Performance incentive contracting: using the purchasing process to find money rather than spend it.

• Author: Gordon, Stephen B.

By shifting government managers' emphasis from the buying process to the buying outcomes, performance incentive contracting becomes an important tool for obtaining the best possible service at the lowest total cost.

In matters of performance, money is a language that most people in government understand. "Found" money, in particular, is a metric that sings, because it means that the budget for a particular area of need does not have to be increased at the expense of another area, or worse yet, by raising taxes. Performance incentive contracting (PIC) provides a way to find savings, reduce costs, or recoup lost revenue while at the same time getting the job done as well as, if not better than, in the past. PIC is not too good to be true; rather, it is so obvious and effective an approach that one must wonder why governments have not used it more widely.

Performance incentive contracting is contracting with a vendor to identify opportunities for savings, reduce costs, or increase revenues associated with the provision of a service, and doing so without the government or other customer having to make any up-front investment of its own resources. "Found" money is the desired economic outcome, and the contractor, who bears the cost of designing and implementing the service, is paid only if it produces the required economic outcomes. The key aspects of the approach include

* the identification and description of desired technical and economic results ("outcomes") in measurable performance terms;

* use of a competitive procurement process to select the best potential solution, not just a good potential solution; and

* sharing of savings or revenue increases in accordance with a formula specified in the contract.

An Outcome-based Contract

Compensation in PIC arrangements is contingent. The contractor derives its "pay" from the economic outcomes it produces. For example, a job-skills trainer operating under a performance incentive contract would receive a share of the cost reduction resulting from a more skilled workforce. It would receive no fixed rate or fixed fee for outputs such as the number of hours of training provided or the number of students trained.

Performance incentive contracting can be a major paradigm shift because it requires a government to think in terms of what it needs a contractor to produce, rather than simply do. PIC involves seeking and considering several potential solutions to a requirement, where only one solution has been used previously. That, in turn, introduces risk and uncertainty for the government, the officials involved, and the contractors. Officials who intend to contract must step back and perform a significant amount of investigation that they otherwise would not do and perhaps take a little heat from those who are threatened by the prospect of change. Contractors who wish to continue doing business with the government must come to terms with the need to revisit how they do business.

Performance incentive contracting first gained widespread use in government during the energy crisis of the early 1970s, when several federal and state agencies, local governments, and other institutions learned that they could use PIC to finance needed improvements in energy systems and equipment. To this day, PIC remains a popular approach for governments and institutions that want to reduce building energy and facility costs without having to make front-end payments for the equipment and other expenses out of their own pockets.

Many state agencies and local governments use performance incentive contracts to collect bad debt, although they probably do not put the "PIC" label on their approach. Bad-debt collection is a "natural" for performance incentive contracts because the desired economic and technical outcomes obviously are measurable, and collection agencies are very willing to work for a share of the recouped receivables. Many governments also apply PIC to the procurement of concessions services, because it places on the vendor the responsibility for inventory investment and management, quality products and service, and doing whatever else is necessary to make a profit.

Performance incentive contracts can be developed for a package of related services. The Virginia Department of Transportation has entered into a pilot PIC agreement with a joint venture firm to maintain 250 linear miles of interstate highway within its jurisdiction. Under the contract, the firm will be totally responsible and at risk for maintaining the assets in "its" identified segments of 1-95, 1-81, and 1-77. The scope of work encompasses all activities that occur in those stretches of highway, from pavement and bridge repair to drainage, signage, and incident response. A representative of the firm has said...