Pay for Performance Contracting

There are a few basic principles that all students are taught when they take Economics 101: the fundamentals of supply and demand, the concept of GDP and, of course, how to incentivize individuals in order to achieve the most effective and efficient outcome. Using incentives as a way to maximize outcomes is fundamental to everyday economics and nearly everyone encounters the practice in one way or another.

The idea of incentives begins at an early age, whether it’s a gold star for doing well on a spelling test or an ice cream party for making the honor roll in elementary school. Eventually, these incentives evolve into job promotions or salary increases. Whether consciously or not, the use of incentives is ingrained at an early age as a way to push individuals or groups to do their best work.

With this in mind, it should come as no surprise that incentives are used in government contracts as a way to motivate private and public entities to reach certain goals. Typically referred to as either performance-based contracting or pay for performance (PFP), these contracts are specially formulated so that contracted entities are paid for the outcomes or results of their work, and not just the services that are provided. PFP contracts also minimize the financial risk to taxpayers by allowing the government entities to only pay providers when the provisions in the contract are successfully met.