Performance-based contracts: KPIs that drive performance and strategic outcomes

By Daniel Byrne - June 18, 2018

Infrastructure is fundamental to the success of a nation and, within Australia, provides direct and indirect employment across multiple sectors. With population growth forecast to continue, new industry evolving, and a growing Asia-Pacific region, Australia must continue to invest in infrastructure projects that enhance prospects for long-term growth.

While the Australian government has a $75 billion ten-year rolling infrastructure plan, this will only address some of the projects and initiatives included on Infrastructure Australia’s priority list.

Funding Australia’s ongoing infrastructure is an ongoing challenge for governments. This, together with increasing project complexity; new technologies; and the need for skilled resources, collaboration and for long-term planning; is leading to new procurement models focused on performance-based contracts.

A performance-based contract is a procurement model with clear objectives and key performance indicators (KPIs) to drive behaviours that achieve the required procurement and project objectives. Consequences (reward and risk) for contract participants are based on performance against specific KPIs, which may include safety, community, environment, completion, quality, cost and more.

The famous management consultant and educator Peter Drucker once said "If you can't measure it, you can't manage it." While organisations can establish well-intentioned and strategic KPIs, failure to measure them effectively impacts assessment and management of the desired outcome. Pitcher Partners’ research reveals it is common for organisations to experience inconsistencies between intended and actual outcomes of performance-based contracts.

Having robust and defendable measurements is critical to the successful management of KPIs. Project directors, and those charged with governance and contract management, should consider the following factors when setting KPIs in a performance-based contract:

  • Aligning performance measures to the project and procurement objectives.
  • Establishing a clear KPI score spectrum and building a robust calculation methodology.
  • Understanding the required and available calculation data and identifying the correct supporting documentation or systems.
  • Determining the appropriate impact (reward or risk) for the KPI, engaging in regular monitoring, and taking appropriate action where necessary.

Below are a range of common challenges experienced when establishing KPI frameworks, together with tips to address them.

Defining desired outcome

KPIs must be aligned to the project and procurement objectives. Outcomes should be objective and if it can’t be measure, it likely can’t be managed, which may impact the ability to comply with contractual requirements such as incentive payments or abatements. The absence of relevant or unenforceable metrics is cited as a leading reason for not adhering to a performance-based contract.

Measuring performance

KPIs should be measured across a consistent performance spectrum or scale, ranging from unacceptable to exceptional performance.

With the spectrum known and understood, individual KPI calculations should be clear and include examples to reduce complexity, which may otherwise lead to KPIs not being measured and monitored or undesired methods of calculating performance. It is recommended to develop a supplementary detailed KPI management plan to enable KPIs to be understood and managed effectively.

Results should be defensible

KPI calculations should be supported by data and relevant documentation and stipulated in a KPI management plan. These should be derived from reporting systems not open to interpretation or manipulation. Too often KPIs are supported by untraceable or unreproducible inputs.

When setting KPIs, both the client and contracting parties often fail to consider the source(s) of data to evidence performance. The more accurate, comprehensive and accessible the data the easier it is for both parties to agree on results. For complex procurements and KPIs heavily reliant on data and the reporting systems of the contractor, it is often desirable to collaboratively (client and contractor) define the KPIs and how they will be measured and calculated.

Driving desired behaviour - the carrot or the stick?

Each organisation has unique expectations regarding the standard of performance – often referred to as Minimum Conditions of Satisfaction (MCOS). When a contractor achieves MCOS there should be no penalty or reward as the contractor has fulfilled the brief as agreed.

However, reward payments may be utilised to improve performance beyond MCOS. Importantly, these must be designed to incentivise the contractor but also add value to the business or project. Conversely, penalty payments may be implemented to disincentivise under performance on key metrics, while providing suitable compensation to the client for actual or potential loss.

KPI monitoring and management fails to occur in the absence of suitable performance measures and systems. When it does, it typically occurs later in the project timeline (near completion) when it is too late to take corrective action, and where unanticipated adverse results can have a significant financial impact on the project.

Instead, KPIs should be measured periodically, with the first KPI measurement often the most important to identify measurement, reporting and data challenges. An early reference point will also begin to drive desired behaviours.

Undertaking preparation upfront to develop a robust performance-based framework will reduce and even overcome many of the above challenges, driving collaborative and more mutually beneficial outcomes.

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