Performance basis

No one doubts that federal officials will continue to encourage performance-based contracting in the coming year. But some emerging success stories could give agency officials guidance about using this alternative contracting approach, which requires a hands-off attitude.

For proof of the continued emphasis, look at a directive issued in September by Rob Burton, associate administrator of the Office of Federal Procurement Policy. Burton urged agency officials to use performance-based contracts for at least 40 percent of their service procurements worth more than $25,000 in fiscal 2005.

The goal is ambitious — too ambitious for some observers. Charles Self, president of the Self Group, said agency officials should be allowed to evolve into the practice rather than throw themselves into it.

Creating performance-based contracts is more difficult than many think, he said, and agency managers are often learning new skills as they go. "It's not like they don't have enough to do," Self added.

Chip Mather, senior vice president of Acquisition Solutions, said performance-based contracting may finally be gathering some steam after more than a decade of talk. This year, the firm has trained more than 1,000 officials to use the new approach compared with 250 in 2003. He said 2005 promises to be even busier.

DLA's lessons, good and bad

The Defense Logistics Agency's Business Systems Modernization project has been complex, and officials encountered several challenges that have caused it to fall behind schedule and surpass its budget. But the project is emerging as a successful performance-based acquisition. Its goal is to improve the provision of supplies to the Defense Department. Led by Accenture, contractors are replacing aging systems with updated commercial software.

The decision to write a performance-based contract was driven in part by necessity, said Rich Cromley, chief of corporate contracting at the Defense Supply Center-Philadelphia, who guided the contract award process.

Officials discovered early on that they didn't know how to write requirements for using commercial software, he said. "They started writing out the typical steps of how to do a development project," which are irrelevant for software that has already been developed, Cromley said.

Because the decision to use commercial software was already made officials decided to develop metrics for how the system would perform and let the contractors decide how best to accomplish the goals. They required bidders to include implementation plans in their proposals.

Contracting officials paved the road to success in the pre-award phase, providing an important lesson for DLA officials and other agencies, he said. To help determine the best factors for measuring the project's success, DLA officials contacted private companies that had implemented enterprise resource planning systems such as the one they were considering. They also met with other agency officials, such as those overseeing the Army's Logistics Modernization Program, he added.

"There weren't really templates" to draw from, Cromley said. Officials ultimately settled on straightforward measurements, including customer satisfaction, system usability and interoperability with other DOD systems.

Agency officials also tried to be realistic when evaluating contractor proposals, he said.

Because the contract covered five years, "we knew the detail in the [later] years wouldn't necessarily be there," he said. "But we expected a lot of detail on the first couple of years."

Once contracting officials identified which companies were able to meet the technology demands, Cromley said, the deal-making question was whether they would join the agency in taking risks.

"The thing that really won the award [for Accenture] was their willingness to structure the engagement in terms of money at stake," he said.

Company officials were willing to accept nonpayments or lower payments for not meeting goals, he said. "We had seen that they had been out [in] front of a lot of companies in doing this," Cromley added.

The firm had experience in performance-based contracting in the commercial market, said Jerry Briggs, a partner at Accenture and de facto program manager on the DLA project. That expertise gave company officials the confidence to accept the risks, he said.

Accenture officials knew that the performance-based contract would make the agency a better partner with the company, which would help ensure that performance goals would be realistic.

"This wasn't going to be a traditional contractor-owned, contractor-led project, where the end result gets handed off to the government," Briggs said. "They were partners from the beginning."

Cromley advises officials contemplating performance-based contracts to be flexible in evaluating their performance measures. Some may prove to be less useful than expected, he said.

"As we went through actual performance, we found a lot of [the chosen measures] were not very meaningful, and it was costing us time and money to measure them," he said. Officials settled on about six measures tied to about 120 incentive payments for contractors.

Although the system's full implementation has been delayed until next year, it is already succeeding where it has been launched, said Allan Banghart, DLA's enterprise transformation director.

Developers introduced Version 2.0 of the supply system in July, managing about 170,000 items. About 90 percent of the system is running now, managing 250,000 items, 175,000 users and

$3 billion in sales, he said. Starting in January 2005, Banghart said, officials will add another 200,000 items and 200,000 users per month until the system manages 5.2 million items and more than $20 billion in sales, he said.

Banghart and his team used the upgrade transition to make further adjustments to the performance measures, he said. For example, the first version's target time for processing requisitions was 40 minutes or less. But officials decided that the resources needed to maintain that speed could be better used to support other aspects of the system. In the new version, processing requisitions can take up to two hours.

Officials also improved the system's forecasting capability, part of its inventory management.

"We manage about $11 billion worth of inventory DLA owns that we keep on the shelf," Banghart said. "If we can improve our forecasting by just 10 [percent] or 15 percent, that's a huge savings to the taxpayer."

Integrators on track to take risks

Integrators are generally open to undertaking performance-based contracts despite the risks because the potential rewards are greater, said Ernst Volgenau, chairman and chief executive officer of SRA International. The company has several performance-based contracts under way.

"We like performance-based contracts, as long as they are well-defined," said Volgenau, who is ending his 26-year tenure as SRA's CEO this month. "We have good confidence in our ability."

Briggs agreed that contractors stand to gain from performance-based contracts. "I'm not talking necessarily about a financial upside but a competitive upside," he said. "There are few [companies that] have figured out how to make it successful in the government. Knowing how to do it, and how to structure the deals, is an advantage."

The most important factor for integrators is that the criteria for success must be clear and measurable, Volgenau said. One example is a contract SRA has with the Department of Health and Human Services to run the National Practitioner Data Bank, a database of health care professionals who have been sanctioned by disciplinary organizations. The database's purpose is to allow state officials to check the histories of physicians applying for new state licenses. SRA's performance is judged primarily on its response time, he said.

"Those types of criteria are well-defined," Volgenau said. "As a result, our fees are good. It gives us incentive to innovate and be more responsive."

He said agency and industry officials are learning how to make performance-based contracting work.

"I've seen tremendous improvement in this decade that for the past two decades hadn't occurred," he said. "It takes time."

Agencies slowly boarding the train

In 2005 and beyond, performance-based contracting will become more widely used throughout government, many observers predict. As successful engagements emerge and agency officials grow more comfortable with the idea, the rewards to agencies and contractors become clearer.

"I am a major, major supporter of it," said Robert Guerra, a partner at Guerra, Kiviat, Flyzik and Associates.

The sticking point for many agency officials continues to be old habits, Guerra said. The notion of leaving a contract free of detailed instructions, allowing the contractor to determine the best way to approach a project, is still uncomfortable for many, he said.

"The fundamental concept is you're telling somebody why you want to buy something, what goal you want to achieve," Guerra said. "In a prescriptive environment, you're telling them what you want to buy. When should the government ever not tell industry what they're trying to accomplish? I don't think it's hard. What's hard is the culture."

He said he sees signs of change. One request for information that Army officials recently issued for the Army Knowledge Online Web portal offers no direction for interested contractors.

"There is not one technical statement in the document," Guerra said. "So I believe [performance-based contracting is] really starting to take hold. And unlike procurement reform, where

we put it out there and said, 'Go do it, '[here] we're tackling the culture."

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Diplomacy 101

To succeed with performance-based contracting, agency officials must understand that the arrangement necessarily takes control from the agency and gives it to the contractor, said Ernst Volgenau, chairman and chief executive officer of SRA International. Many officials struggle with this.

Trouble arises when "the agency, because of its prior habits, insists on managing us directly," he said, or when "the agency doesn't give us enough free rein to innovate and it makes it more difficult for us to meet the criteria."

When those problems occur, company leaders must address them diplomatically, Volgenau said.

"We politely but persistently point out the problems that our customer is causing us," he said. "Rarely, we might go to the higher [official] in the agency, and without getting personal about the customer, we point out that it might be good if the agency develops a better strategy."

Being angry or blaming someone never pays, Volgenau said. So if company officials have to go over the heads of their agency counterparts, "we do that delicately, of course," he said. "You don't want to alienate your customer."

— Michael Hardy

A learning curve for all

Although integrators are finding value in cross-pollinating their commercial and government sides, sharing ideas and best practices, such exchanges can only go so far. Integrators cannot approach agencies and businesses as if they are interchangeable, said Jerry Briggs, a partner at Accenture.

"The fraud, waste and abuse risk in government creates the regulatory need to do things in a very structured manner," he said. On the other hand, working with private-sector customers often allows much more give and take. "In the commercial world, you'd go have a discussion with one or more executives, and you would right there say, 'How do you want this deal structured? What do you want it to look like?' " Briggs said.

For their part, government officials are also learning that they can benefit from selectively borrowing some commercial approaches.

"The feds have an announced interest in commercial best practices," said Phil Kiviat, a consultant at Guerra, Kiviat, Flyzik and Associates. "They've been saying that for a long time. [But] in some cases, federal policies are such that commercial best practices won't fit."

One area where the crossover is starting to work is performance-based contracting, a direct transplant of a commercial best practice, or at least as much as is possible given the different environments, said Chip Mather, senior vice president of Acquisition Solutions.

Government buyers are not the only ones who

have had to adjust to this different way of handling contracts.

"The cultural aspect [that integrators are] addressing is that for years, the government bought compliance, and now they're buying results, which is a commercial best practice," Mather said.

"In a sense, it's not fair to companies because the goalposts have been moved," he added. "In the past, if you did what the government told you and if it didn't work, you weren't held responsible because it met the specs. Now if you do what the government tells you and it doesn't work, they are holding you responsible."

Many integrators are restructuring internally to aid in the exchange of information between public- and private-sector divisions, Mather said. "It's truly transformational, what they are doing," he said.

— Michael Hardy

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