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An Incentive for Commercial Items Contracts

A Guest Article for Where in Federal Contracting?

by Vernon J. Edwards

June 19, 2000

  On April 5, 2000, Deputy Under Secretary of Defense for Acquisition and Technology Dr. Jacques Gansler directed the military departments and defense agencies to make 50 percent of their service contracts performance-based by the year 2005.  An attachment to the memo said that performance-based contracting facilitates use of the commercial items procedures in FAR Part 12 and that incentives should be used on fixed-price contracts.  In the Arnet Open Forum, one participant asked whether the use of incentives would be consistent with FAR 12.207, which requires that all contracts awarded pursuant to FAR Part 12 be firm-fixed-price or fixed-price with economic price adjustment.  Another participant expressed the opinion that agencies cannot use incentives on commercial items contracts. 

FAR 16.202-1 defines a firm-fixed-price contract as one that “provides for a price that is not subject to any adjustment on the basis of the contractor’s cost experience in performing the contract.”  The fixed-price incentive contracts described in FAR 16.403 are not firm-fixed-price contracts, because the incentive payoff depends on the contractor’s incurred cost and the contract price thus varies based on the contractor’s cost experience.  However, an agency could use a firm-fixed-price contract that promises to pay a bonus for excellent performance, but that does not link the bonus to the contractor’s cost experience.  Such a contract meets the definition of firm-fixed-price in FAR 16.202-1 and thus could be used for commercial items contracts, whether the bonus was to be a lump sum or a variable amount.  Such a contract would also satisfy FAR 16.402-1, which says, “No incentive contract may provide for other incentives without also providing a cost incentive (or constraint),” because the price would not be subject to any adjustment based on the contractor’s cost experience.

Although I think that the use of such bonus incentives would be permissible under FAR Part 12, I do not think that agencies should use them on contracts for commercial items, because I do not think that such incentives are consistent with commercial practice.  Instead, agencies should use what I call award purchase incentives.  Under an award purchase incentive the government promises to fulfill certain additional requirements for supplies or services through the contractor in return for excellent performance.  Under an award purchase incentive, the government awards a commercial items contract that includes line items and prices for both a purchase quantity (or term) and an award purchase quantity.  The contract includes a clause that reads as follows:

Award Purchase.  The contracting officer will evaluate the contractor’s performance in delivering the items identified in line item 0001 of this contract in accordance with the criteria in Attachment 1, Award Purchase Evaluation Criteria.  If at the completion of this contract the contracting officer has determined that the contractor’s performance was excellent overall, then Agency X shall purchase from the contractor its requirements for the items identified in line item 0002 of this contract during the period DD MMM YY through DD MMM YY, at the prices stipulated, up to a maximum of _____ units, and the contractor shall deliver those items to Agency X as purchased and as otherwise specified in this contract.  Nothing in this clause may be construed to limit the Government’s right to terminate this contract in accordance with the Termination for the Government’s Convenience and Termination for Cause articles in clause 52.212-4, Contract Terms and Conditions—Commercial Items.

End of Clause

(The clause can be adapted for use in service contracts.)

The line item for the award purchase includes both an estimated quantity and a maximum quantity, like a requirements contract, and limits the government's purchase obligation to its actual requirements during a specified timeframe and up to the maximum quantity.  The prices for the award purchase are subject to economic price adjustment based on established market prices (see FAR 16.203-1(a)), so that at the time of purchase they will reflect what is considered to be fair and reasonable in the marketplace.  In order to satisfy the requirements of the Competition in Contract Act, the government must evaluate the prices for the both the purchase quantity and the award purchase quantity during source selection or the evaluation of sealed bids.

The government should not use an option provision as authorization to buy the award purchase quantity, but should cite the award purchase clause prescribed above, instead. The clause makes the incentive binding within the limits described therein, which should make the incentive more attractive to a contractor than an option.  Using the award purchase clause instead of an option would also avoid the need for the contracting officer to comply with FAR Subpart 17.2 concerning the use and exercise of options.  If necessary, the contract can include a clause similar to the ordering clause at FAR 52.216-18, so that the government can specify delivery of the award purchase quantity as needed.

The award purchase contract must include a description of the criteria that the contracting officer will use to evaluate the contractor’s performance, which must be sufficiently clear and detailed to enable the contractor to know what it has to do to earn the award purchase incentive payoff.  The criteria should reflect typically commercial considerations such as product quality, delivery, customer service, etc.  Agencies should not use elaborate award fee-type plans or procedures, but should use informal and streamlined processes of communication, evaluation, and documentation.     

One Open Forum participant suggested that IDIQ contracts accomplish the same ends as the award purchase incentive, because the contractor knows that the government will not issue more orders if it is not happy with the contractor’s performance.  However, the incentive in IDIQ contracts is not explicit, there is no firm commitment to buy more than the minimum quantity, and IDIQ contracts require agencies to order a minimum quantity and make multiple awards.  Award purchase is an explicit incentive; there is a commitment to buy that is contingent upon only performance, requirements, and funding; and it is based on a requirements-type bargain, which means that there is no need to order a minimum quantity or to make multiple awards.  

Commercial firms will like the award purchase incentive because it is the kind of simple incentive that they like best--loyalty from a satisfied customer.  Government agencies will like it because it offers them the prospect of reduced administrative costs in the making of additional purchases.  All that agencies have to do to make award purchase work is to keep it simple and use commercial performance evaluation criteria.

Vernon J. Edwards researches, writes, lectures, and consults about Federal acquisition.  From 1974 through 1986, he was a Federal acquisition official and worked for the U.S. Department of the Air Force, the U.S. Small Business Administration, and the U.S. Department of Energy.  From 1986 until 1998, he was a member of the faculties of The George Washington University's government contracts programs in the School of Business and Public Management and the Law School.
Copyright © 2000 by Vernon J. Edwards 


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