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Is outcomes-based procurement right for the water sector?

With growing populations, ageing infrastructure and tightening budgets, water businesses and suppliers are under pressure to deliver cost-effective, innovative and efficacious projects.

For those looking to deliver more with less, outcomes-based procurement (OBP) could be the answer.

In essence OBP, also known as performance-based contracting, aims to ensure the contractor and the client’s objectives are aligned. It’s a step away from traditional practices that pit client against contractor, savings vs profits, innovation vs stipulation.

“Under an outcome-based approach, a customer contracts and pays for business results delivered by a service provider, rather than for defined activities, tasks or assets,” said Corrs Chambers Westgarth Lawyers Partner James North, whose expertise is in outsourcing and procurement contracts.

"The contract focuses on the desired outcome of the work to be performed (the ‘what’) rather than the manner in which it is to be performed (the ‘how’)."

For example, under a traditional procurement approach, a business looking to reduce leakages might pay a contractor to detect leaks and conduct repairs. The contractor gets paid the same amount whether or not they succeed. Under OBP, a portion of payment is withheld if agreed targets are not met.

Gathering steam

The approach is not new, but it is gaining traction with support from groups in Australia, the UK, US and Singapore. The International Water Association (IWA) and World Bank have launched a program dubbed Developing Good Performance-Based Contract Practices in the Marketplace to Manage Non-Revenue Water.

The IWA's task group on OBP has written: “[OBP] could be applied to a wide variety of activities in the water utility’s value chain (treatment plants, networks, billing and collection), for improving either operational efficiency (reduce costs), service quality or environmental compliance.”

Australian water businesses are increasingly seeking advice on implementing OBP in order to drive greater efficiencies, the Institute of Collaborative Management’s Davin Shellshear said.

“Water authorities are just sick and tired of the waste and the ineffectiveness of the old style of contracting,” Shellshear said.

“Traditionally, water utilities have used hard-nosed forms of contracts that often end up with a huge range of hidden extra costs or waste, and not really delivering what the client wanted.”

But when outcomes are aligned, contractors are motivated to find better, more cost-effective ways to achieve a utility’s goals, said Procure Services Managing Director Charles Salinas.

“Vendors always complain that they don’t have any time for innovation – the only thing they can do in the 26 days they have to respond to a tender is pull a solution off the shelf,” noted Salinas, who has over 20 years’ experience in strategic procurement and infrastructure project management.

Hosing down enthusiasm

But if OBP was a silver-bullet, everyone would be doing it. The fact is, not all projects or water businesses are suited to OBP.

“It’s typically best for longer-term contracts where there’s considerable complexity, like when you’re delivering services over a period of five or 10 years,” Shellshear said.

“Short-term infrastructure contracts might well be better done through traditional contracts because of the complexity involved in establishing an outcome-based contract.”

Successful OBP implementation also depends on the attitudes of those involved, Shellshear said.

“The main reason for the failure of collaborative contracts is failed relationships. It’s like a marriage: not all clients can work collaboratively.”

Salinas added that water businesses considering OBP must be willing to embark on cultural change. “Usually procurement staff stay away from vendors altogether – they have to avoid even the appearance of impropriety, and because of that there’s no collaboration,” he said.

“But with outcomes-based procurement, it’s a matter of trusting the vendor. You need to be able to form relationships, negotiate, gather information. All of that culminates in this cultural renaissance that definitely needs to be addressed by business leaders.”

As North has noted, many procurement departments are now staffed with the engineers and technicians who themselves used to do the work they’re outsourcing.

“What they tend to do is what they were trained to do: engineer. They like to minimise risk and tell the supplier how to deliver on the requirements,” he said.

"But by being prescriptive about what the supplier must do you box them in, reduce flexibility and then the benefits of outcome-based procurement, including better pricing, better outcomes, are really missed.”

North said training and advice on setting objective, measurable, clear and realistic outcomes was vital for success. “A lack of relevant metrics or unenforceable metrics is often cited as one of the primary pitfalls of implementing a successful outcome-based contract,” he said.

The setting of standards can be complicated if there is insufficient historic or comparable data to act as a benchmark. “If sufficient data is unavailable, consider including a transition period to baseline the relevant standards before applying the incentives or risk and rewards payment model,” North said.

Such standards also need to factor in growing customer expectations, around not only cost and quality of water supply but also environmental sustainability.

Setting the standards

Whether or not an OBP drives quality and efficiency is dependent on setting appropriate incentives. Most outcomes-based contracts include a combination of fixed and variable payments that serve as positive and negative incentives. A gain-share model or contingency arrangements might also be included.

The IWA says that: “While a 5–10% bonus provides some incentives for performance, a ‘true’ outcomes-based contract shall aim for at least 20–30% of the remuneration paid through variable fees so as to include not just profit but also part of the contractor’s costs.”

With so much hinging on the establishment of an effective value-add contract, North advised water businesses to seek expert input.

“When clients call you back after the implementation of a contract it tends to be about the service specifications and the pricing issues rather than the intellectual property rights clause, or the liability clause,” he said.

“There’s often a gap in the client capability to come up with a suitable commercial model and then document it properly. The difference between a good contract and a bad one will be the client saving 20% of their cost base verses nothing.”

Luckily, there’s a growing pool of expertise to draw on, including two of the nation’s biggest adopters of OBP: the National Broadband Network and Department of Defence.

Salinas said he expected many of the current barriers will fall away as experience grows.

“Once an organisation is experienced and their culture is right, they will be able to do it quicker, faster, cheaper,” he said. “They’ll get more bang for their buck.”

First published in Current magazine February 2017.