12.2 Direct financial or indirect non‑financial incentives

If the private party fails to perform, both direct and indirect incentives through the payment mechanism can be applied to remedy the failure.

The direct approach involves immediate reductions in payment. In a project with an availability-based payment mechanism, the whole of the payment is subject to abatements for unavailability. For example, when considering a hospital project, the reduction could be an hourly rate that differs according to the private party's ability to manage the risk, illustrated in Table 12‑1.

Table 12‑1: Sample scale of payment abatements for unavailability (availability-based contract)

This structure motivates the private party to proactively manage those risks which it can manage, on a basis which delivers best value to government.

The indirect approach depends on the level of performance of the available service. It involves the award of performance points for substandard performance - the number of points varying according to the severity and regularity of the breach (if a ratchet mechanism is used). When the private party accumulates a certain level of performance/abatement points, a range of other incentives can be imposed, from formal warnings to financial penalties or, in extreme cases, eventual termination for breach of contract.

Other indirect measures may include public reporting of performance against agreed benchmarks. If implemented sensibly, this can be a strong motivator for the contractor to perform or risk public pressure. In constructing points-based performance payments (for incentives and penalties), care needs to be taken that unintended consequences do not arise whereby incentives cancel out sub-optimal performance.