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Contract ManagementContract Management
Better Practice Guide
February 2001

Page 2

ISBN 0 642 44304 1

© Commonwealth of Australia, 2001

This work is copyright. Apart from any use as permitted under the Copyright Act 1968, no
part may be reproduced by any purpose without prior written permission from the
Australian National Audit Office.

Requests and inquiries concerning reproduction and rights should be addressed to:

The Publications Manager
Australian National Audit Office
GPO Box 707
Canberra ACT 2601

Information on Australian National Audit Office
publications and activities is available on the following Internet address:


The Auditor-General, the ANAO, its officers and employees are not liable, without
limitation, for any consequences incurred, or any loss or damage suffered by an
organisation or by any other person as a result of their reliance on the information
resulting from their implementation or use of this Better Practice Guide, and to the
maximum extent permitted by law, exclude all liability (including in negligence) in respect to
the Guide.

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Contract ManagementContract Management

Table 9—Examples of performance incentives

Forms of incentive Possible approaches

Extending the contract If the original contract was for three
years, an extension could be granted
for an additional one, two or three

For a project where time is Bonus payment amounts payable per
critical, the provider is given day, week or month ahead of schedule
financial incentive for completing (subject to quality checks of course)
ahead of time (or alternatively

penalised for late completion)

Target costs established Appropriate in an alliance relationship
when the scope of services is broad
and requires reimbursement at cost
(established using an external
benchmark). If the target is
achieved, the ratio for shared savings
may be on 50:50, 60:40 or an 80:20

Part (usually 50%) or all of the Appropriate when management fees
provider�s potential profit placed are applied with ‘transparent’ pricing—
at risk against achievement of alternatively, 100% of the provider’s
performance potential profit may be placed at risk

with an incentive of additional potential
‘bonus’ if performance targets are
reached or exceeded

A reward at the discretion of SLAs linked to the purchaser’s strategic
the purchaser plan, would be used to measure

performance, but not necessarily to the
formal incentive—the bonus is then
based more on total customer

Incentives can be

important but need

to be well managed

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Contract ManagementContract Management

Escalation and savings

In establishing a performance based contract, organisations need to consider
escalation or savings provisions. Escalation addresses the need for pricing
increases over the term of the contract. In single year contracts, escalation is not
normally necessary. In longer-term contracts, a facility for escalation is needed
and a method of dealing with it adequately should be considered. Lengthy
calculations or complicated formulas are not generally checked effectively, as
time or other constraints and day-to-day pressures often apply.

As can be seen in Table 10, a traditional contract (ie. with a control and
compliance focus) would generally be more suited to a 3 year contract using,
say, the consumer price index (CPI) as the adjustment, as prices should be
reasonably fixed and easily identifiable and caters for the changing market.
Alternatively, the more flexible (cooperative, partnering and alliance)
relationships are more suited to a longer term contract using actual costs as the
basis of payment as the terms of such contracts are more likely to vary.

Table 10—Escalation provisions and relationship type

Contract Type 1 Year 3 Years 5 Years Plus

Traditional fixed—no escalation CPI adjustment

Cooperative fixed—no escalation cost cost

Partnering cost cost

Alliances cost cost

Along with escalation, it is normal for the contract to provide for consideration
of savings resulting from increased experience. Experience in the delivery of
services may result in savings, eg. through reduced man-hours. It is common in
cases where it is evident that efficiencies will be gained with experience to ask
providers to state their savings per annum throughout the term of the contract,
so that savings may be generated every year. Internal processes need to be in
place to track and account for these.

The vertical axis in Figure 8 is typical of some private sector contracts where
the providers nominate the increase in performance per year required for each
year of the contract. This often results in a lower final year cost than starting
year cost, even accounting for inflationary aspects of the general economy. The
gains in performance over time in this example (shown left to right) more than
make up for the increase in costs, resulting in a lower final year cost than in the
initial year.

It is normal for the

contract to provide

for consideration of

savings resulting

from increased


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Contract ManagementContract Management

Appendix 3

Checklist for the appointment of providers

Task Yes/No

Contract Management

1 Does the tender statement of requirements/procedural
manual/SLA specify:
• objectives
• milestones and timetables
• reporting requirements
• proposed fees and charges
• proposed payment arrangements
• content, timing and format of reports
• information to be provided by the provider
• responsibilities of the purchaser and the provider
• contact officers and numbers

Assessment of Performance

2 Have periodic assessments been made throughout the

3 Has a report been prepared after each milestone/
evaluation period of the contract commenting on the
provider’s performance?

4 Has a report been prepared at the completion of the
contract commenting on overall performance?

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Contract ManagementContract Management

Appendix 4

Relationship constraints and remedies

Constraints are any factors (existing or forecast, internal or external) that may
prevent the use of a preferred relationship type. The table below provides some
examples of constraining factors and some approaches that may be used to
remedy them.

Constraint Possible remedy

Poor management skills – • determine required skills and
internally or externally competencies

• provide appropriate training
• recruit skilled contract managers

Deficiencies in resourcing • establish resource needs and provide

Inaccurate information with • ensure service levels are appropriate
which to define performance • involve provider in designing
levels performance measures and obtaining


Insufficient information in the • ensure tender is open and advertised
marketplace from which to to the public
choose a final supplier • promote tender

• use contract specialists
• request more information from all


Insufficient suppliers in the • seek alternate solution
marketplace • use all suppliers in panel arrangement

• seek fixed price contracts

Inadequate support systems • improve support systems
with which to measure • measure performance using alternate
performance approaches

Poorly defined specifications • use experts in designing specifications
• involve stakeholders in setting

• involve industry in setting specifications
• use benchmarked standards in


Contract managers are not • adjust management structures and
sufficiently empowered to approaches to allow managers sufficient
perform their roles flexibility in their role

• change reporting structures
• move to flatter management style

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