSIs/PSPs Not Achieving Required Outcomes (“Penalties”)

Workload

Work previously split between a Government and commercial activity is realigned according to the provisions of the PBL arrangement and in accordance with statutory requirements and DoD policy
Risk of shift of workload to other organic organizations (including those of other Services/Agencies/Commands)
Depot maintenance work previously performed at a Government activity risking being transitioned to a commercial repair facility (in accordance with statutory and/or DoD policy)
Risk of potential loss of non-depot maintenance work (e.g., supply chain management, transportation services, sustaining engineering) not covered by 10 USC 2464, 2466, or 2469 to a commercial provider
Rework required in instances of poor quality

Workforce

Individual performance appraisals/annual performance reviews
Risk of potential reductions in force (RIF) in instances of excess capacity or as part of Service workload allocations

Other

Risk of future/potential base realignment/closure (BRAC) vulnerability
Risk of increase in excess capacity
Intangible (e.g., organizational reputation, loss of warfighter confidence, impact on combat capability, etc.)

Several related resources from the Government Accountability Office (GAO):

To view a 15-minute video on contract incentives, click here.

Click here to view a video on PBL Best Practices, featuring perspectives by Ms Lisa P. Smith, DASD(PS), and two Service practitioners describing successful PBL arrangements at the subsystem/component and system (platform) level.

Statutes and Codes

10 USC 4324, Life-cycle management and product support

FAR Parts

Part 10 - Market Research

Part 15 - Contracting by Negotiation

Part 16 - Types of Contracts

Part 17 - Special Contracting Methods

Part 37 - Service Contracting

DFARS Parts

Part 217 Special Contracting Methods

Part 237 Service Contracting

DAU Tools