PERFORMANCE BASED PAYMENTS

1
Using Performance-Based Payments Linking
Contract Financing to Performance and
Schedule Advanced Program Management
Course Elective 486A Presented By Timothy
Frank Defense Contract Management Agency

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Performance-Based Payments
About the Defense Contract Management Agency

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What We Do
Achieve Customer Outcomes!

• Provide Customer Focused Contract Management
  Services
• Right Item Quality
• Right Time On-Time Delivery
• Right Price Value for Money
• Combat Support Agency
• Military Operations
• Readiness of Fielded Systems
• Modernization of Military Equipment
• Industrial Surge During Conflict

Teaming with Military Services and Defense
Contractors to ensure that tax dollars achieve
mission requirements
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CAS Life Cycle Involvement
What We Do!!!

• FAR 42.302(a) Standard Functions
• DFARS 242.302(a)
• FAR 42.302(b) Additional Functions
• DFARS 242.302(b)

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Full Service Acquisition Impact

• Scope of work
• All major weapons system programs
• 850B in Contract Face Value
• 95B Unliquidated Obligations
• 360,000 Contracts
• 25,000 Contractors
• Flight Operations (1200 Aircraft/yr)

• Span of Control
• 12,500 Professionals
• 1,000 Locations Worldwide
• 65 Major Field Commands
• 100M Reimbursable Foreign
• Military Sales
• DoD Standard Procurement
• System
• Combat Support Agency

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About Performance-Based Payments

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What Are Performance-Based Payments?
PBPs are

• Part of the acquisition reforms of FASA
• Contract financing relying on performance
  measured by
• Objective, quantifiable methods
• Accomplishment of defined events
• Other quantifiable measures or results
• Focus on performance rather than incurred costs
• The preferred method of contract financing

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What is OSD Policy?
Increase the Use of Performance-Based Payments

• Under Secretary of Defense for ATL memorandum,
  November 13, 2000
• Established goals for expanding use of PBPs in
  contracts with contract financing
• 25 of contracts in 2002
• 50 of contracts by 2005
• Services and Agencies are working hard to meet
  these goals!

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What are the Trends?
Use of Performance-Based Payments is Growing
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Why increase use of PBPs?

• Enhanced technical and schedule focus
• PBPs require contractor performance before
  payment is made
• This is the performance aspect Good for the
  Government
• Enhanced cash flow to contractors
• PBPs can be up to 90 of the contract or line
  item price
• This is the payment aspect Good for the
  contractor

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When Can PBPs Be Used?

• Federal Acquisition Regulation (FAR) requires the
  contract to be
• Fixed Price
• 6 months duration or longer
• 4 months for small businesses
• Minimum of 2 million
• Minimum of Simplified Acquisition Threshold
  (currently 100,000) for small businesses
• PBPs are particularly well suited for major
  programs

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What Other Conditions Apply?

• Can Be Used
• With definitized contracts
• When the Contracting Officer finds them practical
• When the contractor agrees to their use
• And, as of March 2000, with competitive
  procurements and RD
• Cant Be Used
• In conjunction with most other financing types
• Such as progress payments
• On undefinitized or cost-reimbursement contract
• When contractor and Government cannot agree on
  terms
• For architect-engineer services or construction
• For ship building or ship conversion, alteration,
  or repair

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Why would you want to use them?

• Government
• Payment contingent on performance encourages
  performance, not costs
• Can be structured to motivate improvement
• Potentially easier to administer low level of
  monitoring/audit
• Contractor
• Higher payment ceiling (90 of price vs. 80 of
  costs
• (90-95 for Small Business or SDB)
• Better cash flow when initial costs are low, or
  contract is ahead of schedule (in both an
  over-run and under-run)
• Somewhat less system oversight required

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What About Negotiation of PBPs?

• Payments must be clearly defined amounts
• Dollar value or percentage of known amount such
  as unit price
• Payments may be based on
• Accomplishment of defined events
• Other quantifiable measures of results
• Financing shall be provided only to the extent
  actually needed for prompt and efficient
  performance
• Amounts may be established on any rational basis
  including
• Engineering estimates of stages of completion
• Engineering estimates of hours or other measure
  of effort
• Projected costs of performance

PBP terms are part of the total negotiation of a
fair and reasonable contract price
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How Are Events Selected?

• Events may be severable or cumulative
• If cumulative, no steps can be skipped
• Events must be integral and necessary part of
  contract performance
• No administrative or perfunctory events
• No reliance on costs rather than accomplishment
• Schedule and amounts must take into account value
  of completed work, and Government financial
  security needs
• Need to motivate continued performance
• If contract ends at this event, what do we have?

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How is a payment processed?

• Contractor presents request for payment to ACO,
  no more than monthly, for all performance events
  completed in the period
• The request contains all required supporting
  documentation and will be certified by the
  contractor.
• ACO verifies completion of performance events,
  approves request for payment, and forwards
  request to payment office.
• Payment office processes payment

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What happens if?

• There is Government-caused delay?
• Contracting officer may renegotiate the PBP terms
• There is a modification to the contract?
• PBP terms may have to be changed by the
  contracting officer negotiating the change
• Contractor fails to make progress, financial
  condition deteriorates, or doesnt pay its
  vendors?
• PBPs can be reduced or suspended

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How is Surveillance performed?

• ACO determines what reviews are required based on
  assessment of Government risk
• Reviews may include
• Verification of performance events
• Assessment of financial condition
• Evaluation of progress on the contract
• Surveillance performed by technical specialists

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Performance-Based Payments
A Performance-Based Payments Success Story
The C-17 Globemaster

Note C-17 information provided courtesy of The
Boeing Company
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C-17 Program 2 PBP Applications

• C-17 Production Contract - 14.2 Billion
• Established On The 80 Aircraft Multi-Year
  Production Program
• Groundbreaking Implementation - Highly Successful
• Affordability Improvement Projects - 300 Million
• One Time Only Engineering and Manufacturing
  Development (EMD) Efforts
• Struggled To Success

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C-17s Application of Production PBP
Part I

• Contractor, SPO, DCMA, DFAS Early Partners In
  PBP Process
• Process Designed To Meet Needs Of All Parties
• Deliverable Item (Aircraft) Rather Than Whole
  Contract
• Event Definition -- Each PBP Event Has Two Parts
• The Action An Easily Observable Physical Move
• -- And --
• The Criteria A Quantifiable Measure Of
  Completeness
• Contractually Defined Description, Criteria,
  Required Verification

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C-17s Application of Production PBP
Part II

• Manufacturing Variability Recognized - Success gt
  95 Of Events Work
• Chosen Events Are Central To The Build Of The
  Aircraft
• Both Severable (Stand-Alone) And Cumulative
  (Dependant) Events
• Predetermine Estimated Schedule Dates
• Payments Replicate Net Present Value Of 100
  Progress Payments

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PBP Events For Each Aircraft
1
Rough Machining Of MLG Bulkhead Frames
2
Receipt Of Aft Pressure Bulkhead Details
Completion Of Wing Spars
3
4
Completion Of Wing Halves
Cumulative Assembly Series
5
Completion Of The Four Major Sub-Assemblies
6
Completion Of Final Assembly
Aircraft Delivery
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Notional Aircraft Cost Profile
Performance Events With PBP Billing Percentages
Aircraft Delivery
110
100
Event Billing Percentages
100
Events
90
Major Sub-Assemblies
Normative Cost Curve
90
80
Lot IX ATP Milestone
80
Completion Of Wing Halves
70
70
60
Percentage Of Cost
Completion Of Wing Spars
60
Percent Of Price
50
50
Recv Aft Press Bulkhead Details
40
MLG Bulkhead Frames Machined
A/C Assembly Complete
40
30
30
20
20
10
10
0
0
Feb-96
May-96
Aug-96
Nov-96
Feb-97
May-97
Aug-97
Nov-97
Feb-98
May-98
Aug-98
Nov-98
Quarter Mid-Points
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C-17 Production PBP Status

• C-17 Program Implemented PBP On September 1996
• First Successful Implementation Of PBP On A Major
  Program
• Process Stable And Functioning Extremely Well
• DFAS sees the C-17 Program is an Example To
  Emulate
• Increased Cash Flow For Contractor - Lower Unit
  Cost For Gov't.
• Improved Relationship Between Contractor and
  Govt

WIN - WIN For Government And Contractor

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Production PBP Lessons Learned

• Communication Between Govt Contractor Is
  Essential
• Early Attention To Detail and Risk Mitigation Pay
  Dividends
• Exhaustive Contractual Definition Absolutely
  Required
• Events
• Methodologies
• Responsibilities
• Resets
• Changes
• Electronic Billing system Needed for PBPs
• (Help is on the way! Ed.)
• Subcontractors Reluctant To Use PBP
• Need Assistance from Primes

Note These charts represent Boeings current
approach to the C-17 program, but the company
continues to explore methods that would improve
on the process.
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Affordability Improvement Projects PBP

• Affordability Improvement Effort Adapted to PBPs
• 270 Affordability Improvement Projects -- 300M
  in Funding
• Manufacturing Processes Improvements
• Engineering Redesign For Producibility
• Software Systems and Others Types
• 23 Events Pulled From Eight Representative
  Golden Projects
• Available Plans Conceptual -- Event Definition
  Problematic
• Each Event Unique
• High Level Schedules
• ROM Expenditure Forecast
• Observation
• Not Easy To Implement PBPs On RD / EMD Type
  Projects

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Affordability Improvement PBP
Lessons Learned

• Situation
• Plans For First Time Efforts Always Subject To
  Change
• Schedule, Work Flow, Expenditures, Event
  Definitions
• At Odds With PBPs Need For Contractually Precise
  Definitions
• Risk To Event Completions, Cashflow, and
  Programs Health
• Response
• Early Risk Mitigation And Adaptability Planning
  Essential
• Contractual Language Defining Change Process
  Recommended
• Establish and Maintain Partnering Relationship
• Use PBPs As A Financing Methodology - Not As A
  Cudgel
• PBP Can Be Made To Work On First Time Efforts

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The Wrap Up

• PBPs Are An Excellent Means Of Program Financing
• Many Advantages To Customer and Contractor
• Attention To Contractual Definition Pays Long
  Term Benefits
• Customer Contractors Joint Ownership Helps
  Success
• The Key Ongoing and Open Communication -
  Teamwork

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Resources References

• DCMA Onebook chapter 9.3, Performance-Based
  Payments http//home.dcma.mil/onebook/9.0/9.3
  /PerfBasedPay.htm
•   Director, Defense Procurement memorandum,
  Performance-Based Payments, Nov. 9, 1998
  http//www.acq.osd.mil/dp/oldmemos/perform.pdf
•   DCMA Draft Contract Financing Application
  Guide http//www.dcma.mil/onebook/9.0/9.2/sp
  ot-workingdraftAug30_1.htm
• DCAA Audit guidance on PBPs at
  http//www.dcaa.mil/mmr/m98pfc105.pdf

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Performance Based Payments
Contact
Timothy Frank tfrank_at_hq.dcma.mil 703-428-1005 Proc
ess Owner Performance-Based Payments Defense
Contracts Management Agency http//www.dcma.mil/


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Performance-Based Payments
Some Additional Information

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Contract Financing Trends

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What are some pitfalls?

• Security provisions are unclear in regulations
• If defined events do not include deliverable
  work of sufficient value, PBPs become advance
  payments. In this case the CO must comply with
  FAR 32.4 requirements for advances
• All contract financing requires security. FAR
  PBP clause gives Government title to materials
  (similar to PP clause), but this may not be
  adequate security if events are too generously
  defined.
• PBPs paid must be commensurate with the value of
  the performance event not cause unreasonably
  low or negative level of contractor investment
• To avoid undue risk of loss, contracting
  officers should negotiate PBPs that establish
  payment amounts not expected to exceed the
  projected tangible value of the titled
  property. (Director, Defense Procurement Memo,
  Nov, 9, 1998)

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Performance Based Payments
Some Lessons Learned Performance
Events Examples of bad events

• Definitization of Contract F12345-99-C-0002
  This event is successfully completed upon
  contractor signature FAR 32.1004 prohibits
  using signing of contracts or modifications
  as performance events raises fiscal concerns.
• Initiate testing of avionics software
  Meaning of initiate not clear no criteria
  for accomplishment.
• Fabrication complete for forward fuselage
  100,000 hours charged to work order as
  verified by DCMC. Charging time not the same as
  accomplishing work. Is the verification test
  that fabrication is complete, or hours charged?
• Six months prior to delivery Not a
  performance milestone.
• Attendance at Management System Review Does
  not show true progress.
• Contractor places orders for all materials for
  main body assembly. Since contractor has
  not acquired title, this raises security
  concerns.

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Performance Based Payments
Some Lessons Learned Payment Amounts Examples
of bad PBP amounts

• 90 of actual costs incurred since prior
  payment. Must be specific dollar amounts
  known in advance, not cost reimbursement
• 40 of projected costs of next event a known
  amount. Must be commensurate with value of
  performed work. This is an advance payment.
  
• An amount to be determined by contracting
  officer, taking into account . . . Amount
  must be predetermined and objective.
• Unit price of end items completed at this
  event. Must be limited to 90 of price.
• Unit price of end items delivered at this
  event. PBPs are not installment payments
  and not associated with acceptance.

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Performance Based Payments
A Successful PBP Contract NAVAIR Contract
N00019-97-C-0114, for 118 Aircraft Engines

• It works because
• Product and processes were well understood by
  all the parties
• Performance events are limited to 7 events per
  engine
• Performance events are clear and
  understandable, and integral and necessary
  part of contract performance
• e.g. Receipt of Vane Casting for LPT Nozzle
  Segment
• Performance verification is clear
• e.g. Casting received by GE and documented in
  IMPACT System

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Performance Based Payments
Early CAS and Contract Review Checklist

• FAR 52.232-32 used if applicable, or other
  clear clause? (52.232-29 also used if
  commercial contract?)
• Performance events clearly defined?
• Are events verifiable by unambiguous
  standards?
• Do events reflect actual work which is
  integral to performance?
• Payment amounts clearly stated?
• Do payments appear (a) commensurate with value
  of undelivered work and (b) adequately
  secured by title to goods?
• If not, what is the security for payment?
• Is it clear how payments will be requested?
• What surveillance is needed?

39
Using Performance-Based Payments Linking
Contract Financing to Performance and
Schedule Advanced Program Management
Course Elective 486A Presented By Timothy
Frank Defense Contract Management Agency