Reengineering Through Information Technology

Recommendations and Actions

IT12: 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.


1. Retain a portion of agency information technology savings for reinvestment. (2)

By July 1994 the Office of Management and Budget (OMB) should instruct agencies to identify IT savings in agency budget submissions for potential reinvestment starting in fiscal year 1996. As part of its instructions, OMB should establish the reporting requirements by which agencies quantify IT savings and track reinvestment in successive fiscal years as part of agency budgets. The instructions to initiate this budget process must be available to agencies no later than July 1994, to accommodate the fiscal year 1996 budget cycle.

Another NPR accompanying report proposes that up to 50 percent of agency appropriations unobligated at the end of a fiscal year be identified for carryover to the next fiscal year.[12] For IT savings, this could be accomplished in two ways. During the current fiscal year, recognized savings could be transferred to an agency's WCF to support IT innovation.[13] In future years, recognized savings could be identified within the annual budget and appropriations process and included in agency appropriations. Through these two mechanisms, a percentage of recognized savings would effectively be carried forward to fund credible programs for IT innovation and experimentation. Such programs would specifically take advantage of new IT technology, demonstrate measurable improvements in agency services, and realize additional savings.

OMB should also collaborate annually with the General Accounting Office to identify the minimum agency accounting procedures and performance measurement criteria required to support agency claims of IT savings. This will facilitate agreement between OMB and congressional appropriations committees on the specific agency savings that will be considered for reinvestment. Results of the collaboration should be reflected in the OMB instructions recommended earlier.

Success-based funding must be grounded in an auditable baseline of agency performance in terms of outcomes and costs in order to attribute specific savings to IT innovation. Only those agencies that meet the challenge of demonstrating auditable results would receive the benefits of success-based funding. Consistent accounting procedures and performance measurement criteria must be employed across agencies to clearly identify those savings resulting from IT innovations. The close relationship between documented agency savings from IT innovation, agency budgets, and the appropriations process point to the central role of OMB in implementing success-based funding.

2. Promote performance-based contracting for information technology. (2)

The Administrator of GSA, by April 1994, in coordination with the interagency team developing a plan for Federal IT acquisition, should lead a governmentwide effort to promote performance-based contracting for IT, starting with the preparation of an action plan by July 1994. A concerted effort is essential to address the needed revision of agency IT acquisition practices, development of new training materials, and publication of case studies to exemplify performance-based contracting. Consideration should also be given to include specific language in the FIRMR and FAR encouraging performance-based contracts and clarifying the latitude available for IT procurements.

3. Use multi-year funding for agency information technology projects. (3)

Beginning in July 1994 OMB should identify major agency innovations appropriate for multi-year funding beginning with agency budget submissions for fiscal year 1996. OMB should then collaborate with the congressional appropriations committees on an annual basis to secure multi-year funding for these IT projects thereby establishing its acceptance and use.

OMB should also complete an agency-by-agency review of current WCF legislation by December 1994. Based on the results of this review, OMB should assist agencies in establishing or revising WCFs to support multi-year funding for agency IT innovation.

4. Establish a governmentwide innovation fund for innovative information technology projects. (3)

By September 1994, OMB should develop a proposal to establish a government- wide innovation fund - including draft legislation, if needed. This fund would support projects with significant benefits to more than one program or agency. Enabling legislation for the fund should parallel the legislation for existing agency WCFs; with concurrence from appropriations committees, appropriated monies should be transferred to the fund and retained without fiscal year spending restrictions until expended on fund-sponsored initiatives. The legislation would also contain provisions establishing funding procedures and operating mechanisms that distinguish this fund from a traditional WCF. Consideration should be given to the options of creating an independent fund or expanding the scope of the existing Information Technology Fund administered by the General Services Administration.[14]

Considerations in the fund's operational framework must ensure that the fund is established and operated with the conditions necessary to promote partnership with the IT industry; leverage the fund with other resources of federal, state, and local agencies, and the private sector; and manage the risk of IT innovation. The criteria by which initiatives are evaluated and selected for fund sponsorship are critical to the value of the fund. The criteria should be established, reviewed, refined, and published in a process open to public comment. The objective of the criteria should be to identify those initiatives that present the best value to the government, considering both return on investment and risk. The criteria would need to address potential improvement of agency, interagency, and intergovernmental operations. Implementation costs, demonstrated savings, agency competency, technological feasibility, interagency and intergovernmental commitments, and the participation of the IT industry would all be carefully weighed.

Capital equivalent to 1 percent of the federal government's annual expenditures for IT would provide sufficient capital to operate the fund. Based on fiscal year 1993 estimates, the 1 percent formula would result in a funding level of approximately $250 million.[15] However, it would be self-defeating to IT innovation to obtain this funding from agency IT funds which are already constrained. Therefore, funding should be identified from within existing agency program appropriations and, with concurrence from the appropriations committees, transferred to the fund to avoid new appropriations. The method of capitalization, together with procedures for periodically reviewing and setting the funding level in succeeding fiscal years, would be key ingredients of the enabling legislation to establish the fund. The relationship of the fund and fund-sponsored initiatives to agency information system plans, budgets, and appropriations points to OMB for fund oversight and development of its operational framework.

Recommendation of projects to be sponsored by the fund would be an appropriate role for the Government Information Technology Services (GITS) Working Group proposed earlier in this report. In addition, the views of state and local government and the private sector should be considered through an advisory role for industry groups and government associations and/or a consultant role for distinguished innovators.

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.


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).

12. National Performance Review Accompanying Report, Mission-Driven, Results-Oriented Budgeting (Washington, D.C.: U.S. GPO, September 1993).

13. Working capital funds have been authorized for a number of agencies. For example, the Departments of Transportation and the Treasury have long-established funds.

14. The Information Technology Fund was authorized by the Paperwork Reduction Reauthorization Act of 1986. The fund enables the General Services Administration to efficiently provide common information technology resources to federal agencies on a coordinated basis.

15. OMB, Current Information Technology Resource Requirements of the Federal Government: Fiscal Year 1993, p. 3.

16. Arky, p. 3.

17. Treasury, Establishment of Executive Agents, p.2.

18. Treasury, Innovation in Telecommunications Management, p. 7.

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