Big Rewards for Defense Firms

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Big Rewards for Defense Firms
Extra Fees Paid Regardless of Performance, GAO Finds

By Charles R. Babcock
Washington Post Staff Writer
Monday, April 17, 2006; D01

In late February 2004, the Army announced that it was canceling plans to build a radar-evading helicopter called the Comanche, a project that was nearly three years behind schedule and more than $3.5 billion over budget. Those problems, however, didn't stop an Army panel a few weeks later from granting the Boeing Co.-Sikorsky Aircraft Corp. partnership running the program a $33.9 million "award fee" for their work on the helicopter, part of more than $200 million in such fees paid to the partnership over four years.

Award fees are meant in theory to motivate defense contractors with extra money for performance. But a recent Government Accountability Office study found that the fees are often paid regardless of whether a project is on schedule and within its budget.

Instead of encouraging efficiency, the GAO found, award-fee payments have become routine in some major weapons contracts, built into company expectations and paid almost as a matter of course.

Current practices "undermine the effectiveness of fees as a motivational tool and marginalize their use in holding contractors accountable," the GAO concluded. Defense contractors are paid award fees for work that is simply "acceptable, average, expected, good, or satisfactory."

An estimated $8 billion was paid in award fees from fiscal 1999 to 2003, when many of the projects involved were over budget and behind schedule. Bethesda-based Lockheed Martin Corp., for example, collected $1.5 billion in award fees on three major programs, the F/A-22 Raptor jet fighter, the F-35 Joint Strike Fighter, and the Space-Based Infrared System High satellite, despite cost, schedule and reliability problems, the GAO found.

Defense industry officials say award fees are sometimes the only way companies can profit from high-risk contracts that might never reach full-scale production -- and are of particular importance to companies that bid on large weapons systems.

Government officials say they are tightening the rules for awarding them. Late last month, the Pentagon issued new guidance that said that award fees must be tied to identifiable outcomes as much as possible and that the contracting officials should limit the common practice of rolling over fees from one period to the next, effectively giving companies a second chance to earn them.

Shay D. Assad, a former Raytheon Co. executive who is the Pentagon's new director of defense procurement and acquisition policy, said in an interview Friday that it was clear that defense officials have been granting award fees on the basis of "process performance and behavior" -- a category the GAO said included things such as whether reports were filed on time.

Instead, he said, they should concentrate on "events . . . that are going to be correlated to the outcome" of the contract.

The GAO began looking at corporate award fees after Marvin Sambur, who was the Air Force acquisition chief, attended a New York investor conference in 2003 and heard defense industry executives talk cavalierly about receiving high award payments.

"I was amazed," Sambur said in a recent interview, likening the executives' attitude to that of students expecting an "A" in class "just for showing up." He then found that the Air Force was paying contractors about 90 percent of the possible fees, no matter what their performance, so he said he set out to tighten Air Force policies.

The GAO study was requested by John Ensign (R-Nev.) and Daniel K. Akaka (D-Hawaii), members of the Senate Armed Services Committee, in response to Sambur's concerns.

Industry officials say that award fees are not simply bonuses and that the question of how and when they should be given is complicated.

John W. Douglass, president of the Aerospace Industries Association, whose members include the large defense contractors, said award fees may look "almost automatic" to the outside world, but actually are the result of complex negotiations.

In the case of the Comanche, for example, an Army spokesman said, "The fact that the Army was considering termination and did terminate would not relieve the government in any way of paying the contractor the fee he earned." The program was killed to allow the Army to pay for many other priorities, the spokesman said.

Joseph LaMarca Jr., a spokesman for Boeing, said in a statement that Boeing-Sikorsky received the final award fee for work completed prior to the termination. The decision to cancel the contract "was based on changing requirements and not due to technical costs or schedule issues," he said.

Thomas J. Jurkowsky, a Lockheed Martin spokesman, said in a written statement that large, complex development programs like the three the report cited for Lockheed "have cost, technical and schedule issues in their early stages because of the unpredictability of the technology."

The Pentagon has approved full-rate production of the F-22, "a decision that reflects the government's confidence in the aircraft," while the strike fighter is on schedule for a first flight this fall, Jurkowsky said. And though the satellite project "has faced technical challenges because of its sophisticated design," it has met some significant milestones and the government says "the program has turned the corner," he said.

Richard L. Aboulafia, an investment analyst with the Teal Group Corp., said award fees have become more important to the defense industry in recent years as the size of lucrative production contracts have been cut. As companies must invest relatively more in research, award fees became a way to boost earnings.

The difficulty in being more strict about award fees, Aboulafia said, is determining "who is at fault for mission creep and changing requirements," the usual reasons for programs escalating in cost while falling behind schedules.

Lt. Gen. Donald J. Hoffman, the military deputy for Air Force acquisition, said Friday that his service was following "the spirit" of Sambur's initiatives but has not formally adopted a new award fee policy. He said, for example, that Air Force headquarters now reviews the findings of award-fee panels and at times has cut fees it found excessive.

Sambur left the Air Force early last year.

Some Defense Department agencies have done better than others in connecting fees to performance, the GAO said. The Missile Defense Agency, for example, restructured Boeing's airborne laser contract in 2002. In the process it changed the award-fee plan to focus on a successful demonstration of the system by the end of 2004.

Until that restructuring the contractor received 95 percent of the available fees, even with cost increases and schedule delays, the GAO report said. But because it didn't meet the 2004 test deadline, Boeing received none of the $73.5 million award fee available under the revised plan.

Rick Lehner, a spokesman for the Missile Defense Agency, said Boeing also lost $107 million in fees last year for not meeting goals in the Ground-Based Midcourse Defense System, which is based in Alaska and California and is supposed to shoot down long-range ballistic missiles.

"We have a policy of rewards for good performance and penalizing for bad performance," Lehner said.

Maria McCullough, spokeswoman for Boeing's missile defense programs, said it was not surprising that fees were reduced because they were tied to performance in particular flight tests. More recent successful tests show both programs are "absolutely on track," she said.