Performance Based Payments - Guide Book & Analysis Tool

(DOD PBP Tool Version 3.1)

Draft Guide Book

Although Performance Based Payments (PBPs) have been authorized for use as a type of customary contract financing since 1996, most contracting and acquisition professionals are not familiar with the steps necessary to create an effective PBP arrangement. Unlike progress payments which are incorporated by simply including the appropriate clause, PBPs require considerable thought and effort on both sides to construct the detailed PBP arrangement that will be documented in a special provision in the contract.

The purpose of the guide is to provide assistance to users based on lessons learned over the past fifteen years. It is important for users to read the entire guide because of the inter-relationship of the topics covered. It includes such Chapters as:

• Contract Financing Basics – FAR Part 32
• Performance-Based Payments (PBPs) Basics
• Determining When PBPs Are Practical
• PBP Planning
• Identifying PBP Events
• Establishing Completion Criteria For PBP Events
• The Importance of the Expenditure Profile
• Establishing PBP Event Values

The Guide is issued as a Draft and available for download here. We welcome your questions and comments, which you may send to CPIC@osd.mil.

The Guide will be finalized after the proposed PBP DFARS rule(DFARS Case 2011-D045), issued January 30, 2012 for public comment, becomes final. A Microsoft Word format document showing the DFARS changes proposed by this rule is here. A Microsoft Word format document showing the DFARS PGI changes proposed by this rule is here.

Analysis Tool

The amount and timing of contract financing has a direct impact on the cost to the Government and the financial outcome to the contractor as measured by the Internal Rate of Return (IRR) and Net Present Value (NPV) of the contract cash flows. The purpose of this tool is to demonstrate the financial impact to both the Government and the Contractor of using Performance Based Payments (PBPs) versus Customary Progress Payments.

As outlined in Mr Assad’s Memorandum of April 27, 2011, SUBJ:  Cash Flow Tool for Evaluating Alternative Finance Arrangements, this tool was developed to allow the contracting officer and industry to easily determine a win-win price that equitably accounts for the cost, benefits and potential risk associated with PBPs.

A Win-Win

PBPs offer a unique opportunity for a real "Win-Win" financial arrangement for the Government and the contractor. This opportunity presents itself due to the Government and the contractor having differing views of the time-value of money. The "Win" for the contractor is better cash flow resulting in a more favorable financial outcome as measured by the IRR and NPV of the cash flows at a reduced contract price.

The "Win" for the Government is a lower contract price that more than offsets the additional financing costs of providing a better cash flow to the contractor. The PBP Analysis Tool employs a discounted cash flow analysis to help the contracting officer to determine the Win-Win financial solution for any PBP arrangement. The tool provides a unique and simple to use “what if” feature on the timing of PBP event completion and payment that enables both sides to objectively assess the potential risk of PBPs in determining the Win-Win solution.

Progress Payments – the Benchmark

Customary Progress Payments are used as the benchmark for determining a Win-Win arrangement for several reasons. First and Foremost, in Dr. Carter’s September 14, 2010 memo, he stated “I expect that the basis of negotiations shall be the use of customary progress payments. After agreement on price on the basis of customary progress payments, the contractor shall have the flexibility to propose an alternate payment arrangement for the Government’s consideration”, such as PBPs.

Second, progress payments are the financing method most commonly utilized between the Government and Industry. And third, progress payments are considered by industry to be a low-risk form of financing. For these reasons, the Customary Progress Payment scenario is the right financial benchmark for a risk/reward analysis.

Downloading the Tool

Version 3.1 of the tool is now available.  Version 3.1 accommodates Undefinitized Contract Actions (UCAs) and other situations involving the conversion from progress payment financing to PBPs. The tool allows the user to select between “New Award” and “Conversion”. The “Conversion” option will allow the model to reflect financing provided before the conversion to PBPs. The tool uses XNPV and XIRR functions which are standard functions in Excel 2007 and later versions but are only contained in Microsoft's Analysis Toolpak on earlier versions. Under the "Important Notes" section of the Instructions worksheet tab in the tool are the steps needed to enable the Analysis Toolpak in Excel 97-2003. Users should review the Version Notes sheet in the tool to understand the changes incorporated in Version 3.1. Demo versions of the tool are provided to demonstrate the new features of the tool are also available for download. We welcome your questions and comments on the tool, which you may send to costandprice@osd.mil.

DOD PBP Tool (Version 3.1 – Demo – New Award) – Example of how the model can be used to provide a win-win arrangement for new contract awards.

DOD PBP Tool (Version 3.1 – Demo – Conversion) – Example of how the model can be used to provide a win-win arrangement for contracts converting to PBPs from progress payment financing.

DOD PBP Tool (Version 3.1 ) – PBP tool for Excel 97-2003 and later versions of Excel.

DOD PBP Tool (Version 3.1) Macros – The formulas used to calculate the values on the win-win analysis sheet.