19.6.3.1 The Contract must set out clearly the consequences of any failure by the Contractor to perform to the standard required by the output specification.
19.6.3.2 The simplest approach is to categorise the various types of performance shortcomings and use a simple grid of monetary deductions. A more complex two-stage approach is for the Contractor to incur a specified number of performance points for each failure, with the number of points incurred varying according to the seriousness of the failure and for there to be then a mechanism for translating points to monetary deductions. As this approach is inherently more complex it is not recommended.
19.6.3.3 There should be a clear link between the seriousness of the failure and the financial impact on the Contractor. For example, a failure to cut the grass outside a prison should not accrue as large a deduction as a failure to carry out security checks. Similarly, the same type of failure may also incur different deductions depending upon the nature of the area in which it arises.
19.6.3.4 If performance deteriorates below a particular level then a range of other non-financial mechanisms can be implemented to encourage the Contractor to improve performance. These range from a formal warning to eventual termination for breach of the Contract (see Section 19.12 (Other Remedies for Poor Performance) and Section 23.2.2 (Events Leading to Termination)).
Ratchet mechanisms
19.6.3.5 It may be appropriate to have a ratchet mechanism to encourage the Contractor to improve performance if it is consistently poor in relation to a particular part of the Service or a particular failure is not rectified. This can be particularly useful where the initial deduction is insufficient to provide an appropriate incentive on the Contractor to rectify the fault. Too complicated a regime can, however, be difficult to manage and including onerous measures in the pricing mechanism can lead to poor value for money. A key advantage of a ratchet mechanism is that poor performance that continues for a significant period of time will be more difficult for others interested in the Contract (e.g. lenders) to ignore, encouraging early action by the Contractor. It is recommended that ratchets be used in most payment mechanisms.
19.6.3.6 A simple ratchet mechanism will work by increasing the deduction for a particular failure in the Service which recurs too often within a specified period. For example, if a deduction of £X is incurred for a failure to achieve a particular output then a deduction of £(X x Y) may be awarded for each failure over and above a specified maximum number of failures within a pre-defined period.17 It is of vital importance to tailor the ratchet mechanism to a particular project in a way that produces best value for money. Ratchets might also apply to failures which occur in a high proportion of areas within a large project, i.e. for repeated failures geographically rather than repeated failures over time.
19.6.3.7 There is an argument that deductions should not be capable of being "earned back" retrospectively by the Contractor performing above the standard required:18 the required performance level should be set at what is considered reasonable and achievable, so if the Contractor is capable of performing at a consistently higher level then either the level is too low (i.e. the payment mechanism has been poorly calibrated) or the Contractor is simply performing very well and delivering a standard of service at a higher level than the Authority expected or required. However, for some projects it may be considered that the higher level of performance is of additional benefit to the Authority, in which case it may be appropriate for the Contractor to receive additional consideration over and above the usual Unitary Charge. See also Section 19.2.4.
19.6.3.8 The performance regime should as far as possible cover every aspect of the Service. Where an all-encompassing performance regime is not feasible or does not sufficiently address persistent failures, the Authority should consider what recourse it has against the Contractor for sub-standard performance which is not covered under the performance regime (see Section 23.2.3 (Termination for Persistent Breach by the Contractor)).
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17 Alternatively, the level of deduction may increase for each failure over and above a de minimis level.
18 The performance points mechanism should after a certain time, however, disregard points accrued in circumstances where the relevant thresholds for warnings, deductions etc. have not been reached or, if reached, have been dealt with in accordance with the Contract. This is often achieved by using periodic test periods or rolling points-accrual periods.