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Procurement Perspectives: Performance-based contracting in the private sector

Stephen Bauld
Procurement Perspectives: Performance-based  contracting in the private sector

Performance-based contracting with private sector suppliers was a popular technique to address the problem of unsatisfactory service.

Under this approach, the government spells out the final product that is desired, but leaves it to the supplier’s discretion to devise a method to achieve the objective.

These contracts give public officials the opportunity to design public-private agreements that are tied to some performance objective. The most aggressive of these contracts are known as “share-in-savings” contracts because contractors get paid based on a percentage of what they actually save the government.

However, actual experience with performance contracting is mixed. In one article, Robert Behn of Duke University and Peter A. Kant of the Department of Agriculture reported performance -based contracting:

Inhibits experimentation with new service techniques to minimize uncertainty.

Encourages innovation in cost-cutting but not in service delivery. The reason is that if the contractor finds less expensive ways of delivering the same product, it gets to keep the extra profit. However, there is no incentive for the contractor to deliver a better product than is called for in the contract.

Rewards promises rather than performance. Contractors have an incentive to make grand promises. Behn and Kant argued it is incumbent upon public officials to ensure contractors make reasonable claims and follow through.

Relies on measures that may distort behaviour. If public officials authorize contracts without specifying their objectives precisely, the contractor may fail to produce the desired results.

Inhibits a symbiotic relationship between government and contractors. In the private sector, companies have no incentive to establish friendly, open relationships with their subcontractors. In government, strict adherence to fairness prohibits such relationships from developing and can make the contracting process less efficient.

In my view, Behn and Kant are wrong in their conclusion that this is a consequence of performance contracting.

Rather, it seems more likely to result from adherence to the principles of openness, transparency and fairness.

Repeatedly going back out to the market, rather than staying with a supplier on a long-term basis frustrates efforts to develop a committed relational supply arrangement.

The highly charged and polemical nature of much of the debate surrounding privatization initiatives makes it difficult to find reliable information on which to base an assessment of the value of privatization measures in the municipal sector.

Cost reduction was the key benefit claimed by privatization.

However, in published econometric studies on water and waste production dating as far back as the 1970s it was concluded there is little evidence of a link between privatization and cost savings. Cost savings were not found in water delivery and were not systematic in waste.

Privatization did lead to enhanced investment in infrastructure, but the cost of such investment was passed along to customers in the form of increased charges.

This made the privatized services (including basic utilities) more expensive to all customers, with a disproportionately severe impact on the poor.

Nevertheless, despite the ambiguity of the information available, that which is available suggests a great deal.

While privatization can lead to benefits, it can also lead to increased cost and poorer service. The willingness and ability of the private sector to phase in cost pass-through is limited in comparison to that of government.

Successful outsourcing requires the satisfaction of several conditions.

First, the service to be contracted must be carefully specified. Only if the service expectation is clearly defined is it possible to obtain an accurate price for a contract for the performance of the work concerned.

Second, the service level and other aspects of overall quality of service historically provided need both to be understood and factored into any outsourcing decision.

Third, outsourcing a number of different aspects of municipal operations requires special attention to co-ordination of activity.

Stephen Bauld is a government procurement expert and can be reached at Some of his columns may contain excerpts from The Municipal Procurement Handbook published by Butterworths.

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