How to create a smart public sector contract

The central challenge in public sector service provision is overcoming the assumption that outsourcing contracts should be static, single sided, and time-limited. For the most part, many of the outsourcing failures can be attributed to poor contract negotiation or contract execution. So effective outsourcing for public sector organizations should start with the use of smart contracts - or rather, creating smarter contracts. Evaluating past contracts is imperative in improving the process of designing contacts, but what are other things public service organisations should consider? Need for control, input-output measurement practices, short vs. long term contacts and moving away from full-lifecycle contract terms and lastly, defining value.

Control over public service provision

One of the fundamental issues outlined by interviewed subject-matter experts’ points to the issue of control over public service provision. That is, how can the public sector retain control in an outsourcing partnership, and in what ways can this be controlled for within the parameters of a contract? According to Norman Rose, Former Director-General of the Business Services Association, complex contracts are much more difficult to manage. On one hand, outlining too many contractual provisions, organizations run the risk of stifling innovation. However, on the other hand, minimal contractual specifications, organisations face the problem of monitoring for accountability.

Input-output measurement practices

These issues are directly linked to the input-output dominant measurement practices that persist in contracts today. Outsourcing providers often get tied down under an input-, or output-based model, which limits their capacity to develop innovative solutions. Incentive mechanisms are typically not designed into contracts, where providers are awarded a particular degree of freedom to innovate and get rewarded accordingly, in addition to realizing their own operational savings. Rather, contracts tend to be heavily focused on penalties for defaulting on the terms. The challenge here resides in the fact that there exists an inherent difficulty in holding providers accountable to outcomes given the ambiguity and arbitrary nature of outcomes in general, but also due to the lack of trust between provider and customer. As a result, providers are typically contracted for a specific, well-defined function, and are expected to fulfil their service obligation as is.

Short-term versus long-term contracts

Shorter-term contracts are expected to continue, especially as public sector organizations continue to shift to project-based procurement strategies and one-off solutions on an as-needed, case-by-case basis. Short term, well-articulated contracts are also perceived as being increasingly viable, since the pace of change in today’s operating environment is fast and accelerating. However, this trend increasingly occurs within the framework of existing established partnerships or professional relationships.

Conversely, many public sector organizations are beginning to rationalize larger contracts with many providers to reduce supply costs. There is growing interest in a developing a much more long- term, relationship-based contracts, and in developing a mutual understanding of outcomes and expectations that allows them to work together with service providers in a strategic way. Companies involved in longer termed contacts, are forced to solve their issues eventually building trust and confidence between purchaser and supplier for years to come.

Full life-cycle contracts and value

Moreover, there is a strong urge to look at full life-cycle contracts. As Siep Eilander, Director of Facilities, Management, and Procurement for the Dutch Ministry of the Interior and Kingdom Relations, comments: “I know our procurers generally do not have the experience to dive into those types of contracts, but that is what we are aiming for. I believe these types of contracts tend to be better on the cost-risk-value triangle. For one thing, the cost is not something that should be as low as possible. Despite austerity measures, cost is not the most important to us. Value is. Our primary aim is to gain value and reduce risks. As such, I believe risks should be shared to a greater extent, and service providers should increasingly be concerned with how they can package their services with added value.”

Value can be different things

In order to be successful, value should be redefined as being different things to different organizations. One criteria of value should to fulfil the contracted service, but also by supporting the broader policy ambitions of other public sector organizations and the government of the day. Thus, service providers must demonstrate that their services and processes are value-driven and act in the public interest. The value proposition of the business provider has to be better and clearer. One way to ensure this is to use a matrix contract mechanism where contracts would vary depending on deliverables, level of responsibility, and thus level of risk. The greater number of deliverables, assessed across the level of responsibility in fulfilling such deliverables, has an impact on the degree of risk-reward for each activity. This would in turn, encourage and allow outsourcing providers to create service wraps for them to overlap inputs, outputs, and outcomes for the entire pathway of services delivered.

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Long-term contracts might take some work, but as one interviewee Dan Froden puts it, it’s like a marriage; once you put work into it to achieve the perfect harmony, benefits can be realized for all. For others, short-term contracts satisfy an immediate need. What defines a smart contract after all, is evaluating the needs of the one provisioning the contract and providing a clear value proposition while considering the right combination of measurements to provide value for all parties involved.

Do you have any tips to share on creating a smart contract? Will you use any of these in your next smart contract design? Please share in the comments below!

This blog post is based on the ISS 2020 Vision: Future of Public Sector Outsourcing  whitebook.