Guidelines for Performance-Based Contracts

for Fossil Fueled Power Plants

Technical Report
 Guidelines for Performance-Based
Contracts for Fossil Fueled Power Plants

1004829

Final Report, March 2005

EPRI Project Manager

R. Chambers

Electric Power Research Institute • 3412 Hillview Avenue, Palo Alto, California 94304 • PO Box 10412, Palo Alto, California 94303 • USA
800.313.3774 • 650.855.2121 • askepri@epri.com • www.epri.com
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CITATIONS

This report was prepared by

Framatome ANP, Inc.

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Charlotte, NC 28262

Principal Authors
K. Barker
M. Bonasera
K. Branch
M. Kelly

This report describes research sponsored by the Electric Power Research Institute (EPRI).

The report is a corporate document that should be cited in the literature in the following manner:

Guidelines for Performance-Based Contracts for Fossil Fueled Power Plants. EPRI, Palo Alto,
CA: 2005. 1004829.

iii
REPORT SUMMARY

Contracts, which enable a plant to outsource work, are an important component of the economic
and operational success of a power plant. Traditional contracts embody an agreement between
contracting parties wherein a contractor performs a scope of work, within a prescribed timetable,
and typically for monetary compensation. Performance-based contracting, on the other hand,
rewards good results with bonuses and punishes bad results with liquidated damages. This report
specifically focuses on performance-based contracts and offers guidelines for negotiating and
administering performance-based contracts for outage and maintenance work at fossil fueled
power plants.

Background
Performance-based contracts are a win-win undertaking for both parties involved in the
negotiation. These contracts ensure that required performance quality levels are achieved and
that total payment is related to the degree to which the services performed meet or exceed
contract standards. Performance-based contracts specifically describe the expected and required
results of the work to be performed. They use measurable performance standards and quality
assurance plans to oversee and evaluate the work. Familiarity with and the use of performance-
based contracts can lead to the creation of business relationships that recognize the efficient and
effective nature of these arrangements and build an atmosphere of trust, which may lead to
mutually beneficial teaming arrangements, alliances, or partnerships.

Objectives
• To provide power plant personnel with a definition, overview, and understanding of the
advantages of performance-based contracts versus traditional types of contracts
• To provide guidelines for power plant managers to use in negotiating and administering
performance-based contracts for outage and maintenance work at fossil fueled power
facilities

Approach
Based on research compiled by Framatome ANP, Inc., this report provides a thorough
description of the key elements and importance of performance-based contracts.

Results
This report provides a general definition of performance-based contracts versus traditional
contracts. It further defines the various elements of any contract, such as the scope of work,
schedule, cost, quality of work, and a statement of the safety program in place for the work.
Different types of contracts are outlined and defined as are types of services that might be
outsourced. Finally, an overview of performance measures used to determine the success or

v
failure of the contracted work, a description of incentives, and guidance for overseeing a contract
are included. All of this information will serve as a blueprint for power plant management to
effectively negotiate and administer performance-based contracts for outage and maintenance
work.

EPRI Perspective
It is EPRI’s goal to assist power plants in more effectively and efficiently operating their
facilities. With this report, EPRI is assisting power plant managers in gaining a better
understanding of when and under which circumstances performance-based contracts are most
effectively used. Most importantly, the information provided also helps power plant managers to
outsource work through a contractor with the overall goals of encouraging and rewarding
excellence, providing for continuous improvement, and ensuring the timely completion of
necessary work.

Keywords
Outage
Contract
Performance-based
Contractors
Vendors

vi
ABSTRACT

As companies continue to do more with less, outsourcing of work is becoming more frequent in
power plants. This report focuses on establishing contracts to outsource work and, in particular,
it describes the inherent advantages of negotiating and establishing performance-based contracts.
Performance-based contracts ensure that required performance quality levels are achieved in the
contract work being performed and that total payment for the work is related to the degree to
which the services performed meet or exceed contract standards.

Performance-based contracts specifically describe the results required of the work, and they
define measurable performance standards and quality assurance oversight plans for the
contracted work to be performed. A performance-based contract also specifies procedures for
reducing fees or pricing when services are not performed or do not meet the contract
requirements. When appropriate, performance incentives can also be included and defined.

This report outlines the elements of performance-based contracts such as the scope of work,
scheduling, cost, quality of work expected, and safety provisions that are to be in place. Different
types of contracts are defined as are types of services that are favorable for outsourcing. The
final sections of the report describe how to measure the level of performance quality in the work
being performed, ascribe incentives, and assign responsibility for contract oversight. All of this
guideline information can be used as a blueprint for power plant management to effectively
negotiate and administer performance-based contracts.

vii
CONTENTS

1 INTRODUCTION ................................................................................................................. 1-1

Purpose.............................................................................................................................. 1-1
General .............................................................................................................................. 1-1

2 TERMS AND DEFINITIONS ................................................................................................ 2-1

3 CONTRACT OBJECTIVES ................................................................................................. 3-1

General .............................................................................................................................. 3-1
Scope of Work.................................................................................................................... 3-2
Schedule ............................................................................................................................ 3-2
Cost.................................................................................................................................... 3-3
Quality of Work................................................................................................................... 3-3
Safety................................................................................................................................. 3-4

4 TYPES OF CONTRACTS .................................................................................................... 4-1

General .............................................................................................................................. 4-1
Fixed Price..................................................................................................................... 4-1
Time and Material .......................................................................................................... 4-2
Straight Unit Price.......................................................................................................... 4-2
Incentive ........................................................................................................................ 4-2
Single-Time ................................................................................................................... 4-3
Short-Term .................................................................................................................... 4-3
Long-Term ..................................................................................................................... 4-3
Partnership/Alliance....................................................................................................... 4-3

5 TYPES OF SERVICES ........................................................................................................ 5-1

General .............................................................................................................................. 5-1
Routine Maintenance.......................................................................................................... 5-1
Seasonal Maintenance ....................................................................................................... 5-1

ix
 Projects .............................................................................................................................. 5-1
Planned Outages................................................................................................................ 5-2
Forced or Unscheduled Outages........................................................................................ 5-2
Housekeeping .................................................................................................................... 5-2
Environmental Services...................................................................................................... 5-2
Engineering Services.......................................................................................................... 5-3

6 MEASUREMENTS............................................................................................................... 6-1
General .............................................................................................................................. 6-1
Schedule ............................................................................................................................ 6-2
Cost.................................................................................................................................... 6-3
Quality................................................................................................................................ 6-3
Safety................................................................................................................................. 6-3
Monitoring .......................................................................................................................... 6-3

7 INCENTIVES ....................................................................................................................... 7-1

General .............................................................................................................................. 7-1
Pluses and Minuses ........................................................................................................... 7-1
Difficulties........................................................................................................................... 7-1
Types ................................................................................................................................. 7-2
Establishing Incentive Amounts.......................................................................................... 7-2

8 CONTRACT OVERSIGHT ................................................................................................... 8-1

General .............................................................................................................................. 8-1
Project Manager On-Site .................................................................................................... 8-1
Corporate Project Management.......................................................................................... 8-1
Third-Party Contracted Management.................................................................................. 8-2

9 REFERENCES .................................................................................................................... 9-1

In-Text References............................................................................................................. 9-1
Other References ............................................................................................................... 9-1

x
LIST OF TABLES

Table 7-1 Incentive Work-Up Example.................................................................................... 7-4

xi
1
INTRODUCTION

Purpose

The purpose of this report is to provide guidelines for management in negotiating and
administering performance-based contracts for outage and maintenance work at fossil fueled
power facilities. These guidelines will help the management team to better understand when and
under what circumstances performance-based contracts are best used, and how to establish a
contract with the overall goals of encouraging and rewarding excellence while providing for
continuous improvement and ensuring the timely completion of work.

General

Performance-based contracting differs from traditional contracting methods in significant ways.

It is worthwhile to consider some of the key differences.

Traditional contracting calls for an agreement between contracting parties wherein the contractor
performs a scope of work within a prescribed timetable and typically for monetary
compensation. If the price is fixed, the contractor has an incentive to perform the work as
inexpensively as possible to improve the contractor’s profit. If the price is a variant of a “cost
plus” contract, the contractor does not have the same incentive to perform the work as efficiently
or as timely as they might otherwise. In the latter case, the owner has to take more control over
quality and schedule outcomes; otherwise, costs may escalate beyond budget.

The traditional approach encourages an adversarial relationship between owner and contractor,
especially if the price is fixed and competitive bidding has taken place. Contractor claims of
additional compensation, overpriced extras, and delays are frequent issues. In the worst cases,
these contracts wind up in arbitration or in the civil courts. In cases that are settled, one party or
the other often feels that they have been taken advantage of.

In contrast, performance-based contracting is intended to create a non-adversarial contracting

relationship by rewarding good results with bonuses and punishing bad results with liquidated
damages.

Performance-based contracting methods are intended to ensure that required performance quality
levels are achieved and that total payment is related to the degree that the services performed
meet or exceed contract standards. Performance-based contracts describe in specific terms the
results required of the work. They use measurable performance standards and quality assurance
surveillance plans. The contract specifies procedures for reduction of fees (for time and material

1-1
Introduction

contracts) or reduction to the price (of a fixed-price contract) when services are not performed or
do not meet contract requirements. It also includes performance incentives where appropriate.

Plant and contractor personnel should receive training so that each is familiar with performance-
based contracts and how they are a win-win proposition for both parties. Supervisory and
managerial personnel of contracting parties need to be familiar with the requirements in order to
work together and accomplish their goals.

Familiarity with and use of performance-based contracts may lead to the creation of business
relationships that recognize the efficient and effective nature of these arrangements. They may
also build an atmosphere of trust that can then lead to teaming arrangements, alliances, or
partnerships to the mutual benefit of the contracting parties.

1-2
2
TERMS AND DEFINITIONS

Contingency – A dollar amount or percentage added to the cost estimate or contract value to
cover unforeseen costs.

Cost Plus Contract – Contract that pays the contractor for their incurred cost, plus profit and
overhead at a fixed rate or fixed sum.

Cost Report – Financial report submitted by the contractor that lists the costs incurred for each
cost account item, typically work breakdown structure (WBS) items. Generally, such a report
will include a forward-looking cost estimate based on the actual costs incurred, completion
status, and the projected completion schedule.

Critical Path – The sequence of activities upon which the overall completion date of the project
is dependent. A delay in the critical path has a direct impact on the entire project’s schedule.

CPM Schedule – A schedule based on the Critical Path Method (CPM) of analysis. A CPM
Schedule is used to plan the work, schedule time and resources, track progress, and calculate
effectiveness.

Earned Value Analysis – Method of calculating the progress of a project or amount payable to a
contractor based on measurement of work task and schedule completion.

Escalation – A rate, expressed as a percentage, by which future costs or payments will be

increased. The escalation rate is generally fixed to a financial index related to the cost of money,
labor, or materials in future years.

Front End Loaded Costs – Costs charged or payments made at the outset of the work. When on
a percentage basis, costs of project startup are high as compared to total project costs.

Hold Point – A point defined in the schedule at which a work activity is suspended so that a
quality assurance activity can be performed or validated.

GMP – Guaranteed Maximum Price.

Level 1 Schedule – The outage Level 1 Schedule provides an overall view of the outage plan,
schedule, and key milestones, including shutdown and startup. This schedule provides baseline
versus current projection capability and serves as the basis for periodic management reviews.
This schedule shows start dates and ending dates for major activities planned for the outage.

2-1
Terms and Definitions

Level 2 Schedule – The outage Level 2 Schedule is a summary of outage work activities. It
includes sufficient detail to define the critical path and to provide a basis for monitoring and
controlling actual versus planned work performance.

Level 3 Schedule – These schedules are detailed logic-based schedules developed for projects or
other complex work evolutions in support of summary work activities in the Level 2 schedule.
Their purpose is to provide the project manager or outage project lead with sufficient
understanding of job interrelationships and requirements of day-to-day management to enable
anticipating and avoiding potential problems. Detailed schedules are generally developed
independently and later merged to form the integrated outage schedule.

Liquidated Damages – A financial penalty for failure to complete an activity in accordance with
the contract terms.

Loaded Payments – see Front End Loaded Costs.

Milestone – A significant or important event of zero duration that summarizes the start or
completion of one or several related activities or decisions.

Overruns – Costs or schedule time usages in excess of what is specified in the contract.

Performance-Based Contracts – Contracts designed to ensure that a specified level of

performance quality is achieved and that payments for work are keyed to measures of
performance of the work. Performance-based contracts provide the contractor incentives for a
specified work result and penalties for failure to achieve the specified work result.

Punch List – A checklist itemizing activities that require completion and generally used to
measure remaining work when the overall project nears completion.

Qualitative Measure – A measure that expresses a categorization of performance, such as the

terms satisfactory and unsatisfactory.

Quantitative Measure – A measure that expresses an explicit quantity of performance, such as a

measure of actual man-hours or dollars expended.

Resource Leveling – A method of analysis in which scheduling decisions are based on resource
management concerns.

Retainage (or Retention) – An amount withheld from a contract payment until such time as
completion is fully verified. A retainage is used as a financial incentive for the contractor to fully
complete the work.

Substantial Completion – A level of completion wherein the component or system is installed,

tested, and operationally ready for service.

2-2
 Terms and Definitions

Target Man-Hours (MH) – Allotment of man-hours set forth in the contract. A performance-
based contract provides incentives for the contractor to complete the scope of work within the
allotted man-hours or incur a penalty for man-hour expenditures in excess of the allotment.

Target Price – Price set forth in the contract. A performance-based contract provides incentives
for the contractor to complete the scope of work within the target price or incur a penalty for
costs in excess of the target price.

Underruns – Costs or schedule time usages less than what is specified in the contract.

Work Breakdown Structure (WBS) – Chart used to list tasks for each project that separates
tasks and shows time and resources required to complete. The chart is then used to develop a
schedule.

Work Authorization – A contract addendum that is used to authorize the scope of work to be
performed in accordance with the requirements, terms, and conditions of the contract. Work
authorizations are generally used to authorize a contractor to perform additional work under a
previously executed contract.

2-3
3
CONTRACT OBJECTIVES

General

A contract is needed when a plant wants an outside organization to perform work. The contract is
a legal document that states the technical requirements, general terms and conditions, what is
expected from each party to the contract, and remedies for non-performance.

The technical requirements will include major sections that define the scope of work and
technical specifications that determine the quality of work expected to be produced. A timetable
of key milestone dates must be included as well as the contractors’ pricing and payment details.
Each of these sections has to be clearly stated and defined so that there is no question of what is
contracted for and expected. While there are almost always ambiguities, changes, and
clarifications needed, the goal is to minimize these problems. All of this relates to a traditional
contract as well as forming the core of a performance-based contract.

The performance-based contract goes a step further by promoting in several ways superior
performance by the contractor. Financial incentives may be offered for or based upon several
different milestones. These may include the following:
• Early completion of work
• Outstanding technical performance of key equipment
• Minimal re-work required of key operations (for example, welding)
• Smooth and orderly startup
• Few, if any, lost-time or more serious accidents
• Dollar volume of cost savings initiated by the vendor

Alternatively, if the contractor fails in these areas, they may be subject to a financial penalty or
sanctioned from doing further work. For example, should the plant not be returned to service on
schedule due to the fault of the contractor, the contractor may be required to pay liquidated
damages that could amount to many thousands of dollars for each day of delay.

The following sections discuss major areas of the contract documents.

3-1
Contract Objectives

Scope of Work

Generally, the scope of work identifies the specific work to be completed and defines the
requirements in clear, concise language. In addition, drawings and detailed lists may be used to
help define the scope. Multiple scopes under one contract for the same contractor need to be
itemized and detailed individually for clarity of the requirements for each scope, particularly if
they are set up with individual incentives. A division of responsibility (DOR) document is
suggested in cases of multiple overlaps and interfaces. In the case of a scope of work having
several tasks that are required, the expectation and deliverable for each task must be defined.

When preparing a scope of work, it is preferable to describe and detail the required deliverables
or work product rather than the means and methods of how the work should be performed. It
should enable assessment of work performance against measurable performance standards or
expectations. It should rely on the use of these measurable performance standards and financial
incentives in a competitive environment, encouraging competitors to develop and institute
innovative and cost-effective means and methods of performing work. The requirements need to
be defined as precisely as needed so that they are not combined into too few groups or into a
single category that is too broad for the plant or contractor to understand and manage effectively.

Schedule

The required schedule should be clearly shown in the contract.

Schedules for work other than outages may need to be defined as regular work hours or when
work can be accomplished. At times, work may be required off-shift or off-site. It must be clear
what the schedule requirements are for the plant’s operation so that the contractor can plan the
resources required to meet that schedule.

If the contract is for an outage, the duration of the outage and the duration of specific tasks
should be stated. In the case of an outage, there may be several other projects or tasks that are
tied to what a contractor may be doing. These should be shown on the schedule as prerequisites,
and the ties to other tasks should be clearly shown. The consequences of not completing certain
key tasks on schedule should be defined as well as any bonuses earned for early completion.
These will be discussed more fully in Section 7.

On large outages, a critical path method (CPM) schedule should be prepared. A Level 1 schedule
should be issued to the contractor for review. The owner and the contractor should work together
on the outage team to further develop the Level 2 schedule. The contractor and the owner should
then further refine the schedule to show work at the work-package level (Level 3) [1]. The use of
work breakdown structures (WBS), resource leveling, cost reporting, and earned value analysis
reporting is encouraged on large outages but may not be practical on smaller outages. These
schedules, acting as tools available to the outage and project teams, are a part of the overall
outage planning process that the owner and the contractor should use to make the outage
successful.

3-2
 Contract Objectives

Cost

The contractors’ cost breakdown generally determines the cost of each specific task of the work
and a way of providing for progress payments. This must be reviewed carefully to avoid
unnecessary “front end loading” of costs. On the other hand, some up-front “loaded” payments
for certain activities, such as production of shop drawings, is a good way to provide an incentive
to the contractor to produce engineering and other documents early when they are needed to
complete other technical work (for example, if instead of an incentive 10% payment for shop
drawings submitted on time, the contractor is offered an incentive of 20% payment to encourage
the submission of drawings on or ahead of schedule).

In addition to typical retainage (sometimes called retention), it is advisable to maintain additional

holdback monies when the contractor is incurring penalties for missing performance incentives.
Thus, it would be good to place language in the contract referring to bonus/penalty holdbacks.

Quality of Work

Quality of work is a function for specifying the technical requirements of the finished product. It
should include inspecting the work in progress to determine if it meets the specified level as
called for in the specifications, industry codes, industry standards, manufacturer’s
recommendations, and any federal, state, or local governing permit requirements.

The specification terms should be precise wherever possible. Vague terms such as “good quality”
or “normal industry practice” should be avoided. Such terms will only encourage disagreement
and discord. The following minimum guidelines are recommended:
• Tolerances should be specified where significant and open to interpretation. This is
particularly important when there is an interface between contractors and when an out-of-
tolerance situation by one contractor could require extra work by a successive contractor for
which the contractor will want to be paid.
• Specification of materials is very important. For example, too often dissimilar materials are
installed that invite galvanic corrosion. Sometimes, a general term like “mild steel” is used
where specific ASTM-designated steel should be specified.
• Identify specific manufacturers and catalog numbers for certain parts. This helps in
standardizing warehousing, minimizing investment in spare parts, and promoting
interchangeability.
• Identify cases where certain critical components from one manufacturer work better and have
fewer failures than other products on the market. This is especially important in the global
marketplace business environment.
• Inspection requirements should be specified, such as visual inspection by competent
inspectors or a nondestructive test done by appropriate personnel or a laboratory. Anything
that can become a hidden defect after the work is performed needs to be inspected carefully
beforehand. Concrete operations and heavy wall welding are two prime examples. Inspection
“hold points” should be identified in the specifications for such critical operations.

3-3
Contract Objectives

• Quality Control audits also help to ensure quality. A high level of quality during installation
always comes about because a properly planned Quality Control/Quality Assurance program
has been put in place. Audits help to determine if the contractor is meeting the quality
objectives across the board as contracted.
• Quality Control should also extend to off-site vendor facilities where assembly, testing, and
documentation records can be examined. Operational tests of key components should be
witnessed by the owner or their representative.

Safety

The health and safety of everyone working in the plant is of paramount importance to the success
of the work. The contract needs to spell out the owner’s health and safety program and how the
contractor will be involved. This is a vast topic that goes beyond the scope of this report to detail.
However, there are three areas that are part of a Health and Safety program that should be
addressed by the contract:
• Job rules – Job rules cover such topics as start and quit times, gates, parking areas, breaks,
unacceptable activities or demeanor, response to fire drills, and medical facilities. These
topics are covered in the planning process and in the contractor orientation that each
contractor should attend prior to starting any work on site. The observations and contractor
reviews will document contractor compliance with these requirements. Job rules should be
prominently displayed on bulletin boards throughout the plant.
• Jobsite Safety – Jobsite safety covers personnel protective equipment (PPE) (including hard
hats, eyewear, hearing protection, boots, and outerwear), safety practices, barricades, roping
off, tying off, tag lines, trenching, and other safety practices as required by federal OSHA
regulations, state safety regulations, and company policies. These topics are also covered in
the contractor orientation prior to starting work on site.
• Fitness for Duty – The fitness for duty program identifies and removes from site any person
who is in such a state that they could be a danger to themselves or to others. A fitness for
duty program generally prohibits the use of controlled substances. It also prohibits the use of
alcohol on the job and generally requires personnel who have been drinking heavily the night
before or who have an illness or some other impairment that would interfere with doing the
work to not report to the job site or be subject to disciplinary action if they do. It may also
include requirements for personnel who are required to work in hazardous areas or in areas
that require more than normal PPE, such as special clothing and protective suits and/or self-
contained breathing equipment.

3-4
4
TYPES OF CONTRACTS

General

There are several types of performance-based contracts that can be used for services. These can
be for a one-time task performed on-site or off-site, or for long-term work lasting several years.
The scope of work that is defined determines what type of contract is best. The following types
of contracts are the most commonly used and are described in general terms. Specifics for each
contract will vary with the requirements of each plant.

Fixed Price

A fixed price (that is, lump sum) contract is one in which a contractor agrees to perform a
specific scope of work within a timeline and under the terms and conditions of the contract for a
specified sum of money. Performance-based incentives (such as bonuses or penalties) will most
likely relate to completion times of the outage or specific sub-tasks, plant output, and plant
efficiencies. Other incentives could be offered for quality measures and safety achievements,
such as no lost-time accidents and deaths.

The key to knowing when to use this type of contract is when the scope can be clearly and tightly
defined. This type of contract will generally work to the detriment of the owner if the scope is
not well defined or inspection is not practicable. An example of the latter is with painting. It is
almost impossible to fully verify paint surface preparation or coat thickness of paint with a
reasonable level of inspection.

A hybrid type of fixed price contract can be used when most but not all of the scope can be fully
defined. As much as possible of the scope is defined, with unit prices for additions and deletions.

One problem with fixed price contracts is how to fairly cost out extra work items. Contractors
have been known to bid fixed price work competitively with no profit, knowing that there will be
changes on which they can earn higher margins. The contractor tries to anticipate where the
scope of work is soft and where there most likely will be changes and then factors this into their
final pricing.

4-1
Types of Contracts

Time and Material

Time and material (T&M) contracts (that is, cost plus or T&M) are best used when the scope is
not defined in precise terms but time is an important factor in contracting for the work. This type
of contract provides the contractor with reimbursement for labor, materials, construction
equipment, and other items at their cost, plus a percentage for corporate overhead and profit.
This diminishes the risk to the contractor but puts the responsibility with the owner’s
management team to make sure monies are spent wisely and not wasted waiting for instructions.

As with fixed-price contracts, incentives can be built into the T&M contract, but penalties may
be much harder to enforce because the owner is the driver of the project.

Straight Unit Price

While commonly used in Europe, these are only scarcely used in the United States except on
large civil projects such as road construction. As implied by the name, unit price contracts pay
the contractor for the installation of measured units of work at a price established in the contract.
This type of contract is not generally used in power plant work due to the diversity of units but is
mentioned here in the event that a special project might call for its use. For example, a straight
unit price contract would be used if an ash pond needed to be built and the engineering was not
completed but the schedule was critical.

Incentive

A hybrid contract between the fixed price and the time and material contract types is the so-
called incentive type contract. These contracts come in several different forms, including
guaranteed maximum price (GMP) with sharing of underruns, target price with sharing of
underruns and overruns, and target man-hour contracts with sharing of both underruns and
overruns. The common features of these types of contracts are that the contractor’s costs are an
open book (subject to review and even audit by the owner). The GMP and targets are adjustable
with scope additions and deletions; the contractor’s profit can be a fixed sum or a percentage of
costs with a final adjustment near the end of the project based on cost/schedule performance.

The sharing feature can also have limits. For example, the first 10% of the underrun/overrun may
be shared equally between the owner and contractor, the next 5% may be shared 25% by the
contractor and 75% by the owner, and any underruns/overruns over 15% might inure to the
owner. Such a formula limits the contractor’s profitability but, perhaps more importantly, limits
the contractor’s risk.

In establishing the GMP or target price, it is important that the owner has qualified estimators
because there will generally be several meetings to negotiate costs. It is also important to
establish at the beginning of the contract discussions the figures for escalation and contingency
that will be used.

4-2
 Types of Contracts

This type of contract makes sense when the owner has not finished defining the entire scope of
work—meaning full, completed, detailed outage design drawings and specifications—but when
sufficient scope has been defined or will be defined to allow an estimate of costs to be
established with some degree of certainty.

Finally, a non-adversarial, collaborative team environment is essential to completing this type of

contract successfully. When carried out professionally on both sides, this type of contract can
result in a very favorable outcome for both owner and contractor.

Contracts can also be defined in terms of frequency of usage of the contractor, as described in the
following paragraphs.

Single-Time

One of the biggest incentives for a contractor is repeat business. When a very specific scope of
work is required that most likely will never be repeated and requires a very specialized
contractor, the contract can be thought of as a single-time contract. Other than the general
reputation and owner’s possible recommendation or non-recommendation, there is little
incentive for the contractor to perform in an outstanding fashion under this type of contract.

Short-Term

Some owners like to spread work among several contractors so that a competitive environment
exists. This can be a good reason not to enter into long-term contracts. Short-term contracts that
end with re-bidding of work may be a way to ensure good competition and best pricing.
Contractors tend to bid with lower profit margins when they need work and there is competition.

Long-Term

Long-term contracts may be to the owner’s and contractor’s benefit. Certain maintenance work
may be required every year or every few years, and if a contractor has proven to be reputable,
provides excellent work and fair pricing, has an understanding of various plant constraints and
conditions, and is easy to work with, a long-term contract may be an appropriate contracting
method. Work can be authorized with separate work authorizations as needed and can be a fixed
price or time and material contract, depending on the need. There are some large projects that
keep a work force of contractor personnel working on site on a continuous basis. Again, a
trusting, collaborative environment is the necessary ingredient to making long-term contracts
successful. Performance-based incentives can also be built into long-term contracts as with other
contracts.

Partnership/Alliance [2]

Another way around the adversarial contracting mode is for companies to form alliances, which
is nothing more than two or more companies agreeing to work together in an “open book”
fashion, offering each other favorable treatment. This type of arrangement affords the

4-3
Types of Contracts

opportunity for several organizations to blend together the best of their skills and resources into a
synergistic entity that implements “best practices.” Alliances can be exclusive or non-exclusive.
Owners may ally themselves with individual or multiple service providers to perform
maintenance services as needed. Alliances are generalized agreements to work together, whereas
partnerships are specific and defined for an identifiable group of tasks or scope of work.

Because the service providers’ marketing and bidding costs have essentially been eliminated, the
service provider should be able to offer services at a very favorable rate. However, significant
time and costs are expended up front in cementing the working relationship between the parties;
this may offset the contractors’ marketing/bidding costs. In addition, team building efforts along
with actual experience working together help to ensure good communications and generally
smooth running operations. Clearly, the effort that goes into establishing a good partnership
makes sense only if the relationship is long term, such as a period of several years.

Partnerships represent a formal arrangement whereby costs and profits are shared by an entity
created for the purpose of carrying out work. In a partnership, each entity becomes responsible
for the work of the whole group to the extent of their percentage share of the partnership.

This should be distinguished from joint ventures, whereby two or more companies join together
to carry out work, but each entity remains responsible for its own costs and profitability. The
joint venture works best where there are not many dependencies between the entities making up
the joint venture; otherwise, one entity may be profitable at the expense of a second entity. There
are few opportunities for joint ventures in maintenance, and, therefore, they will not be discussed
any further.

In summary, there are many ways an owner can contract for work, and performance-based
contracts can be used with any of the forms. The particular circumstances of the owner’s
management capabilities, time constraints, availability of service providers, past experiences,
scope definition, budgets, and other factors will enter into the decision as to which contract types
are best suited for the individual situation.

4-4
5
TYPES OF SERVICES

General
Today, the trend is for fossil power generators to maintain a small plant organization and utilize
the contracted services of professional maintenance providers. While there will always be a need
to have permanent maintenance staff at the plant, the staff level is generally maintained to
respond to emerging problems and perform preventive maintenance between outages. The
maintenance staff is also heavily involved in maintaining an inventory of spare parts and
performing continuous improvement studies of equipment and systems. The central or core
maintenance group is becoming more and more a managerial operation with much plant
maintenance, repair, replacement, and overhaul being performed by contractors.

Routine Maintenance
Routine maintenance describes those day-to-day maintenance activities that are performed by the
core maintenance staff. These may include oil and grease additions, filter changes, and predictive
maintenance activities such as a vibration test program, oil sampling and screening, or regular
thermography scans. As plant equipment ages, routine maintenance activities tend to increase,
and opportunities will arise to supplement core staff with outside sources. Routine maintenance
presents an ideal situation for a partnering arrangement whereby staff may be seconded to the
core staff as needed for a period of time.

Seasonal Maintenance
Seasonal maintenance includes recurring maintenance activities related to seasonal changes in
the way the plant facilities are operated. For example, heating systems that may have been shut
down during late spring and through the summer need to be cleaned, inspected, and put back into
service in the fall. Seasonal maintenance offers an opportunity to use outside resources to
perform maintenance activities not normally performed during the rest of the year.

Projects
Projects can involve the addition or replacement of a facility on the plant site or the maintenance
and repair of equipment, such as retubing a section of a boiler during an outage. They may also
include services on distribution lines and substations required for inspections and maintenance or
the repairs needed after storm damage. Anything other than a small project generally entails the
use of outside engineering and contractor services. Projects represent an excellent opportunity to
implement performance-based contracting.

5-1
Types of Services

Planned Outages

Planned outages are often an annual or semiannual occurrence at most plants and are scheduled
during off-peak seasons of the year. Because several units may be scheduled to have an outage in
sequence, it is important that plants meet their outage completion dates so as not to delay
subsequent outages at other plants. In addition, because planned outages by definition are
planned in advance, they represent a good opportunity to implement performance-based
contracting. These outages require contractors to be a part of the outage planning team over an
18-month (or more) planning process. The outage may include stand-alone projects or additional
labor for outage support. The milestones that are required to be met can be measured by the
contractors’ input where required.

Forced or Unscheduled Outages

Forced or unscheduled outages occur when a key piece of equipment, a system, or a component
fails to perform, resulting in a complete shutdown of operations or partial load reduction. In
general, the plant operations and maintenance staff are challenged to fix the problem and get the
unit back on line to support the needs of the electrical grid. Resources must be applied
expeditiously and effectively to resolve the problem, determine the root cause of the failure, and
take steps to correct the situation. In such cases, it is good for the plant to call upon known
outside sources of assistance, if needed, which may be effected through partnering agreements or
use of a time and material contract.

Housekeeping

Housekeeping involves the cleaning of occupied spaces and trash removal on a regular basis. It
may also include landscaping requirements. Cleaning services and landscaping services can be
contracted on a short-term or long-term contract. Trash removal also can be contracted in a
similar fashion. This is a good opportunity for performance-based contracting. Specific
schedules should be developed showing how often these types of services should be performed
and inspections and check lists developed to document job completion.

Environmental Services

Most power plants either have an environmental engineer on site or use a central office
environmental engineer to monitor waste generation and disposal, air emissions, and water
discharges to ensure compliance with environmental permits. While the management of the
environmental program should be part of the full-time core staff of the operating company’s
organization, environmental services can be contracted for performing studies, issuing reports,
and advising on environmental law. There are some opportunities to use performance-based
contracting in obtaining these services. There are also opportunities to contract disposal services
that require special handling such as PCBs, asbestos, waste oil, ash disposal, and other hazardous
or plentiful waste material. These can be performance-based contracts that are monitored for
compliance with local, state, and federal regulations.

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 Types of Services

Engineering Services

Most power plants will have a small engineering staff as part of their core staff to perform day-
to-day engineering activities in support of operations and maintenance. As plants age, more and
more engineering is required to replace outdated systems and equipment. Most plants will have
an annual budget for capital expenditures to replace or add to the existing plant. Contracting for
outside engineering services will generally be required either on a case-by-case basis or on a
continuing basis. This represents an opportunity for partnering and using performance-based
contracting methods for quality improvement purposes.

5-3
6
MEASUREMENTS

General

Performance measures that determine the success of the contractor will be part of the
performance-based contract. The plant should consider the objectives of the contract as the basis
for defining and setting the performance measures. While the plant is looking for low costs and
the contractor is trying to achieve a reasonable profit, there should ideally be mutual acceptance
of a win-win formula. Having a good cost system tied to work orders through a WBS is helpful
in tracking and benchmarking costs for repetitive maintenance work.

Measurements can be qualitative or quantitative. Quantitative measures are preferred where

possible to obtain. In setting performance measures, the following points should be considered:
• Measurement points should be simple, understandable, and unambiguous.

Example: Measure – New pump installation

Not Good: New feed pump installed

Better: New chemical feed pump P-CF-03 installed, including piping connections,
electrical, grouting, coupling alignment; tested and accepted for operation.

• Measurement points should be easy to obtain.

Example: Measure – Work orders completed

Not Good: Scheduled work orders completed on time

Better: Minimum 15 work orders completed and closed per week.

• Measurement points should be auditable and obtainable from existing information systems.

Example: Measure – Turbine overhaul labor

Not Good: Labor hours not to exceed 12,000

Better: WBS accounts 334.24.500 through 334.24.530 sum not to exceed 12,000 hours.

6-1
Measurements

• Measurement points should be relatively few in number.

Ask what are the 5 to 15 most important items that need to be measured. Keep in mind that
the contractor will concentrate efforts on the items that will pay a bonus or not result in a
penalty.

• The measures should not be set at such a high level of achievement that they cannot be
reached. They should be simple (as noted previously) and have sufficient financial weight to
produce the desired motivation.

Stating the performance measures in terms of the contractor’s scope of work will have the most
direct effect. To keep the measurements to a smaller number and simple to understand, the
measures should fall under these four general headings:
• Schedule
• Cost
• Quality
• Safety

Schedule

All work activities should be prioritized by a simple system, for example:

• A – Must be completed
• B – Important and needs to be completed
• C – Would like but not necessary

Most of the schedule measures should come from Priority A work. Schedule measures should
relate to completion dates rather than start dates, with the exception of plant re-start.

For planned outages and forced outages within projects, the schedule should also address the
critical path and the consequences of not meeting it. The issues for a critical path may have
greater impact on the operation and several other tasks that are planned and scheduled. It is
critical that the contractor be aware of the requirements, rewards, and penalties for meeting the
schedule.

Completion should also be understood to reflect what is legally referred to as substantial

completion. For example, if a piece of equipment is installed, tested, and operationally ready, it is
substantially complete. The fact that it may need a final coat of paint, a tag is missing, or some
other minor punch list item remains open should not be a factor in determining completeness.

Because time is generally an important factor in outage work, schedule items should represent a
third to half of the measures.

6-2
 Measurements

Cost

What cost factors will be factored will depend largely on the contract type. While the owner is
generally not privy to contractor cost figures for fixed-price contracts, they may have total
visibility of costs under time and material and incentive type contracts. Another factor to
consider is whether shift work or scheduled overtime is to be used during the work. Labor costs
escalate quickly with shift work and overtime.

The owner might consider providing a bonus for completion under budget for a few large-ticket
items or for the contractor’s total hours as compared to the budget. This would pertain to
partnered type contracts of either a time and material nature or an incentive-based open book
contract, such as a target price arrangement.

Quality

Quality is one of the most important things to measure. Because of strict licensing requirements
designed to protect the safety of the public, nuclear power plants are much more stringent about
meeting quality measures than fossil plants. However, fossil plants need to control quality of
certain key functions, including high pressure pipe welding, nondestructive testing, concrete
materials, concrete testing, structural steel bolt tensioning, fire protection systems, and wire and
cable integrity. Each plant must define its own quality concerns based on any code requirements
and its experience with construction, maintenance, and other contractors and develop measures
that reflect the satisfaction of those concerns during maintenance operations.

Safety

Safety can be measured in several ways:

• Number of lost-time accidents (zero is always the goal)
• Number of accidental deaths (zero is the only acceptable goal)
• Fires caused by unsafe work practices
• Housekeeping violations
• Number of safe work practice violations

Monitoring

The size of the contract influences how plants monitor contractor performance. For large
contracts, for which the contractor is responsible for providing supervision and management,
periodic reports, management meetings, and plant quality assurance/quality control oversight are
typically used. For smaller contracts, a variety of monitoring methods can be used. These may
include some or all of the following:
• Technical supervision is provided.
• A daily report is given.

6-3
Measurements

• A log book is kept.

• A supervisor is in charge of the contractor.
• For each task completed, an evaluation is prepared by the supervisor.
• Plant employees lead the work.
• The contractor prepares a detailed schedule, and the plant staff will periodically check the
progress.
• A plant supervisor posts contract critiques with formal feedback and holds quality
improvement meetings.
• The contractor’s work leader is responsible for informing the plant coordinator about the
status of work and notifies the coordinator to perform a final check at the completion of the
task.
• A plant supervisor reviews the completed work orders.
• Costs are collected for work completed and posted to the cost reports.

6-4
7
INCENTIVES

General

Performance incentives, both positive and negative, should be incorporated into the contract to
encourage contractors to increase efficiency and ensure that the requirements are met as
described in the scope of work and technical documents. It should be expected that contractors
will emphasize those items that have been assigned incentives. There should be a number of
specific incentives but also a few global incentives.

Incentives should be placed on those important items largely under the control of the contractor.
These may include attending planning meetings and scheduled update meetings, complying with
a schedule, completing milestones that have been established and agreed to, and examining
results of testing after completion of work or to confirm improvements that were needed based
on the work required.

Safety compliance is an important area that can have specific requirements. These may include
required safety meetings, use of PPE, reduction in first aid issues, and reduction or goals of
reduced reportable and non-reportable accidents.

Pluses and Minuses

As noted earlier, care should be taken not to use too many incentives. If there are too many
incentives, it may be impossible for the contractor to estimate the pluses and minuses available
and determine the effect on profit/fee. In addition, it becomes more of an accounting task to track
a lot of incentives. The incentives are usually paid at the conclusion of the contract work when a
full accounting of the pluses and minuses can be sorted out.

Difficulties

The question arises as to how to establish incentives and set target values for rewards and
penalties that are fair and reasonable. This is the difficult part. Every plant is different, and every
power market is different. Plants that are shut down or otherwise unavailable to produce power
in a market in which all megawatts generated could be sold represent a different situation from
plants in a market that is soft and in which operating plants experience low load factors.
Incentives should address these factors, and there may be different sets of incentives based on
plant operating conditions. As plant operating requirements change, then the incentives that the
contractor is measured by also change.

7-1
Incentives

Types

In general, incentives fall into three broad categories:

• Cost incentives
• Technical performance incentives
• Schedule incentives

Cost Incentives – Most incentive contracts (GMP, target price, and target man-hour) include
incentives for controlling cost. Fixed price contracts are suitable for using a cost incentive but
must be more specific in the requirements, while time and material contracts may be suitable
under other circumstances. If a fixed price contract is performed well and with a positive impact
on the schedule, this may free up resources for other work or provide an opportunity to get the
unit back on line sooner than scheduled. The contract could include a bonus clause for this
situation.

Technical Performance Incentives – Technical performance incentives are set in connection with
specific equipment characteristics or other specific elements of contract performance. In power
plants, electrical output, heat rate, and environmental compliance are frequently used as technical
performance incentives. However, there may be other performance incentives based on
equipment efficiencies, reduction in auxiliary power, and reliability that can also be used.

Schedule Incentives – Schedule incentives are significant when improvement of an allotted

outage schedule is a significant plant objective. Schedule incentives should specify the
application of the incentive structure in the event of delays beyond the control and without the
fault or negligence of the contractor or subcontractor.

If multiple incentives are used, they should be structured in a manner that recognizes trade-off
decisions among the incentive areas. For example, to avoid a schedule penalty, a contractor may
elect to hire more people, work longer hours, and perform shift work. The avoidance of a
schedule penalty will increase the contractor’s costs and, therefore, they may lose out on a cost
incentive.

Establishing Incentive Amounts

Arbitrary incentive and/or penalty amounts must not be utilized. There needs to be some realistic
and justifiable basis for any reward or penalty. This brings into play a fundamental rule in
economic decision making regarding trade-offs—risks and rewards should be in balance. The
smaller the risk, the lower the reward, and conversely, the higher the risk, the higher the reward.

To be attractive for both owner and contractor, incentives need to be set so that they make
financial sense. The owner needs to ask questions such as the following:
• What is it worth to me to have this plant on line a day early, and what will it cost me if the
plant is back on line a day late?
• What is it worth if we improve the heat rate by so many Btu/kWh?

7-2
 Incentives

• What is the value to the plant of reducing air emissions?

• If the maximum output of the plant could be increased, how much would that be worth?
• If certain pieces of equipment were more reliable, how would that impact plant economics?
• What is an improvement in availability worth?

For example, consider a plant that has partnered with a contractor and has planned an outage to
overhaul a major piece of equipment. They have been studying the technical issues with the
original manufacturer and have devised a detailed work scope. They estimate that the work will
take 30 work days and have targeted $2,000,000 as the contractor’s cost. The contractor has
agreed to an 8% profit, which could be incentive-based. The owner estimates that each day the
plant is back on line is worth $100,000 to the bottom line.

The contractor would be very happy to double their profit from $160,000 to $320,000 and
prefers not to risk more than the original fee on this project. The contractor further believes that
the best case scenario is to possibly improve the schedule by five days and, in the worst case,
would experience a delay of six days. The contractor also believes that the target price includes
about $100,000 in contingency, 50% of which will have to be used up by completing the work
ahead of schedule. If the contractor is late, the entire contingency will have been used up.

Given this information, what would be a fair cost and schedule performance incentive for the
owner and contractor to agree on? We need to examine the economics on the basis of three
scenarios: target case, best case, and worst case—from both the contractor’s and owner’s
position. They further agree on a 50/50 split on any cost savings below the target price, not to
exceed the contingency amount.

A work-up of this is provided in Table 7-1.

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Incentives

Table 7-1
Incentive Work-Up Example

Target Case Owner Contractor

Final price achieved -$1,900,000.00 $1,900,000.00

Contingency not used 100,000.00 -100,000.00

Contractor profit -160,000.00 160,000.00

Cost incentive -50,000.00 50,000.00

Schedule incentive 0.00 0.00

Power sales profit 0.00 0.00

Total -$2,010,000.00 $2,010,000.00

Best Case (five days schedule improvement)

Final price achieved -$1,950,000.00 $1,950,000.00

Contingency not used 50,000.00 -50,000.00

Contractor profit -160,000.00 160,000.00

Cost incentive -25,000.00 25,000.00

Schedule incentive -160,000.00 160,000.00

Power sales profit 500,000.00 0.00

Total -$1,745,000.00 $2,245,000.00

Worst Case (six days late)

Final price achieved -$2,000,000.00 $2,000,000.00

Contractor profit -160,000.00 160,000.00

Cost incentive 0.00 0.00

Schedule incentive 160,000.00 -160,000.00

Power sales profit -600,000.00 0.00

Total -$2,600,000.00 $2,000,000.00

When the numbers are examined, it is clear that a greater burden of risk is with the owner.
However, the owner also has a greater share of the rewards if the best case is achieved. While the
contractor’s position has improved by $135,000, the owner’s position has improved by $365,000.
If the worst case scenario is achieved, then the contractor has basically broken even on labor
(some economists would argue that the contractor lost $160,000), and the owner is some
$490,000 worse off, mainly due to loss in power sales profit.

What is worth noting about the above example is that, assuming that no incentives were offered
to the contractor and the outage was six days late, the cost to the owner would be higher than
with the incentives. By introducing the incentives to the contract, there became a much better

7-4
 Incentives

possibility that the contractor would give a greater effort to achieve a significant increase in
profits with even larger rewards going to the owner. Therefore, one must conclude that this was a
good deal for both parties.

Could the contractor have taken a bigger share of the risk/reward? Possibly. Most plant owners
have greater financial resources than a contractor and, therefore, have less at risk in terms of total
net worth. Most contractors will want to set some reasonable limit on losses.

There are many issues that the owner and contractor need to address for a performance-based
contract. If they are agreed to and documented, a performance-based contract will be a win-win
contract. As each side completes a contract, the next one will be better for both, and the plant
will have the benefits of continued improvements in all areas.

7-5
8
CONTRACT OVERSIGHT

General

Responsibility for making sure that the contract is followed and completed as required has to be
taken in house. Oversight of the contractor’s work and the documentation should be on site so
that the contractor and the owner can communicate the progress and items needing to be changed
as the requirements change. Oversight can be assigned to different individuals depending on their
role in the owner’s company and their responsibilities in the area or department that the contract
covers.

Project Manager On-Site

Single-use contracts usually have a project manager assigned for the duration of the contract.
The project manager oversees the project from planning to completion. Daily reports, meetings,
and documentation are used to follow the progress of the project. The contract for the project is a
part of this oversight.

Long-term contracts may be assigned to a supervisor at the plant. A good example of this would
be a housekeeping contract. The contractor could be assigned to the facilities supervisor and
report to this person on a daily basis for assignments and time keeping. This supervisor would
have the oversight responsibility to make sure that the contractor cleaned the areas that are on the
schedule for that day and, with inspections and meetings, confirm that the work was completed
as the contract requires.

Corporate Project Management

Some companies may have contracts in place that are not plant-specific. These contracts are used
company-wide at several facilities, and the individual plants may not have the resources to assign
a person to oversee the contractor when contract work is being performed on site. In this case, a
corporate project manager would have the oversight responsibility on a company-wide basis. It
would be that individual’s responsibility to make sure that the contract requirements were met at
each facility as the work was completed and document the progress for each site. These contracts
are paid out of corporate funds and are not under the direct control of the plants.

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Contract Oversight

Third-Party Contracted Management

As companies continue to do more with less, outsourcing of work is becoming more frequent in
power plants. Contract management is an area in which outsourcing is being used. There are
many placement services that specialize in specific skills for contract work that can recommend
individuals for short-term or long-term contracts to oversee a specific performance-based
contract. This individual would report directly to plant management or to corporate management,
depending on the areas or facilities covered by the contract. The contracted project manager
would have the same responsibility and authority as an in-house employee would, but the
contractor’s employment status would be based on the length and completion of a specific
contract. Note that hiring a project manager also presents the opportunity for a performance-
based contract to be put into place.

8-2
9
REFERENCES

In-Text References
1. Outage Effectiveness Measurement Methodology. EPRI, Palo Alto, CA: 2004. 1004830.
2. Partnering with Contractors and Vendors to Perform Maintenance Activities. EPRI, Palo
Alto, CA: 2003. 1007547.

Other References

Federal Publication Seminars. “Evaluating and Managing Performance-Based Contracts.”

October 2004.

Oak Ridge Associated Universities, “The Performance-Based Management Handbook,” 2004.

Office of Federal Procurement Policy. “A Guide to Best Practices for Performance-Based

Service Contracting.” October 1998.

Maintenance Technology, “Using Incentive-Based Contract Maintenance,” 1998.

9-1
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