Critical success factors for contracting

Contracting is a critical component of the procurement process that creates the basis for performance management.

In this section you will learn:

  • The definition of third-party contracting
  • The benefits of vendor contracting
  • Critical factors for successful contracting
  • Most accepted costing models for public-private outsourcing contracts

Definition of third-party contracting

Third-Party contracting and management can be defined as the execution and monitoring of a contract for the purpose of maximising financial and operational performance and minimising risks that involve tracking purchases against contracts to ensure preferred suppliers are used, rates are adhered to, and discounts and rebates are collected. It further establishes performance measures that regulate contract delivery.

Benefits of vendor contracting

In the context of outsourcing, vendor contracts create standardised processes and procedures for both parties, which transfers risk in supply chain function to third-parties, while retaining public sector oversight; and increases certainty on the obligations of the contracting parties to be governed according to the contract objectives.

Vendor contracts ensure a predictable foundation for budgeting of public resources as once contract conditions and fees are signed, the cost is known and available for planning and budgeting purposes.

Finally, vendor contracts create the basis for performance management by ensuring compliance and performance delivery to the Service Level Agreement (SLA) due to contracting parties have well-defined and measurable key performance indicators.

Critical success factors for contracting

Analysis and feedback from experts reveal six key factors for contracting success and good practice.

Success factor 1: Rigorous risk profiling of service providers

For successful contracting strict capability assessments and site reviews are conducted to assess proven service delivery of key requirements.

This success factor assists the ministry of health to determine capability to deliver excellence in the functional area being outsourced. For instance in distribution, vehicle tracking or surveillance capability, supplier ownership of own fleet, comprehensive truck driver training programmes, etc.

Success factor 2: Contracting expertise

Expertise in contracting is an essential skill-set required by ministries of health for successful contracting

A competent and expert contracting team to design, negotiate and accurately craft a balanced and enforceable contract is critical to delivering the contract objectives. This team can be outsourced or legal capacity can be developed in-house.

Success factor 3: Key performance indicators (KPIs)

For successful contracting ministries of health must ensure KPIs are well developed and directed to the functional requirements and contract objectives.

Well-developed KPIs regulate and guide service contract deliverables and private sector performance that supports adherence to SLAs.

Success factor 4: Multi-year contracts

For successful contracting durations exceeding more than one year should be considered to offset possible investment by the private sector.

The private sector may need to invest in a truck fleet, warehousing, staff, systems etc. A ministry of health can do an upfront assessment of the asset level of the investment requirement from private sector against the functional need. Many contracts in more mature supply chains have evolved from a single year to multi-year durations, often up to three year periods.

Success factor 5: Incentives and penalties

For successful contracting consider performance incentives (and penalty) programs, under strict conditions and procurement law guidelines.

For more mature partnerships, bonuses and penalties provide upside earning opportunities for improved performances (and penalties for poor performance). These are in addition to appropriate KPIs and base-line contract requirements. Performance incentives work because the private sector is commercially motivated. However, strict adherence to procurement law is critical to mitigating harmful payment practices.

Success factor 6: Regular performance reviews

For successful contracting ministries of health should hold performance reviews at least once every three months.

There should also be strict governance procedures to mitigate underperformance. KPI tracking and identification of issues through regular reviews ensure adherence and rapid responses. This helps to develop transparent and dynamic relationships while holding private sector partners accountable to the KPIs.

Costing models

Two generally accepted cost models can be utilised to underpin public-private outsourcing contracts. These are described below:

Open book (cost plus)

In open book costing the supplier declares what resources and costs are required to conduct the services or functional area. The ministry of health and supplier agree to what costs are remunerable and the margin percentage (%) that the supplier can add to these costs.

The supplier services are then invoiced based on the actual costs incurred plus the agreed margin percentage.

The supplier provides the ministry of health with an estimated annual budget for the work and the associated overhead or running costs, direct labour costs, indirect labour costs.

The agreed margin percentage (or management fee) is then applied to the budget. A baseline cost model (e.g. rate per case, rate per order) is agreed as the productivity measure and to track ‘gain or pain’.

Activity-based costing

This is a costing methodology that identifies supplier activities and assigns the cost of each activity with resources to all products and services. Activity-based costing is applied according to the actual consumption and/or usage of that product or service (e.g. rate per case, distance travelled for transportation). This rate would include a supplier profit margin.

The supplier provides the ministry of health with a unit price per activity for the functional area and/or contracted service. For example inbound handling of freight, storage, outbound handling, distribution and/or administration.

1Source: Lighthouse Strategic Leadership, Team Analysis 2020, drawn from interviews for the OSTK with ministries of health, subject matter experts, Central Medical Stores in Sub-Saharan Countries: May-July 2020