Performance Based Contracting

Designing State of the Art Contract Administration and Monitoring Systems

Executive Summary

Across the globe, governments are opening up traditional public services to the competitive marketplace. The government of the future will be more a focuser of resources than an owner, and more a purchaser and manager of services than a supervisor of personnel and direct service provider.

This dramatic change in the nature of government requires fundamental organizational changes. For governments to avoid failures and mishaps, they must concentrate on becoming smarter shoppers.

This means creating contracting systems that are outcome based; writing contracts that contain clear performance standards; incorporating financial incentives and penalties into the contract; and developing advanced measurement techniques. Such state-of-the-art contracting is often referred to as “performance-based-contracting.” When properly structured, performance-based contracting holds great promise to reduce contracting costs while increasing service quality.

Performance-based contracting systems have several key components:

1. Outcome Based Contracts

Performance contracts clearly spell out the desired end result expected of the contractor, but the manner in which the work is to be performed is left to the contractor’s discretion. Contractors are given as much freedom as possible in figuring out how to best meet government’s performance objective.

Example: The Air Force saved 50 percent by modifying its statement of work for a janitorial contract. Previously, the agency required the contractor to strip and rewax floors weekly. Now it requires the floors to be clean, free of scuff marks and dirt and have a glossy finish.

2. Performance Standards

The process of drawing up the Request for Proposal is a great way to focus a manager’s mind on exactly what it is the agency wants accomplished from the delivery of a service, operation of an enterprise, or running of a program. A Example:: A Navy contract for aircraft maintenance doesn’t specify how many mechanics or parachute riggers must be on a crew,, butt it does hold the contractor accountable for achieving precise and measurable performance standards, such as a ground abort rate of less than 5 percent and meeting 100 percent of flight schedules.

3. Financial Incentives and Penalties

Privatization gives public officials the freedom to creatively design contractor payments to correspond with certain performance pegs. Incentives to increase productivity,, cut costs and raise service quality can be built into the contract. Incentive-based contracts shift much of the risk onto the contractor, who is rewarded for productivity improvement and penalized for poor performance or rising costs. Example: After the California earthquake, Caltrans, the state transportation agency offered the contractor substantial performance incentives and penalties for rebuilding a highway overpass: a $200,000 per day bonus for completing the project ahead of schedule and a $200,000 a day penalty for each day the project was behind schedule.

4. Advanced Monitoring and Measurement Techniques

As more governments rely on private companies to deliverer public services, monitoring and assessing these outside partnerships becomes vitally to achieving an administration’s goals.

The monitoring plan defines precisely what a government must do to guarantee that the contractor’s performance is in accordance with contract performance standards.

Different services require different types and levels of monitoring. For highly visible services that directly affect citizens such as snow removal and garbage pickup, poor service will be exposed through citizen complaints. For complex or technical services, it may make sense to hire a third party to monitor the contractor.

The contractor should be considered a strategic partner and given incentives to innovate, improve, and deliver better customer service.


Implementing state-of-the-art performance-based contracting requires new evaluation techniques, new management approaches, improved top-level know-how on designing and managing contract relationships, better logistics systems, and a whole new set of skills for public officials. Perhaps most important of all, what is needed is a changed mindset where public managers are rewarded for effectively managing projects and networks of contractors rather than for the number of public employees under their command.