Performance-based contracting

Performance based contracting (PBC), also known as performance-based logistics (PBL) or performance-based acquisition, is a product and services purchasing strategy used to achieve measurable supplier performance. A PBC approach focuses on developing strategic performance metrics and directly relating contracting payment to performance against these metrics. Common metrics include availability, reliability, maintainability, supportability and total cost of ownership. The primary means of accomplishing this are through incentivized, long-term contracts with specific and measurable levels of operational performance defined by the customer and agreed on by contracting parties. The incentivized performance measures aim to motivate the supplier to implement enhanced practices that offer improved performance and cost effective. This stands in contrast to the conventional transaction-based, or waterfall approach, where payment is related to completion of milestones and project deliverables. In PBC, since a part or the whole payment is tied to the performance of the provider and the purchaser does not get involved in the details of the process, it becomes crucial to define a clear set of requirements to the provider. [1] Occasionally governments fail to define the requirements clearly. This leaves room for providers, either intentionally or unintentionally, to misinterpret the requirements, which creates a game like situation.[2] Recent studies highlighted that the shift from transaction-based to outcome-based relationship requires a business model innovation.[3]

Performance-based approaches are widely used within the defense industry, but can be applied across any spend category.

Overview

PBC is about buying performance, not transactional goods and services, through an integrated acquisition and logistics process delivering improved capability to a range of products and services. PBC is a support strategy that places primary emphasis on optimising system support to meet the needs of the user. PBCs delineate outcome performance goals, ensure that responsibilities are assigned, provide incentives for attaining these goals, and facilitate the overall life-cycle management of system reliability, supportability, and total ownership costs.

A PBC in practice involves a contracting agency (who are contracting the work to an external provider) and a contractor (who are responsible for completing the work set out in the contract). Several other parties are often involved, including subcontractors, a legal team and consultants. These parties work for both contracting agency and contractor completing various elements of work associated with contract development, contracted work completion or performance management / measurement.

United States federal law defines performance-based acquisition [4] and treats it as "the preferred method for acquiring services".[5]

Implementation

A typical process for implementing a PBC is as follows:

Business Case – a document which reviews potential risks, benefits and other potential impacts of a PBC, usually presented to senior managers to aid in their decision making
Outcomes – a short statement reflecting the desired result or final deliverable of the contract
Measures – define a set of performance measures that collectively measure the organisations performance against the outcome statement
Levels – set performance levels for the performance measures, i.e. how well the contractor needs to perform
Payment – develop a set of payment curves which set out the pay for performance regime i.e. how much the contractor gets paid for their performance level
Incentives – set out a group of incentives that encourage positive behaviours and discourage negative behaviours
Contract – draft, review, workshop and finalise a contract which covers all aspects of the performance, payment and terms and conditions of the relationship
Review – conduct an analysis of the outcomes of the PBC, taking into account the differing definitions of success from the different groups involved in the contract.

Naming

PBC is the name used in Australia, New Zealand and Canada to describe the practice of attaching contract payment to a set of performance metrics. It is commonly known as performance-based logistics in the US and Contracting for Availability or Contractor Logistics Support in the UK. Although it was developed in the US for defence applications, and is most actively applied there, PBC strategies are growing in popularity around the world and in industry sectors other than defence. In particular, PBC frameworks are becoming popular in shipping, transport, health services and the energy sector.

Alternative terms include:

Performance-based life-cycle product support
Contracting for Availability
Contractor Logistics Support (CLS)
Contracting for Capability
Power-By-The-Hour [6]
Managed Services (or IT and BPO Business Process Outsourcing contracts)
Facilities Management contracts
Outcome Based Contracting,[7][8]
Pay for Performance[9]

Applications

Defence

PBC is widely applied in the Australian defence sector, primarily by the major acquisition and support organisation, the Defence Material Organisation (DMO). It is particularly useful in the defence environment because of the inherent complexity and large scale of the projects. Recently, Australian Defence has initiated an escalation of the use of PBCs with the strategic aims of improving capability outcomes and reducing total cost of ownership. In Australia and the US, PBC frameworks are most commonly applied in Defence situations.

PBC frameworks are currently being used in numerous defence-related projects, including:

Industry

Although it is applied primarily in the defence environment, PBC is becoming more popular in a broader range of private and public sector organisations as they seek to reduce costs and create a closer link between expenditure and performance goals.

Areas outside defence where PBC is applied include:

Commercial Shipping
Public Transport
Health Services
Energy Generation
Maintenance, Repair and Overhaul
Commercial Airlines
Manufacturing
IT and Business Process Outsourcing (BPO)
Facilities Management

Some examples:

PBC for Australian Road Maintenance. This case study provides insight into road maintenance contracts conducted in Western Australia and New South Wales. In both instances, very positive outcomes are recorded. Another case study related to Performance Based Contracting in Road Maintenance claims that in 2005, 35 countries were employing PBC for Road Maintenance, and in 2006 15 others had implemented a PBC or were investigating its use.

PB Contracts as related to Sourcing Business Models

Procurement/Sourcing Business Models

A performance-based model is one of seven Sourcing Business Models.[10] Sourcing Business Models theory is a systems-based approach to structuring supplier relationships. A sourcing business model is a type of business model that is applied to business relationships where more than one party needs to work with another party to be successful. There are seven sourcing business models that range from the transactional to investment-based. The seven models are: Basic Provider, Approved Provider, Preferred Provider, Performance-Based/Managed Services Model, Vested Business Model, Shared Services Model, and Equity Partnership Model. Sourcing business models are targeted for procurement professionals seeking a modern approach for achieving the best fit between buyers and suppliers. Sourcing business model theory is based on a collaborative research effort by the University of Tennessee (UT), the Sourcing Industry Group (SIG) the Center for Outsourcing Research and Education (CORE), and the International Association for Contracts and Commercial Management (IACCM). Their initial research formed the basis for the 2015 book, Strategic Sourcing in the New Economy: Harnessing the Potential of Sourcing Business Models in Modern Procurement.[10]

Studies

There is discussion about the efficacy of PBC as a product support measure. However, there is significant research to suggest that PBC can reduce costs and result in better supplier outputs/performance against metrics than traditional contracting approaches, such as transaction-based contracts.[11][12]

The U.S. Department of Defense/Air Force/Defense Acquisition University sponsored a research project conducted by the University of Tennessee study An American study into the effectiveness of PBC frameworks in Defence projects. The study found that projects employing a true PBC framework resulted in substantially lower costs and improved system readiness / capability when compared to non-PBC arrangements. The U.S. Department of Defense has many documented case studies from award-winning PBL contracts.

In addition, a study by Booz Allen Hamilton found that even incorporating a small amount of a PBC framework into weapons system support will create positive results.

In a more general sense, implementing a PBC framework has a broad range of benefits for organisations, contractors and contracting agencies, including:

Improved contracting for supplier performance against supplier performance metrics
Possible reduction in Total Cost of Ownership (TCO)
Ability to forecast cost within contract bounds
Improved accountability for performance
Development of a clear understanding of performance requirements
Promotion of strategic benefits for Contracting Agency and Contractor
Integration of all contracting aspects in a single set of performance measures
A 'Fair' contract
A greater understanding of life-cycle costs
Investment in workforce and skills

References

Asadabadi, M. R., Saberi, M., & Chang, E. (2017, August). A fuzzy game based framework to address ambiguities in performance based contracting. In Proceedings of the International Conference on Web Intelligence (pp. 1214-1217). ACM.
Asadabadi, M. R., & Sharpe, K. (2019). The ambiguity dilemma in procurement projects. Journal of Business & Industrial Marketing.
Sjödin, David; Parida, Vinit; Jovanovic, Marin; Visnjic, Ivanka (2020). "Value creation and value capture alignment in business model innovation: A process view on outcome‐based business models". Journal of Product Innovation Management. doi:10.1111/jpim.12516.
Federal Acquisition Regulation, Subpart 37.7: Performance-Based Acquisition, accessed 13 October 2016
Federal Acquisition Regulation, Subpart 37.102: Service contracts: general - policy, accessed 13 October 2016
Wharton, Power by the Hour: Can Paying Only for Performance Redefine How Products Are Sold and Serviced?, 21 February 2007 accessed 13 October 2016
Ng, I. C., Maull, R., & Yip, N. (2009). Outcome-based contracts as a driver for systems thinking and service-dominant logic in service science: Evidence from the defence industry. European Management Journal, 27(6), 377-387.
Visnjic, I., Jovanovic, M., Neely, A., & Engwall, M.. (2017). What brings the value to outcome-based contract providers? Value drivers in outcome business models. International Journal of Production Economics, 192, 169-181.
Durham, C. C., & Bartol, K. M. (2000). Pay for performance. Handbook of principles of organizational behavior, 150-165.
Keith, Bonnie; et al. (2016). Strategic Sourcing in the New Economy: Harnessing the Potential of Sourcing Business Models for Modern Procurement (1st ed.). New York: Palgrave Macmillan. ISBN 978-1137552181.
Vitasek, Kate; et al. (2012). Vested: How P&G, McDonald's, and Microsoft are Redefining Winning in Business Relationships (1st ed.). New York: Palgrave Macmillan. ISBN 978-0230341708.
Decarolis, Francesco; Pacini, Riccardo; Spagnolo, Giancarlo (2016). "Past Performance and Procurement Outcomes". doi:10.3386/w22814.