Commercial Policy Group Guideline No 2 - Incentivisation Of Contractor Performance

Transcription

1 Commercial Policy Group Guideline No 2 - Incentivisation Of Contractor Performance SUMMARY The following broad principles are to be pursued, in the area of incentivisation in order to help to implement Smart Procurement. Their implementation is subject only to agreement on the manner of their application in specific negotiations, and further formal consultation on appropriate contract terms and conditions. PRINCIPLES Making best use of competition at prime and sub-contract level remains the Ministry of Defence s (MOD s) preferred means of supplier selection for defence requirements and achieving value for money; Industry understand this principle while wishing to explore the relationship in the context of current discussions on longer term partnering. Making the best use of effective pricing mechanisms, including Fixed, Firm and Target Cost Incentive Fee (TCIF) pricing to reflect the circumstances of the procurement will be used to promote incentivisation of performance. MOD and Industry have common objectives in trying to ensure that incentives produce demonstrable value for money (VFM) benefits for the MOD and sustained shareholder value for Industry. Risks and rewards should be shared between the MOD and Industry in an equitable manner. Risk should be owned by those best placed to manage it. The prospect of longer term commercial relationships in return for good performance should be a major spur to good performance supported by incentivisation arrangements. The benefits of incentivisation arrangements should apply to the subcontract supplier base and continue to be nurtured to achieve VFM. Gainsharing opportunities should be actively explored and pursued wherever possible. Partnering arrangements for longer term contracts must include a framework for continuing incentivisation. 1 of 9

2 Benchmarking of performance against recognised best in class processes and practises will aid assessment of achievement against incentivisation measures. Sanctions for unsatisfactory performance against the contract requirement need to be available and will be used where appropriate. Sharing of future contract savings in subsequent contracts. GROUP GUIDELINES Background 1. In considering the approach to incentivisation of Defence suppliers, the baseline of the Treasury guidance (Central Unit on Procurement (CUP) No 58 - Incentivisation) - copy attached, for ease of reference - has been used. 2. The relationship and influence of certain aspects of Smart Procurement initiatives (e.g. incremental acquisition, partnering, Integrated Project Team (IPT) membership and role, team pricing) have to be borne in mind in developing an incentivisation strategy. Strategic Relationship 3. MOD and Industry should be seeking to establish greater mutual understanding and insight into each other s longer term plans, as the basis for developing constructive, long term commercial relationships, whether these are established as a result of competition or are based upon a single source environment. It is within the security of such relationships, that long term planning can be developed to identify and promote opportunities to improve performance in terms of cost, time, quality etc. In the non-competitive environment, there also exists the opportunity for contracts of medium or shorter duration, collectively, to contribute to a strategic relationship which will provide the basis for incentivisation. This relationship should be capable of being developed over a number of IPTs just as well as being established in the context of a single, large requirement, managed by a single IPT. The scope to introduce incentivising measures should be examined on a continuing basis pre- and postcontract award, and have regard to existing and prospective business between customer and supplier. 4. MOD and Industry (at the prime contract level) should also be seeking to effectively engage the sub-contractor supplier base, in order to ensure that the benefits to be gained from the use of Smart Procurement measures are available from as wide a spectrum of the industrial base as possible. Furthermore, subcontract suppliers in product related areas should be nurtured in such a manner as to promote continuing value for money. 5. Making best use of competition at prime and sub-contract level remains the MOD s preferred mechanism for ensuring value for money in defence 2 of 9

3 procurement. The MOD intends to develop, with Industry, a Supplier Information System which tracks and records past performance and motivates contractors to want to become suppliers to the MOD as a result of being able to demonstrate sustained good performance. Additional tools will also be used to promote good performance such as the use of pre-contract award evaluation techniques, the listing of contractors on the Contractors Requiring Special Attention (CRSA) list, where performance falls short of required standards and the continued adoption of a "no acceptable certification, no contract" (NACNOC) procedure to promote effective quality certification standards. 6. The continuing demonstration of ongoing competitiveness will be a key feature of longer term strategic relationships which may be underpinned through partnering arrangements. Where appropriate, this may be achieved by periodic re-competing in a pre-determined programme to ensure a visible market based benchmark of performance. Alternatively, benchmarking against agreed metrics and performance measures should be used to ensure that a supplier is meeting best in market standards, as measured by mutually acceptable best in class techniques, during the course of long term partnering contracts and in cases where competition is not practicable. Both MOD and Industry agree there needs to be a clear understanding of how the timing of the competitive process, the form this takes, and the selection process can be best aligned with the aims of the partnering concept. This is an issue which is being considered further by the Smart Procurement Implementation Team. At the same time, there is mutual benefit to be gained in seeking to establish a satisfactory balance in the benchmarking process which also sustains the continuous effectiveness of the sub-contract supplier base. Common Objectives 7. Incentivisation needs to be seen in the light of common objectives to which both MOD and Industry subscribe. Principally, these are: a. to support and be seen to support the operational capability deployed by the Commanders-in-Chief in the field, at the front line of the defence business; b. to drive down the through life cost of ownership from initial acquisition through to disposal; c. to improve standards of service delivery; d. to benefit from gainsharing opportunities wherever possible; e. to maintain and improve reliability and performance; f. to maintain or enhance industrial competitiveness in home and overseas markets; 3 of 9

4 g. to establish a balance between value for money (VFM) for the MOD and shareholder satisfaction for the contractor; h. to establish equitable sharing arrangements of risks and rewards. The Nature of Incentivisation 8. Many of the mechanisms for incentivisation depend on identifying mutual interests. This will require a greater degree of exchange of information than has been customary in the past. A move towards more effective incentivisation implies the need for cultural change in MOD and Industry. Both MOD and Industry recognise there must be a greater willingness to consider methods of incentivisation, which are both positive (and therefore can be seen to reward contractual performance) and negative (which can be used as sanctions in the event the contractor fails to perform his obligations under the contract). In this context, both MOD and Industry also recognise that as well as having common objectives (see above), they also have individual aspirations. On the one hand Industry, while needing to satisfy MOD as its major customer, has its principal allegiance to its shareholders interests. On the other hand, MOD is accountable to Parliament and the taxpayer and must be able to demonstrate value for money (VFM). MOD and Industry both accept that the challenge lies in being able to create a commercial environment which achieves a successful balance between these aims, and within which incentivisation plays an appropriate part in achieving common and shared objectives. A key influence on the nature of the relationship and the extent to which incentivisation may apply, is the degree of debate and visibility achieved as part of the development of the Procurement Strategy for each requirement. Effective team working will resolve many of the issues if they are tackled early. 9. It is important to recognise that, quite understandably, attitudes to risk will vary between MOD and Industry. Risk should be placed with those best able to manage it based upon a common understanding of what those risks comprise. The move away from the adversarial approach of the 1980 s has been only partial, and benefits can be seen for both MOD and Industry in taking this further, especially in the non-competitive environment where, in assessing the balance to be struck, the MOD has to bear closely in mind a contractor s performance in the context of his track record. The Purpose of Incentives 10. MOD and Industry both recognise the need to avoid thinking of incentives solely in terms of "price"; and by implication reduced prices. While most forms of incentive (and disincentive or sanction) ultimately have an impact on price, incentives need to be seen in a broader value for money context, such as: a. performance and reliability; b. improved service delivery; 4 of 9

5 c. reduced through life costs of ownership from initial acquisition through to disposal; d. effective gainsharing wherever the opportunities are available; e. improved cash flow; f. effective defect investigation and rectification; g. improved availability and reliability growth; h. good quality with growth potential for improved quality; i. the opportunity for beneficial investment as well as cost saving efficiencies which will only arise under stable, long term contractual relationships. As envisaged in "Setting New Standards", closer, longer term and more open relationships need not be cosy, and can exist within a taut contracting regime which include a range of incentives aimed at striking the right balance between competition and co-operation with a view to promoting continuous improvement and benefit sharing. As part of the process of developing future guidelines for the implementation of incentivisation techniques in an agreed manner, Industry will be encouraged to offer their own examples of best practice incentivisation techniques in the commercial environment, in order that best practice can be read across to the MOD/Industry relationship and can be considered for adoption, where not already implemented. Drivers for Incentivisation 11. The principal drivers which influence a mutual approach to incentivisation are:- a. achieving VFM in defence procurement and profitability and shareholder satisfaction; b. the satisfactory and timely conclusion of contractual obligations; c. longer term planning within a stable commercial relationship; d. driving out costs of acquisition and support while sustaining and improving standards of output, leading to increased competitiveness; e. security of future work and seeking improvements in the performance of the supplier base; f. extended contracts and repeat orders in return for sustained good performance; 5 of 9

6 g. the prospect of re-competition within the partnering and taking due account of past performance; h. achieving an equitable balance of risk ownership between those best placed to manage them; i. seeking to develop arrangements that provide for income generation and utilisation of spare capacity with sharing of rewards; j. variable management fee arrangements whereby provider is paid according to level of service provided. Incentivisation Examples 12. Both the MOD and Industry agree that there are joint benefits to be gained from further exploration of the ways in which the specific mechanisms for incentivisation can be developed, in order that they may be used as the basis for individual contract negotiations. These can take the form of specific terms and conditions in the contract or through the adoption of certain strategic procurement practices (eg: operation of past performance criteria for the selection of bidders). The following areas are illustrative of some of the mechanisms that have been proposed by MOD and Industry, in the Group s discussion for further consideration: a. Incentives i. The choice of appropriate pricing mechanisms is a powerful incentive: Firm and Fixed prices where the requirement and how it is to be achieved can be clearly defined; Target Cost Incentive Fee (TCIF), for higher value, longer term and/or more complex contracts, where changes may occur. Target Cost Incentive Fee (TCIF) arrangements have a positive role to play in incentivising the supplier, with shared benefits flowing to both parties. The arrangements should not be over complicated even for larger value requirements; ii. the exploitation, wherever possible, of continued cost improvement and gainsharing opportunities in the context of specific contract provisions which allow contractors to keep a proportion of the costs saved under innovative proposals throughout the life of the project; iii. in the context of longer term commercial relationships, exploit wherever possible, cost reduction measures, where the benefits flow to 6 of 9

7 the supplier but are re-invested in the business where they can provide mutual benefits; iv. arrangements whereby the level of profit is linked to enhancement of the product or service; v. where appropriate, flexing interim payment arrangements whereby proportions of any retention element can be advanced as a reward for good performance, such as the successful achievement of critical milestones. This improves cash flow by making earlier payment with no increase to the price; vi. linking interim payment to performance is a strong incentive to perform. Need for key performance indicators; vii. payment of profit related to overall service performance (customer satisfaction) provides incentive to perform, but against clear targets; subjectivity must be avoided; viii. paying bonuses where value is added and is beyond the baseline contractual requirement and where value for money can be demonstrated e.g. for early delivery; ix. options in the contract to extend contract if performance is satisfactory or better; x. sharing of future contract savings in subsequent contracts. b. Sanctions i. retention and recovery of interim payments made against the contract price; ii. the use of Liquidated Damages in an era when the introduction of Resource Accounting and Budgeting will better support the assessment of a genuine pre-estimate of loss, will bring into sharp focus for the supplier, the importance the MOD attaches to timely performance, albeit the provisions are contractual compensation for loss incurred; iii. where appropriate, flexing interim payment arrangements whereby no retentions apply initially and where proportions of any retention are increased as a result of poor performance, such as the failure to achieve critical milestones; iv. a greater use of express warranty provisions, where appropriate, and the exercise of the remedies under them;. 7 of 9

8 v. use of SC14 default for routine procurement where that is feasible. Possible use of a condition in the context of anticipatory breach of contract that would enable the customer (MOD) to terminate due to failure to meet the fundamental requirements of the contract; vi. use of DEFCON 92 (Failure of Performance), where appropriate. The Way Ahead 15. Discussion should focus on the prevailing cultures of incentivisation and how these might be adapted or changed to benefit the MOD and Industry. Best practice should be identified and deployed wherever possible. The goal should be to incentivise contractor performance within a framework of mutuality of interest, trust and openness, aimed at securing objectives which are clear, measurable and shared. 8 of 9

9 [1] Setting New Standards A Strategy for Government Procurement" Cm 2840 May 1995 MOD/Defence Industry Council: Commercial Policy Group Action Plan - Incentivisation Serial Task Action Lead Output Reporting Frame and Timescales Comments 1 To confirm baseline of the Incentivsation Paper agreed by CPG MOD/DIC Agreed starting point for further discussions and issue of the guidelines February 2000 Completed 2 Draft Industry Guideline on Incentivsation MOD/DIC Guideline to Industry March 2000 Completed Guideline No 2 Agree/Publish Guideline MOD/DIC April To draft a paper exploring TCIF arrangements MOD/DIC Proposed Annex to Guideline to Industry October 2000 Final Paper to be agreed by April 2003 Agree Draft MOD/DIC 4 To agree a document presenting the principles of Gainshare DIC/MOD Guideline to Industry by end Mar 2000 Completed Guideline No 1 5 To draft proposals for future Interim Payments MOD/DIC Proposed Annex to Guideline to Industry April 2003 Agree draft MOD/DIC December 2003 (Guideline) 9 of 9