Before Slashing Budgets, Find the Savings

Value-based contracts could be a boon for the federal government.

It was a bold move for a government entity. In 2005, the commonwealth of Pennsylvania hired a private company to overhaul the archaic way it buys goods and services. It seemed simple enough, but what was innovative -- and daring -- was a key condition: 30 percent of the contractor’s compensation would come from the savings achieved. No savings, no payment.

Putting such a risk on the contractor paid off handsomely. Among other things, officials combined the buying clout and pricing data of all 89 executive branch agencies and departments to strike better deals. Without cutting a single program or service, Pennsylvania saved more than $140 million, or 21 percent, from its annual $700 million tab for everything from office and cleaning supplies to information technology services and tires. The savings far exceeded projections.

Pennsylvania is not alone. Similar value-based contracts enabled the New York City Board of Education to shave $86 million from its $720 million procurement budget, and state and local agencies are experiencing similar savings.

At a time when the federal government is looking to slash trillions of dollars from its budget to curb the national debt, it’s time for Washington to consider the same approach on a broad scale. Even before the 2011 Budget Control Act was passed, the Defense Department, for example, faced the daunting challenge of cutting $465 billion over the next 10 years. If value-based deals could be struck by the Pentagon and other agencies whose budgets dwarf state and county spending, then the federal government would be much better positioned to achieve significant savings on products and services.

In fiscal 2011, the federal government spent $269 billion on services, excluding research and development. If the government could cut 20 percent of that sum -- the same percentage that state and local governments have been able to achieve -- that would result in savings of $53.8 billion, a significant sum by anyone’s measure.

The federal government already has shifted significantly from its routine contracting practices. For many years, a high percentage of its contracts were cost-plus agreements written in a way that guaranteed contractors a profit beyond simply covering their costs. Under cost-plus contracts, companies had no incentive to reduce spending, so the government began favoring fixed-price contracts, which put more of the risk for overruns on the contractors. But there still was no incentive to save money. So, as agencies focus greater attention on cutting costs, the time has come to take the next step and tie at least some contractor payments to their ability to identify and achieve savings.

This is good for government in several ways. First, it holds contractors accountable and provides a better return on investment if they succeed. If contractors do not succeed, then they don’t get paid.

Value-based deals can change the future of contracting by giving agencies a chance to align their budgets within the confines of tighter fiscal realities. Rather than writing contracts that offer bonuses for a job well done, which is how some agreements are structured, agencies should design value-based deals that are ruthlessly outcome-centric.

The trend is forcing government and industry to forge new partnerships: Vendors are betting that their work will achieve maximum results, and agencies are reducing the risk of costly failures at taxpayers’ expense.

Two years ago, President Obama declared: “It's time to fundamentally change the way that we do business in Washington. To help build a new foundation for the 21st century, we need to reform our government so that it is more efficient, more transparent and more creative. That will demand new thinking and a new sense of responsibility for every dollar that is spent.”

The states are the laboratories in which government innovations can be tested and, if successful, adopted in Washington. Value-based contracting is one of those pilots ready for prime time -- and desperately needed -- at the federal level.

John Goodman is a managing director and Stephen Pimpo is a senior executive of supply chain and operations in Accenture’s U.S. defense and intelligence agency business.