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We can define a performance-based contract (PBC) and a relational contract easily enough, but do we know how to maximize the benefits these unconventional contracts offer us? And, are the improved supply chains and the new “hybrid” contract leading us into favorable results for 2021? How did this success story begin?

Events of 2020 have forced many commercial practitioners to conduct countless, detailed reviews of their supply chains and associated contracts to see how their traditional practices might need to change. First they focused on what the trading relationship between buyer and seller looks like today. Then they asked, specifically, how does this relationship operate during times of normal trading and uncertain times as well?

Results of their research inspired many practitioners to start using “unconventional” contracts – like performance or outcome-based, relational contracts -- to see whether these types could help and if so, which to choose. For example, late in 2020, a colleague of mine, as part of this contract review, asked whether his organization should be using a performance-based contract (PBC) or a relational contract for their long-term services contract.

This led me to rethink about a deeper issue. Many times we see our contracts as black and white; either performance based or relational. But why can’t it be both? The answer of course is that it can be. Both a PBC and relational approach can be used concurrently. They are not mutually exclusive.

So let’s look at this further.

From a PBC perspective, the definition typically used is:

“Performance Based Contracting is an outcomes-oriented contracting method that ties a range of monetary and non-monetary consequences to the contractor based on their accomplishment of measurable and achievable performance requirements.”1

From a relational contracting perspective, I tend to use the Australian Defence Collaborative Contracting Better Practice Guide,2 a practical extension of ISO44001 Collaborative Business Relationships, which defines a Collaborative (rather than

Relational) Contract as:

“Collaborative contracting is where parties work together to achieve common outcomes. Collaborative contracts are underpinned by parties working together in good faith, focusing on fixing problems and not blame, managing risk equitably and jointly where appropriate, promoting transparency, and avoiding disputes.”3

A quick look at both definitions, and as illustrated in Figure 1, we can observe a range of options available to the commercial practitioner in defining their trading relationship.

Jacko1

Figure 1 : PBC vs. Collaborative Contracting

Looking at the two extremes, points 1 and 2 in Figure 1, we can observe these are well known trading arrangements as follows:

  • Point 1 - a “pure” PBC which is “transactional” focused only the delivery of contract scope and not the health of the business relationship. These arrangements tend to be conventional, arms-length (i.e. master-slave) contracts reflecting short-term, commodity based with a well-defined scope, and individual roles and responsibilities. 
  • Point 2 – at the other end of the spectrum we have a “pure” relational contract, which relies on the relationship between buyer and seller to deliver the contract scope. This is a realm of the true alliances reflecting high levels of uncertainty in scope in which parties share risks and rewards, working seamlessly together as a collective to deliver mutual success.
  • Point 3 is a “hybrid” option combining the best features of each. That is a contract that has the performance elements from a PBC (necessary in the public sector to ensure Value for Money) while embracing the relational (collaborative) aspects necessary in long-term (10+ years) contracts where there is a high likelihood of a change in scope. These hybrid contracts (let’s call them performance-based collaborative contracts) have been operating since 2013 in what is sometimes referred to as Generation 3 PBCs.

The key difference between Generation 3 PBCs and older PBCs is they explicitly include a number of strategic, “relational” performance measures linking collective performance and behaviors with financial and non-financial consequences. By explicitly including these as part of the contract we are not only defining a positive and collaborative business relationship, but also, by making it an integral part of the contract management process, we are defining this as a critical element of contract success. Importantly, these are in addition to those traditional performance measures focused on individual contractor performance. Figure 2 and Table 1 together illustrate and describe these measures and the interaction.

In Figure 2 and Table 1 the word “Enterprise” means the collection of organizations and individuals (including buyer, seller, and others) that are collectively responsible for delivering the Enterprise Outcome. The Enterprise may be tightly defined and managed through commercial documentation, or loosely organized via an unwritten understanding of individual roles and responsibilities in delivering the Enterprise Outcome.

Jacko2

Figure 2 : Generation 3 PBC Tiers of Performance Measures 

Performance Measure Name

Scope of Performance Measure

Consequences

Enterprise Performance Measures (EPMs)

 

EPMs assess the collective performance against Enterprise performance (outcome) and behaviors.

EPMs are not subject to adjudication and adjustment.   This means that regardless of whether an organization has impacted the performance rating of the EPMs, the same performance rating is applied to all organizations in the Enterprise.

The indirect nature of EPMs, means they are typically linked to incentives and other non-monetary rewards such as contract extension.

Strategic Performance Measures (SPMs)

SPMs are used to assess the individual contractor performance against more strategic, long-term contract outputs.

Given SPMs represent individual contractor performance, they are subject to adjudication and adjustment to remove any non-contractor impact on performance.

The more strategic and longer-term nature of SPMs typically link them to incentives and other non-monetary rewards such as contract extension.

Key Performance Indicator (KPI)

 KPIs directly relate to individual contractor performance (outputs) against their contracted scope of work.

KPIs represent individual contractor performance and are subject to adjudication and adjustment to remove any non-contractor impact on performance.

 

The direct nature of KPIs mean they are typically linked to a potential reduction in contractor payment.

System Health Indicator (SHI)

SHIs provides the insight into past and future collective Enterprise and individual contractor performance by highlighting drivers and constraints.

Typically, the role of an SHI is to provide confidence in the delivery of the KPIs, SPMs and EPMs to ensure the delivery of both the contract output and Enterprise Outcome.

SHIs are typically linked to other non-monetary rewards and remedies such as contract extension.

Table 1 : Description Generation 3 PBC Performance Measures

In a previous article4 I used the terms outputs and outcomes to try and differentiate between collective responsibilities (outcomes) and individual accountabilities (outputs) for the delivery of performance and behaviors.

Critical to this hybrid approach is aligning the consequences with collective responsibilities and individual accountabilities. Typically, collective responsibilities are linked to positive consequences (e.g. additional contract term, payment of a performance incentive fee, etc.) whereas individual accountabilities are linked to negative consequences (e.g. remediation plans, reduction in performance fee, application of service credits, etc.).

That said, experience has shown us that a critical success factor is not the drafting, but rather whether both buyer and seller teams have the maturity (culture) to use a contract of this nature. Just because you can do it, doesn’t mean you should do it.

In a previous article5 I described simple, sequential questions:

  • Step 1 asks “should I?” and “could I?” and “how?” to assess whether a PBC should be used.
  • Step 2 the “could we?” question was designed to determine whether we have (or could we) put in place all the enablers to support the successful application of a PBC approach including cultural aspects. Conditions to consider include:
  • stakeholder support of a PBC approach that includes executive, users, contract managers, procurement and contracting, legal, etc.; 
  • governance structure that supports the regular reporting and discussion of performance management;
  • contracting architecture that has PBC built-in, or has the ability to be readily tailored; and 
  • potential suppliers who accept a PBC approach as a part of the Approach To Market 

The same questions apply to whether a collaborative contract can be used.

So regardless of which commercial approach you intend to use, hopefully by now you realize a range of options are available other than simply a black or white approach; that is, either PBC or relational. Instead, through careful consideration, planning and drafting, you can enjoy all benefits of both approaches. So why wouldn’t you?

And speaking of relational approaches, why not join us at Relational Contracts: Theory and Practice Virtual Academic Symposium Friday, April 23 through Saturday April 24, 2021. Registration deadline is April 23, 2021.

END NOTES

  1. JACOPINO, A., Mastering Performance Based Contracts, 13 October 2018
  1. ISO44001 : Collaborative Business Relationship Management Systems, Edition 1, March 2017
  1. Collaborative Contracting Better Practice Guide, Australian Department of Defence, Version 1.0, dated 28 September 2017
  2. JACOPINO, A., Performance Based Contracting - Leap before you look and miss your targeted outcome!, Contracting Excellence Journal, 2 October 2019
  3. JACOPINO, A., When to Use a Performance Based Contract, 19 April 2015

ABOUT THE AUTHOR

Dr Andrew “Jacko” Jacopino is a Senior Advisor in Ngamuru Advisory, an Australian Small-Medium Enterprise (SME), and Fellow of IACCM.  Andrew has a unique and diverse set of skills and experiences based on over 30 years of commercial, engineering and logistics experience for both the ‘buy’ and ‘sell’ side.  Although best known for his work on Performance Based Contracts (PBC) and Performance Based Logistics (PBL) arrangements, as the former Assistant Secretary for Supplier Analysis and Engagement within the Australian Department of Defence he has extensive skills and experience in designing, leading and running large scale commercial operations.  This includes developing procurement strategies, tender development and release, evaluation, negotiations, transition, and operation, with a focus on long-term, collaborative arrangements.  Andrew regularly writes and delivers workshops, both domestically and internationally, on PBC and in 2018 released his book, Mastering Performance Based Contracts.

Content reflects views and opinions of the author and do not necessarily reflect the views and opinions of World Commerce & Contracting.

Dr. Andrew Jacopino, Senior Advisor at Ngamuru Advisory Canberra, Australia


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