Sunday, August 29, 2010

Award Fee, Incentive Fee, Fixed Fee

If your project does any contracting, then you're no doubt aware that fee--aka "profit", aka "incentive"--is either a cost, part of an investment, or a project management tool that can help drive surprise: the latter is my bent. 

But there's a new 'hat' to go with these 'old hats':  a relatively new project idea of incentive built around prizes [more about that later]

And, there's been no repeal of the law of unintended consequences: people [and organizations] will act to maximize their benefit, some times in contravention of established processess and protocols.  Although people have friends, they also have interests. More important: organizations only have  interests.  Incentives set in motion and influence behaviors--personal and organizational--and sometimes those behaviors are unintended and unacceptable.

My advice:
  • Never put incentives in place without doing a behavior countermeasures analysis [what would you do to maximize your benefit?  What would others do?]. 
  • And, as simple as it sounds, do not put incentives in place that conflict with each other [an example from my own contractor experience: cost incentive and best value incentive on the same contract]
  • And, never put incentives in place where the situation is compromised with conflicts of interest.

Firm Fixed Price
Maybe you do all your contracting as 'firm fixed price'--FFP. In that case, you'll have no insight to the fee, but be assured, it's there.

Actually, in FFP you are paying two fees: one is the contractor's forecast profit on the forecast cost; the second is the contractor's charge for accepting the transfer of risk from the project to the contract. Think of this second fee as an insurance premium, except that you, as project manager, have no insight to the premium you're paying. Your recourse is to obtain competitive bids and let market dynamics set these fees for you

Other fee arrangements
On the other hand, if you are not contracting FFP, but using a more imaginative vehicle that gives you some insight and control over the incentives, then you have a decision to make: incentive fee, or award fee?

Incentive and Award Fee
Incentive fee arrangements have historically been used to reward behavior--or, at the very least, forestall bad behavior.  But most incentive fee arrangements are on cost or schedule, something entirely objective, and not on value per se.  In fact Federal contracting requires that incentive fee be applied first to cost before other considerations.

However, award fee arrangements--around for at least thirty years--are designed to place incentives on value to the contract beneficiary--value being a larger concept than just cost.  Value does not always have to be objective, and the value proposition can change over the course of the contract, providing the project manager with a much more nimble tool that the rather blunt instruments of fixed fee and cost-driven incentive fee. 

It's obvious that award fee is more difficult to administer.  First, for each award fee period during the contract [and periods do not have to be equal length], as project manager, you are obliged to furnish the criteria for earning fee to contractor.  And, at the end of the period, the contractor is obliged to furnish proof of performance that you then are obliged to evaluate fairly. 

The evaluation is almost always 'analog'--that is, fee is awarded on a sliding scale, rewarding just that part of performance that is meritorious.  This means that the award fee is always at risk, and some is likely to be 'lost' at each award period. Sometimes, 'lost' fee can be 'rolled over' to provide a end-of-contract incentive.

Prize Fee
And now comes a relatively new entrant: prize fees  [new, if you don't count what the British offered in the 18th century for a better way of measuring longitude].  Many have heard about the "XPrize" phenomenon that began with a $10M prize for a reusable space craft that could reach 100KM altitude, now extended to other endeavors. 

But now, some corporations looking for corporate solutions to everyday problems are going the prize route: witness 55,000 entrants for Netflix's search for a better algorithm to suggest movies to its subscribers.  A recent article has described an almost exponential increase in doing projects the prize wit: the ultimate agile way.  State a vision, put up the investment, set a milestone, and get out of the way!

And, they're not all millions for billionaire financiers like Paul Allen.  Some serious results accrue with prizes as small as $10K.  And generally it's been observed that any prize activity brings a lot of activity--critical thinking and innovation--even from the losers.  In fact, the losers line up at the patent office.

Maybe there's something to this for the agile visionary.

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