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Performance-based contracting (PBC) or results-based contracting, is a procurement 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 strategy, where payment is related to completion of milestones and project deliverables.
In PBC, 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 therefore 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. [2]
Performance-based approaches are widely used within the defense industry, [3] but can be applied across many sectors. In the defense industry they are also known as performance-based logistics (PBL). In international development the concept is known under output-based aid.
Payment by Results (PbR) is a closely related concept. It can be used as a public policy instrument whereby payments are contingent on the independent verification of results.
The terms performance-based and results-based are mostly used interchangeably. The latter may signal more the achievement of broader social and economic outcomes
Performance-based contracting is the term used in Australia, New Zealand and Canada to describe the practice of attaching contract payment to a set of performance metrics.
Terms that are either synonyms, or at least closely related, include:
Performance-based contracting (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.
PBC and PbR instruments have three key features:
Performance-based contracting 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.
A typical process for implementing a performance-based contract is as follows:
There is discussion[ where? ] 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. [10] [11]
The U.S. Department of Defense/Air Force/Defense Acquisition University sponsored a research project conducted by the University of Tennessee,[ when? ] looking at 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. [12]
An analysis in 2015 has suggested that greater benefit is achieved under a PBC strategy where the supplier is a "total service provider" with ownership of the assets being supported. [13]
An international workshop on PBC held in 2014 found both a wide variety of practical applications had been identified for PBC alongside a level of academic interest, but also observed that PBC is "by no means always appropriate". [6]
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Commissioners (central or local government) may face a number of challenges that may make a pure payment by outcomes approach either impractical or sub-optimal in terms of achieving the aims of PbR models. These challenges largely stem from commissioners’ ability to manage different risks and responsibilities, especially in relation to their understanding of desired outcomes and their measurement.
Challenges of PBC or PbR models can include:
PbR will not always be the optimal contracting model, especially where in-house delivery is more appropriate, or where greater control is required over the service to be delivered.
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.
United States federal law defines performance-based acquisition [14] and treats it as "the preferred method for acquiring services". [15] The National Defense Authorization Act for Fiscal Year 2001 established an order of precedence for:
PBC is widely applied in the Australian defence sector, primarily by the major acquisition and support organisation, the former Defence Materiel Organisation (DMO). It is particularly useful in the defence environment because of the inherent complexity and large scale of the projects.[ citation needed ] 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 a defence context.
In October 2000, US Congress approved an incentive for the use of performance-based contracts, through legislation giving the Department of Defense time-limited authority to treat certain performance-based service contracts as contracts for commercial items, which may be awarded using streamlined procedures under Part 12 of the Federal Acquisition Regulation (FAR). [16] : Section 821(b) The Defense Department issued regulations to implement the legislative authority, but the Government Accountability Office reported in 2003 (at the end of the period of temporary authorisation) that no tracking mechanism had been put in place and therefore the Department did not know "the extent to which the authority [had] been used". Defense officials estimated that use had been "limited, at best". [17]
PBC frameworks are currently being used in numerous defence-related projects, including:[ citation needed ]
PBC is becoming more popular[ citation needed ] 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 in industry where PBC is applied include:[ citation needed ]
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There are many cases of Payment by Results (PbR) models being used to achieve domestic policy goals, in particular the delivery of social or community services, with payments linked to the results a provider achieves, rather than its inputs and processes. The use of PbR models is often promoted as a way to drive service improvements and achieve increased value for money by aligning incentives to desired outcomes.
In practice, a diverse range of PbR models have been implemented by governments, varying by the degree to which:
The purest form of PbR is payment by outcomes, which seeks to maximise payments linked to outcomes. This is where the commissioner (central or local government) is fully able to contract in terms of the outcomes it wants and to transfer the financial risk of non-delivery to providers.
Performance-based contracting is used in international development as part of output-based aid approaches. In this context, the approach is often referred to as results-based aid (where the funding relationship is between a donor and a recipient country) or results-based financing (where the funding relationship is between a developing country government or a development agency, and public or private sector providers).
Health care reform is for the most part governmental policy that affects health care delivery in a given place. Health care reform typically attempts to:
A value chain is a progression of activities that a business or firm performs in order to deliver goods and services of value to an end customer. The concept comes from the field of business management and was first described by Michael Porter in his 1985 best-seller, Competitive Advantage: Creating and Sustaining Superior Performance.
The idea of [Porter's Value Chain] is based on the process view of organizations, the idea of seeing a manufacturing organization as a system, made up of subsystems each with inputs, transformation processes and outputs. Inputs, transformation processes, and outputs involve the acquisition and consumption of resources – money, labour, materials, equipment, buildings, land, administration and management. How value chain activities are carried out determines costs and affects profits.
Procurement is the process of locating and agreeing to terms and purchasing goods, services, or other works from an external source, often with the use of a tendering or competitive bidding process. The term may also refer to a contractual obligation to "procure", i.e. to "ensure" that something is done. When a government agency buys goods or services through this practice, it is referred to as government procurement or public procurement.
A performance indicator or key performance indicator (KPI) is a type of performance measurement. KPIs evaluate the success of an organization or of a particular activity in which it engages. KPIs provide a focus for strategic and operational improvement, create an analytical basis for decision making and help focus attention on what matters most.
Purchasing is the procurement process a business or organization uses to acquire goods or services to accomplish its goals. Although there are several organizations that attempt to set standards in the purchasing process, processes can vary greatly between organizations.
Output-based aid (OBA) refers to development aid strategies that link the delivery of public services in developing countries to targeted performance-related subsidies. OBA subsidies are offered in transport construction, education, water and sanitation systems, and healthcare among other sectors where positive externalities exceed cost recovery exclusively from private markets. OBA is a form of results-based financing, with similar principles as performance-based contracting.
E-procurement is a collective term used to refer to a range of technologies which can be used to automate the internal and external processes associated with procurement, strategic sourcing and purchasing.
Strategic sourcing is the process of developing channels of supply at the lowest total cost, not just the lowest purchase price. It expands upon traditional organisational purchasing activities to embrace all activities within the procurement cycle, from specification to receipt, payment for goods and services to sourcing production lines where the labor market would increase firms' ROI. Strategic sourcing processes aim for continuous improvement and re-evaluation of the purchasing activities of an organisation.
The Federal Acquisition Regulation (FAR) is the principal set of rules regarding Government procurement in the United States, and is codified at Chapter 1 of Title 48 of the Code of Federal Regulations, 48 CFR 1. It covers many of the contracts issued by the US military and NASA, as well as US civilian federal agencies.
In the healthcare industry, pay for performance (P4P), also known as "value-based purchasing", is a payment model that offers financial incentives to physicians, hospitals, medical groups, and other healthcare providers for meeting certain performance measures. Clinical outcomes, such as longer survival, are difficult to measure, so pay for performance systems usually evaluate process quality and efficiency, such as measuring blood pressure, lowering blood pressure, or counseling patients to stop smoking. This model also penalizes health care providers for poor outcomes, medical errors, or increased costs. Integrated delivery systems where insurers and providers share in the cost are intended to help align incentives for value-based care.
A cost-plus contract, also termed a cost plus contract, is a contract such that a contractor is paid for all of its allowed expenses, plus additional payment to allow for risk and incentive sharing. Cost-reimbursement contracts contrast with fixed-price contract, in which the contractor is paid a negotiated amount regardless of incurred expenses.
In the United States, the processes of government procurement enable federal, state and local government bodies in the country to acquire goods, services, and interests in real property. Contracting with the federal government or with state and local public bodies enables interested businesses to become suppliers in these markets.
Military supply-chain management is a cross-functional approach to procuring, producing and delivering products and services for military materiel applications. Military supply chain management includes sub-suppliers, suppliers, internal information and funds flow.
Government procurement or public procurement is when a governing body purchases goods, works, and services from an organization for themselves or the taxpayers. In 2019, public procurement accounted for approximately 12% of GDP in OECD countries. In 2021 the World Bank Group estimated that public procurement made up about 15% of global GDP. Therefore, government procurement accounts for a substantial part of the global economy.
Performance-based logistics (PBL), also known as performance-based life-cycle product support, is a defense acquisition strategy for cost-effective weapon system support which has been adopted in particular by the United States Department of Defense. Rather than contracting for the acquisition of parts or services, DoD contracts to secure outcomes or results. Under PBL, the product support manager identifies product support integrator(s) (PSI) to deliver performance outcomes as defined by performance metric(s) for a system or product. The integrator often commits to this performance level at a lower cost, or increased performance at costs similar to those previously achieved under a non-PBL or transactional portfolio of product support arrangements for goods and services.
The Canadian Commercial Corporation is a Canadian federal Crown corporation mandated to support the growth of international trade by helping Canadian exporters gain access to foreign government procurement markets and by helping government buyers abroad to obtain goods from Canada. The ability to enter into commercial contracts as a Government of Canada entity through CCC is designed to give Canadian exporters the opportunity to mitigate risks associated with foreign procurement and international contracting. Canadian businesses exported $2.92 billion in products and services through CCC contracts during the CCC’s 2020-2021 fiscal year.
Military acquisition or defense acquisition is the "bureaucratic management and procurement process", dealing with a nation's investments in the technologies, programs, and product support necessary to achieve its national security strategy and support its armed forces. Its objective is to acquire products that satisfy specified needs and provide measurable improvement to mission capability at a fair and reasonable price.
A reverse auction is a type of auction in which the traditional roles of buyer and seller are reversed. Thus, there is one buyer and many potential sellers. In an ordinary auction also known as a forward auction, buyers compete to obtain goods or services by offering increasingly higher prices. In contrast, in a reverse auction, the sellers compete to obtain business from the buyer and prices will typically decrease as the sellers underbid each other.
The Gateway Logistics Services will be a series of uncrewed spaceflights to the Lunar Gateway space station, with the purpose of providing logistical services to the Gateway. Overseen by NASA's Gateway Logistics Element, the flights will be operated by commercial providers, contracted by the agency in support of crewed expeditions to the Gateway made under the Artemis program. As of March 2023, SpaceX is the only company contracted to provide the services.
At around £290 billion every year, public sector procurement accounts for around a third of all public expenditure in the UK. EU-based laws continue to apply to government procurement: procurement is governed by the Public Contracts Regulations 2015, Part 3 of the Small Business, Enterprise and Employment Act 2015, and the Public Contracts (Scotland) Regulations of 2015 and 2016. These regulations implement EU law, which applied in the UK prior to Brexit, and also contain rules known as the "Lord Young Rules" promoting access for small and medium enterprise (SMEs) to public sector contracts, based on Lord Young's Review Growing Your Business, published in 2013.
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