High-Risk Contracts A Balanced Approach Breakout Session

High-Risk Contracts: A Balanced Approach Breakout Session # B 03 Monday, July 30, 2012 2: 30 -3: 45 Mr. John Dobriansky, MBA, CPCM, Fellow Lead, Major Systems Acquisitions U. S. Department of Transportation Dr. Rene G. Rendon, CFCM, CPCM, Fellow Associate Professor Naval Postgraduate School 1

High-Risk Contracts: A Balanced Approach • Background • Current Deficiencies in Contracting • Factors Leading to the Use of High-Risk Contracts • Strategies for Mitigating Risks • Case Studies on Contract Type Selection • Lessons Learned and Best Practices 2

Background • White House Memo-Government Contracting – Increased use of sole-source and cost reimbursement contracts – Wasteful, inefficient, subject to misuse, poor contractor performance – Inadequate accountability – Need to minimize sole source risks – Ensure capacity for management and oversight of contracts (March 4, 2009)

Background • White House Memo-Government Contracting – Blurred and inadequate definition of inherently government functions – Directs Office of Management and Budget (OMB) to issue more guidance on: • Govern use of sole source contracts • Maximize the use of competitive processes • Govern appropriate use of contract types • Assessing ability of acquisition workforce • Clarify when outsourcing services is and is not appropriate

Background • Remarks by the President on Procurement – Focus on how government does contracting – We must uphold public trust – Overruns, fraud, absence of oversight and accountability, no competition, contractors overseeing other contractors (March 4, 2009)

Background • Remarks by the President on Procurement – Defense contracting • False choice--securing the nation and waste billions of taxpayer dollars • GAO report---cost overruns totaling $295 B • Investments in unproven technologies • Lack of oversight • Influence peddling • Indefensible no-bid contracts • Iraq—services never performed

Background • Remarks by the President on Procurement – Immediate Steps: 1. Develop new contracting guidelines: – Stop outsourcing inherently government activities – Open up to small businesses – End unnecessary no-bid and cost plus contracts – Strengthen oversight, transparency, accountability

Background • Remarks by the President on Procurement – Immediate Steps: 2. Make investments that will keep our country safe – Invest in proven and cost effective technologies – Increase competition

Background • OMB Memo - Improving Government Acquisition 1. Savings Plans--$40 B – End contracts that do not meet program needs – Build skills of acquisition workforce, recruit new talent – Develop more strategic acquisition approaches – Increase the use of technology to improve contract management – Reengineer ineffective business processes (July 29, 2009)

Background • OMB Memo - Improving Government Acquisition 2. Reduce the use of high risk contracting authorities • Sole source contracts • Cost reimbursement contracts • Time and Materials • Labor Hour (July 29, 2009)

Background • OMB Memo - Improving the Use of Contractor Past Performance • Currently use of fragmented methods to collect and maintain contractor performance information 1. New FAR requirements for strengthening the use of contractor performance information 2. Chief Acquisition Officer (CAO) and Senior Procurement Executive (SPE) responsibilities 3. Establish Office of Federal Procurement Policy (OFPP) review process(July 29 2009)

Background • OMB Memo - Managing the Multi-Sector Workforce Use of both federal and private sector employees – Process of developing and implementing policies, practices, and tools for managing multi-sector workforce (July 29, 2009)

Background • OMB Memo - Managing the Multi-Sector Workforce Immediate steps: • Adopt a framework for planning and measuring the multi-sector workforce • Conduct a pilot human capital analysis • Use guidelines that facilitate consistent and sound application of statutory responsibilities for insourcing (July 29, 2009)

Current Deficiencies in Federal Government Contracting • GAO High Risk – Do. D contract management is listed as a “high risk” by the GAO (since 1992) • Lack of well-defined requirements • Use of ill-suited business arrangements • Lack of trained contract management personnel GAO-11 -278

Current Deficiencies in Federal Government Contracting • Do. D IG Findings – Not conducting adequate market research – Use of inappropriate contract type – Lack of management structure and processes – Insufficient requirements management – Insufficient contract administration and contractor oversight Do. D IG D-2009 -071

Determining Contract Type • Objectives in Selecting Contract Type – Reasonable allocation of risk between buyer and contractor – Provide contractor maximum amount of incentive – Minimize contract administration cost for both parties

Determining Contract Type • Factors to Consider in Selecting Contract Type – Capability of seller’s accounting system – Uncertainty in the cost estimate – Type and complexity of the requirements – Urgency of the requirement – Marketplace and competition – Seller’s technical capability – Administrative costs to both parties – Size and amount of the contract

18

Implementation Project Life Cycle Technology Challenge Procurement Risk High Cost-Reimbursement Time & Materials Cost High Fixed-Price More Defined Low Conceptual Requirement Less Defined (Adopted from Fleming, 2003)

Factors Leading to High-Risk Contracts • Lack of market research • Insufficient requirements determination and definition • Insufficient systems engineering effort • Inadequate cost estimating • Lack of government monitoring or contractor surveillance

GAO-01 -288

Strategies for Risk Mitigation Using High Risk Contracts • High Risk Contracts – May NOT be High Risk • In fact High Risk Contracts when used effectively may result in reduced cost, schedule and performance risk to Government.

Strategies for Risk Mitigation Using High Risk Contracts Apply a Program Management Approach • Contracting is one of the key core program team members • Select and develop an experience and capable core team of Government acquisition professionals to perform strong contract oversight and surveillance. Who should be on the team? • Experienced Level III Certified Contracting Officer • Experienced Level III Certified Program Manager • Experienced, Certified Contracting Officer’s Representative

Strategies for Risk Mitigation Using High Risk Contracts Apply a Program Management Approach Who should be on the team continued? • Subject Matter Experts • Key internal stakeholders- must be actively engaged • Key external stakeholders – must be actively engaged • Support contractors under the oversight of a Federal Employee Lead

Strategies for Risk Mitigation Using High Risk Contracts Program Management Approach Stakeholder Management Critical to Program Success Key internal stakeholders- must be actively engaged Key external stakeholders – must be actively engaged • The Chief Acquisition Officer and Senior Procurement Executive • The Chief Financial Officer • The Chief Information Officer • Flag Officers

Strategies for Risk Mitigation Using High Risk Contracts Program Management Approach Stakeholder Management Critical to Program Success Key internal stakeholders- must be actively engaged Key external stakeholders – must be actively engaged • Program Directors • Program Executive Officers • Unions

Strategies for Risk Mitigation Using High Risk Contracts Negotiate and execute a good business deal • Avoid Cost Plus Fixed Fee Contracts for other than pure research • Cost Plus Fixed Fee (CPFF) Contracts provide little incentive for contractor cost control • If you must use a CPFF contract, use a CPFF completion type contract

Strategies for Risk Mitigation Using High Risk Contracts Negotiate and execute a good business deal • Use Cost Plus Incentive Fee Contracts for major systems and technology intensive programs with not well defined requirements • Use measureable and doable cost, schedule and performance incentives

Strategies for Risk Mitigation Using High Risk Contracts Negotiate and execute a good business deal Use measureable and doable cost, schedule and performance incentives Apply the SMART approach when developing, negotiating and implementing contract incentives • • • Specific Measurable Attainable Realistic Timely

Strategies for Risk Mitigation Using High Risk Contracts • Use CPIF contracts for technology intensive, major systems acquisitions with loosely defined requirements for the early phases (prior to limited or first lot production) • Make use of measureable and doable cost, schedule and performance incentives and disincentives • Make the right risk allocation between the Government and the Contractor. • Do a great business deal, hold the Contractor accountable.

Case Studies on Contract Type Selection Case of Inappropriate Use of a High Risk Contract Type with the Type of Program The United States Navy’s A-12 Avenger II Background: • The Navy’s A-12 Avenger II was a proposed aircraft carrier based stealth bomber replacement for the Grumman A-6 Intruder. 858 of the A-12 were planned to be acquired for the Navy and Marine Corps. • Concept development fly-off contracts were awarded to two teams in January 1988: • Mc. Donnell Douglas/General Dynamics • Northrup Grumman/Vought

Case Studies on Contract Type Selection Case of Inappropriate Use of a High Risk Contract Type with the Type of Program The United States Navy’s A-12 Avenger II Background continued: • The A-12 was a flying wing design in the shape of an isosceles triangle, with the cockpit situated near the apex of the triangle, powered by two General Electric F 412 -D. The A-12 was designed to carry precision weapons internally including AIM -120, AMRAAM air-to-air missiles, AGM-88 HARM air-to-ground missiles and large air-to-ground ordnance. The A-12 gained the nickname the “Flying Dorito” • Concept development fly-off contracts were awarded to two teams in January 1986: • Mc. Donnell Douglas/General Dynamics • Northrop Grumman/Vought

Case Studies on Contract Type Selection Cases of Inappropriate Use of a High Risk Contract Type with the Type of Program The United States Navy’s A-12 Avenger II A firm fixed price development contract was awarded to the Mc. Donnell Douglas/General Dynamics team in January 1988: By 1990, Significant problems were reported the Navy and the Contractor team • The A-12 was $2 billion dollars over budget, • The A-12 more than 30% overweight potentially jeopardizing the aircrafts suitability for Carrier operations, • The A-12 state of the art radar system was not working.

Case Studies on Contract Type Selection Cases of Inappropriate Use of a High Risk Contract Type with the Type of Program and Contract Issues • Fixed Price Research and Development Program and Contract Type • All risk is on the contractor to perform, right? • Wrong, billions of dollars of requests for equitable adjustments and billions of dollars of claims from the contractor to the Government • In the end, the risk allocation to the Government using an inappropriate firm fixed price contract type may cost the Government billions of dollars more without achieving the planned cost, schedule and performance objectives.

Case Studies on Contract Type Selection Cases of Inappropriate Use of a High Risk Contract Type with the Type of Program • Fixed Price Research and Development Program and Contract Type • The United States Navy’s A-12 Avenger II • Results: Dick Cheney, then Secretary of Defense ordered the A-12 program terminated for breach of contract in 1991. • The Mc. Donnell Douglas/General Dynamics Contractor Team litigated. The case has gone all the way to the U. S. Supreme Court. • The contract termination is still in litigation today some 23 years later.

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts The Department of Transportation, Federal Aviation Administration’s (FAA), En Route Automation Modernization (ERAM) Program • The FAA’s ERAM program is a $2 billion dollar program that replaces and upgrades the 50 year legacy HOST system for air traffic control of 29000 flights per day. The HOST system, written in computer languages such as Assembler and Algol, is expensive and difficult to maintain. • The ERAM provides updated air traffic management capabilities including better aircraft separation management – 3 miles versus the current 5 miles. A win-win situation for the FAA, the Airlines and passengers. • ERAM is to be fully deployed at 20 major Air Traffic Control Centers (ARTCCs) across the country. Like other major systems programs the ERAM is behind schedule and over cost.

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts The Department of Transportation, Federal Aviation Administration’s, En Route Automation Modernization (ERAM) Program • Acquisition Strategy and Contract Type(s) Selected • The initial acquisition strategy was essentially a competition between Lockheed Martin and Raytheon. The award to Lockheed Martin was protested by Raytheon. A settlement was reached with Lockheed Martin (LM) as the Prime Contractor and Raytheon as a major subcontractor to LM. • The resulting contract to LM was awarded in December of 2003.

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts The Department of Transportation, Federal Aviation Administration’s, En Route Automation Modernization (ERAM) Program Acquisition Strategy and Contract Type(s) Selected • Hybrid contract type • The contract type is a hybrid contract type: • Specific work packages for software development, integration and test, deployment and on-site support linked to specific Contract Line Items (CLINS).

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts The Department of Transportation, Federal Aviation Administration’s, En Route Automation Modernization (ERAM) Program • Hybrid contract type • The contract type is a hybrid contract type: • Specific work packages for software development, integration and test, deployment and on-site support linked to specific Contract Line Items (CLINS). • Each specific work package and CLIN can have different contract types reflecting different levels of requirements maturity and risk allocation.

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts The Department of Transportation, Federal Aviation Administration’s, En Route Automation Modernization (ERAM) Program • Hybrid contract type • Specific work packages for software development, integration and test, deployment and on-site support linked to specific Contract Line Items (CLINS). • Each specific work package and CLIN can have different contract types reflecting different levels of requirements maturity and risk allocation. • Earlier in the program some of the software development contract CLINS were Cost Plus Fixed Fee. (CPFF)

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts The Department of Transportation, Federal Aviation Administration’s, En Route Automation Modernization (ERAM) Program Hybrid Contract Type • Each specific work package and CLIN can have different contract types reflecting different levels of requirements maturity and risk allocation. • Earlier in the program some of the software development contract CLINS were Cost Plus Fixed Fee. (CPFF) • This did not provide for effective program and contract cost, schedule and performance management.

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts The Department of Transportation, Federal Aviation Administration’s, En Route Automation Modernization (ERAM) Program • Each specific work package and CLIN can have different contract types reflecting different levels of requirements maturity and risk allocation. • For improved program and contractor management, the extensive use of Cost Plus Incentive Fee (CPIF) CLINs for software development, integration and test, and deployment. • As the program and requirements matured CPIF CLIN Share Ratio’s were applied that placed more risk on LM for software development and integration and test and deployment.

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts The Department of Transportation, Federal Aviation Administration’s, En Route Automation Modernization (ERAM) Program • For improved program and contractor management, the extensive use of Cost Plus Incentive Fee (CPIF) CLINs for software development, integration and test, and deployment. • As the program and requirements matured CPIF CLIN Share Ratio’s were applied that placed more risk on LM for software development and integration and test and deployment. • Specific incentive arrangements in cost, schedule and performance (software quality assurance) are developed and applied to enhance contractor performance.

Case Studies on Contract Type Selection Case of Appropriate use of High Risk Contracts • The Department of Transportation, Federal Aviation Administration’s, En Route Automation Modernization (ERAM) Program • As the program and requirements matured CPIF CLIN Share Ratio’s were applied that placed more risk on LM for software development and integration and test and deployment. • Specific, measurable and doable incentive arrangements in cost, schedule and performance (improved software quality assurance) are developed and applied to enhance contractor performance. • Specific measurable and doable incentives are placed on LM achieving successful and on-schedule or better Initial Operational Capability (IOC) at more of the 20 Air Traffic Control Centers (ARTCCs).

Lessons Learned and Best Practices Use a Program Management Approach: • Establish the program management team – Select and maintain a highly capable Federal team of contracting officer (s), program management, contracting officer’s representative, and subject matter experts to perform superior contractor management and oversight. • Use effective life cycle management techniques from start to finish – Manage program requirements well to mitigate cost, schedule and performance overruns and issues.

Lessons Learned and Best Practices Use a Program Management Approach Continued: Use effective life cycle management techniques from start to finish • Manage program requirements well to mitigate cost, schedule and performance overruns and issues. • Use integrated Processes for effective contract management and oversight

Lessons Learned and Best Practices Mate the right contract type with the right program type • Assess your program requirements and maturity level early in acquisition strategy phase when choosing contract type

Lessons Learned and Best Practices Negotiate and execute a good business deal Use measureable and doable cost, schedule and performance incentives Apply the SMART approach when developing, negotiating and implementing contract incentives • • • Specific Measurable Attainable Realistic Timely

References Do. D IG D-2009 -071 Fleming, Q. W. , Project Procurement Management, 2003 GAO-01 -288 GAO-11 -278 OMB Memo, July 29, 2009 Rendon R. , Snider, K. Management of Defense Acquisition Projects, 2008 USD(AT&L) Memo, September 14, 2010 White House Memo, March 4, 2009