Establish/Refine Product Support Arrangements

Traditional Support Strategies vs. Outcome-Based Strategies

Reducing "Risk" to the Government

Contract Types

Table 1. DoD Contract Types

Contract Incentives

Table 2. Award Fee Table

Contract Strategies

Figure 1. Notional PBL Contract Strategy

Document the implementing Product Support Arrangements (contract, MOA, MOU, PBA, CSA, SOO/SOW for the Performance Work Statement, etc.) that assign and delineate the roles, responsibilities, resourcing, and reciprocal aspects of product support business relationships.

Product Support Arrangements, discussed in detail in Section 2.2 and Appendix F – Product Support Arrangement (PSA) Types of the Product Support Manager’s Guidebook serve to formalize the roles, responsibilities, relationships, and commitments of the active participants in the product support strategy. These participants include, at minimum, the PM, PSM, Warfighter customer, resourcing Commands, PSIs, PSPs, and associated stakeholders or participants in product support. Product Support Arrangements may take a variety of forms, including Memoranda of Understanding (MOUs), Memoranda of Agreement (MOAs), Product Support Arrangements (PSAs), and contracts, or a combination of any or all of these. The PSM should ensure that PSAs are in place to document and define each relationship that is part of the execution of the product support strategy. These PSAs should reflect the exact price and performance agreements used in source selection and include agreed on mechanisms to demonstrate achievement of outcomes. The PSAs should ensure the PSM's plan will be executed in a manner agreeable to both the PSI and the PSM.

With on-going budget challenges within the department, a high degree of focus has been brought to the structure of agreements. Additional guidance and information can be found on the Better Buying Power website.

Traditional Support Strategies vs. Outcome-Based Strategies

In traditional support strategies, where DoD purchases transactional goods and services, it is incumbent upon DoD to specify which goods and services are desired, and how many of each is desired. The support provider’s only responsibility is to provide the goods or services requested. If DoD managers make inaccurate decisions about which items need to be repaired, or what quantity of items need to be purchased, then responsibility for the subsequent degradation of system operational effectiveness lies with DoD, not the support provider. Conversely, when DoD buys a level of support or performance, then the responsibility for the subordinate decisions (i.e., which items to repair, what quantity of items to procure) transitions to the product support provider, along with the risk for the resulting effect on operational effectiveness.

Reducing "Risk" to the Government

Inherent in any business transaction where a level of performance is purchased, rather than discrete goods and services, there is a de facto shift of risk to the provider of support. This is true of outcome-based partnerships, as well. While DoD can never completely delegate risk for system operational performance, outcome-based strategies move a level of risk away from DoD to the product support provider commensurate with the scope of support for which the product support provider is responsible. If structured with the right metrics, incentives, and strictly limited exclusions to coverage, a product support package will highly incentivize the product support provider to make good decisions and manage to avoid financial consequences of bad decisions.

If responsibilities are delineated to match core competencies, overall programmatic risk is reduced. Good risk management means that the entity best positioned to manage and mitigate a risk should be responsible for it, and that can be the product support provider. Correctly structured product support strategies will significantly reduce, but not eliminate, risk to the government.

Contract Types

Contract types vary according to:

1. The degree and timing of the responsibility assumed by the contractor for the costs of performance; and
2. The amount and nature of the profit incentive offered to the contractor for achieving or exceeding specified standards or goals.

DoD support contracts fall into two broad categories: Cost Plus or Fixed Price. Product support contracts can be of either type, but typically the objective is to work towards a Fixed Price contract, in conformance with the concept of buying defined outcomes at a defined price. A recent discussion of the use and applicability of different contract types occurred in the Memorandum for Secretaries of the Military Departments and Directors of the Defense Agencies (November 3, 2010), signed by USD(ATL).

Table 1. DoD Contract Types

Within these two broad categories (Fixed Price and Cost Plus), there are further delineations of specific contract types:

• Cost Plus
  • Cost Plus Fixed Fee (CPFF):
    • Used when cost and pricing risk is maximum (VERY early);
    • Basically reimburses the contractor for level of effort work accomplished, plus reasonable profit.
  • Cost Plus Incentive Fee (CPIF):
    • Used early in program when the metric baseline is immature;
    • Primarily oriented toward cost (allowable and target);
    • Can include some performance incentives other than cost.
  • Cost Plus Award Fee (CPAF):
    • Used when subjective assessments of contractor performance are desired (i.e., customer satisfaction);
    • When used - usually in combination with CPIF.
• Fixed Price:
  • Firm-Fixed Price (FFP) or Fixed Price - Award Fee (FPAF):
    • Used when cost and resource baseline is fully mature - pricing risk is minimum;
    • Puts highest risk on the contractor and lowest risk on the government.

The major determinant factor in choosing between Cost Plus and Fixed Price contracts is the degree of pricing risk present in the support cost. In general, pricing risk is high during the early phases of program development and deployment; hence the use of Interim Contracting Support (ICS) contracts on a cost reimbursable basis. As costs become more stable, but still subject to pricing risk, a transition to a Contractor Logistics Support (CLS) contract of a Cost Plus (CP) type is feasible, including the addition of either Incentive Fee (CPIF) or Award Fee (CPAF) features, or a combination of both (CPIF/AF).

These types of Cost Plus contracts can be structured with cost targets, incentives, and other features that realize most, but not all, the price benefits of Firm Fixed Price contracts while still accommodating pricing risk. Again, the ultimate objective should be to convert to a long term Firm Fixed Price contract with appropriate incentive features (i.e., FPAF). Fixed Price contracts are inherently cost-controlled. The contractor will not be paid more or less than the specified fixed price.

When used in outcome-based strategies, where achievement of specified performance outcomes is desired, the Fixed Price Award Fee (FPAF) is the usual form of fixed price contract utilized. The contractor receives the fixed price negotiated in the contract, while also having the opportunity to earn a “bonus” amount in the form of the Award Fee based on their success in meeting the metrics specified in the Award Fee plan. In a Fixed Price contract, a commercial PSI enters into a contractual arrangement with the understanding that they will receive a fixed price, regardless of the amount of resources or cost they contribute to the effort. This financial risk is a factor in their negotiation of both contract price and incentives. The nature of the incentives will dictate the type of fixed price contract, such as Fixed Price Award Fee, Award Term, Gain Sharing, or others as appropriate.

"Award term" is a contract performance incentive feature that ties the length of a contract's term to the performance of the contractor during the performance period. The contract can be extended for "good" performance or reduced for "poor" performance. The award term feature is similar to award fee contracting where contract performance goals, plans, assessments, and awards are made regularly during the life of a contract. But, unlike an Award Fee, an Award Term does not result in the award of a fee. Instead, an incremental change to the period of performance is awarded. Award term solicitations and contracts should include a base period (e.g., 3 years) and a maximum term (e.g., 10 years) that can be earned through good performance.

The critical advantage to Fixed Price contracts is that they tend to be self-motivating. They motivate the contractor to do inherently good things such as procure ultra-reliable parts and perform high quality repair actions, since the contractor ultimately benefits from less cost (and higher profit) resulting from fewer parts and repairs required over the long term. Developing a contracting strategy, encompassing the phasing and types of contracts, is a critical factor in product support strategy development. A notional example of contract phasing is shown below.

Contract Incentives

Outcome-based product support has been described as a transition from arms length to arm-in-arm relationships between commercial providers and organic organizations. It requires open and honest communication, a commitment to team relationships that optimize system objectives over parochial interests and long-term success over short-term gain. Outcome-based contracts and formal agreements are, with intent, structured to produce win-win scenarios. For many years, DoD contracting had a strong “win” orientation, negotiating the best terms with little regard for the benefits or terms of the other party. In performance-based product support strategies, it is possible to describe and document terms that optimize performance outcomes and objectives for both parties in the relationship.

One of the best ways to achieve a win-win scenario in contracting is through the use of contractual incentives. Contract incentives will vary depending on the program phase, level of risk, and level of baseline maturity. Product Support Integrators should be motivated to achieve those performance outcomes that are 1) most relevant to the program activities ongoing at the current program phase, and 2) are consistent with the scope of PSI responsibility for managing activities to achieve those outcomes.

The most common incentives are listed below:

• Incentive Fee
  • Incentive Fee evaluations are quantitative in nature and are considered to be more objective than Award Fee contracts, which rely on subjective criteria.
  • Most incentive contracts are primarily oriented toward cost incentives, which take the form of a profit or fee adjustment formula and are intended to motivate the contractor to effectively manage costs. No incentive contract may provide for other incentives without also providing a cost incentive (or constraint).
  • Incentive contracts may include a target cost, a target profit or fee, and a profit or fee adjustment formula that (within the constraints of a price ceiling or minimum and maximum fee) provides that
    1. Actual cost that meets the target will result in the target profit or fee;
    2. Actual cost that exceeds the target will result in downward adjustment of target profit or fee; and
    3. Actual cost that is below the target will result in upward adjustment of target profit or fee.
  • Performance incentives may also be included, and should be considered in connection with specific product characteristics (e.g., a missile range, an aircraft speed, an engine thrust, or vehicle maneuverability) or other specific elements of the contractor's performance. These incentives should be designed to relate profit or fee to results achieved by the contractor, compared with specified targets achieved by the contractor.

• Award Fee
  • An Award Fee plan is established
  • Can be a combination of quantitative and qualitative assessments, but it is more subjective than an incentive fee plan
  • Award fee (or portion thereof) is earned by meeting Award Fee plan performance goal

• Award Term
  • Additional (option) years are added to the original contract based on satisfactory contractor performance
  • Like an Award Fee contract, an Award Term contract relies on evaluations that are qualitative in nature, and tend to be subjective.

• Shared Savings (Gain Sharing)
  • When a pre-negotiated maximum contractor profit increases (meaning costs decrease due to contractor achieved savings), DoD and contractor share the savings based on a percentage formula (e.g., 50/50); (NOTE: The Contractor should share in any cost OVER-RUNS as well!)
  • The recently awarded USAF tanker contract is an example of a gain sharing approach.

Earning contractual incentives is based on meeting the contractual metrics for performance and/or support. Although varying from contract to contract, metrics should be structured to earn a full incentive if metrics are met or exceeded, and lesser portions of the incentives if the metrics are not fully met, with lesser amounts of incentive earned down to a metric floor at which point no incentives are earned. As an example, a metric may be Non-Mission Capable Supply (NMCS), which measures the percent of time that a system is not Mission Capable due to lack of a critical part supplied by the PSI. A typical percentage target for this metric would be 5%, meaning that the metric would be fully met if, for the weapon system fleet, the total Non-Mission Capable percent attributable to critical parts supplied by the PSI does not exceed 5% for the measurement period (i.e., the PSI makes the part available 95% of the time). If met, the PSI would receive the full incentive. However, the contract should also identify a sliding scale of NMCS percentages, for example, from 6-10%, with an incentive amount (less than the full incentive amount) identified for each percentage point higher than 5% but not greater than 10%. For example, if the NMCS percentage for the measurement period was 6%, then the PSI would receive the incentive amount (again, less than the full 5% NMCS incentive amount) identified at that percentage level, and correspondingly decreasing incentives at 7, 8, 9, and 10% respectively. An NMCS percentage of 11% or higher would earn no incentive. This award fee structure is shown graphically in the table below.

Table 2. Award Fee Table

Although the focus of outcome-based contracts is positive, through inclusion of incentives, it may be necessary to include disincentives, or remedies, when the PSI does not achieve a minimum performance requirement. Although not earning an incentive should be adequate sanction, as described above, there may be circumstances where an actual reduction in the base contract amount, vice non-earning of an incentive, will apply. Use of remedies in contracts should be rare and, as stated, will usually be suitable only for unusual, but highly mission critical, situations.

Contract Strategies

Figure 1. Notional PBL Contract Strategy

Figure 1 relates the notional contract type for a PBL Product Support Strategy to the applicable acquisition and sustainment life cycle phase. An initial CPFF contract is used for Interim Contractor Support (ICS) during the Engineering & Manufacturing Development phase in order to capture performance and cost data which will be used to improve the cost estimate accuracy and to reduce risks in subsequent contracting stages.

In the Production and Deployment phase, a Cost Plus Award Fee (CPAF) or Cost Plus Incentive Fee (CPIF) contract may be implemented to incentivize the Contractor to meet the more accurate performance and cost objective metrics.

By the Operations and Support Phase, sufficient performance and cost data has been captured to enable contracting with Industry at reduced risk with a Firm Fixed Price or Cost Plus Incentive Fee contract with cost reduction targets.

Long Term Contracting

A long-term contract is a contract issued for a period longer than one year. It may be awarded for a basic year with options for additional years (usually in one-year increments) or it may be a multi-year contract (where the base period is more than one year). It may be for a single item or service or for a group of related items or services.

In most cases a vendor quotes a single contract price based on the range and parameters set in proposed quantity range. The solicitation may request pricing separately for shipments that will go to different locations and separate prices for each option period. Whether he bases his unit price on the estimated annual demand or on the minimum or maximum quantities of the contract or delivery orders, is up to the vendor. A vendor must weigh his/her risks when quoting a long-term contract. Quoting based on a guaranteed minimum quantity may be the safe way to not lose money but may not be competitive. On the other hand, quoting based on an assumption of the maximum contract quantity may place a burden on the vendor if and when the government only orders a small portion of that. Requirements contracts have an even greater risk, with no guaranteed quantity, but the benefits of secured sales over a period of time may be worth the risk. It is a judgment made by the vendor. Distributors, in particular, must ensure that they have long term agreements with manufacturers, so that they can provide the item at the prices quoted.

These include:

• Establishing a reliable source of supply.
• Taking advantage of modernization efforts the contractor may implement to reduce costs.
• Locking in a long-term commitment for supporting programming and budgeting requests.

Multi-Year Contracting

• Multi-year contracting is a special contracting method to acquire known requirements in quantities and total cost not over planned requirements for up to 5 years unless otherwise authorized by statute, even though the total funds ultimately to be obligated may not be available at the time of contract award. This method may be used in sealed bidding or contracting by negotiation.
• Multi-year contracting is a flexible contracting method applicable to a wide range of acquisitions. The extent to which cancellation terms are used in multi-year contracts will depend on the unique circumstances of each contract. Accordingly, for multi-year contracts, the agency head may authorize modification of the requirements of this subpart and the clause at 52.217-2, Cancellation Under Multi-year Contracts.
• Agency funding of multi-year contracts shall conform to the policies in OMB Circulars A-11 (Preparation and Submission of Budget Estimates) and A-34 (Instructions on Budget Execution) and other applicable guidance regarding the funding of multi-year contracts. As provided by that guidance, the funds obligated for multi-year contracts must be sufficient to cover any potential cancellation and/or termination costs; and multi-year contracts for the acquisition of fixed assets should be fully funded or funded in stages that are economically or programmatically viable.
• The termination for convenience procedure may apply to any Government contract, including multiyear contracts. As contrasted with cancellation, termination can be effected at any time during the life of the contract (cancellation is effected between fiscal years) and can be for the total quantity or partial quantity (where as cancellation must be for all subsequent fiscal years' quantities). For DoD, NASA, and the Coast Guard, the head of the agency may enter into a multi-year contract for supplies if:
  1. The use of such a contract will result in substantial savings of the total estimated costs of carrying out the program through annual contracts;
  2. The minimum need to be purchased is expected to remain substantially unchanged during the contemplated contract period in terms of production rate, procurement rate, and total quantities;
  3. There is a stable design for the supplies to be acquired, and the technical risks associated with such supplies are not excessive;
  4. There is a reasonable expectation that, throughout the contemplated contract period, the head of the agency will request funding for the contract at a level to avoid contract cancellation; and
  5. The estimates of both the cost of the contract and the cost avoidance through the use of a multi-year contract are realistic.

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