What is share in savings?

Several government and industry representatives recently raised the following questions: What are share-in-savings contracts? What rules apply to them?

This is another topic that shows how difficult it can be to discuss complex issues in general terms. Everyone seems to be in favor of share-in-savings contracts. After all, who could be opposed to "savings" or "sharing"? However, what people have in mind when discussing share-in-savings programs can be very different. A little more rigor would help the discussion.

Commentators use the term "share in savings" to describe at least three scenarios. First, an agency is seeking to enhance revenue—for example, by improving the collection of taxes or user fees. Second, an agency wants to reduce a net expenditure—for example, by cutting the cost of a required operation. Third, an agency wants to reduce a net expenditure but also wants to keep the "savings" for its own use. For convenience, let's call these three scenarios revenue enhancement, cost avoidance and agency reward, respectively.

Most people who write or talk about share-in-savings contracts like to cite as a success story one of the revenue-enhancement scenarios. Thus, the most frequently cited example is a California contract in which an information processing modernization effort allowed the state to collect back corporate taxes more efficiently. The contractor's pay was based on the improvements in revenue generation. In such cases, an agency might pay a little more for the services it receives, but the government arguably gets an even larger benefit.

Most agencies that are involved in revenue-generating activities have all the legal authority they need to make this sort of contract. Even at the federal level, most agencies that collect taxes or fees are funded in part by retaining a portion of the collections. The revenue-enhancement scenario is relatively straightforward, even though the results may be spectacular.

However, when looking into the future, most people who address the share-in-savings idea focus on the cost-avoidance scenario, because it covers a lot more opportunities. Thus, a frequently discussed example involves the possibility of contracting for better management of a data processing center with payment to the contractor based on its success in cutting costs. In principle, this idea is not new. Agencies have been contracting on an incentive-fee basis for years.

Federal Acquisition Regulation subpart 16.4 describes several different "incentive contracting" methods that agencies can use to compensate contractors based on results. Although most incentive fee contracts are cost-plus contracts, fixed-price incentive contracts also are seen. With most incentive contracts, the contractor is expected to recoup its costs primarily in its base price while risking its profit or fee on its success. (See, for example, Newport News Shipbuilding & Drydock Co., B-254969, Feb. 1, 1994, 94-1 C.D. : 198, which involved discussing a fixed-price, incentive-fee contract with a 50-50 contractor-government share in savings.)

For some projects a few commentators have argued that the base price should be set at zero, with the contractor's entire compensation based on performance. At first glance this might seem to be a plausible idea to some. In almost all cases, however, the idea has nothing to do with legitimate share-in-savings concepts but is an attempt to avoid the prohibition on contracting for a product or service before appropriations. A more detailed discussion of this point will have to wait until another column.

As part of the National Defense Authorization Act for 1996 (Pub. L. No. 104-106, & Sect; 5311, 110 Stat. 186, 692), under the heading "Share-in-Savings Pilot Program," Congress authorized the administrator of the Office of Federal Procurement Policy to designate two agencies to "test the feasibility of" paying information technology contractors based on a percentage of the savings derived from the contractors' solutions. As seen from the previous discussion, this "pilot program" offers agencies nothing that they don't already have. Accordingly, no agency has had any reason to ask for designation under the act.

Under the cost-avoidance scenario, the government automatically shares in any savings that are achieved. Moreover, unless Congress decides that the money saved is better used elsewhere, and reduces the agency's annual appropriations accordingly, the agency itself will benefit directly. Either way, the public is better off.

Some agency officials prefer to think of share-in-savings contracts using the agency-reward scenario. These officials believe that Congress is almost certain to reduce an agency's appropriations if it becomes clear that a significant savings has been achieved. It is not enough for these individuals that the government achieves a savings unless their own agency can keep the money as a reward for their savvy management. Sometimes these officials will try to structure a deal to hide the savings as rebates or in other ways to make it look as though the money was spent, even though it is returned to the agency. As I wrote in a Jan. 19, 1998, column, schemes of this kind generally constitute an illegal augmentation of the agency's appropriations.

There is room for a lot more discussion on share-in-savings contracts. However, because the rules in each environment are so different, much of that discussion will be a waste of time unless the participants clearly distinguish among the alternative scenarios involved.

--Peckinpaugh is a member of the government contracts section of the law firm Winston & Strawn, Washington, D.C.