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Austraods Review of Perfromance Contracts
Austraods Review of Perfromance Contracts
Austraods Review of Perfromance Contracts
Paul Hardy
Opus International Consultants
ABSTRACT
Paul Hardy
Opus International Consultants Ltd
th
Nelson Office, 4 Floor Civic House,
106 Trafalgar Street
Private Bag 36, Nelson
Tel (03) 548 1099
Fax (03 548 9528
Email paul.hardy@opus.co.nz
1 INTRODUCTION
Over the past 10 years or so Road Authorities (RAs) around the world have
undergone significant changes. In many instances this has meant a
redefinition of their role. Whereas previously they were providers of services,
including design, construction and maintenance, with expertise in carrying out
these functions, they are increasingly becoming asset managers and the
purchasers of services. The levels of ‘traditional’ technical skills required in the
design, construction and maintenance of road networks has been replaced in
many RAs with expertise in asset management and procurement of the
outcomes desired by their customers. For these RAs their role is evolving
from that of expert supplier to ‘informed purchaser’.
This paper comments upon the first element, the potential benefits. It draws
heavily upon the research undertaken for the study but reflects the author’s
opinion on the findings.
2 CONTEXT
To define the context, within which performance contracts are used, a model
of the hierarchical needs of a typical road authority is shown below, figure 1.
This model will be used to explain the drivers behind the adoption of
performance contracts.
Inputs
Inputs: are the means by which the outputs are
delivered. They are governed by technical specifications
and may dictate work method, material specifications
etc. Inputs deal with “what” gets done and “how”.
Figure 1: Road Authorities’ Hierarchy of Needs
Figure 1, illustrates the linkage between individual tasks (inputs) and their
overall objective to provide a road network that meets the needs of their
customers. Increasingly, RAs are endeavouring to align their contracts with
their higher-level goals, i.e. the outcomes they wish to provide to their
customers. Performance contracts are in part driven by a desire to focus on
the higher level needs rather than the means of achieving them and to allow
suppliers increased freedom to determine how to achieve the desired
outcomes. To explain this we need to consider how various current road
maintenance contracts align with the model above.
3 TERMINOLOGY
3.1 DEFINITIONS
5 POTENTIAL BENEFITS
Incremental Benefits?
B •
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t • Own
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PSMC03 (Northland)
As part of the study 3 workshops were run and were attended by 54 people
representing a range of interests within the industry including contractors,
consultants, road authorities and funding agencies. In addition a
questionnaire was sent out to a wide industry group. 19 replies were
received. Whilst this is statistically a small sample the respondents almost all
had significant experience with performance contracts. Their views are
consequently worthy of comment.
100.0%
90.0%
80.0%
70.0%
Percentage Agree
Industry
60.0% Road Authority
50.0% Both
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There was strong agreement amongst the respondents that the benefits
claimed could be achieved. The questionnaire went on to ask are these
benefits quantifiable? The responses received are summarised in figure 4.
100.0%
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Clearly there is less confidence that the benefits can be quantified than the re
is that they can be achieved. However it is worth noting that the greatest
agreement on this question is with the benefits of better value for money and
better definition of the level of service required. Most road authorities would
be happy to achieve these two benefits alone and would consider other
potential benefits to be subsidiary to them.
There was discussion within the workshops are to whether these benefits
could only be achieved by the use of performance contacts. This resulted in
the production of the following table. A “ü” indicates general agreement. A “?”
indicates a mixture of opinion between the workshop attendees.
Achieved only
Easier through
through a
Potential Benefit a Performance
Performance
Contract?
Contract?
Aligned with Road User Requirements ü ü
Ownership by Contractor ü (?)
Better Value ?
Better Knowledge of Asset ?
Risk transfer to those who can manage it best ü ü
Encouraging move to Pavement deterioration ü
modelling
Intervene at optimal time ü
Longer term planning ü
Encourages innovation ü
Price certainty for level of service ü
Up-skilling staff ü
Greater uniformity of measures ü
Better programming / flexibility ü
Table 2: Workshop Output: Comparative Ease of Achieving Benefits
Interestingly the workshop attendees were divided on whether the two key
benefits (better value and better knowledge of the asset) could be more easily
achieved using a performance contract compared to a traditional contract.
This I belief reflects a generally mixed opinion amongst the industry as to the
credibility of the benefits claimed for performance contracts.
The following section comments upon the specific benefits that have been
claimed by various parties as attributable to the adoption of performance
contracts and in particular relates to the use of performance specified
maintenance contracts (PSMC).
It is too early to judge whether these contracts are providing better value for
money, it is clear that they almost always lead to tendered prices, which are
less than the estimated costs of using other procurement methods. The acid
test will be to monitor long-term performance and determine whether:
• The level of service provided meet long term expectations
• The tendered price remains intact over the contract period
Most performance contracts are tendered on a single lump sum basis. The
lump sum is then subject to price adjustments for performance achieved as
measured by KPIs, changes to the asset etc. The potential benefit is that this
approach reduces the risk of cost over-runs and budget blow- outs.
Budgetary certainty is an issue that is largely internal to the supply chain. It
may not in fact be desirable to the RA as it could lead to a global inflexibility of
expenditure. The customer is interested in value for money, rather than
certainty of expenditure. It is therefore debatable whether this is a benefit at
all.
Greater certainty of expenditure is feasible and is relatively easy to measure
through a simple comparison of tendered cost against out-turn cost. In many
respects a measurement of this may be useful to demonstrate whether the
contract has delivered the savings indicated at the time of tender. If the price
increases during the contract through variations careful consideration will
need to be given as to whether these have eaten into the “savings” declared
at the commencement of the contract
The downside of being committed to lump sum payment for 10 years is
covered in the limitation section that follows. Many authorities, particularly
local authorities that may be managing other assets as well as roads, prefer
the ability to manage their budget globally. They may, for example, wish to
reduce road expenditure in one year to allow funds to be allocated to utility
upgrades and then catch up the deferred road maintenance in the subsequent
years. “Fixed” lump sum performance contracts reduce this flexibility.
There are two key considerations in determining if the customer benefits from
increased innovation through the adoption of a performance contract
• Does a performance contract provide greater incentive to a contractor
to innovate?
• If so, does the benefit get to the customer?
As previously described, the guaranteed long-term revenue streams provided
by PSMCs might assist contractors fund the development of innovations that
improve effectiveness and hence reduce the cost of their operations. It is
highly likely that in tendering contractors will anticipate some efficiency gains
during the contract and reduce their price accordingly. The current speed of
technological advancement means that it is likely that during the life of the
contract improved techniques will be available to the contractor. The longer
term means that the contractor has a much greater incentive to invest in the
development of new products and techniques.
The negative aspect of this is that innovations may be carried out on a
commercial-in-confidence basis that may lead to duplication of effort and loss
of industry wide benefits. The cost savings from innovation may not be
passed on to the road user. Some contracts have endeavoured to address the
potential loss of innovation, due to contractors retaining the benefits for their
own commercial gain, by requiring compliance with their existing technical
specifications as a starting point for the contract. The contract then allows
negotiation of changes to these if they are seen as an improvement. This
allows the RA the opportunity to share in the benefit of innovations developed
and implemented under the contract.
Whilst it is clear that some skills have simply transferred from one party
to another, performance contracts have created an increased focus on
performance measurement, risk management and deterioration
modelling/prediction. Enhanced skills in these areas have almost
certainly been created as a result of being involved in the tendering and
running of PSMCs.
To obtain a balanced view of the potential benefits the potential risks and
constraint associated with the adoption of a performance contract must also
be evaluated. There are some significant constraints limiting the wide-scale
adoption of performance contracts
The majority of performance contracts let to date have been large contracts in
excess of $100m. This is to ensure that there is sufficient economy of scale, to
provide financial incentive to contractors to offset the high initial tendering
costs and to counteract the potential downside of taking on additional risk (in
particular the network condition risk). The downside to this is that the scale of
the contracts and the high tendering cost is such that it effectively precludes
the smaller contractors from tendering and it will become increasingly difficult
for them to stay in the market.
In addition, the length of the contracts means the size of the market is
reduced for the duration of the contract, thus placing greater pressure on the
small and medium sized contractors.
Competition is a key driver of efficiency and needs to be retained in any long-
term procurement strategy. The size of the market and the ability to retain a
During the life of a performance contract many factors affecting the contract
could change. These could be physical, political or environmental. The lump
sum nature of performance contracts means that the ability to deal with such
changes is potentially reduced by being “locked in” to outdated contract
The transfer of responsibility for design and technical specification means that
RAs will require a reduced level of technical expertise. There is a risk that if
this downsizing in key technology areas is taken to an extreme level, then that
RA could loose the ability to be an informed purchaser. In addition, if RAs do
not retain sufficient technical skills to keep pace with developing technologies
they risk being unable to take advantage of emerging technologies in future
contracts. This is more of an item to be aware of than a significant risk. The
developing role of RAs as procurement specialists still requires technical skills
and in many respects requires a higher level of technical skills focused on
asset management rather tha n day-to-day design and supervision.
The potential benefits but also comments upon the difficulty of quantifying
these. Currently there appears to be minimal objective data available for use
in documenting the perceived benefits. Whilst this doubt exists it will always
present an obstacle to the wide scale adoption of performance contracts.
Performance contracts rely heavily upon the use of complete, accurate and up
to date asset data. Whilst most RAs will have asset inventory and condition
In many rural areas road maintenance activities provide vital employment that
assists in sustaining the viability of small communities. The efficiency gains
that large region wide performance contracts create place pressures on this
employment. That is contractors may not retain staff in all the communities
that currently employ a small road maintenance work force. There is
consequently a potential social cost to rural communities of implementing a
performance contract, which may override the economic arguments.
Organisational politics within the RA may provide another constraint. The
threat of job losses in the RA and the erosion of traditionally held roles and
responsibilities may produce a resistance to change that makes it difficult to
make the changes required to implement a performance contract.
8.3 CONCLUSION