In this week’s blog post on Mason GovCon’s acquisition playbook study, we discuss modular contracting for software-intensive systems. The Federal Acquisition Regulation prefers modular contracting when it comes to information technology because it reduces risk and incentives contractor performance. When paired with agile work statements, government can take full advantage of commercial development practices. Creating a modular contracting strategy can help the formulation of a repeatable process.
Read the Draft Playbook, May 13, 2021
Background
In the 1950s and 1960s, management experts started deploying two general methods for improving federal contracts where the guiding hand of the market was absent. First was to use incentives, such as providing award fees or sharing in the profit/loss. Second was participation in the contractor’s internal controls, exemplified by the Program Evaluation Review Technique (now called Earned Value Management).
RAND analyst Oliver Williamson complained in 1965 how the management experts did not even “consider task definition as a means of influencing contract behavior.” He continued,
“… neither the manipulation of profit incentives nor the monitoring of contract progress can be expected, in any dependable sense, to yield significant improvements in contract performance as long as the specification of the task remains unchanged. From a contractual point of view at least, the ‘systems approach’ to weapons procurement which has prevailed since 1953 appears to be distinctly suboptimal.”
He advocated partitioning contract tasks into smaller efforts. Williamson went on to be a founder of the transaction cost theory of economics and won a Nobel prize for it in 2009. Along with Armen Alchian, Burton Klein, and William Meckling, the early transaction costs economists got their start examining systems acquisition at RAND. Yet their advice was largely ignored by the Department of Defense, which adopted the long-duration “total responsibility” concept found in TPP and later TSPR. The first TPP contract for the C-5A led to a bailout of the contractor after high cost growth and performance shortfalls.
In 1996, Congress started to push in the opposite direction for information technology programs. 41 US Code §2308 states, “To the maximum extent practicable, the head of an executive agency should use modular contracting for an acquisition of a major system of information technology.” This is reflected in FAR 39.103, making modular contracting the preferred approach for digital products.
Modular Contracting
Modular contracting is a companion concept to the previous software-intensive play on Agile Contracting. When technical direction is separated from work statements, accountability for performance is no longer built into the contract. Modularization and shorter periods of performance creates an incentive for the contractor to continuously deliver or risk being replaced. Williamson noted advantages in modular contracts in 1968:
- “It reduces the amount of uncertainty and hence increases objectivity in contract negotiations, reduces the felt need for defensibility in administering contracts, and permits more reliable evaluations which in turn allow cost-performance reputation effects to be assigned with confidence. Each of these effects should help to prevent excessive contract costs.
- It creates a contract environment in which the full potential of parallel R-and-D approaches… can be exploited.
- It complements R-and-D strategies which emphasize the need for maintaining options by providing support for work on adaptable components and flexible capabilities…
- It permits greater competition by increasing the number of eligible contractors.
- It lends itself to sales and employment stabilization.”
Unfortunately, many in the acquisition community believe modular contracts induce greater risk. An integrated master schedule (IMS) outlining all important tasks from beginning to end provides something to measure against. While an IMS gives the appearance of risk reduction, an analysis shows that many IMSs actually hide task performance until 60 or 70 percent complete when major rework and delays are recognized. The FAR clearly states that modular contracts “reduce program risk.” This is because of early and continuous feedback of product, not paper.
Another major concern is that modular contracts increase transaction costs rather than reduce them. For example, the procurement administrative lead time (PALT) in the Army is 180 days on average for a contract of $1 million or more and the figure grows to 600 days for $50 million or more. Turning a single $50 million contract (600 days) into fifty separate $1 million contracts (50 x 180 days) could increase administrative work by 15-fold!
While the FAR 39.103 advises for a PALT of 180 days or less, in most cases modular contracts can be awarded in less than two weeks. This is made possible by the lightweight structure of the agile work statement. It has been accomplished by several program offices. By cutting modular contract PALT from 180 days to 14 days, the work required for fifty $1 million contracts is made comparable with a single $50 million contract.
Unfortunately, many practitioners did not feel that modular contracting led to reduced transaction costs in their experience. In many cases, workload increased. Yet they often felt it was still the right thing to do. Programs that had adequate government staff and a few years under their belt were more likely to have a repeatable process.
Application
Modular contracting can be achieved using a number of tools in the contracting cone. One path recommended in the playbook is to use a Broad Agency Announcement or a Commercial Solutions Opening to receive proposals on a broadly stated topic. These solicitations can stay open for long periods of time, use written proposals or oral presentations, result in one or many awards, and allow for quick, merit-based selections. Simplified acquisition procedures are often best for this stage.
Promising firms can then compete for bigger opportunities by being added during an on-ramp period to a multiple-award Indefinite-Delivery, Indefinite-Quantity (IDIQ) contract. Roughly than 40 percent of all defense contracts use IDIQs, and the GAO recently found only one-quarter using multiple awards. FAR 16.5, however, prefers multiple award IDIQs which creates fair opportunity and relieves some administrative burden. For example, FAR 15.3 source selection and FAR 6 competition requirements do not apply. This allows multiple-award IDIQs to use the full range of best practices in DHS PIL Bootcamp including oral presentations, confidence ratings, and comparative evaluations. These best practices are also available to federal supply schedules (FAR 8.4) and simplified acquisition (FAR 13).
FAR 16.505(b)(ii) says the contracting officer may “exercise broad discretion” and “keep submission requirements to a minimum” using “streamlined procedures.” It is also the only contract type in the FAR that explicitly advises consideration of FAR 39.103 modular contracting. These advantages make IDIQs a good choice for allowing contractors to compete for larger firm-fixed price contract tasks. Firm-fixed price is preferred, especially when dealing with non-traditional contractors, because it is exempted from the six business system requirements described in DFARS 242-70. Moreover, tasks should often be structured with one base award and four options of six-months each. This approach can also be paired with FAR 14.5 two-step sealed bidding if time allows.
While this process is used by some program offices, there’s never a one-size-fits-all approach. Many other contracting tools can be used, as is often repeated in our interaction with acquisition practitioners. What they share is the outcome that the contractors do not feel like they are constantly preparing proposals. Rather, past performance should directly feed each subsequent phase.
Discussions with the acquisition community has led to recommendations for improvement.
Strategy
The approach to modular contracting should be added to the acquisition strategy to make sure there is alignment over time. Rotating acquisition and contracting officials can lead to a loss of knowledge, creating a reversion to traditional methods. A strategy for modular contracting should describe how contract types fit with the situation. Considerations for the strategy include:
- Product line: Based on the standards for interfaces and data exchange, what parts of the system are contractually severable? Software-intensive elements should be given preference for modular contracting.
- Life cycle: For market research activities and experimentation using BAAs or CSOs, maximize use of simplified acquisition vehicles. For prototyping work, Other Transactions Authority are useful and can transition into production if planned for. Engineering and Manufacturing Development might be done on FAR-based IDIQs. Continuous upgrade efforts with a sole source can benefit from contracts by negotiations. Production and sustainment contracts, however, should avoid modularity and consider financing options when appropriate.
- Vendor pool: If nontraditionals may be competing, strong preference for FFP or OTAs should be provided to avoid numerous business requirements. Nontraditionals may benefit from single-award IDIQs because they can be treated as FAR 12 commercial items. If traditional primes are the likely competitors, then cost reimbursable contracts may have advantages.
- Integrator: Modularity is preferred when government has more technical expertise to oversee contractor-led effort. When government is the integrator and uses development services, there are often advantages to using the federal supply schedules or using Time & Materials contracts. When government does not have the staff to monitor the contractor, large traditional contracts make sense.
- As a service: When possible, buy operational capability using consumption-based solutions. These will often be digital services like cloud computing but can apply to many situations with a metered price like transportation, space-based sensing, counter-UAV, and more.
Reviews
Just like agile contracting requires recurring collaboration between supplier and customer, so does modular contracting. Many major programs have quarterly integrated program reviews with the contractor, which itself can seem like a lot when the contract spans several years. Yet these infrequent checkups often make the customer and their stakeholders suspicious that they are getting taken advantage of. When progress meetings are more frequent, everyone is on the same page and feels invested in the solution which lowers tensions.
Functionals should review the work of their counterparts at the contractors at the end of sprints. The participants should be the “doers” rather than higher level management or business development. Users can be brought in as much as practicable for their feedback on functionality. Their buy-in will be crucial for successful transition and fielding. These frequent reviews should not be run in the traditional manner with slide preparation and risk matrices. Functionality should be the primary thing contractors have to prepare, making the interaction lightweight but informative. Major reviews every six months or year should then be used with the full program team. These may look like more traditional reviews. There should be no surprises at these meetings, and they should be tied to options.
Grow Organic Capabilities
A good way to build up government technical expertise is to bring on advisory and assistance services for systems engineering and technical direction. Rules for these contracts are found in FAR 37.201 while FAR 9.5 describes the rules for conflict of interest. Advisory and assistance services can be bought from a vendor, FFRDC, university, or consultant. The purpose is not to offload technical work to the service providers, but rather to have them work hand-in-hand with government staff to grow in-house capabilities. Think of an apprenticeship model.
A major consideration should be defining exit criteria. Technical services should probably not extend past two years or the government may become reliant. The support is most crucial in the early phases as the program navigates towards an architecture. When competition gets narrowed down and intellectual property gets hammered out, the services contract should have wrapped up.
Conclusion
Modular contracting pairs well with agile work statements for software-intensive efforts. There are a number of potential contract types that can help reduce risk and transaction costs. One common method is to use a multiple award IDIQ with six-month fixed price tasks. The preference for contract types may change depending on where the program is in the lifecycle, participation of nontraditionals, and other factors. These choices should be outlined at a high level in the modular contracting strategy. Performance at major reviews should be directly tied to options and influence future awards. Using advisory and assistance services contracts to help build technical acumen in the government staff is a best practice, but exit criteria should be defined early.
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