Contract Management: DOD's Profit Policy Provision to Stimulate  
Innovation Needs Clarification (26-JUL-01, GAO-01-801). 	 
								 
In negotiating profit on contracts, the Department of Defense	 
(DOD) requires contracting officers to set negotiating objectives
by relying on guidelines in defense regulations. Congress	 
mandated that DOD review its profit guidelines and consider	 
whether modifying them would provide more incentive for 	 
contractors to develop and produce complex and innovative new	 
technologies for weapon systems. After completing its review, DOD
issued a final rule in December 2000 that added a technology	 
incentive to its guidelines for setting profit objectives on	 
negotiated defense contracts. This report reviews whether the new
policy is (1) likely to achieve its intended objective of	 
stimulating increased innovation and (2) consistent with the	 
revised policies for acquiring weapons systems. GAO found that	 
the new profit policy may have limited effect on incentivizing	 
additional innovation because the policy has limited reach during
research and development and it does not provide adequate	 
guidance on when to apply the incentive. The policy may not	 
reinforce DOD's emphasis on technology maturity in its guidance  
on the system acquisition process.				 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-01-801 					        
    ACCNO:   A01470						        
    TITLE:   Contract Management: DOD's Profit Policy Provision to    
             Stimulate Innovation Needs Clarification                         
     DATE:   07/26/2001 
  SUBJECT:   Department of Defense contractors			 
	     Weapons research and development			 
	     Federal procurement policy 			 
	     Defense procurement				 
	     Weapons systems					 
	     Profits						 

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GAO-01-801
     
Report to the Honorable Tom Harkin, U. S. Senate

United States General Accounting Office

GAO

July 2001 CONTRACT MANAGEMENT

DOD's Profit Policy Provision to Stimulate Innovation Needs Clarification

GAO- 01- 801

Page 1 GAO- 01- 801 Use of Profit Policy to Promote Innovation

July 26, 2001 The Honorable Tom Harkin United States Senate

Dear Senator Harkin: In negotiating profit on contracts, the Department of
Defense (DOD) requires contracting officers to set negotiating objectives by
relying on guidelines contained in defense regulations. Congress mandated in
the National Defense Authorization Act for Fiscal Year 2000 (P. L. 106- 65,
Oct. 5, 1999) that DOD review its profit guidelines and consider whether
modifying those guidelines would provide an increased incentive for
contractors to develop and produce complex and innovative new technologies
for weapon systems. After completing its review, DOD issued a final rule in
December 2000 that added a technology incentive to its guidelines for
setting profit objectives on negotiated defense contracts. At your request,
we reviewed DOD?s change to its profit policy to determine whether the new
policy is (1) likely to achieve its intended objective of stimulating
increased innovation and (2) consistent with its revised policies for
acquiring weapon systems.

Although the rule is new and has not yet been widely used, the new profit
policy may have limited effect on incentivizing additional innovation for
two reasons. First, the policy has limited reach during research and
development when technology innovation is a high priority. Most research and
development contracts either do not fall under the profit guidelines
containing the incentive or are appropriately excluded from the incentive.
Second, the rule does not provide adequate guidance on when to apply the
incentive. And the definition of innovation is so broad that it could be
interpreted to apply to almost any program with more demanding performance
characteristics than the system being replaced. This creates a risk that
contractors may be paid more for their current level of innovation and may
not reach for the technology incentive?s additional profit dollars by
introducing new, significant technological innovation.

United States General Accounting Office Washington, DC 20548

Results in Brief

Page 2 GAO- 01- 801 Use of Profit Policy to Promote Innovation

The new profit policy may not reinforce DOD?s emphasis on technology
maturity in its revised guidance on the system acquisition process. 1 The
linkage between the technology incentive and the new system acquisition
process is unclear. The technology incentive encourages innovation while the
acquisition process stresses technology maturity. This sends mixed signals
to contractors and DOD?s own contracting and program management staff about
when innovation should be rewarded.

We are recommending that DOD clarify the definition of innovation used in
the new profit policy and define the policy?s relationship to DOD?s new
acquisition process. DOD stated it will re- examine the types of innovation
that may be rewarded with the technology incentive to determine if they can
be stated more clearly. However, DOD disagreed with the need to define the
relationship between the new profit policy and DOD?s new acquisition
process, saying that the two policies are not inconsistent. We believe the
potential for conflict exists if clear guidance is not provided to support
implementation. The best way to minimize the potential for conflict is to
articulate the relationship between these two policies in the profit policy
regulation.

DOD contracting officers use a structured approach called the Weighted
Guidelines Method to develop profit objectives for use in contract
negotiations. 2 Using these profit guidelines, contracting officers address
a contractor?s (1) risk in fulfilling the contract requirements, known as
performance risk; (2) degree of cost risk because of the type of contract
(e. g., fixed- price versus cost contract); and (3) investment in facilities
that benefit DOD. Prior to the profit policy change, the performance risk
factor consisted of three elements:

 Technical- the technical uncertainties of performance.

 Management- the degree of management effort necessary to ensure that
contract requirements are met.

 Cost control- the contractor?s efforts to reduce and control costs. 1 This
guidance is in DOD Directive 5000. 1, DOD Instruction 5000. 2, and DOD
Regulation 5000. 2- R. 2 Generally, these guidelines would be used in
negotiating sole source contracts, where price is negotiated using certified
cost or pricing data. Cost or pricing data means all facts that prudent
buyers and sellers would reasonably expect to affect price negotiations
significantly. Background

Page 3 GAO- 01- 801 Use of Profit Policy to Promote Innovation

In the National Defense Authorization Act for Fiscal Year 2000, Congress
included provisions to stimulate technical innovation in military research
and development. Section 813 required DOD to review its profit guidelines to
consider whether modifications to the guidelines- such as placing increased
emphasis on technical risk as a factor for determining appropriate profit
margins- would provide an incentive for contractors to develop and produce
complex and innovative new technologies. After completing its review, DOD
reported to Congress that it planned to make two changes to the guidelines.

As shown in table 1, the first change was to increase the weight contracting
officers would likely assign to technical risk by reducing performance risk
from three to two elements. The second was to add a special incentive for
contractors that propose significant technological innovation. Using the
technology incentive, contracting officers can assign a profit range of 6
to10 percent for the technical element instead of the standard range of 2 to
6 percent. On December 13, 2000, DOD published a final rule in the Federal
Register to implement the two changes. (Appendix I presents an example of
the application of the incentive to a contract.)

Table 1: Changes in Profit Policy Before After Performance risk element
Profit range Performance risk element Profit range

Technical Standard range a of 2- 6 percent Technical Standard range of 2- 6
percent Technology incentive range of 6- 10 percent Management Standard
range of 2- 6 percent Cost control Standard range of 2- 6 percent

Management/ cost control Standard range of 2- 6 percent

a The standard range is used to price most contracts. Source: Defense
Federal Acquisition Regulation Supplement.

During the same time period, DOD sought to realize the benefits of best
commercial practices 3 by revising its policies that guide the system

3 Commercial best practices are discussed in several GAO reports: Defense
Acquisition: Employing Best Practices Can Shape Better Weapon System
Decisions

(GAO/ T- NSIAD- 00- 137, Apr. 26, 2000); Best Practices: Better Management
of Technology Development Can Improve Weapon System Outcomes (GAO/ NSIAD-
99- 162, July 30, 1999);

Best Practices: Successful Application to Weapon Acquisitions Requires
Changes in DOD?s Environment (GAO/ NSIAD- 98- 56, Feb. 24, 1998).

Page 4 GAO- 01- 801 Use of Profit Policy to Promote Innovation

acquisition process. The result was a new system acquisition life cycle 4
that separates technology development and system development. The technology
development phase generally begins with paper studies of alternative
technology concepts for meeting a mission (concept exploration) and ends
with the demonstration of component technology in a relevant environment to
reduce the risk of integrating the components or subsystems into a full
system (component advanced development). A program is usually initiated at
the beginning of system development, at which point the system?s technology
should be mature. During system development and demonstration, the
subsystems and components are integrated into the system, the design is
stabilized, and the system is demonstrated in a realistic environment. The
system then enters low- rate initial production, during which the
manufacturing capability is established. By the time the system reaches
full- rate production, the technology should be mature, the design stable,
and the manufacturing processes established.

The profit guidelines containing the technology incentive do not apply to
most research and development contracts and, therefore, the incentive has
limited reach in the phases of DOD?s acquisition cycle where technology
innovation is expected to be high. Many contracts awarded in these high
innovation phases have technical reports as contract deliverables, and these
are appropriately excluded from the incentive. The profit guidelines
containing the incentive do not apply to contracts awarded with competition,
which is commonly the case for research and development

4 DOD?s system acquisition process begins when technology concepts are still
in research and development. During the process, technologies, designs, and
manufacturing processes are established and matured, and a system is
ultimately produced, deployed, sustained, and eventually retired. This
process is referred to as the system acquisition life cycle. Technology
Incentive

May Not Achieve Intended Objective

Incentive Has Limited Reach Where Innovation Is a High Priority

Page 5 GAO- 01- 801 Use of Profit Policy to Promote Innovation

contracts. Also, contracting officers already have available another
mechanism- award fees 5 -to reward innovation.

Table 2 shows the expected level of innovation and the typical contract
deliverable for each phase of DOD?s system acquisition cycle. It also shows
what type of profit (fixed/ incentive fee versus award fee) is used to
reward contractors during each phase- the profit guidelines only apply to
fixed/ incentive fee contracts. For fixed/ incentive fee contracts, the
percentage and dollar value of awards made without competition is shown- the
profit guidelines only apply to these awards. The table shows that the
guidelines (and therefore the technology incentive) do not apply to many
contracts in early research and development where innovation is a priority.

Table 2: Innovation, Deliverables, and Profit Method in Acquisition Cycle
Phase Innovation Typical contract

deliverable Type of profit and percent of

dollars awarded in phase (fiscal year 2000)

Percent and dollar value of fixed/ incentive fee awards without

competition a (fiscal year 2000) Percent Dollars

Concept exploration High Paper Component advanced development High Hardware

Fixed/ incentive fee 40 Award fee 46 Unknown b 14

26 $0.5 billion System development & demonstration High Hardware

Fixed/ incentive fee 48 c Award fee 48 c

Unknown b 4 c 57 $2.3 billion

Low- rate initial production Moderate Hardware Full- rate production &
deployment Low Hardware

Fixed/ incentive fee 88 Award fee 5 Unknown b 7

60 $32.0 billion a The dollar values represent an estimate of the value of
contracts to which the profit guidelines apply. b The specific type of fee
could not be determined from information in DOD?s contracting database
(DD350). c Some of the contract funds in this category were used to conduct
initial operational test and

evaluation and live fire test and evaluation, which normally occur during
low- rate initial production. Sources: DOD acquisition officials and DOD?s
fiscal year 2000 contracting database (DD350).

5 Profit can take the form of fixed fees, incentive fees, or award fees.
Fixed fees are negotiated and fixed at the time of contract award and are
not subject to change regardless of a contractor?s performance. Incentive
fees are adjusted throughout contract performance based on the extent to
which the contractor achieves cost or performance targets set at contract
award. Award fees are earned based upon a government panel?s periodic
assessment of the contractor?s performance against qualitative evaluation
criteria.

Page 6 GAO- 01- 801 Use of Profit Policy to Promote Innovation

The profit policy excludes many contracts awarded during technology
development (concept exploration and component advanced development).
Concept exploration commonly consists of paper studies of alternative
concepts for meeting a mission and, therefore, contracts generally have a
technical report as their primary deliverable. The technology incentive
range does not apply to efforts restricted to studies, analyses, or
demonstrations that have a technical report as their primary contract
deliverable. Technical reports were excluded from coverage because these
efforts do not involve the risk inherent in producing and fielding weapon
system hardware.

Technology development contracts are typically awarded through competition.
DOD?s profit guidelines do not apply to competitively awarded contracts
because price reasonableness is established through price competition rather
than through use of the guidelines.

Contracting officers have available another contracting mechanism- award
fees- to reward innovation in research and development. Award fees are used
to motivate contractor performance in those areas critical to program
success, such as technical, logistics support, cost, and schedule.
Contracting officers can use the award fee to encourage contractors to
develop innovative new technologies by including these objectives in the
criteria for evaluating how much of the award fee the contractor has earned.

The definition contained in the policy guidelines of what qualifies for the
technology incentive is so broad that it could be applied to almost any
contract with enhanced system performance. Our discussions with contracting
officials indicate that there is confusion over how and for how long the
incentive should be applied. This confusion may lead to inconsistent and
possibly inappropriate application of the incentive and could result in
contractors being paid more profit for their current level of innovation,
not for the intended new technological innovations that significantly
enhance performance, improve reliability, or reduce costs.

The rule states that contracting officers may use the technology incentive
range when a contractor proposes to develop, produce, or apply innovative
new technologies during contract performance. It further states that
contracting officers are to use the incentive only for the most innovative
efforts. The rule defines innovation as

 ?Development or application of new technology that fundamentally changes
the characteristics of an existing product or system and that Rule Does Not
Provide

Clear Guidance for Applying Technology Incentive

Page 7 GAO- 01- 801 Use of Profit Policy to Promote Innovation

results in increased technical performance, improved reliability, or reduced
costs; or

 New products or systems that contain significant technological advances
over the products or systems they are replacing.?

Although the rule describes in broad terms when the application of the
incentive is appropriate, it leaves many questions unanswered in defining
key terms. For example, how ?new? must a technology be to qualify? Does

?new? mean it is just out of the laboratory and has never been used before
on any system, or does it refer to a recently developed technology that has
been used on other products but not on the product in question? Should the
incentive apply to demonstrated technology or to the promise to develop
technology? And if a contractor is awarded additional profit for developing,
producing, or applying new innovative technology, when should the reward
stop? Should it apply only to the immediate contract, or should a contractor
receive the reward throughout some portion of production contracts? By the
same token, what measures are to be applied in determining whether a
technological advance is ?significant? or whether new technology
?fundamentally changes? a product or system? Without this information, the
rule could be interpreted so that the incentive could apply to almost any
program with more demanding performance characteristics than the system
being replaced.

Although, at the time of our review, the new rule had not been widely used,
we discussed with agency officials the circumstances under which they might
apply the technology incentive. Air Force, Army, and Navy officials agreed
that the technology incentive could apply to both research and development
and production contracts, but they did not interpret the rule?s guidance on
when to apply the incentive in the same manner. For example, officials at
two Air Force program offices judged that upgrades to their systems that
included state- of- the- art technology used on other products would not
qualify for the technology incentive, but those at an Army office said that
similar applications of state- of- the- art technology to their system would
qualify. In fact, contracting officials at two Army program offices told us
that all weapon systems at their buying command incorporated state- of- the-
art, leading edge technology and would, therefore, qualify for the
incentive. On the other hand, officials for one Air Force system did not
believe a future upgrade to their system that may incorporate brand- new
technology developed by another military service would qualify for the
incentive because the other service would have developed the new technology.
Finally, the contracting officer for a Navy system that incorporated brand-
new, never- before- used, technology that allowed the system to exceed
performance requirements stated that the

Page 8 GAO- 01- 801 Use of Profit Policy to Promote Innovation

system would qualify for the incentive. These examples point to potential
confusion over how the rule?s broad definition of technological innovation
should be applied.

The officials were also uncertain about how long a contractor should be
rewarded with the technology incentive for significant, new innovative
technology introduced in the research and development phases of the
acquisition process. For example, a procurement official for an Army system
currently in the latter stages of research and development stated that the
system may qualify for the incentive during production, depending on how the
language in the rule is interpreted. A technical official for this system at
first stated that, hopefully, innovation and risk would be finished before
the system enters production, and therefore, the system would not qualify
for the incentive at that point. But, after reading the language in the rule
(? New products or systems that contain significant technological advances
over the products or systems they are replacing?), he said the system may
qualify after all. Also, technical officials for the Navy system discussed
previously did not disagree with the contracting officer that the system,
with new technology that enhanced performance, would qualify for the
incentive. However, they stated that, in general, the technology incentive
should be awarded during research and development because, by low- rate
production, the technology should be set, and, during production, the
emphasis should be on making manufacturing processes more efficient and
reducing costs.

The new profit guidelines do not identify how the incentive relates to the
revised policies that guide DOD?s system acquisition process. The new
acquisition process emphasizes technology maturity before committing to a
program to reduce its risk, but the profit guidelines reward contractors
with additional profit for introducing new technology, sending mixed signals
about the relative importance of innovation and technology maturity. The new
profit policy could be interpreted in such a way as to be inconsistent with
the new acquisition process.

In DOD?s traditional system acquisition process, program managers matured a
system?s technology throughout the weapon system phases, resulting in a
system that cost significantly more, took longer to produce, and delivered
less than was promised. A new weapon system was encouraged to possess
performance features that significantly distinguished it from other systems.
Consequently, the acquisition environment led DOD program managers to
promote performance features and design characteristics that relied on
immature technologies. Managers were also subject to the pressures of
successfully competing for Relationship of Profit

Policy to DOD?s Revised Acquisition Policies Is Not Defined

Page 9 GAO- 01- 801 Use of Profit Policy to Promote Innovation

the funds to start and sustain a DOD acquisition program. This encouraged
managers to launch product developments with more technical unknowns and
less knowledge about performance and production risks than best commercial
practices dictate. These managers relied on attaining technology, design,
and manufacturing knowledge concurrently- in the higher cost environment of
product development- throughout the weapon system phases. 6

In keeping with best commercial practices, DOD adopted a new system
acquisition approach in which key acquisition and long- term funding
commitments are discouraged until technology is mature and risks are far
better understood than under the traditional process. DOD?s new system
acquisition life cycle separates technology development from system
development. A system?s technology should be mature and demonstrated before
a program is initiated and system development begins. According to DOD
Instruction 5000.2, ?entrance into System Development and Demonstration is
dependent on three things: technology (including software) maturity,
validated requirements, and funding. Unless some other factor is overriding
in its impact, the maturity of the technology will determine the path to be
followed.? When the system goes into full- rate production, the technology
should be mature, the design stable, and the manufacturing processes
established.

The technology incentive is not tied to the new acquisition cycle, and the
profit policy does not address technology maturation and risk reduction,
which are central to DOD?s revised acquisition policies. The revised
acquisition policies stress that technology be mature and demonstrated
before it is integrated into a system. But, the profit policy does not
discuss when in the acquisition cycle innovative technologies should be
rewarded with higher profits. Nor does the profit policy address if or when
contractor efforts to mature innovations should be rewarded through use of
the technology incentive. As a result, the risk is created that the two
policies will work against each other rather than reinforce each other.

The new profit policy may reward contractors for existing levels of
innovation rather than incentivize additional innovation. The definition of
innovation contained in the rule is overly broad and covers all programs
that improve performance over systems that are being replaced- the very

6 For a fuller discussion of this issue, see Best Practices: Better
Management of Technology Development Can Improve Weapon System Outcomes
(GAO/ NSIAD- 99- 162, July 30, 1999). Conclusions

Page 10 GAO- 01- 801 Use of Profit Policy to Promote Innovation

reason for having a program in the first place. Moreover, the rule is silent
on several issues, including how long contractors should be rewarded for
significant innovation. And the relationship of the profit policy to the
acquisition process is not addressed, sending mixed signals to contractors
and contracting officials as to the relative importance of technology
innovation and technology maturation at different points in the acquisition
cycle.

To assure that the technology incentive is appropriately interpreted and
applied, we recommend that the Secretary of Defense

 clarify the definition of innovation contained in the profit policy rule;

 define how long contractors should be rewarded for innovations introduced
during research and development phases; and

 reconcile the relationship of the technology incentive with DOD?s new
acquisition process, including the emphasis on technology maturation.

In written comments on a draft of this report, DOD partially concurred with
the first recommendation that it clarify the definition of innovation
contained in the profit policy rule. DOD stated that it would examine how
the policy is being used after it has been in place for a year and, at that
time, determine if the types of innovation that may be rewarded with the
technology incentive factor can be stated more clearly.

DOD partially concurred with our second recommendation that it define how
long contractors should be rewarded for innovations introduced during
research and development phases. DOD stated that, after the policy has been
in place for a year, it will re- examine the regulations to determine if
there are relevant factors that can be provided for contracting officers to
consider in making this judgment.

DOD disagreed with our recommendation that it reconcile the relationship of
the technology incentive to the new acquisition process. DOD stated that it
did not believe the revised profit policy was inconsistent with its new 5000
series acquisition regulations. DOD pointed out that the 5000 series
stresses the need for balance among several key factors in planning
acquisition strategies and that, ultimately, DOD decides what it will buy
and how much technological risk it will accept. According to DOD, after that
decision is made, the technology incentive factor can be used to reward
contractors for the technical risk they undertake in developing or applying
new technologies or significant technological advances. Recommendations for

Executive Action Agency Comments and Our Evaluation

Page 11 GAO- 01- 801 Use of Profit Policy to Promote Innovation

While the 5000 series discusses several factors to be considered in planning
acquisition strategies, there is a clear emphasis on technology maturity to
reduce program risk as a system progresses through the acquisition process.
DOD Regulation 5000.2- R identifies technology maturity as a ?principal
element of program risk.? DOD Instruction 5000.2 provides managers with
specific guidance for managing this element of program risk and makes it
clear that technology should be matured and demonstrated during the
technology development phase before a program is initiated and component
technology is integrated into a system. The instruction states that ?unless
some other factor is overriding in its impact, the maturity of the
technology will determine the path to be followed.? According to the
instruction, ?technology must have been demonstrated in a relevant
environment ? to be considered mature enough to use for product development
in systems integration. If technology is not mature, the DOD Component shall
use alternative technology that is mature and that can meet the user?s
needs.?

Although the acquisition guidance emphasizes technology maturity to reduce
program risk, the profit policy rewards contractors with additional profit
for undertaking technical risk in developing or applying new technology at
unspecified points in the acquisition cycle. Because the profit policy does
not discuss when in the acquisition cycle innovative technologies should be
rewarded with higher profits, it could be interpreted in such a way as to be
inconsistent with the new acquisition process. We discussed this issue with
the officials in the office responsible for developing the new 5000 series.
These officials were familiar with the profit policy rule and, while they
noted that the two were not necessarily inconsistent, the potential for
misinterpretation existed. These officials said that if innovation meant
new- but mature- technology, there would be no conflict between the
policies. On the other hand, they noted that if

?innovation? was misread for ?risk taking? or ?technology immaturity,?
especially late in the acquisition cycle, the policies could work against
each other. They added that the technology incentive would need to be
carefully managed to prevent a conflict and that this could be achieved
through means such as training. We continue to believe that the best
approach for managing this potential conflict is to explicitly discuss the
relationship between the two policies- particularly as they relate to
innovation- in the guidelines contained in the profit policy regulation on
when the technology incentive should be used.

DOD comments appear in appendix II.

Page 12 GAO- 01- 801 Use of Profit Policy to Promote Innovation

To determine whether the new profit policy is likely to achieve its
objective of stimulating increased innovation, we selected programs at some
of DOD?s highest dollar buying commands to review how contracting and
acquisition officials would apply the new policy to various programs. We
selected one buying command to represent each service. We discussed the
profit policy rule in general, the types of contracts the rule might apply
to, and the points in DOD?s acquisition cycle in which it could be applied.
We also talked specifically about each program selected to determine whether
there were innovative technologies that would have qualified for the
technology incentive if the policy had been in effect at the time of
contract award. In addition, we asked representatives from some of the
programs to reprice a sample contract using the new profit policy to
determine whether the profit objective would have been higher.

We also analyzed DOD?s fiscal year 2000 contracting database (DD350) to
identify the types of contracts awarded at each phase of the acquisition
cycle, the percentage of dollars awarded using the various profit award
mechanisms, and the proportion of dollars awarded with or without
competition.

To assess the relationship between the new profit policy and the new
acquisition process, we analyzed what the acquisition guidance and profit
policy say about technology development, maturation, and innovation. We also
discussed these policies with DOD officials who developed them.

We reviewed relevant documents and held discussions with officials at the U.
S. Army Aviation and Missile Command, Huntsville, Alabama; Aeronautical
Systems Center, Dayton, Ohio; Naval Air Systems Command, Patuxent River,
Maryland; Office of Defense Procurement, Cost, Pricing, and Finance,
Washington, D. C.; and Office of the Deputy Under Secretary of Defense
(Acquisition Reform) for Acquisition, Technology, and Logistics, Washington,
D. C.

We performed our review between January 2001 and May 2001 in accordance with
generally accepted government auditing standards.

As agreed with your office, unless you publicly announce the contents of
this report earlier, we will not distribute this report until 30 days from
its date. At that time, we will send copies of this report to the
appropriate congressional committees; the Honorable Donald H. Rumsfeld,
Secretary of Defense; and the Honorable Mitchell E. Daniels Jr., Director,
Office of Management and Budget. Scope and

Methodology

Page 13 GAO- 01- 801 Use of Profit Policy to Promote Innovation

Please contact me at (202) 512- 4841 if you or your staff have any questions
concerning this report. Major contributors to this report are Karen
Zuckerstein, Erin Baker, Julia Kennon and John Van Schaik.

Sincerely yours, David E. Cooper Director Acquisition and Sourcing
Management

Appendix I: Impact of Using Technology Incentive on Sample Contract

Page 14 GAO- 01- 801 Use of Profit Policy to Promote Innovation

The following table shows the impact of using the technology incentive on a
sample contract repriced for us at one of the buying commands we visited.
The actual profit objective calculated prior to the profit policy change was
based on technical performance risk valued at the top of the standard range.
The repricing to reflect what would likely have occurred after the profit
policy change was based on technical performance risk valued at the top of
the technology incentive range. No other changes were made in the profit
objective calculation.

Table 3: Sample Contract Profit objective before change Profit objective

using new method Increase from prior method Increase in

profit rate

Dollars Rate Dollars Rate Dollars Percent $ 8,472,933 13.98% $ 9,584,982
15.81% $ 1,112,049 1. 83%

Appendix I: Impact of Using Technology Incentive on Sample Contract

Appendix II: Comments From the Department of Defense

Page 15 GAO- 01- 801 Use of Profit Policy to Promote Innovation

Appendix II: Comments From the Department of Defense

Appendix II: Comments From the Department of Defense

Page 16 GAO- 01- 801 Use of Profit Policy to Promote Innovation

See p. 10.

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