Central to the use of Performance Based Contracts (PBC) is the balancing of buyer needs with seller (contract) consequences, referring to the variety of commercial rewards and remedies that apply as part of a PBC and can include contract extension, payment, remediation plans, stop payment, contract termination, etc.
One of the main incentives used in PBCs is the awarding of additional contract duration (or term) for good or superior performance. This additional tenure, called an Award Term by many PBC practitioners, is the process that determines whether additional contract duration will be granted. While Award Term is the label generally used in Australia, other labels include Rolling Wave or Rolling Window, both highlighting the reoccurring nature of granting of contract extensions.
Over the next few blog entries I will discuss what an Award Term is, including key features, and how to use them. At the end I will give some scenarios to illustrate how they work. So how does an Award Term work and what are the key features?
The key elements of an Award Term contract are as follows:
- Initial Term– this is the base duration of the first contract and for many long-term contracts (greater than 10 years) the initial term will typically be between 5 – 7 years. For shorter-term contracts (less than 10 years) this will typically be 3 years.
- Maximum Term– if all Award Terms were granted, this is the total contract duration.
- Award Term– this the duration of the extension that, when granted, will cumulatively add onto the initial term. The size of the duration balances the cost associated with assessing and granting the Award Term with the need to keep the seller motivated by having Award Term assessments. While many Performance Based Contracts will use the simplicity of a fixed extension duration of 1 or 2 years, many advanced Performance Based Contract will use a variable Award Term. For example, using a variable Award Term the buyer could initially grant only a 1-year extension. Once the seller has proven their performance, the buyer could grant a 2 or 3 year extension instead. Should the seller’s performance reduce, the buyer can either go back to shorter extensions (e.g. 1 year) as a form of performance probation or not grant an extension.
- Off-Ramp Date– is the date where the buyer will automatically begin a retendering activity for either all or some of the contract scope. This date is set by allowing the buyer sufficient time to undertake a retendering activity before expiry of the current contract. For many large contracts, this can be between 1 and 2 years. For many government agencies, this will be 2 years.
- Initial Award Term Assessment Date– is the date where the buyer is first assessing the seller for a contract extension. Typically, it is at least 2 years before the Off Ramp Date to allow the seller at least one failed Award Term Assessment before the buyer commences a retendering activity.
To help illustrate these elements and their sequence consider the example shown below. In this example, consider a large contract that provides a range of support services to a buyer including maintenance, logistics and training.
Firstly, given the large scope of the contract, it is likely that the initial term of the contract would be at least 6 years and has a maximum term of 15 years. Additionally, the buyer has sought internal funding for $150 million based on the assumption that the price per year was $10 million up until the end of the Maximum Term. However, it should be remembered that the seller is only entitled to $60 million as that is the price of the initial term of the contract. Any additional contract term, and therefore price, will need to be earned through the Award Term process.
Secondly, given the complexity and size of the contract it typically takes the buyer 2 years to undertake a complete tendering process from writing the tender through waiting for a response, evaluation, negotiation and signature, the buyer has set the Off-Ramp Date at 2 years from the end of the Initial Term.
Finally, to allow at least two assessment periods between the initial Award Term Assessment date and the Off-Ramp Date, the Initial Off Ramp Assessment Date has been set 2 years earlier than the Off-Ramp Assessment Date.
In the next entry we’ll look at the assessment methodology for whether an Award Term is granted.