Performance based contract types group a range of financial and non-financial consequences related to the ability of a contractor to meet measurable and achievable performance requirements. Performance-based contract have historically been used for road maintenance. They are designed to specifically offer payments when the management and maintenance of road assets are met or when they exceed clearly defined minimum performance goals.

Here are some of the key characteristics of a performance-based contract:

  • The requirements of the contract should focus on the contractual outcomes.
  • The contract does not include language pertaining to how the work is performed.
  • Indicators are set that are tied to the expected outcome.
  • Each indicator includes an achievable performance standard.
  • Each indicator has a way to collect, analyze, and report necessary data.
  • The contract includes performance-based rewards and penalties that have either monetary or non-monetary consequences.

Performance-Based Vs Method-Based Contracts

Performance-based contracts are different than traditional method-based contracts where the techniques, technologies, materials, and material quantities are specified by the client. In traditional contracts, payment to the contractor is based on what was used, how many hours were worked, and other similar factors. Instead, performance-based contracts allow the client to set performance indicators the contractor must meet when completing services.

An example would be a road maintenance contractor that is paid for the results of his work. If a contractor is tasked to fill potholes, their contract might be based on performance. If no potholes remain, they have fully met the performance expectations and payment will be made as per the contract. If they fail to meet the performance indicators or to offer solutions to fix the incomplete portion, their payment will be affected and a series of penalties will be levied.

Performance-based contracts also remove the issue of personality conflicts or other subjective measures by judging success on the clearly defined metrics.

Components of Performance-Based Contracts

Outcome-based contracts focus on what the result of the contract will be. How the result is reached is up to the contractor, who is usually given the ability to use the method that will meet the client's standards. In one example, the Air Force was able to modify a janitorial contract and save fifty percent because instead of requiring a contractor to rewax the floors each week, they changed the contract so it instead specified that the floors needed to be clean, un-scuffed, and glossy.

A request for proposal is used to relay what is expected from the contractor in regards to the specific tasks that are needed. This can include delivery expectations or how operations are run. In an aircraft maintenance Navy contract, for example, it might not require a specific number of mechanics but instead would focus on expected outcomes like meeting flight schedules.

Financial incentives and penalties act as a way to increase productivity, reduce costs, and improve quality. These are written into the contract and put both the risk and the reward on the contractor. In California, when a highway overpass needed to be rebuilt after an earthquake, Caltrans offered major rewards for completing the project ahead of time, while also including major penalties for every day the project was past the agreed upon deadline.

More reliance on the use of private companies requires the government to have ways to properly assess and monitor the services being delivered. This helps ensure that the goals listed in the contracts match the government goals without needing to monitor aspects that are not directly related to the results.

Changes in Responsibilities

While a performance-based contract on the surface seems to put the responsibility on the contractor, the reality is that the person writing the contract must properly define the metrics that are expected. To do this, the person must be well-educated in the subject matter of the contract and be able to properly calculate the performance terms of the contract.

When a contract is drafted the following steps should be completed:

  • Build a team of subject matter experts.
  • Explain the problem that needs a solution.
  • Review existing private-sector and public-sector solutions.
  • Write a performance work statement (PWS) or a statement of objectives (SOO).
  • Determine the metric that will be used to measure and manage performance.
  • Choose the best contractor.
  • Manage performance.

The most important aspect of these steps is properly understanding the technical aspects and related metrics at the beginning of the project. This will limit issues in the future.

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