Extending on our simple description of Performance Based Contracting (PBC), a form of contracting that directly relates the delivery of the products or services to payment; we need to examine the 3 key differences between a PBC and traditional contracts:
- PBCs are centred on the outcome of the work to be performed and emphasises objective, measurable performance requirements;
- the Contracting Agency pays for results, not just efforts, as in the case of a typical “cost plus contract”; and
- modification of the payment will be based on a comparison between achieved performance measured against the contractual requirement(s).
Simply put, PBC is about buying performance, not transactional goods and services, through an integrated acquisition and logistics process. PBC is a strategy that places primary emphasis on optimising product support to meet the needs of the user; that is, the delivery of performance. So a PBC:
- delineates outcome performance goals of products,
- ensures that responsibilities are assigned,
- provides incentives for attaining these goals, and
- facilitates the overall life-cycle management of system reliability, supportability, and total ownership costs.
A common question is while this sounds great in theory, what evidence is there that this has been a success for the Contracting Agency and Contractor?
This debate around the efficacy of PBC solutions, especially in the Defence contracting environment, has largely been reactive, opinion based and emotive. In order to determine the validity of this the US Department of Defense (US DoD) commissioned a detailed study into the effectiveness of Performance Based Logistics (PBL). The aim of the study, referred to Project Proof Point, was to provide independent, facts based assessment of PBL strategies and through assessment of real examples, provide conclusive evidence on the effectiveness and affordability of US PBL contracts. It should be noted that the US DoD typically refers to a PBC as a PBL. See the resources, books and links page for a link to this article.
The results of the study highlighted that the benefits of broadly transitioning to PBL sustainment would result in:
- 17 of 21 programs having improved performance and lowered cost over time; and
- a conservative estimate of savings over the US DoD ranging from 10% to 20% every year.
The study also showed that to ensure the delivery of these benefits organisations must effectively manage the PBL over the whole contract lifecycle including:
- development of the approach to market including selection of performance measures and incentives;
- conduct of tender evaluation and negotiation; and
- active contract management during contract execution (i.e. in-service).
A 2010 Study from The Wharton School and Yale School of Management indicated an improvement in product reliability of between 20 – 40 % can occur under a PBC, compared to a traditional arrangement. See the resources, books and links page for a link to this article.
Finally, I have recently observed a small Maintenance, Repair and Overhaul (MRO) contract between a federal government and a small contractor. In this case, the overall performance management framework was correctly tailored to suit the simple contract outcome and resulted in 2 outcomes from the previous traditional contract:
- a 16% improvement in contract outcome; and
- a reduction in the government withhold of contractor payment from 6% to 1.6%
This result is clearly a beneficial outcome for both the Contracting Agency and Contractor.
That said, there are also many circumstances that did not result in benefits for a variety of reasons from the overall the improper application of a PBC (as opposed to a different contract style) through to the incorrect selection of a performance measure and/or performance level and finally inappropriate application of rewards and remedies. In these circumstances, the incorrect application of a PBC can lead to all manner of poor outcomes from a reduction in performance to higher contract costs due to unreasonable contractor risks.
So if applied correctly, PBCs can result in benefits for both Contracting Agency and Contractor. The key, and the topic for further entries, is how to achieve this!