Provide Incentives For Innovation

Provide Incentives for Innovation

Creating the Win-Win Scenario

Federal agencies expect to spend over $25 billion in fiscal year 1993 to
buy and use information technology (IT) but the dollars are being used
so agencies can work faster--not smarter.1 Agency use of IT has failed
to keep pace with private industry, where IT innovations have enabled
companies large and small to reengineer their business practices. More
IT dollars must be focused on the innovation needed for government
reinvention as opposed to the automation of existing processes.

To promote innovation, the government needs to reinvent its funding of
information technology and its relationships with the IT industry.
Agencies must be encouraged to experiment and accept managed risks,
which are inherent in innovation.  Agencies, the IT industry, and the
public will benefit from funding mechanisms and contract terms that
encourage the continual introduction of IT solutions--and make
government more responsive.

Four recommendations are presented here to foster much needed IT
innovation in and among agencies by overcoming fiscal, procedural, and
cultural barriers and by providing opportunities for creative
partnerships between government and the IT industry:

---retain a portion of agency IT savings for reinvestment,

---promote performance-based contracting for IT,

---use multi-year funding for agency IT projects, and

---establish a governmentwide venture capital fund for innovative IT
projects.

Need for Change

The Budget Paradigm:

Today, agency IT managers have few organizational incentives to
innovate.[2] In addition to the cultural resistance that reinvention can
generate, funding of new IT initiatives has become increasingly
difficult.  Agencies face budget reductions in direct response to any
savings generated by IT innovation. IT managers are thereby provided
with negative incentives to challenge the prevailing culture and accept
the risks inherent in innovation. New investment in and experimentation
with IT is relegated to a low priority in the face of recurring budget
constraints.  Agency budgets must include the funds for IT innovation
as well as the funds to operate, maintain, and modernize existing
information systems. Agencies that have successfully innovated using IT
must be allowed to continue IT investment and experimentation.
Success-based funding of IT innovation would provide a new incentive for
managers to reinvent agency business practices, since the funds
available for new IT investment would relate to savings previously
achieved.

Contracting Practices.

With the technical complexity of IT procurements, most agencies have
favored low-risk, fixed-price contracts that place the IT industry in
the role of a supplier of commodities rather than a partner in
innovation.  This approach may work when agencies want IT commodities,
but it is unresponsive to agencies seeking creative IT solutions, since
the contractor is encouraged to sell as much of the offered product or
service as the agency is willing to buy. For example, agencies
frequently lease equipment from a contractor. Since the contractor needs
to fully depreciate the investment in capital equipment being leased to
the government, the contractor is discouraged from recommending
solutions that would result in termination of the lease. The leased
equipment remains in the agency despite the availability of new, more
cost-effective products.  Under these circumstances, there are few
incentives for the IT industry to partner with agencies to get current
technologies in place.

Contractors must be allowed to be more than suppliers of goods and
services. Contract terms need to incentivize the contractor to perform
as a partner, potentially permitting the contractor to share in actual
cost savings realized by the agencies in implementing new solutions
while minimizing the financial risks when agencies accept new solutions
in place of old. Agencies need to create win-win scenarios for
government-industry relationships. This points to making improvements in
the contract vehicle itself.

The objectives of major IT initiatives are not easily met by a single
contract type. The acquisition of innovative information technology
often requires a complex systems integration effort that may best be
articulated as a combination of fixed-price, cost-reimbursement,
incentive, indefinite delivery, time-and-materials, and labor hour
provisions within an overall contract structure. Integral to the
contract, clauses incorporating performance incentives, award fees, and
value engineering must be crafted as positive instruments of reinvention
through IT innovation rather than high-risk exceptions to accepted
procurement practice.

Through effective management of hybrid contracts, industry IT providers
can be given performance-based incentives for making the government more
effective and efficient. Where contract terms and conditions allow the
industry provider to increase profits by saving the government money, a
win-win scenario is created. The price curves in IT hardware and the
rapid pace of technology evolution make this scenario possible.  For
example, a creative solution that uses IT to save an agency $1.00 can be
shared as $0.50 in savings to the government and $0.50 in increased
profits to the industry provider. This solution truly puts the
government and industry in a strategic partnership, working together and
using IT-based approaches to reengineer government.

The Office of Federal Procurement Policy has previously encouraged the
use of performance and quality measures in service contracts, but
limited knowledge and mixed experiences with this type of contracting
have resulted in uneven implementation by the agencies.3 Agency IT
managers and contracting officials need to be educated and encouraged to
use performance-based contracting techniques for IT. Hybrid contract
types and contractual relationships based on partnership represent a
significant culture change to many in both the government IT and
contracting communities. As a starting point, a reeducation process is
needed to change the common perception of the Federal Acquisition
Regulations (FAR) as imposing an inflexible structure for government
contracting.4 Too few government IT acquisitions have effectively used
the latitude provided by the FAR.

However, success stories will need to demonstrate the advantages of this
approach on a pilot basis before the risks of trying something new will
be accepted more broadly. As an example of successful performance- based
contracting, the Department of Housing and Urban Development (HUD) has
documented its experiences with the HUD Integrated Information
Processing Services (HIIPS) procurement, a 12-year contract valued at
$540 million. The HIIPS program office used performance mechanisms to
create a strategic partnership with a vendor that has realized savings
for the government in excess of $30 million since 1991.5

Funding for IT.

Major reinventions based on innovative uses of IT may begin with
discrete, well-defined pilots, but are typically implemented as complex,
multi-year programs. Such programs experience schedule changes because
of a variety of unpredictable circumstances, with corresponding
adjustments in required funding. The annual appropriations process is
inconsistent with the funding flexibility required to effectively
conduct these programs and efficiently acquire IT. On the contrary, the
year-end spending phenomenon of annual appropriations works against IT
innovation by encouraging agencies to acquire IT commodities that
support current agency automation practices. Existing IT solutions and
technologies are perpetuated and become more difficult to reengineer
based on the ever-increasing "sunk cost." Contracts become "dumping
grounds" in the recurring year-end "spend it or lose it" syndrome of
fiscal year funding. For example, analysis of the federal government's
purchasing practices have shown that 50 percent of all personal
computers are purchased in the fourth quarter of the fiscal year.[6] The
multi-year characteristics of IT programs demand more flexible funding
mechanisms to provide effective funding support.

IT innovations that are authorized by specific appropriation should be
provided multi-year funding. Although multi-year funding can be
accomplished now through the appropriations process, it is done
selectively. Greater emphasis on multi-year appropriations is needed for
IT innovation.  Another means of providing multi-year funding is through
the use of legislatively established working capital funds (WCFs). One
current example of the benefit of multi-year IT funding is available
from the Department of the Treasury. The department operates its working
capital fund in conjunction with its Executive Agent Program to fund
selected agencywide IT projects.[7] This approach has generated
documented savings conservatively estimated at $45 million. The Treasury
attributes these savings directly to the multi-year aspects of its fund.
Additional savings have also been realized through the reduced staffing
requirements and economies of scale inherent in an agencywide
program.[8]

Current legislation authorizes several agencies to operate such
funds.[9] However, the legislation does not consistently address IT
services within the scope of these funds. New legislation to revise WCFs
to support IT innovation may be required. In addition, effective use of
multi-year funding requires concerted agency effort. As the fund
manager, an agency must have in place the expertise and procedures to
ensure accountability of the funds expended for each IT program on a
continuing basis over multiple fiscal years. This requirement can
present a challenge to agencies unfamiliar with this funding
arrangement, but the experience of agencies with successful track
records managing similar funds can serve as a resource base. For
example, the Treasury publishes a handbook that documents the specific
procedures that department has used to successfully manage major IT
programs funded through its WCF.10

In today's budgetary environment, proposals for innovative interagency
use of IT are viewed as low priorities compared to the operation,
maintenance, and modernization of existing agency systems.  Even
promising IT pilots often fail to achieve full implementation.  Senior
managers are too often unwilling to risk scarce agency dollars on IT
innovations with current agency operations and personal careers at
stake. This business-as-usual approach to IT funding by agencies will
not generate the innovative solutions that are the core of government
reinvention. No mechanism currently exists to identify and fund cross-
cutting innovations that will have multi-agency or governmentwide
impact.

IT innovation should be fostered governmentwide through the creation
and operation of a fund that operates as the analog of a venture
capital firm in the private sector. This fund complements the Innovation
Capital Fund recommended in a companion NPR report.[11] Operation of a
venture capital fund would allow agency innovators to compete for
available funding, ensure that agency initiatives are screened through a
critical due diligence process, and permit agency resources to be
augmented by the fund to enable selected reinvention projects to
proceed. However, the fund's benefit would not be just as a dollar pool
for funding IT. A governmentwide IT innovation program would draw the
attention and participation of state and local governments and the IT
industry, all of whom stand to benefit from IT innovation in government.
Thus, the manager of the fund would be positioned to broker the
expertise and resources of other interested parties in fund-sponsored
projects further leveraging fund dollars.

Cross References to Other NPR Accompanying Reports

Mission-Driven, Results-Oriented Budgeting, BGT05: Provide Line Managers
with Greater Flexibility to Achieve Results.

Improving Financial Management, FM07: Create Innovation Funds; and FM12:
Manage Fixed Asset Investments for the Long Term.

Reinventing Federal Procurement, PROC15: Encourage Best Value
Procurement.

Endnotes

1. U.S. Office of Management and Budget (OMB), Current Information
Technology Resource Requirements of the Federal Government: Fiscal Year
1993 (Washington, D.C.: U.S. Government Printing Office [GPO], 1992), p.
3.

2. U.S. General Accounting Office, Transition Series:  Information
Management and Technology Issues, GAO/OCG-93-5TR (Washington, D.C.: U.S.
General Accounting Office, December 1992), pp. 19-22.

3. U.S. Office of Management and Budget, Office of Federal Procurement
Policy, Service Contracting, Policy Letter 91-2 (Washington, D.C., April
9, 1991), p. 2.

4. The FAR is issued as chapter 1 of title 48, Code of Federal
Regulations.

5. Arky, M. Elizabeth, Special Assistant to the Secretary, Department of
Housing and Urban Development, "HUD Comments On Reengineering Through
Information Technology," August 9, 1993, p. 3. (Letter.)

6. Brewin, Bob, "PC Price War Forecast For End of Fiscal Year," Federal
Computer Week (August 9, 1993), p. 4.

7. U.S. Department of the Treasury (Treasury), Establishment of
Executive Agents, TD 84-02 (September 4, 1991), p. 2.

8. U.S. Department of the Treasury, Office of Telecommunications
Management, Innovation in Telecommunications Management (February 1993),
p. 7.

9. Agencies with a legislatively enacted WCF include the Departments of
Commerce, Health and Human Services, Housing and Urban Development, the
Interior, Justice, Labor, State, Transportation, and the Treasury.  

10.  Treasury, Innovation in Telecommunications Management, pp.  11-27.

11.  National Performance Review Accompanying Report, Improving
Financial Management (Washington, D.C.: U.S. GPO, September 1993).