Painshare / gainshare

In the typical alliance selection process the Owner (through the EOI or RFP) will nominate a suggested painshare/gainshare model to the market and invite comments. The most common model reflects:

•  A gainshare of 50% for NOPs that is unlimited.

•  A painshare for NOPs of 50% that is limited (capped) to the NOP's fee.

While there is merit in Owners advising of their desired principles for the painshare/ gainshare model, there appears little evidence to support the approach of Owners prescribing the actual details of a painshare/gainshare model. It is possible that this prescriptive approach may be inhibiting commercial innovation from proponents at an early stage in the selection process and therefore limiting differentiation between proponents on the basis of VfM potential. It is also possible that a prescriptive approach (even one inviting alternatives) could be viewed as market signalling by the Owners to the NOPs, hence stifling innovative responses. It may also be inconsistent with government procurement policy.

Of particular concern is the prescription of a cap on painshare. Risk and reward are intrinsically linked. The level of fee required by the NOPs will reflect, amongst other things, the risk (gainshare/painshare) that the NOPs face and the desired reward for taking that risk. A crucial ingredient is the cap (if any) of painshare. The desired level of such a cap will vary according to the NOP's risk appetite, the fee received and the project specific risks. Therefore the level of cap that is appropriate is contextual on the project, the wider market and the NOP. The Owner will likewise have its own views.

There is little evidence that the (typical) current approach where Owners prescribe the compensation model, involving the level of capped painshare, optimises VfM.

The issue of a capped painshare also raises the serious whole of government issue of moral hazard. Moral hazard arises because a party to a transaction does not bear the full consequences of their actions. They therefore have less incentive to act as carefully as would otherwise be the case. With a capped painshare only one party (the Owner) will bear the cost if things go badly on the project. In this situation, the moral hazard implications are unclear but unlikely to be positive from a whole of government perspective. Further research is recommended in this area.

The capped painshare is most likely to be exceeded if the project is in distress for whatever reason. At this time of distress, commercial alignment is essential to eliminate the natural potential for traditional position based adversarial behaviours to emerge. However, the introduction of a cap means that the alliance will move from win:win to win:lose if the cap is exceeded. That is, the NOPs will be insulated if things continue to go badly beyond their cap. At the time of greatest need, a cap has the potential to destroy a fundamental alliance principle and create significant commercial misalignment.