Consider Performance-Based Contracting
In a performance-based contract, the supplier provides the Postal Service
with specific benefits, such as cost reductions or revenue generation, and in
return, the supplier shares in the value created. A portion of the price of the
contract is linked to a series of key performance indicators that the supplier is
responsible for meeting and to business benefits achieved by the Postal
Service through the fulfillment of the contract. The Postal Service shares
risks with suppliers in a performance-based contract and allows them to
define the methods of performance, thus differing from traditional contracts.
Performance-based contracting agreements create an incentive for the
supplier to control its costs. In some contract types, the Postal Service and
supplier have conflicting motivations (e.g., the Postal Service wants to
minimize costs, but the supplier is motivated to increase its revenue);
however, performance-based contracts align the interests of both parties.
Performance-based contracts tend to encourage closer relationships with
suppliers. The Purchase/SCM Team specifies the outcome or result it desires
and leaves it up to the supplier to decide how to best achieve the desired
outcome. This can include what to do, when to do it, how to do it, where to do
it, or whether to subcontract out (if restrictions do not exist).
Performance-based contracts should be implemented for projects with
outcomes that can be measured objectively (e.g., grounds maintenance,
security, computer maintenance, network operations). Performance-based
contracts can be used for any contract, including small-dollar-value contracts,
but are generally most appropriate when:
• Projects are large, have new technology, or have high risks
• Existing contracts can be converted to define as much of the
requirements in performance-based terms as possible
• Large umbrella contracts are experiencing cost overruns or
• Contract is awarded competitively for task order contracts
• Benefits contributed by suppliers can be quantified
• Project implementation and production time need to be reduced
Postal Service suppliers that are strategic or key should be considered for
performance-based contracting. Performance-based contracting allows for
the resolution of payment or other issues more quickly and efficiently
because of the nature of the shared-risk relationship. In a performance-based
contract, the Postal Service must be committed to supplier support because it
may have to address issues outside the contract that limit supplier success
on the current project.
The contract type selected should motivate suppliers to perform as well as
possible. To do this, the Client must specify what it wants and know what the
project will do for it. The two most frequently used are fixed-price incentive
contracts and cost-plus-incentive-fee contracts.
The two constants are that a portion of supplier payment is based on
performance and that the supplier shares some degree of risk on the
contract. Possibilities for the structure of a performance-based contract
• The supplier receives a share of any increased revenue
generation in return for risking a share of its profits to pay for
• The supplier's profits are contingent on meeting explicit
performance measures of the indicators
• The supplier is required to make a substantial up-front investment
and assume most of the project risk
Additional information on contract types can be found in the Select Contract
Type topic of the Develop Sourcing Strategy task of Process Step 2:
Client objectives and goals must be clear to ensure the success of the
contract. Indicators are specified to monitor performance of the requirements.
Requirements should be clearly defined and stated in terms of results
required, rather than the method of performing the work. A work breakdown
structure (WBS) can be utilized to assign requirements to tasks.
Target performance measures are assigned for each indicator and are the
basis to financially reward or sanction suppliers. Incentives should be put in
place to motivate the supplier's performance. The performance work
statement (PWS) or statement of objectives (SOO) describes the effort in
terms of measurable performance standards (outputs). Additional information
on PWS and SOO can be found in the Start Request for Proposals (RFP)
Development topic of the Prepare Project task of Process Step 2: Evaluate
Sources. A quality assurance plan (QAP) determines whether supplier
services meet the applicable statements' contract requirements.
Performance standards establish the performance level required by the
Postal Service. Correspondingly, the target measure establishes a maximum
allowable error rate or variation from the standard. These measures tie
supplier payment to performance. Failure to perform within this target results
in a contract price reduction. Examples of standards include quality of work,
productivity, and cost-efficiency. The Purchase/SCM Team should ensure that
each standard is necessary, carefully chosen, and not unduly burdensome.
For example, in a requirement for airline services, the performance standard
might be "arrival within 15 minutes of an agreed-upon time." The target
performance measure might be 10 percent; the airline can be more than 15
minutes late no more than 10 percent of the time. Indicators and performance
measures will be customized based on the nature of the purchase.
Incentives are employed to induce better performance and may be positive,
negative, or a combination of both. They are applied selectively to motivate
suppliers and to discourage inefficiency. Incentives apply to the most
important aspects of the work, rather than each individual task.
Incentives will vary from contract to contract and are subject to discussion
during source selection and negotiations. The incentive structure should
reflect both value to the Postal Service for the various performance levels
and a meaningful incentive to the supplier. Effective performance incentives
reward suppliers for outstanding work, but do not penalize them for fully
satisfactory (but less-than-outstanding) work.
A quality assurance plan (QAP) is a component of the purchase plan and
describes the strategy and methods deployed to ensure that the purchase
and its deliverables are on track to meet Client expectations. In the case of
performance-based contracts, it directly corresponds to the performance
standards, and it measures supplier performance. The QAP ensures that the
Client receives the quality called for in the contract and pays for only what is
received. The QAP should include a surveillance schedule and clearly stated
surveillance method(s). Surveillance can range from a one-time inspection of
a product or service to periodic in-process inspections of ongoing product or
service delivery. Additional discussion can be found in the Execute Quality
Assurance Plan topic of the Manage Delivery and Contract Performance task
of Process Step 5: Measure and Manage Supply.
Performance-based contracts require more interaction with suppliers than
traditional contracts do. The Contracting Officer works with the supplier to
determine the monitoring methods, appropriate incentives, risk sharing,
payment options, and methods for reporting performance against metrics.
Other considerations that may need to be addressed when using this type of
• Increased initial up-front costs (e.g., more time and resources to
be allocated by Postal Service and suppliers to set up a contract,
possibility of a delay to the start of the project, or converting from
a traditional statement of work [SOW] to a PWS or SOO)
• Payments need to be tied to concrete milestones and
deliverables and not necessarily set dates
• Data rights and intellectual property issues should be clearly
• Method to resolve failures is defined; acceptance criterion and a
method to inspect are needed
A quadrant approach classifies Postal Service purchases into four categories,
depending on their impact on the Postal Service core competencies (noncore
versus core) and complexities (standard versus custom). Depending on the
quadrant, performance-based contracts will be structured differently;
examples of this are illustrated in Figure 2.10.
Custodial - Performance-based contracts are appropriate. The standards
identified are desired quality levels. The supplier's technical proposals
identify only the frequency and methods to be employed to meet the quality
standard. The result is maximum flexibility for the suppliers.
Mail Transport Equipment (MTE) - Performance-based contracts are
appropriate. The supplier is held to a standard of performance and is
empowered to use best commercial practices and management innovation in
performance. The contract does not specify how many supervisors,
mechanics, or other members are required to be in a crew or on the job for
servicing and maintenance of mail transport equipment.
Information Technology (IT) - Performance-based contracts have limited
appropriateness. When developing a new system, the contract is for delivery
of a working solution. Acceptance occurs only when the solution is
successful, and payments are provided only when (and if) the solution
delivers sufficient benefits to cover costs.
Transportation - Performance-based contracts are appropriate. For
example, a supplier may be held to performance standards of on-time
delivery, accuracy, and quality.
Start Request for Proposals (RFP) Development topic, Prepare Project task,
Process Step 2: Evaluate Sources
Select Contract Type topic, Develop Sourcing Strategy task, Process Step 2:
Execute Quality Assurance Plan topic, Manage Delivery and Contract
Performance task, Process Step 5: Measure and Manage Supply