Privatization in Practice: Case Studies of Contracting for TANF Case Management. It Is Possible to Design Contracts that Include Performance Incentives but Limit Risk to Contractors


Pure pay-for-performance contracts offer the strongest financial incentives for contractors to meet performance goals. In study sites where the contractors payment depends on performance, all contractor employees  from top management to line staff  are aware of the performance goals and their importance. Incentives to perform still exist in cost-reimbursement and fixed-price contracts if they contain performance standards, but these incentives are usually much weaker.

Pure pay-for-performance contracts, however, can be financially risky for the provider because payments are made only when there are successful outcomes. These outcomes may depend on the strength of the local economy and other factors beyond contractors control. Contracts in which payments are based on the number rather than the percentage of clients who meet specific goals are particularly risky because they depend on the referral flow. As payments under pay-for-performance contracts do not occur until performance goals are met, providers must have the resources to cover initial expenses.

Although contractors bear the financial risk in pay-for-performance contracts, the public agency can be affected as well. First, if contractors with limited financial resources are not performing, they may end up either cutting costs or terminating the contract, both of which may have detrimental effects on service provision. Second, smaller organizations with limited financial resources may be much less likely to bid for pure pay-for-performance contracts, reducing the diversity of service providers and the extent of competition.

To provide incentives but reduce the financial risks on providers, some agencies combine elements of both pay-for-performance and cost-reimbursement or fixed-price contracts. Some contracts provide a fixed payment up front, but make the majority of payments conditional on performance. Others reimburse costs and provide incentives through performance-based financial bonuses  further reducing the contractors risk. In addition, some contracts allow adjustments in performance targets if there are significant changes in the economy or caseloads.

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