Up until now we have spoken about single performance measures. However, typically a Performance Based Contract (PBC) will use more than 1 performance measure. Therefore, the question is how do we amalgamate two or more performance measures into one overall Weighted Performance Score (WPS)?
Firstly, my colleagues and I define a WPS as a single number (typically a percentage) that represents the overall score of all performance measures used within the PBC. Typically the WPS is the value that is then applied to any form of payment.
In terms of the calculating the WPS there are two methods; (1) equally weighted or (2) unequally weighted. Additionally, the PBC practitioner can also add ‘gates’ into the WPS calculation, however, this is the topic of a future post.
Equally Weighted WPS
The equally weighted WPS is based on the following equation:
- Total Score (%) of all PM = the sum of all performance measures (in the same units, typically percentage)
- Number of PMs = the total number of performance measures
For example if we had a PBC with 3 performance measures with the performance scores for each performance measure in the last performance period being PM1 = 90%, PM2 = 80% and PM3 = 100% then the equally weighted WPS would be:
The advantage of the equally weighted WPS is that it is simple to apply and easy to understand. However, the disadvantage of the equally weighted WPS is that it can mask under performance in a critical performance measure.
Unequally Weighted WPS
The unequally weighted WPS is based on the following equation:
- Weighting PM = the weighting represented as a percentage (typically between 0% and 100%) for the individual performance measures
- Score PM = the performance score of the individual performance measure for the last performance period
Using the same example as before, if we had a PBC with 3 performance measures with the performance scores for each performance measure being PM1 = 90%, PM2 = 80% and PM3 = 100%, however, in this case the weightings of the performance measures were PM Weight 1 = 50%, PM Weight 2 = 30% and PM Weight 3 = 20% then the unequally weighted WPS would be:
The advantage of the unequally weighted WPS is that it is highlights to the seller the buyers performance priorities based on performance measure with the highest weighting. However, the disadvantage of the unequally weighted WPS is that it more complex to apply and harder to set the weightings
Critical to the successful operation of an unequally weighted WPS is setting the weightings. In establishing these weighting the designer must remember that the weightings reflect the relative importance of each performance measure over the other performance measures. For example, is performance measure 1 more (or less or equally) important as performance measure 2? If more important, how much more important? When establishing the unequal weightings the following rules of thumb should be observed:
- Consider the relative values of weights to highlight priority (e.g. KPI-1 is twice as important as KPI-2)
- Use only 5% increments (e.g. not 2.5 or less)
Again, considering the previous example where PM1 = 50% weighting, PM2 = 30% weighting and PM3 = 20% weighting we can determine that PM1 is more than 1.5 times more important than PM2 and more than 2 times more important than PM3. Based on this simple observation the PBC practitioner can then check with the buyer whether this accurately reflects their priorities.
In summary, while the calculation of the WPS is typically considered a minor element of the design of a PBC the use of weightings (or not) is a critical element in highly successful PBCs.