Another challenge is the complexity of establishing relationships between the government and private-sector organizations through requests for proposals and contracts (Sclar 2000; Yates 1998; Cohen and Eimicke 2001a). When well designed, these documents create a durable understanding about the services the contractor will offer and the cost. Insufficient detail or clarity in contract language, on the other hand, can lead to confusion regarding basic issues such as the frequency of service provision, arrangements for billing and payment, and standards for data collection and reporting (Yates 1998; Cohen and Eimicke 2001).
Effective contracting relationships begin with a suitable match between the services required and the type of contract drafted. Governments might use at least three varieties of contracts, each presenting specific advantages and disadvantages:
- Fixed-price contracts. Under fixed-price contracts, the amount a contractor will receive is established in advance and cannot be altered unless the contract is amended.
- Cost-reimbursement contracts. Cost-reimbursement contracts set payments in line with the costs actually incurred by the contractor.
- Performance-based or incentive contracts. These agreements provide for payment to contractors as they accomplish a predetermined set of results. Payments might be related to services performed by the contractor, such as recruiting and enrolling a target number of clients in a training program. Performance also can be defined according to outcomes achieved by clients--for example, obtaining employment, obtaining employment with a wage above a certain level, receiving employment with certain benefits, and/or staying in a job for a certain number of days.
Contracts may incorporate more than one of these approaches. For example, a cost-reimbursement contract might be combined with an incentive structure, so that a service provider's total compensation is based both on costs and the achievement of desired goals.
The advantage of a fixed price contract is predictability--both the service provider and the government agency know in advance how much will be paid--but it is not easily adapted to unforeseen circumstances such as excess service demand or operational costs. Contractors also might have the incentive to reduce the quality of the service. In contrast, a cost-reimbursement contract reduces financial risks for the contractor, but provides no incentive for the contractor to reduce costs and potentially obligates the public agency to spend more for the service than it has budgeted.
Performance-based contracts, if well defined and monitored, can create incentives for service providers to meet the government's objectives. However, these incentives can lead to unintended consequences. For example, if payment is made for employment but not for job retention, the service provider might not have the incentive to find a job that is a good match for the client. If payment is made only on the basis of employment outcomes, the provider may have the incentive to "cream,'' recruiting most aggressively the easier-to-employ clients. In addition, collecting the documentation necessary to verify that the contractor has met the performance targets can be burdensome. Another issue arising with performance-based contracts is that payment might not be made until some time after the costs are incurred. This can cause cash-flow problems, especially for smaller contractors. Finally, performance-based contracts can place contractors at considerable financial risk if the flow of clients to the contractor is not as expected or if unexpected changes in the economy occur.
The drawbacks of performance-based contracts led one state agency, the Pennsylvania Department of Public Welfare (DPW), to switch from performance-based to cost-reimbursement contracts to operate its employment retention program, Community Solutions (Paulsell and Stieglitz 2001). Initially, the contracts were all purely performance-based, with payments based on a client completing a five-day assessment and reporting for the first day of program participation, job placement, and job retention. Many contractors faced financial problems under these contracts because they hired staff to serve the expected number of participants, but referrals turned out to be lower than expected. Moreover, the payment system was challenging to implement for both DPW and the Community Solutions contractors. Contractors had to obtain documentation necessary to report and substantiate participant outcomes and then request payment for achieving performance goals. DPW then had to compare the contractors' reports with participant data collected in its management information system. Payments were not made until the documentation was available and any discrepancies between the information provided by contractors and information collected by DPW were resolved.
In general, prior research suggests that several characteristics distinguish effective RFPs and contracting arrangements (Cohen and Eimicke 2001a, 2001b; Yates 1998; GAO 1997b and 1999; Johnston and Romzek 2000). These include a well-defined request for services, a carefully designed incentive structure that focuses on results instead of outputs or program rules, and the freedom to renegotiate contract terms as necessary. Specific service requests and correct incentives increase the likelihood that government agencies and contractors will work toward common goals. The ability to renegotiate contracts permits a constructive response to new circumstances or to contracting arrangements that do not function as planned.
An additional prerequisite for effective contracting is the capacity within government agencies and private contractors to develop productive and fair agreements. Johnston and Romzek (2000), studying contract implementation in Kansas, note that "executing a contract prove[d] to be surprisingly difficult for all parties involved." Substantial attention to detail, understanding of program components, and knowledge of applicable laws and regulations are necessary for the process to move forward smoothly. Government staff new to contract management--including those with substantial experience in program operation--might require specific training and mentoring in order to develop this expertise (Cohen and Eimicke 2001b; Yates 1998).