Performance Based Contracts for Improving Utility Efficiency

Today’s water utilities around the world are facing increasing pressures to improve their operational efficiencies. While many realize that they cannot do it all alone, they are also wary about how to contract out outside help. While traditional input-based contracts often bring disappointing results, delegating operations, or part of operations, to private management under a performance-based PPP offers a valuable solution, more efficient than traditional input-based contracts.

The whole idea of Performance-based Contracting (PBC) is to make contracts more efficient, by optimizing incentives and allocating risks to the party more able to bear or mitigate it.  Properly designed, a performance–based contract can achieve better results than are normally achieved using traditional public sector, input-based, contracting methods. The advantage comes from a better alignment of incentives with output objectives, coupled with more contractor flexibility in design and implementation to facilitate innovation and encourage efficiency.  A well-designed PBC is a win-win for both the utility and its contractor.

PBCs in the water sector are still quite few, and rather recent, typically less than 15 years. The most frequent type of contracts, that are widely used, is for Non-Revenue Water (NRW) reduction projects.  Quite recently, performance-based contracts have appeared as a suitable type of contracting by municipalities willing to partner with a private company to reduce non-revenue water, a major challenge in several big cities around the globe.

Performance based contracts have been favored for now about 25 years for procurement in many sectors, especially in the USA.  The US General Accounting Office issued a report in 2002 proposing guidance for performance-based service contracting. This report concluded that performance-based contracting offers a viable way toward achieving savings and getting better results from contractors.

OECD has issued guidelines for performance-based contracts between water utilities and municipalities, in 2010.  The report brings a strong insight on best practices to design performance indicators and provide useful recommendations for indicator monitoring so that the contract can execute well.  The guidelines ponder that “bonuses are best applied with management contracts, penalties are mostly suited for lease contracts while regulating risk through tariff adjustment can be the preferred option in both lease and concession contracts”.

A product of this collaboration between water sector experts was the publication of Performance-Based Contracts for Improving Utilities Efficiency: Experiences and Perspectives in August 2018. The book is a compendium of case studies and contributions written by members of the Task Group and experts from the IWA network. Advantages are discussed of using PBC over traditional public-sector, input-based, contracting, highlighting the attributes of a PBC as well as the key screening criteria and capacity considerations for a PBC.  Lessons learned from Performance-based Contracts already executed or under execution, most often for NRW reduction, are also discussed.  The legal and regulatory issues impacting the use of PBCs are reviewed.