Performance fees can be used to supplement time-and-materials or fixed fee approaches by increasing the amounts paid to the firm if it exceeds specified performance targets. For example, while the municipality may agree a fixed fee for operations and management of a system, it may also pay a performance bonus if the firm reduces unaccounted-for water to a greater extent than that reduction specified in the contract. A performance fee thus gives incentive to the contractor to improve performance - including efficiencies - even though it does not make a direct profit; and it helps to create some confidence in the municipality that the operator is working towards its objectives.
All arrangements must address the need for price escalation. Municipalities must ensure that the agreements made include an escalation formula based on standard engineering practice (e.g., use of labour, material and energy price indices), that the calculations are based on national statistical data, and that the clauses also allow for decreases in pricing.
A number of issues characterise payment by fees (rather than profit):
• Payments are guaranteed to the extent that the private partner performs and the municipality is able to make the payments. While some private firms seek guarantees from higher levels of government to cover the possibility of the municipality being unable to meet its obligations, such practices detract from the authority of the municipality.
• The tariffs paid by the final consumers of the service are largely irrelevant to the compensation paid to the private partner. The municipality shoulders the risk of low-cost recovery for the service provided.
• Fee arrangements are generally not linked to improvements in cost recovery, as the private partner has little incentive to increase the rate of cost recovery through improved customer management practices.