Best Practices for Performance-Based Management Contracts for the Power Sector

Performance-based management contracts are frequently used in efforts to reform struggling electric utilities, providing mixed results. This study of several contracts identifies best practices in structuring contracts for success.

In many countries, electric utilities perform poorly, delivering poor-quality electricity with frequent outages at a high price: This is a damper on the economy and on individual livelihoods. Private-sector involvement in struggling state utilities is often impossible for political or legal reasons or because their financial situation turns away investors, leaving donors and partner financial institutions to rely on tools such as management contracts to improve utility performance. There has been a preference for performance-based management contracts which should, in theory, allow a private operator to briefly take full control of a utility, replacing its former management team with its own while assuming part of the operational risks. Through the duration of the contract, the operator is able to improve systems and procedures, introduce new equipment or workflows, and train the management team that will take over operations at the end of the contract.

Actual performance of these management contracts, however, shows that they often fail to achieve their objectives and, in some cases, end disastrously with public anger and extended legal battles over whether success fees were earned or not. This study reviews several performance-based management contracts and some other management contracts that appear to be instructive. We also interviewed practitioners and individuals from companies that held management contracts either successfully or unsuccessfully. The following findings rise to the level of lessons learned and may be informative in structuring future management contracts for success:

  1. Support offered to the operator by the partner government (and, secondly, by the donor) is an essential condition precedent to implementing a management contract. While fee structure matters, lack of government support for the operator makes every other factor moot. Where the government supported the objectives of the reforms and communicated them clearly, and unequivocally, management contracts tended to succeed; where they did not, management contracts failed to meet their objectives no matter what the fee structure.

  2. Clear exit and transition planning for the post-management contract phase, and clear communication to the public and the utility’s personnel about the parameters of the management contract, are essential. Utility labor unions are strong and can resist reforms unless it is made to clear to them that the government supports the operator, and clarifies whether, why, and which jobs are at risk.

  3. Management contracts struggle to achieve their aims when the operator is not given total authority over the utility divisions it is expected to improve. Multiple, lengthy appeals to the board of directors for final approval of budgetary or management decisions slows down and may eventually halt operational progress. All parties that contributed to this study agree that while the operator must be held accountable for its performance, subjecting much of its work to board approval is not effective and ultimately undermines the operator’s ability to effectuate real change. Management contracts are intended to replace a utility’s current management with private management for the express purpose of giving them the authority to make significant operational improvements and frequently to help break the encumbrance of powerful, vested interests. If that authority is not provided, the task at hand degrades naturally into something more accurately considered traditional technical assistance and should be planned and communicated as such.

  4. Operational and management issues are only one part of the problem, and proper financing is often required to address issues related to investment. Where financing is not provided through other mechanisms – or incorporated into the management contract itself – many issues will go unresolved.

  5. Management contracts that involve too many metrics or too burdensome reporting requirements distract the operator from the work at hand and complicate supervision and evaluation of contractor performance. Ideally, the metrics and key performance indicators should remain few in number and simple to measure, with well-established baselines. The best metrics focus on revenue and customer service, ensuring immediate and sustained improvements from the consumer’s point of view: This helps build stakeholder support for the operator and for the changes it is effectuating in the utility’s operations.

  6. Management contracts require a good baseline against which progress will be measured, and clearly defined objectives. Developing both requires thorough due diligence to be performed prior to tendering. The resulting performance improvement plan should identify a few key objectives without being too prescriptive and establish the parameters for utility operation in which the winning bidder will operate. Nonexistent or incorrect data is a risk to all involved. As the operator will report to the utility’s board of directors, properly characterizing the performance of the board is key to success, and should warrant the donor’s obliging changes to the board as a prerequisite to funding the management contract, if necessary to ensure the board is professional and performant.

  7. This study finds resounding support for the concept of performance-based management contracts among all parties interviewed. Structuring them so they succeed has less to do with the financial or legal structure of the contract itself and more to do with ensuring that the political, communication, stakeholder, and donor support framework in which the operator works is properly established before the contract is tendered and is supported during its implementation. The latter can be challenging, given likely changes in government and donor priorities.

Disclaimer

This report was produced for review by the United States Agency for International Development (USAID). It was prepared by Randall Wood of RTI International under USAID’s Energy Sector Technical Leadership task order. The author’s views expressed in this publication do not necessarily reflect the views of the United States Agency for International Development or the United States Government.

Date 
Tuesday, October 2, 2018 - 1:45pm

Last updated: February 27, 2019