Payment mechanism and pricing approach
The payment mechanism and pricing approach, and the approach to risk go hand in hand. The aim of the payment mechanism is to reflect an optimum balance between risk and return in the contract.
As a general principle, the approach should be to link payment to the delivery of outputs and/or of the work value and supplier performance. The approach to pricing should reflect the level of certainty or risk around the scope and requirement.
Dos and don'ts for contracting authorities delivering public works |
Do |
• Apply a proactive risk management approach with suppliers incorporating early warning and joint decision-making. Consider the use of risk pots and allowable assumptions. |
• Ensure that risk allocation and the approach to pricing are aligned with project and wider outcomes. |
• Where not addressed through the payment mechanism, ensure that contracts include appropriate indexation (i.e. using an index or basket of indices or measures that reflect the underlying costs of delivering the service) where the supplier is managing pricing risks outside their control. |
• Share all data (where it is appropriate to do so) relating to the procurement allowing sufficient time for due diligence. |
Don't |
• Issue incomplete tender documents with a poorly defined specification or unclear evaluation criteria (see chapters 3 and 9), this leads to pricing and project risk. |
• Ask suppliers to take unlimited liabilities, and recognise the financial capacity of suppliers in establishing limits of liabilities. Exceptions should be limited to a small number of instances where this would not be lawful or where a commercial cross-government policy has been agreed. |
• Unintentionally increase risk premiums and miss risk mitigation opportunities by late tendering that only allows suppliers to price client and consultant risk assumptions. |
• Hold incoming suppliers responsible for errors in data (excluding forecasts) where they are unable to complete due diligence. Where data turns out to be incorrect, there should be a contractual mechanism for reflecting this adjusting for errors. Recognising outcomes of due diligence may not be available at the outset, develop a fair commercial approach to deal with consequences. |
Where the scope of a project is certain, fixed pricing may be appropriate and, where there is increased uncertainty in scope, a variable approach may be more suitable to achieve best value for money.
There should be sufficient rationale for the selected pricing approach and risk allocation applying scenario testing, with worked examples of any novel or complex mechanism, in tender documents. Where there are a number of linked procurements, it is important to consider the holistic approach and ensure that the individual payment mechanisms support the overall intended outcomes. Before formally going to market, test the proposed payment mechanism and ensure supplier cash flow variances are reasonable.
Contracting authorities and suppliers should always pay their supply chain promptly (see chapter 8).