Performance contracting: Gaining competitive advantage

Editor's note: This is the first of a two-part series on performance contracting. The second part will appear in the August issue. Performance contracting is a tool that more and more companies are applying to outsource plant services. These include maintenance contracts, technical services, logistics support, auxiliary plant operations and maintenance, plant engineering, shutdowns, facilities ...


Performance contracting is a tool that more and more companies are applying to outsource plant services. These include maintenance contracts, technical services, logistics support, auxiliary plant operations and maintenance, plant engineering, shutdowns, facilities management, and MRO management. The challenge is to apply performance contracting to maximize its benefits.

What are performance contracts?

Performance contracts are service agreements in which the service supplier is compensated, totally or in part, based on an attribute of the service that the buyer deems to be of significant value. Performance contracts for one-of-a-kind, ad hoc services usually base compensation on service attributes that are completely or almost completely in the control of the service supplier. Examples include service quality measures, completion milestones, and/or some sort of productivity, savings, or cost metric. At the other extreme, performance contracts for consulting or total plant maintenance can include significant compensation for results achieved in partnership with the client. Plant reliability, production costs, plant throughput, and product quality are compensation metrics in these more advanced performance contracts.

Why use performance contracts?

What and how much you outsource in an industrial facility are questions of operating strategy and strategic compromise.

The benefits justifying decisions to outsource plant services typically include:

  • Lower fixed costs

  • Greater labor flexibility

  • Higher productivity and lower labor costs

  • Access to a broader or better array of skills and expertise

  • Broader, more effective knowledge base

  • Cost avoidance related to establishment of needed training processes, management systems, etc.

  • Desire to focus internal resources on core competencies.

    • In contrast, decisions to self-perform rather than outsource usually involve one or more of the following needs:

      • Tight control of proprietary information or strategic skills

      • Alignment of work force goals and objectives with the strategic imperatives of the plant owner

      • Avoidance of perceived risk related to costs, public relations, productivity, priorities, communications, and/or control of the work force

      • Avoidance of labor relations issues from outsourcing.

        • An effective performance contract maximizes the benefits of outsourcing while eliminating or minimizing the need to self-perform. Properly structured performance contracts also reduce the cost of contracting and contract administration versus more conventional contracting approaches.

          Critical success factors

          Critical success factors for performance contracting include:

          • Establishment and communica-tion of a clear vision and business plan for how outsourced services and the out-sourcing approach will support the operating strategy and create competitive advantage for the plant owner. The staffs of owner and contractor must thoroughly understand the business concepts, performance requirements, and financial ramifications driving performance contracts to deliver expected results.

          • Deep commitment by owners and outsourcers to a partnering philosophy that is centered around candor, win-win decision making, common goals, accountability, transparency, effective teamwork, elimination of redun-dancy, and lasting relationships. The most effective performance contracts for outsourced services eliminate the wastes of convention-al contracting approaches by driving partnering principles deep into the fabric of the plant popula-tion. Training and behavior model-ing by management are essential.

          • Selection of an outsourcing partner with superior competen-cies, cost structures, and a compatible culture that are deliverable for and applicable to the plant strategy and vision. Although the plant owner has significant influence on the success of any performance contract, the benefits of perfor-mance contracting are ultimately limited by the resources and capa-bilities of the contractor. The sidebar on page 26 summarizes contractor selection criteria of some of the Fortune 500 companies that use performance contracting.

          • A flexible performance-based contract that enables, promotes, and requires behaviors and results consistent with the vision, strategy, philosophies, and goals. Although no contract can assure success by itself, the performance contract is a critical tool for enabling achievement of targeted performance levels. Unlike a more conventional contract, a performance contract should set the tone for a win-win business arrangement addressing issues related to teamwork, train-ing, and cultivation of the relation-ship. The performance fees avail-able should be a significant part of potential contractor revenues and relate directly to the value of the owner for achieving targeted per-formance levels. Although princi-pally focused on results, the metrics that drive performance fees can give some weighting to reflect impor-tance of processes, communica-tions, and behaviors.

          • Management visibility and involvement. Steering contract execution and enhancement of the partnering relationship via performance contracts require a higher level of interaction among the management of the plant owner and contractor to achieve superior performance versus conventional contracting. By modeling needed and desired behaviors, management demon-strates the teamwork, communica-tions, problem solving, and accountability necessary to grow the success of the symbiotic reliance owner and contractor must have upon each other.

            • Performance fee metrics example
              Total plant maintenance outsourcing contract

              <table ID = 'id2744375-68-table' CELLSPACING = '1' CELLPADDING = '3' BORDER = '0'><tr ID = 'id2744383-68-tr' STYLE = 'background-color: #CCCCCC'><td ID = 'id2744387-68-td' CLASS = 'copy'> Weight </td><td ID = 'id2744393-70-td' CLASS = 'copy'> Metric </td><td ID = 'id2744400-72-td' CLASS = 'copy'> Comments </td></tr><tbody ID = 'id2744012-75-tbody'><tr ID = 'id2744014-75-tr' VALIGN = 'middle' STYLE = 'background-color: #EEEEEE'><td ID = 'id2744021-75-td' CLASS = 'table'>40%</td><td ID = 'id2744026-76-td' CLASS = 'table'>Overall equipment effectiveness (OEE)</td><td ID = 'id2744031-77-td' CLASS = 'table'>Focusing on all drivers of plant capacity aligns contractor with the plant owner's operations team</td></tr><tr ID = 'id2744039-79-tr' VALIGN = 'middle' STYLE = 'background-color: #EEEEEE'><td ID = 'id2744045-79-td' CLASS = 'table'>30%</td><td ID = 'id2744051-80-td' CLASS = 'table'>Maintenance budget</td><td ID = 'id2744056-81-td' CLASS = 'table'>Placing significant accountability for cost control on contractor assures cost effectiveness of services supplied</td></tr><tr ID = 'id2744064-83-tr' VALIGN = 'middle' STYLE = 'background-color: #EEEEEE'><td ID = 'id2744070-83-td' CLASS = 'table'>10%</td><td ID = 'id2744076-84-td' CLASS = 'table'>Safety and environmental</td><td ID = 'id2744081-85-td' CLASS = 'table'>The maintenance function plays an important role in safety and environmental compliance of the plant and must be part of performance measurements</td></tr><tr ID = 'id2744089-87-tr' VALIGN = 'middle' STYLE = 'background-color: #EEEEEE'><td ID = 'id2744096-87-td' CLASS = 'table'>10%</td><td ID = 'id2744101-88-td' CLASS = 'table'>Value creation</td><td ID = 'id2744107-89-td' CLASS = 'table'>The performance metrics must provide incentives for the contractor and his employees to drive value in other areas of plant performance (capital cost avoidance, return on assets, etc.)</td></tr><tr ID = 'id2744115-91-tr' VALIGN = 'middle' STYLE = 'background-color: #EEEEEE'><td ID = 'id2744121-91-td' CLASS = 'table'>10%</td><td ID = 'id2744127-92-td' CLASS = 'table'>Customer satisfaction</td><td ID = 'id2744133-93-td' CLASS = 'table'>Placing some amount of the performance fee on a number of subjective measurements such as teamwork, responsiveness, communications, etc., emphasizes mutual dependency and the need to build relationships.</td></tr></tbody></table>
              <table ID = 'id3001849-0-table' CELLSPACING = '0' CELLPADDING = '2' WIDTH = '100%' BORDER = '0'><tbody ID = 'id3001581-0-tbody'><tr ID = 'id3003025-0-tr'><td ID = 'id3001871-0-td' CLASS = 'table' STYLE = 'background-color: #EEEEEE'> Author Information </td></tr><tr ID = 'id3001628-3-tr'><td ID = 'id3001630-3-td' CLASS = 'table'>Jim Humphries, Vice President of Performance Technology for Fluor, has spent over 25 years in operations and maintenance. He has inspired step-change improvements in manufacturing, purchasing, materials management, quality, maintenance, engineering, human relations, training, and marketing. He can be reached at</td></tr></tbody></table>

              Performance contractor selection criteria

              A performance contractor should be able to demonstrate these attributes:

              Results-driven culture with history of providing competitive advantage for customers through step changes in productivity, reliability, etc.

              Process-focused quality systems meeting or comparable to ISO requirements

              Availability of required expertise, systems, and processes

              World-class safety record

              Extensive experience establishing performance contracts that generate significant savings or added revenues for clients

              Computer-based training programs to cost effectively establish, maintain, and raise worker skill levels

              Proven performance-based incentives to engage contractor employees in the plant owner's business goals and creation of value in alignment with the performance contract

              Competitive cost structures for labor, materials, and tools

              Industrial relations expertise to assist in addressing any labor and public relations issue proactively and effectively

              Management team that is committed to the business relationship and willing to invest personal time to assure success of the relationship.

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