evaluate contract

Questions to be answered. Was the contract a success? Did the incen-tive mechanisms improve performance? What problems were encountered? Were objectives aligned?

Comments. The success of the contract must be evaluated as part of an ongoing process so that problems can be quickly identified and resolved with as little consequence as possible. Once the contract is complete, a review of the project must be carried out in which the incentive mechanisms are objectively evaluated so that positive and negative factors can be identified and improvements can be made in the future.

Summary

Before deciding to incentivise a contract, it is essential to identify whether the improvement in quality and/or cost reduction can be achieved without incentivising the contract.

Incentives can positively impact contractor performance, but the performance gain must be balanced against the costs of shifting related risk to the contractor. Clients can broaden their incentive options by taking actions that increase the level of contractor control over contractor results, thereby reducing contractor risk.

Assessment of the degree of success of incentive mechanisms is extremely difficult. It has been shown that on a site where a direct financial incentive has been applied, increases in output could MANAGEMENT OF PROCUREMENT

equally well be attributed to operative training, job experience, good supervision, the implementation of management techniques, repetition of work tasks or the extent of mechanisation.

Engineering and construction contractors’ performance affects owner profitability long after project completion. Factors such as instrument and valve placement for maintenance, durability of spec-ified finishes, and provision for future utility tie-ins impact the client’s operation costs for the life of the facility. However, typical contracts do not tie the contractor’s payment to these factors. This concept has very limited applicability. A contractor’s influence on long-term facility profitability is difficult to separate from factors outside the contractor’s control, such as market conditions. Also, the delay of cash flow to contractors that would result from linking the fee to long-term facility performance appears a major obstacle.

Effective long-term incentives based on the contractor’s contribu-tion to owner success appear to be an opportunity for further research.

The general principles upon which incentive mechanisms should be based include the need to ensure that risks and rewards are commensurably and fairly distributed among the parties concerned and that they are tailored to specific project objectives.

An important factor in designing incentive mechanisms is to try to align the separate schedules of designers and contractors with those of the client. In order for this to occur, the objectives of all parties involved, especially those of the client, must be clear from the outset.

Incentive contracts are an attempt to align the interests of the contractor with those of the owner by basing compensation, to some degree, on results that are important to the owner. In basing pay on performance, however, the owner also transfers risk to the contractor. The output of a contractor is typically a function of factors within its control (such as level of effort, quality of assigned personnel, and management attention) and outside its control (such as weather, supplier problems and the owner’s technology).

The performance variation resulting from outside factors intro-duces randomness to the contractor’s output, and therefore to its income. Contractors may charge a premium to bear this risk, so the owner’s challenge in designing incentives becomes one of balancing the gain in contractor performance against the added cost of risk-bearing.

Although incentives can play an important role in making a project a success, a project’s success is determined by the sum of its parts and incentives are just a small part in the make-up of a project.

The basic aim of including incentive mechanisms in contracts is to

use the contractor’s main objective, that of making a profit, to encourage the contractor to make more money by performing the contract efficiently and in line with the client’s objectives.

Care must be taken in designing incentive mechanisms for areas that are a basis of incentive payment. The natural attitude of a contractor is to concentrate effort where the potential return is greatest, thus perhaps leaving areas of neglect. A project may be completed within cost, time and safety targets, meaning the bonus criteria have been fulfilled, and yet, for example, the contractor could have triggered an environmental incident that affects neigh-bours to the construction, causing long-term problems. Incentives have the potential to distract effort from certain areas.

The responsibility of structuring an effective incentive mecha-nism in a construction contract lies with the client. The basis for selecting and designing this mechanism is for the client to consider its own objectives and experience. Performance areas should be correlated with key result areas for the owner, and must sufficiently span the contractor’s performance so that important aspects of performance are not neglected.

One principle of incentive pay is that the more control the contractor has over performance areas covered by incentives, the higher the effectiveness of the incentives in shaping the contractor’s performance.

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