Procurement Contract Management in long term or complex projects: Key commercial principles to help ensure value for money
Contract Management in long term or complex projects: Key commercial principles to help ensure value for money
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Contract Management in long term or complex projects: Key commercial principles to help ensure value for money This guidance document provides practical support for those involved in managing contracts within a complex project environment. It addresses the key commercial principles and associated contractual provisions, mechanisms and remedies aimed at helping to ensure value for money in long term or complex services contracts. Departments are encouraged to adhere to these commercial principles and adopt the recommended contractual contractual provisions, where relevant, and subject to both the particular circumstances of the procurement, and the respective risk allocation between the contracting parties. Further detailed practical guidance is also available in OGC’s Policy and Standards Framework. Please also refer to the NAO/OGC Contract Management Framework Framework,, and the the ICT Model specialist advice will also Agreement for non PFI ICT enabled complex contracts. In many cases specialist Agreement be required.
Although these commercial commercial principles principles relate primarily primarily to non PFI major major contractual arrangements arrangements for services, there is significant alignment alignment with the recommended commercial guidance for PFI procurements which can be accessed on the HMT website. website.
How to use the guidance The guidance is aimed at senior responsible owners, owners, procurers, contract managers, and other senior commercial staff. It aims to help ensure that their contracts (especially those which are complex, of longer duration, duration, or where there is some level of uncerta uncertainty), inty), contain provisio provisions ns which help to ensure value for money during the contract term, and that the provisions are implemented and exercised as appropriate. The guidance needs to be considered at the following stages of the procurement procurement process: - pre-procurement pre-procurement – – as part of developing a strategy for the preferred commercia commerciall arrangements; during the development development of the ITT or ITP, when contractual terms and conditions, and the commercial aspects of the contract are developed; - competition - to inform dialogue with bidders (competitive dialogue process only) or to help refine the invitation to tender t ender and contract documents - delivery delivery – – during the contract contract management management phase, to consider consider how to optimise optimise use of the provisions available available (e.g. addressing areas of poor performance performance or incentivising good performance) At this stage changes in circumstances circumstances also need to be mana managed, ged, and anticipated benefits tracked. (Further guidance and tools for a typical complex procurement journey are available on OGC’s Framework.) .) Policy and Standards Framework
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Key Considerations Developing the right commercial/VFM provisions and arrangements, aligned with the supplier’s Developing capability, is a key opportunity to drive successful delivery of the required outcomes. It also helps to maintain value for money throughout the contract term. A number of general general considerations considerations should be taken into account. account. These are explored further Success.. in OGC’s guide: A Formula for Success
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Getting the requirement right: Defining the requirement in terms of outputs and outcomes allows for innovative proposals, but also helps to keep the door open for the possibility of change. In most cases, the requirements should not define how delivery should occur. occur.
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Contract duration: Consideratio Consideration n of the t he length of the contract is important. A longer contract allows for the potential of a greater investment and more innovation, but may also be restrictive, and not suitable where there is high uncertainty or instability and potential for change. Shorter contracts, or longer contracts with more frequent VFM break points, can offer a better approach where there is low stability stability and technology is evolving evolving rapidly; it can also allow for regular testing of the market or benchmarking. For more guidance on contract duration, refer to OGC’s Risk Allocation Model Model..
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Driving appropriate behaviours and taking a balanced approach: To ensure value for money, there is a need to understand fully how suppliers intend to deliver the contract. This will allow the commercial arrangements to be constructed in such a way as to drive appropriate behaviour. behaviour. The best contracts are flexible and balanced, and are consistent with the need to foster and maintain good productive relationships. Once the contract has started, the commercial arrangements need to protect the legitimate interests of the Authority if things go go wrong. How However, ever, of equal importance importance is the ability ability to update the contract to ensure that rights are preserved throughout the delivery period and that the contract holds true to the original value for money position. position.
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Proactive contract management: Complex contracts require proactive management, which involves continuous review of performance and contractual risks by both contracting parties. Where actions are taken by either or both that sharing lead to the costbenefit. reduction, consideration consideratio n should beare given to the Authority andparties Contractor Likewise where risks have been found to be underestimated, the risk – reward position of the supplier must be open to review.
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Incentivisation: In this area it is essential Incentivisation: essential that a balanced balanced approach approach is taken. It is also also important to recognise that if incentivisation measures are employed inappropriately, disproportionately disproportio nately or too extensively, this may lead to dysfunctional behaviour, such as the supplier neglecting neglecting routine delivery, to focus on a more incentivised area of work. The overall emphasis should be on successful delivery across the whole service.
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Finally, it is essential to ensure ensure that the the fundamental fundamental principle of obtaining obtaining value for money money overall is adhered to when such provisions are being adopted and relied upon.
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Key principles and contractual provisions 1.
Efficiency processes, gain share share and controlling excess profit profit
It should be noted that mechanisms for sharing efficiency savings, or profits and / or variation mechanisms, or gain sharing in any charging regime should ideally be built into the contract from the start. This could be achieved for example, by including a clearly defined review process upfront, setting out the precise steps to be adopted in a range of different circumstances. circumstances. 1.1
Efficiency Savings and gain/benefit sharing
Objective: The Contractor should be encouraged and incentivised to use its expertise to find and implement efficiency improvements, where possible and appropriate. Sharing in the benefits/gains achieved will provide an incentive, but this needs to be consistent with value for money obligations, and Managing Public Money It is also necessary to impose some limits on the return the Contractor is able to achieve from the contract. A business requirement requirement expressed in output output or outcome terms (i.e. one whic which h does not attempt attempt to define “how” delivery should occur) can often be a key precursor to achieving efficiency efficiency savings. It is also worth considering for example, if the contract should provide for the Contractor and the Authority share in the in return over contract term or charges on a periodic period ic basis over an agreed threshold.toThat share may takemade the form ofthe a rebate of service or the provision of free additional services if required
Depending on the contract’s duration, it should provide for an annual service review meeting to consider – amongst other issues - the t he extent to which any continuous improvement improvement programme has been successful in finding and implementing savings in the preceding year, investigating future opportunities, and setting a target saving for saving for the forthcoming year. In such circumstances the Authority Authority should be prepared prepared to consider changing changing its own processes processes or procedures, in order to support the Contractor in providing better overall value (including any internal cost changes). To embed this type of provision, it could be required that a failure by a Contractor 1 to achieve a target saving would lead either to a cash refund equivalent to the gap, or to allow a market test. In extreme circumstances, continued continued failure to achieve such targets could lead to early ttermination ermination or contract break at periods so defined. As a way of incentivising incentivising the Contractor, Contractor, consideration consideration should be g given iven to gain sharing, sharing, or the sharing of savings/benefits, where this is appropriate, and consistent with value for money2 , between the Contractor and the Authority. In a proportion which will be agreed on a case-by-case basis. A [50/50] share line, for example, might be acceptable. In contracts where there is a high degree of sub contract provision it will be important to ensure that such a sharing of benefit is flowed down the supply chain.
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Care will need to be taken in cases where there are obligations placed upon the department upon which the supplier is reliant to deliver the agreed savings. 2 This means that costs of delivery for the services delivered by the contract are reducing at a rate broadly consistent or better than the market.
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The contract may also include provisions requiring a year-on-year reduction in charges (and/or, more rarely, where this can be shown to deliver business value, targeted increases in service levels) throughout the contract term. 1.3
Excess profits
Objective: To ensure that the Contractor does Objective: does not make excess profits within effici efficiency ency or gain sharing initiatives Care should be taken to prevent the Contractor Contractor from making excess profits and separate separate provisions can be introduced wherever a gain-share arrangem arrangement ent is used. To control the level of profit one of two methods could be used – the first caps the level of profit at a predetermined level, possibly possibly with a share-line for profits in excess of the cap. It is import ant that such a cap is not set too low low. The second is to have a variable gain-share arrangement, where the share becomes more favourable to the Authority as the efficiency savings increase.
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Assessing Value for Money
2.1
Financial Model/Open Book Accounting Accounting
Objective: To ensure that it is possible to monitor the financial aspects of the project including the Contractor's return. In many cases, before contract award, the Contractor will submit a financial model of the project showing budgeted items of initial set-up, ongoing service delivery costs and assumed profitability. On the basis of the agreed financial model, the Contractor will be required to provide annual accounts (often in the form of a certificate of costs) in relation to the services. These These accounts will expose the Contractor's actual cost of and return from the service provision over the life of the contract. This will support gain sharing. The assumed return in the financial model will also fform orm the basis for estimation of proper cost to the Authority of change under the Change Control (Variations) Procedure. To ensure the principle of open accounts is adopted effectively, it is usually necessary to extend it tothat affiliates of the Contractor and/or other material or key sub-contractors in projects where there is substantial substantial dependency dependency on these these entities to achieve achieve service delivery. delivery. The links between these accounts and those of the company accounts must be auditable. 2.2
Benchmarking
Objective: In a long term services contract where there is limited scope to compete the services, benchmarking can be a useful means of injecting some continuing competitive pressure. Benchmarking is a process whereby service performance and/or the price of services provided under the contract are compared to the market for such services. it is important to include principles in the contract that permit fair "like for like" comparisons to be made. It can also inform price adjustment mechanisms or parameters for future years. VFM mechanisms such as benchmarking even when designed to add value can, in themselves add to cost which may flow back to the Authority, so care needs to be taken.
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Particular points to consider include: -
Who will carry out the benchmarking? benchmarking? (Independence (Independence is usually vital).
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Will the services be benchmarked benchmarked as a whole or can individual service elements be benchmarked separately?
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How widely scoped with the benchmarking benchmarking be? (price, (price, quality quality (i.e. service service levels))
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Is there a a suitable open / readily available industry benchmark?
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What are the Benchmarker’s Benchmarker’s terms of reference? reference?
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How will the results be implemented? implemented?
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Who pays the fees of the Benchmarker? Benchmarker?
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What happens in the event of a dispute?
Further detailed Benchmarking guidance guidance
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Performance Management and incentivisation
3.1
Managing Delays (with particular reference to the implementation stage of a project)
Objective: Because in many cases the allocation of responsibility responsibility for delay is difficult, progress with the project must not be held up while the issue is debated and, in normal circumstances, circumstances, the Contractor must be obliged to "fix first and argue later".
In relation to delays to t o the project timetable, the Authority should ensure that:
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the Contractor's Contractor's first first obligation, obligation, regardless regardless of fault, fault, is to notify the Authority Authority and fix the cause of delay on an agreed basis; and the cost of the Contractor employing additional additional resources where the delay is the responsibility responsibility of the t he Contractor does not have the effect of eroding the caps on the Contractor's liability (i.e. where the Contractor is not entitled to be compensated).
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if the delay is is due to a breach of Authority Authority obligations, obligations, the Contractor should be entitled entitled to compensation for its proven, additional costs of the delay plus an extension of time, subject to the Contractor's duty to mitigate such costs and delay.
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the contract contract contains contains an obligation on the Contractor to notify the Authority Authority at the time of the delay or when it becomes aware that a breach of the Authority's obligations is likely.
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if the delayofistime duebut, to anormally, Force Majeure Mano jeure Event the Contractor entitled entitled to an extension compensation. In certainshould Force be Majeure situations however, where a contractor agrees to continue with its obligations, obligations, it may be
disproportionate to withhold payment. A Contractor’s ability to recover payment that is disproportionate appropriate to the work done may be covered by the equitable principle of “quantum meruit” and so could not be avoided on a contractual basis. -
Consideration Consideratio n should be given to waiving time delay penalties where the result of such a waiver can improve improve the overall value for money del delivered ivered through the con contract. tract. E.g. where the costs of demonstrating fault exceed the value of the recovery or where it is better to focus such effort on future deliverables, deliverables, which might might otherwise be at risk. In such circumstances it is important that the authority reserves its rights and makes the waiver explicit.
3.2 Delay Payments (aka liquidated damages), (with particular reference to where there is an implementation phase in the project) Objective: To incentivise the Contractor to meet the project timetable and to compensate the Authority for any failure failure to do so. If the Contractor misses a key Milestone Date, the Authority should be entitled to withhold Milestone Payments (until the milestone is achieved) and depending on the criticality of the t he commencement date of the Service and the Milestone, may also charge Delay Payments. The Authority may also charge Delay Payments for failure to achieve interim milestones (that do not attract payment) where the achievement achievement of these is critical. Careful consideration should be given to how this operates in practice particularly as in some circumstances circumstances it may be unfair, e.g. if delay in meeting an interim milestone (which is not linked to payment) is due to the Authority or some other unforeseen / unforeseeable factor and in any event the Contractor is able to t o meet the final milestone for which payment is to be made Any amount identified identified as a dela delay y payment should should be a genuin genuine e pre-estimate of the loss. Care must must be taken that these payments do not amount to a penalty which would not be lawful. For more guidance on Delay Payments/Liquidated Damages Damages refer to the Policy and Standards Framework.. Framework
3.3
Service Levels and Service Credits Credits
Objectives: Service credit regimes enable the Authority to ensure that the Contractor will retain the risk of meeting agreed service levels during the contract term. Service credits are an abatement of the charges so that the Authority is not paying the full price for poor quality service. service. Authorities should should normally seek seek to incorporate service service credit regimes regimes in the event event that contractors fail to deliver in line with the contract. Whilst the default position should be that all service levels must always be achieved, there may be exceptional circumstances where an Authority decides not to apply its contractual right to service credits. These circumstances may include situations where there has been a minor or isolated breach of contractual terms in an otherwise good performance and it is decided that there is a longer term value for money case that outweighs the value of applying an isolated service credit. Authorities should think very carefully before deciding not to
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implement service credit clauses and should be satisfied that such a decision will result in long term value for money. money. The risk of having a detrimental effect on a contractual relationship relationship should not in itself be a reason to not invoke a service credit.
The key principles relating to a typical service credit regime are: -
the Contractor Contractor is required required to meet meet agreed agreed service service levels throughout the contract contract term;
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in the event of a failure to meet meet service levels, the the first obligation of the Contractor is to restore the service, regardless of fault;
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service credits are are payable payable at a higher higher rate for more serious or persistent persistent failures failures to meet service levels;
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the amount amount of service credits that that apply apply should should vary in accordance accordance with the severity of of the Contractor's underperformance. underperformance. Typically this is done through some fform orm of points mechanism, however other methods can be employed. Service credits are often most useful for the less serious failures where it is unlikely that significant loss to the Authority's organisation will result. Accordingly Accordingly service credits should normally be capped at a certain "threshold" level, allowing critical or chronic failures to be dealt with outside the service credits regime. Escalating remedies such as increased monitoring, warning notices, damages (liquidated or general) can then be considered for such failures. Alternative dispute resolution and ultimately termination will also be available in these cases. It is important to consider how effective these other remedies (short of termination) will be;
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a default may be triggered when the number of Service Credits reach any cap and/or a specified level over a period specified in the contract;
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there is no "right "right answer" answer" to the question question of of what the Contractor's Contractor's maximum maximum exposure to service credits should be. Because, compared to a PFI-regime the Contractor is much less exposed to financing-related risk, there is greater scope for flexibility;
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it may be desirable desirable to allow the Contractor Contractor the right to earn back back service service credits credits for satisfactory future performance if appropriate reductions in risk premiums and service charges are offered;
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exceptionally, exceptionally, where there is a clear clear business business benefit benefit - for example example a saving in the cost of Authority resources resources - over-performance over-performance of certain service levels may may justify an additional additional payment but the Authority should should consider whether whether this is justified. Such incentivisation incentivisation can divert the Contractor's attention attention from other aspects of the service service,, and any payment must be affordable within the constraints of departmental departmental priorities. This approach may be appropriate for transaction-based services but is not recommended for availability of infrastructure, for example. Furthermore, care should be taken in this area to avoid “scope creep” and also the risk that instructions to exceed service requirements during the contract term are seen as a contract variation, which in itself may be problematic if not consistent with what was permitted in the original scope of the procurement; procurement;
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where Contractors have the primary responsibility responsibilit y forinmonitoring their ownorservice performance the Authority should have mechanisms place for auditing reviewing this monitoring, and should have have remedies available should should the Contractor not disclose failure.
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Environmental Sustainability
Objective Objective: Authorities are required to seek to promote sustainable development objectives, consistent:with value for money, through their procurement, procureme nt, which will be reflected in contractual terms and conditions depending on the particular circumstances of the procurement and specific requirements The most effective way to pursue environmental objectives through procurem procurement ent is to consider them at the earliest stage of the procurement process. When identifying the need for a procurement Authorities can include consideration of environmental benefits in the business case. This means that environmental objectives relevant to the procurement can be built into the specification. Many energy efficient products incorporated into output based solutions may cost more initially but have significantly lower running costs, making them cheaper over their lifetime than less efficient products. When the respective environmental costs are also taken into account, the value for money case for the more energy efficient product becomes even stronger. In these circumstances, and provided that the product is otherwise fit for purpose – e.g. it provides heat or light to the standard required - the more energy efficient product would be preferable, it would normally have the best whole life net cost-benefit. The sustainability requirements requirements will need to be specified as a key element of the performance measurements and quality quality attributes of the contract. If an objective of the project is to source 20% of energy from a renewable source then this will need to be included as a key performance measure in awarding awarding the contract. Key milestones for deli delivery, very, and anticipated be benefits nefits should also be included and monitored as part of the contract management process. For more information on incorporating sustainability within procurement refer to the Policy and Standards Framework. Framework.
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Glossary of key terms Authority: Authority:
Contracting Authority
Contractor: Change Control procedure:
Contractor providing the services The procedure for changing the contract, as set out in the appropriate schedule of the contract
Delay payments:
The amounts payable by the contractor to the authority in respect r espect of a delay. Also can be defined as “Liquidated Damages”
Force Majeure event:
Any cause affecting affecting the performance performance by a party party of its obligations obligations arising from acts events omissions happenings or non happenings beyond its reasonable reasonabl e control, etc etc
Milestone:
An event or task described in the the contract’s implementation implementation plan, plan, which if applicable must be completed by a relevant Milestone Date Date
Milestone payment:
A payment identified identified in the charges and invoicing section section of a contract
made following achievement of a Milestone
PFI:
Service credits:
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Private Finance Initiative Initiative
The sums payable in respect of the failure by a contractor to meet one or more service levels specified
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