2.4.19 In structuring the payment mechanism, the public agency also has to decide whether to use direct or indirect incentives/penalties for each element of the service. Both direct and indirect incentives/penalties can be applied to encourage the provider to improve service delivery or remedy the failure promptly.
2.4.20 The direct approach involves immediate increases in payments for good performance or immediate reductions in payment if the provider fails to perform up to standard.
2.4.21 On the other hand, the indirect approach involves the award of performance points for above-average performance and/or penalty points for sub-standard performance. For penalty points, the number of points imposed varies according to the severity and regularity of the breach. When the private party accumulates a certain level of performance/penalty points, a range of other incentives/penalties can be imposed. For example, for accumulation of performance points for above-average performance, the public agency can reward the provider with financial bonuses. For accumulation of penalty points above a certain level, the public agency can issue formal warnings or impose financial penalties, or in extreme cases, terminate the contract as the provider's breach of the contract.
2.4.22 In constructing a points-based performance payment, care needs to be taken that unintended consequences do not arise whereby incentives cancel out the penalties due to sub-optimal performance. In addition, public agencies should also introduce caps for positive incentives (performance payments) to ensure that the provider does not put in too many resources to deliver services beyond the performance quality needed by customers/users.