Performance-Based Contracting
In today’s competitive marketplace, industrial customers are continuously looking for ways to get more value from their service providers.
Conversely, service providers must figure out how to add value if they want to stay competitive.
In my experience working with industrial service activities — from hazardous waste handling to industrial water treatment, residuals treatment and byproduct recovery — customers are constantly asking, “What have you done for me lately?” If we saved them half a million dollars last year, they’ll comment, “Well, that’s really nice, but what have you done for me this year?” And next year they are going to ask us the same question. In order to continue to get their business, whether a long-term operating agreement or a short-term tank cleaning job, you must constantly provide additional value over and above the cost of the service.
One way to manage this is through a performance-based contract that by its nature encourages both parties to create additional value in order to realize mutual successes. The customer benefits because he is continually seeing value and getting information from a contractor who answers the question, “What’s in it for me?” And from a contractor’s perspective, he is motivated to bring value to the operator that allows him to benefit financially from the operational savings.
While not without risk for both parties, when performed successfully these types of contracts will drive a reduction in the total cost of ownership for a customer because of all the incremental value added by the service provider. But to be effective, both the operator and the contractor have to be comfortable putting some skin in the game. From the operator side, typically this requires committing to a certain level of spend with the contractor on an annual basis. And for the contractor, he must take on full accountability for service quality, safety performance and results-driven promises.
Ultimately, performance-based contracts are designed to measure the value beyond cost a customer realizes as a result of the services provided. For example, if a service provider chemically cleans a heat exchanger and the resulting work allows the unit to come back online three days ahead of a normal schedule, that’s three additional days of production for the operation. The value of that added production time can be calculated and tracked. For an oil refinery that runs 300,000 barrels a day of crude through the unit with a crack spread of $15 a barrel, the daily savings by having the unit up and running early is enormous.
A service provider can also add value by initiating clever, better and faster solutions for jobs he has normally done a certain way. As an example, if we usually clean a heat exchanger using manual hydroblasting tools manned by an operator in PPE working all day long in extreme temperatures, the quality of the work toward the end of his shift may not be as consistent.
Conversely, if we use automated hydroblasting tools to clean that same exchanger, it takes the fatigue factor and other safety concerns like heat stress and line-of-fire exposure out of the equation. The time to clean the unit is shortened, and the quality of the cleaning is much better. The customer may see an improvement in the length of time between cleanings, benefit from higher heat transfer rates and require less fuel consumption — all things that will reduce operations and keep the plant up and running longer.
It’s worth noting using a performance-based contract is better suited for customers with sophisticated procurement and management philosophies who appreciate the need for value rather than just a commodity service. Chemical plants and refineries are good examples of customers well-suited for performance-based contracts. However, a company that simply wants the lowest, cheapest price is not a good candidate for performance-based contracts. A service provider could never extract enough value from the contract to pay for all additional value-added services provided. Therefore, you really have to go after companies that appreciate the value and have a breadth of complex, industrial operations where you can find opportunities to save them real money. This isn’t theoretical. On the surface level, it may appear we’re delivering incremental savings on individual jobs, but it is optimizing their production operations, improving their run times between maintenance activities and reducing their energy costs — all the big-ticket items.
Of course, all of the value added by the service provider needs to be tracked and measured effectively and assigned a dollar amount to determine if savings have actually been realized. On the customer side, an engineer is required to source and provide the data. On the supplier side, you also need a continuous improvement engineer who takes all that data, analyzes it and generates the benefits in savings and improved efficiency.
These engineers meet regularly to review the metrics and ultimately agree to an assigned value for the cost savings and production efficiencies met.
There are several characteristics of a service provider well-suited for performance-based contracts:
- Having a technology edge. Being able to provide innovative solutions through technology elsewhere.
- Having engaged and knowledgeable employees. They must constantly strive for improved efficiency, understand the customer’s operations enough to know where to look for value, identify how available services can improve efficiencies services.
- Having the financial bandwidth to invest money in resources, equipment and ideas in order to continuously innovate.
- Having the ability to draw upon a network of experienced breadth of expertise.
- Having proven safety results and a safety culture to sustain performance levels.
The most important factor as a service provider is to ensure you’re adding value to the client, which motivates them to continue wanting to do business with you. When you consider Uber, Google or Apple, these companies are where they are because they came up with a clever solution no one else had. They gave the market something it really wanted and added unmatched value. That’s exactly what we as service providers have to do to be competitive: Continue finding new and better ways of adding value.
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