Chapter 2: Competitive Government
Expand the Use of
Performance Contracting
Summary
Performance-based and contingency contracting have proven successful in saving governments money and improving their services. Texas state agencies should be required to increase their use of both types of contracts.
Background
About $14.2 billion of the state’s budget is spent on the purchase of goods and services.[1] Various types of contracts are used for these purchases, depending on agency needs and applicable state laws and rules.
The General Services Commission (GSC) has contracting oversight authority for state government, but delegates this authority to individual state agencies for purchases of goods worth up to $25,000 and services purchases worth up to $100,000. In addition, GSC can delegate purchasing authority for purchases over these thresholds as well. Typically, for contracts above the threshold, GSC determines if the agency has the expertise to handle the purchase. If not, GSC handles the procurement for the agency. GSC also handles purchasing for agencies by request.
According to GSC rules, information on delegated purchases should be reported back to GSC, but the state has no standardized reporting mechanism for this purpose. At this writing, the State Auditor’s Office (SAO) is contracting with the University of Texas to study delegated purchases and determine how GSC should compile information for such purchases.[2]
In addition to delegated purchases, several agencies are exempted entirely from GSC rules and oversight, making it impossible for GSC to enforce any standardization of purchasing policies and procedures.
In any state purchase, the agency administering the contract defines the specifications for the goods or services sought, either in the contract document itself or by referencing specifications described in a formal request for proposals (RFP) preceding the contract. Complex purchases typically begin by issuing an RFP, making their preparation an important activity that can either enhance or limit the effectiveness of the contract itself.
Recent e-Texas hearings and interviews with vendors raised a number of issues concerning the current terms and conditions required by various state agencies. Vendors often argue that these terms and conditions are too onerous and unnecessarily raise costs for the state and its taxpayers. When a contract requires vendors to use state-dictated processes, staffing levels, and materials, it may unnecessarily inflate costs and eliminate the possibility of improvements to state services.
In addition, some vendors point out that required contract deliverables often are scattered through RFPs and contracts, making it difficult to understand exactly what the agency wants. At a forum conducted by e-Texas in August 2000, vendors also suggested that there are as many varieties of state contract provisions as there are lawyers in the various agencies, and that these variances are rarely justified.
Another issue involves cost requirements. Some vendors bid on contracts to establish a presence in the state, and others are willing to conduct state work on a break-even basis or even at a loss if they expect to gain more business in the future. When agencies place unreasonably low cost ceilings on work, however, they sacrifice their ability to attract robust vendor interest, thus weakening competition. Underpriced contracts too often result in the selection of a vendor who proves to be unwilling or unable to sustain the level of performance set out in the contract’s requirements. The costs of rebidding or renegotiating such contracts can lead to delays and wasted effort.
Federal Contract Reform
The federal government has been working on contract reform for many years. The Office of Federal Procurement Policy (OFPP) in the Office of Management and Budget has published a guide to the use of performance-based service contracts (PBSCs), a contracting method used by the Department of Defense with a great deal of success.
Performance-based service contracting is designed to structure all aspects of the contracting process around the purpose of the work to be performed. It requires contract requirements to be described in terms of results rather than methods, setting quality standards instead of dictating procedure. These quality standards are enforced through inspection and acceptance criteria, as well as positive and negative incentives.
Despite its advantages, this methodology has yet to be fully implemented throughout government for a variety of reasons, including inexperience on the part of contract personnel and cultural inertia. In addition, PBSCs work best when government and potential vendors communicate openly about the contract requirements throughout the acquisition process, and some governments worry that this may create the impression of collusion with successful bidders.
To promote the use of performance-based contracts, in October 1994, the OFPP obtained pledges from 27 federal agency heads to use performance-based contracts whenever possible. The pledge committed them to use PBSCs and measure their effects, conform to stipulated project design criteria, and cooperate with each other to institutionalize the approach. Services covered by the pledge ranged from janitorial and guard services to computer maintenance and aircraft and technical support.
Four industry associations representing more than 1,000 companies lent their support to the pledge. They agreed to use conflict resolution mechanisms to avoid protests and disputes, identify services convertible to performance-based contracting, work with the government to eliminate obstacles to implementing this initiative, and identify commercial contracting practices adaptable for use by the government.
As a result of the pledge, by 1998, 15 agencies had converted 26 contracts with an estimated value of $585 million to performance-based methods. These agencies reported an average 15 percent reduction in contract prices and an 18 percent improvement in satisfaction with contractors’ work from switching to performance contracts. Reduced prices and increased customer satisfaction were noted at all price ranges, for both non-technical and professional and technical services.[3]
The pilot achieved a series of notable results. Among those documented in a 1998 evaluation were the following:
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Conversion to performance-based contracting for Navy aircraft maintenance resulted in immediate savings of $25 million, with additional savings anticipated through positive and negative incentives contained in the contract. Proposals, evaluations, and awards for PBSCs required 30 days less than for the previous contracting process.
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The National Aeronautics and Space Administration saved enough money from converting a janitorial service contract to PBSC to reinstate several tasks previously cut due to a lack of funds.
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The Environmental Protection Agency saved enough money from its first PBSC Superfund task order to fully fund the next one.
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The Air Force found that it saved 50 percent by specifying that floors must be clean, free of scuff marks and dirt, and have a uniformly glossy finish, rather than requiring that its contractor strip and wax floors weekly.
The pilot found that the adoption of PBSCs initially increased the time needed for the purchasing process at many agencies. Most of this increase was attributable to agencies’ unfamiliarity with the process, and their need to develop performance-based criteria for various contracts.[4] Now OFPP is taking several steps to expedite the PBSC process. OFPP and various agencies are developing “boilerplate” contracts for standard services and making them readily available to all federal agencies via agency Web sites. Agencies will be able to reuse these templates for multiple contracts, a step that should greatly reduce the time required for the contracting process. OFPP and the Department of Defense are providing staff expertise to assist federal agencies in developing performance requirements for unusual service contracts.[5]
Contingency Contracts
The federal government also has been pursuing opportunities to use contingency contracts to reduce costs and provide vendors with incentives to contract with the government. Contingency contracts essentially are agreements in which governments share any savings generated by a vendor’s improvements in their services with the vendor. Such arrangements place considerable pressure on contractors to deliver results.
A contingency contract between Andersen Consulting and the federal Office of Student Financial Aid (SFA), for instance, pays Andersen nothing up front but guarantees the firm a percentage of savings. Under this arrangement, SFA expects to achieve approximately $46 million in savings, and Andersen is in a position to be paid $14 million. Andersen estimates its costs for the project will run from $10 to $14 million, with the expectation that it will achieve the low-end estimate, leaving a profit of $4 million.[6]
Texas Experience
Some Texas agencies have used both PBSCs and contingency contracting on a limited basis. One example is the state’s TEX-AN 2000 telecommunications contract, signed in July 1999. This contract did not define the type of system needed, but instead defined the state’s service needs in functional terms and allowed the contractor to determine how it would meet these requirements. One advantage gained by this approach is that, if overload problems occur, the contractor is obligated to add capacity. The state no longer will have to bear any cost for additional capacity. This approach has generated considerable interest around the country.
In an effort to change its methods for contracting with private prisons, the Texas Department of Criminal Justice (TDCJ) is considering an example set by Australia, which contracts for some private correctional services under a performance-based structure. Private vendors receive three separate fees: an accommodation fee, which covers inmate housing costs; a correction service fee, which covers services such as food and education and correctional officer salaries; and a performance-linked fee, which ensures that the government receives quality services. The performance criteria include items such as the number of escape attempts, number of deaths, and number of fights.[7] The contract gives vendors a powerful incentive to run safe, efficient facilities. A recent TDCJ report recommended that Texas adopt a similar system.[8]
In 2000, the Comptroller’s office began using a contingency contract to collect debts owed the state. On February 7, 2000, LTD Financial Services, a Houston-based collection company, began work on 73,000 accounts representing $13 million in delinquent taxes. In 2001, the Comptroller will refer an additional 25,000 accounts representing $5.9 million in delinquencies to LTD. The company estimates that it can recover 20 percent to 25 percent of the debts presented to it. LTD will direct taxpayers to pay all amounts to the Comptroller’s office, in return for a monthly contingency fee of 20 percent of the amounts collected. Comptroller employees are training LTD staff in the best way to handle delinquent tax payments. In the first five months of the contract alone, LTD’s collections approached $2.7 million, with $500,000 awarded to the vendor.
No definitive source can pinpoint exactly how much of Texas’ expenditures on contracts are made as part of performance-based or contingency contracts. Definitional questions are part of the problem; contracts described as “performance-based” may not actually use performance standards to determine payment. For this reason and others, it is difficult to gauge the extent to which the state presently engages in performance-based contracting.
Recommendations
A. GSC should be required to develop “boilerplate” performance-based contracts and design contract-drafting guides for various types of contracts.
These template contracts could be used by agencies to improve accountability and performance. In addition, they could help eliminate unnecessarily restrictive or cumbersome contract language, making it easier for vendors to do business with the state.
GSC is in the process of developing a government-to-business (G2B) purchasing Web site. GSC should place the template contracts on this site, with separate sections for contract specifications, deliverables, sample timelines for deliverables, and recommended standard terms and conditions.
B. State law should direct the six state agencies that spend the largest amounts on contracts (the Department of Health, Department of Transportation, Department of Human Services, Department of Mental Health and Mental Retardation, Department of Criminal Justice, and Department of Protective and Regulatory Services) to convert their contracts to a performance or contingency basis as they are renewed or executed, and to report their progress in this effort in their next strategic plans.
While Texas state agencies have begun adopting performance-based contracting, it is not yet standard practice. The rider should require agencies to review all new service-related contracts and those up for renewal and convert at least 25 percent of them to a performance basis by January 2003.
GSC should develop guidelines and evaluation criteria for agencies to use in converting their contracts no later than November 1, 2002. GSC may wish to use the Office of Federal Procurement Policy guide to assist it in developing these standards.
The guidelines then should be posted on the GSC’s Web site to provide access for all agencies. GSC and the Comptroller’s office should provide technical assistance to other agencies as need dictates and resources allow. GSC also should provide agencies with a standard format to use in reporting their results in their next strategic plans.
State purchasing divisions should be required to use an identifier for performance-based contracts. GSC should build this code into its procurement system, to facilitate the tracking of such contracts. The code also would make it easier for GSC to ensure that all of its performance-based contracting methodologies are being incorporated into these contracts.
As part of this recommendation, GSC and the Comptroller’s office should evaluate the effects of the statewide move to performance-based contracting and report to the Legislature no later than December 2003.
Fiscal Impact
GSC already has employees designated to provide technical assistance with the contracting process and the Comptroller’s office has dedicated resources for this project; no additional funding should be required.
The fiscal benefits of moving toward performance-based contracting cannot be estimated without more data on each agency’s existing contracts. The federal government achieved an overall saving of 15 percent in its pilot study. Texas made over $14 billion in vendor payments for services in fiscal 2000; assuming that Texas’ experience mirrors the federal government’s, converting just 10 percent of these statewide to a performance basis could eventually result in saving the state around $210 million annually.
[1] Texas State Legislature, Joint General Investigating Committee, Joint General Investigating Committee Report on State Contracting (Austin, Texas, October 14, 1996), p. 4.
[2] Interviews with Carla James, director of Special Projects, General Services Commission, Austin, Texas, May 17 through June 30, 2000.
[3] US Office of Federal Procurement Policy and US Office of Management and Budget, A Guide to Best Practices for Performance-Based Service Contracting (Washington, DC, October 1998) (http://www.arnet.gov/BestP/PPBSC/BestPPBSC.html#chapter1). (Internet document.) Copies of the May 1998 pilot project report, “A Report on the Performance-Based Service Contracting Pilot Project,” may be obtained at (http://www.arnet.gov/Library/OFPP/PolicyDocs/pbscpilpro.html).
[4] Office of Federal Procurement Policy and Office of Management and Budget executive office of the President, A Guide to Best Practices for Performance-Based Service Contracting.
[5] Telephone interview with David Muzio, contract administrator, Office of Federal Procurement Policy, Washington DC, July 17, 2000.
[6] Matthew Weinstock, “Education Office Pioneers “Share-in-Savings” Contract,” Govexec.com (July 27, 2000) (http://www.govexec.com/dailyfed/0700/072700w1.htm). (Internet document.)
[7] Adrian T. Moore, Private Prisons: Quality Corrections at a Lower Cost (Reason Public Policy Institute, April 1998), p. 22.
[8] Texas Department of Criminal Justice and Texas Department of Criminal Justice Office of Inspector General, Joint Investigative Audit Report on Improving Policies, Contract Provisions, and Oversight of Privately Contracted Facilities (Austin, Texas, April 12, 2000), p. 6.
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