Public Procurement - Waste Performance Contracts

Considering ‘waste prevention’ type of contract for example, one can imagine two different cases of contract:

1. In the first, which might be where a contract is set for specific initiatives, it might be expected that the performance incentives are closely related to the scope of services being provided. In this case, the measures could be ‘input based’ (e.g number of home composting bins issued) or ‘activity based’ (e.g. number of home composting bins issued and used), or they might be related to the quantitative effect of the measures themselves.
2. In the second, the municipality could simply consider performance related measures. This type of approach is likely to require – for it to be justified – an approach akin to payment by results, with the contractor being paid from avoided disposal costs. On the other hand, because the payment is likely to be strongly tied to performance, measurement of the performance level – in such a way that performance can be attributed to the contractor’s activity – becomes crucial.

In the procurement of waste services, these services will be specified, albeit with varying degrees of precision, and this specification will set a minimum level of performance. Therefore, for the award of a contract to any of the prospective bidders, performance levels can be established as a basic minimum requirement.

Besides this, contracts can also contain methods to incentivise contractors to go beyond these basic minimum standards of performance. In other words, other than basic minimum requirements, the contract should incentivize to a better performance, through the inclusion of additional standards, setting targets higher in the waste hierarchy. For example, additional levels of performance over and beyond contractual minima can be stimulated providing bonuses when achieving a better performance (Figure 1).

The idea behind is that of the bonus-malus principle: basically to give benefits to those who have solutions higher in the waste hierarchy, encouraging better performances.

In the example below, the payment might be linked for instance to a specific proportion of the marginal costs or savings of residual waste disposal as measured against a baseline budget. Basically, for a performance meeting the minimum criteria in terms of waste disposal or costs, the contract provides a baseline budget. However, if the performance improves and goes over this basic threshold, gaining savings in the waste disposal or in the costs, the linked payment will increase accordingly.

Certainly, it is important to consider which type of incentive, whether in the form of deductions or bonuses (or a combination of both) are likely to be the most effective, and whether this might differ according to the contract scope and who are the actors involved.

For example, several studies from the UK have failed to find a clear causal relationship between the offering of ‘positive incentives’ (such as shopping vouchers) to residents and increased levels of recycling. Evidence or benchmarking with other comparable municipalities, of the likely potential for improvement in performance is therefore useful to help when introducing new incentive mechanisms.

Another source of data that can be useful to establish appropriate levels for performance incentive mechanism is life cycle assessment data, for example for the different waste types and treatment fates according to greenhouse gas emissions. That being said, it is acknowledged that LCA is a complex area requiring specialist skills to carry out, not least in establishing a suitable system boundary for the assessment.

LIFE FUTURE is a European project involving the development and validation of the GUF Tool, which is an online tool to support public bodies on the decision making related to the purchase of more sustainable urban furniture. The GUF Tool is now available online to be used in a demo version.

Users are asked to fill in a short form to get access to the demo version of the GUF Tool, so they can work with picking environmental criteria for urban furniture, depending on the selection of the product or on the materials that compose it. Usability for the version is easy by following a Quick Start Guide, prepared for learning how to use the main features of the GUF Tool related to environmental criteria. Once users are registered, they can select the criteria they wish to add to the Urban Furniture product of interest.

Environmental criteria can be selected by product – to be used when looking for criteria to include in a tender process – or by material – which help manufacturers identifying best practices for the entire manufacturing, assembly and transport process. Once the product or materials to be assessed have been defined, the GUF Tool generates a list of Specifications and Awards. Users can use this list to identify the most suitable option.

Two types of criteria are given by the GUF Tool: the Specifications and the Awards. Specifications are compulsory; to be included in a Green Public Procurement bid products must comply with these criteria. On the other hand, Awards are voluntary criteria that provide additional points to products, from an environmental point of view.

The GUF Tool enables its users to browse through both Specification and Award criteria and check the verification requirements before completing the selection of relevant criteria to include in the bid.

It is important to distinguish minimum standards/specifications (for example those that are part of the service contract itself and represent the minimum service level that is acceptable to the buyer of services, such as minimum levels of missed collections) from those aspects of performance which the incentive is intended influence.

Indeed, there is a risk that incentivisation could lead to additional payment for items of performance already included in the contract in the form of minimum specifications. That is to say, it is necessary to focus on achieving additionality through the incentive mechanism: it is fundamental that the incentive is directed to pay/prize additional performance levels on top of the minimum required criteria.

Related to this, there is an interesting question as to whether payments to contractors for collecting/handling less waste can be considered ‘fair’ and a reasonable use of taxpayers’ money as well. For the purpose, as long as the costs are borne by the most appropriate actors, or fairly distributed between them, and the overall objective is to reduce the whole system cost and increase the proportion of waste that is genuinely managed at the top of the hierarchy, it is possible to present a solid argument for this method being ‘fair’. However, municipalities should not pay excessive amounts for performance improvements which deliver limited benefit to themselves, unless there are good reasons for doing so.

This raises the question of the level at which the incentive should be set: in general, incentives should not be offered where the benefit to the municipality, or to society in general, or both, is far less than the incentive on offer.

A basic benchmark might be to ensure that performance-related payments for waste prevention did not exceed the avoided costs of residual waste collection and treatment / disposal (unless there were good reasons for this in respect of, for example, the environmental rationale for waste prevention, or the need to meet a specific target).

For instance, it makes sense, from a financial point of view, that bonuses given according to performances to avoid a sort amount of waste are not higher than the money that would have been necessary to cover the cost of the disposal of that amount. This is valid in principle, however, it can be the case that other further variables are taken into considerations, such as external benefits, linked to environment: at this point, it can make sense to pay the performance at a higher rate than the foreseen cost of waste disposal, because it anyhow adds some other environmental benefits.

As a matter of fact, incentives might relate to matters that are not purely financial. Waste recycling, for example, may generate benefits in terms of greenhouse gas reduction which are not reflected (even imperfectly through the ETS) in market prices. As such, environmentally minded municipalities could consider setting incentives related to greenhouse gas savings, and a reputable measure of the external benefits which may accrue to society.

Of course, incentives must change the behaviour of the contractor. Municipalities setting incentive levels should be careful about the risk of unintended consequences from setting incentive levels at too high (or low) a rate. For example in the case of Pay As You Through (PAYT) incentives, a waste prevention effect may be observed at the kerbside as a result but fly-tipping may increase thereby introducing additional cost (linked to litter management) to another part of the system. PAYT works best when it contains a fixed element and a variable element which together partially reflect the cost of waste management.

That does not mean they might not be lower than this: local authorities need to act in a financially prudent manner. Accordingly, there may be good reasons to have a schedule of increasing marginal bonuses, recognising that a contractor is likely to seek the lowest cost wins first, and the more expensive ones later. The maximum level might be an incentive marginally below the avoided residual waste treatment / disposal cost.

An example of this scenario is presented below: for an increasing tonnage of avoided disposal over time, the contractor receives an increasing proportion of the resulting financial saving to the municipality. Basically, the bonus for the contractor is equal to a part of the increasingly saved money by the municipality per tonnage of avoided waste disposal.

Another factor to consider in setting the level of incentive is the potential for the contractor to suffer a loss of turnover (and therefore profit) as a consequence of meeting a performance target.

For example, this might be the case where the contractor is primarily paid based on the quantity of waste collected: here the contractor receive service fees directly from the users of the service; where these fees are directly related, for example, to the quantity of residual waste collected, there is little incentive for the contractor to work to reduce the amount of this waste collected. In these cases, the incentive should be set at a level that at least marginally exceeds the value of the profit ‘lost’. In other words, if the waste is reduced, according to the set contract also the service fee would be reduced, and in order to avoid the contractor to lose profit, the incentive should provide at least the same amount / a bit more of money that are “lost” because of the reduced waste collection. As long as this lost profit is fully compensated, the contractor should accept the compensation as an incentive.

These issues highlight how important it is likely to be for all contracts for residual waste treatment / disposal to be structured in such a way that they get compensated for the reduced amount of waste they send to treatment / disposal. If there are no savings to be made from reducing the quantity of residual waste sent for treatment / disposal, then the financial incentive for waste prevention is, essentially, zero (or close to it, recognising that there may be some limited savings on the collection side).

An alternative to the target-led approach is based on continuous improvement against a baseline: for example, a payment at a set rate for every 5% annual percentage point improvement in recycling rate achieved by a recycling collection contract. All of the indicators identified in the main report would require a well-specified baseline, and regular and robust data monitoring in order to be effective. This baseline could be set by the contracting authority and included within the contract specifications quoted during the procurement process, or developed in conjunction with the contractor, for example, following an initial period of monitoring (e.g. the first contract year).

Evidently, the performance measure is ideally specified in terms of a change relative to a baseline. In other words, it measures a change relative to some standard of performance which can be ‘expected’. This is likely to allow for the use of stronger incentives for performance improvements. For example, for a civic amenity (CA) site contract, a baseline for “% waste deposited that is sent for preparation for re-use” could be established based on historic performance. A payment could then be made linked to the achievement of an increasing annual target for this measure for the life of the contract.

Alternatively it is possible to use a hybrid approach whereby the supplier is invited to “bid-back”/propose a target level of performance, even though this has to exceed a level set by the buyer. For example, a municipality procuring a contract for the collection of household residual and dry recycling from the kerbside may set a minimum rate of recycling to be achieved with bidders invited to bid-back a target level equal to, or in excess, of that minimum rate. Part of the evaluation would then be based on the costs associated with different levels of performance proposed by bidders: the target rate proposed by the successful bidder would then become contractual, and a payment and / or deduction mechanism would be designed around that target rate.

Regarding the use of benchmarking for setting performance targets, benchmarking of municipalities with similar characteristics allows to compare the effectiveness of their policies and can prove to be a strong driver towards better waste management policy. In the Netherlands for example, NVRD (Dutch Solid Waste Association: umbrella organization of public waste management operators) organizes a benchmark survey of groups of municipalities allowing to compare both the efficiency and the effectiveness of their waste management policy. ACR+ is performing on a regular basis some benchmarking activities, as own initiative reports or via the work done through its European projects.

The best approach is likely to be one whereby a (limited) mix of performance indicators is applied with payments or deductions designed to work in combination to incentivise the desired performance. The best combinations will be determined largely by the scope of the contract.

Considering an example of a waste performance contract for bulky waste management, the following is assumed:

• The contractor is responsible for the door-to-door collection of only bulky waste from households within the municipality’s area;
• The municipality is responsible for communications with residents but can delegate this to the contractor;
• The municipality decides the scheme of included bulky waste items for collection;
• The reduction per tonne in the amount of refuse sent for disposal generates a financial saving for the municipality.

The payment mechanism model outlined below is based on incentives to achieve a minimum level of performance related to the following two measures:

1. Amount of collected material prepared for re-use as a proportion of the total collected;
2. Amount of material collected and sent for recycling.

The contractor would be expected to ensure that waste is collected in such a way that opportunities for preparation for reuse are seized, and that the remaining waste is recycled as far as possible.

To establish a baseline figure, historic waste flow data are used to check the above performance indicators and sets out the level of performance required by the contractor (Performance Target) for each successive contract year. In addition, if the contractor performs better than the set target, it receives an additional payment (incentives).

In this model, the performance payment basis is that the contractor shares the same financial benefit as the municipality from avoided residual waste disposal costs (for example, coming from net cost of transport and other associated costs) and from a reduction in the tonnage of waste collected that is neither prepared for re-use or sent for recycling.

Following the end of each contract year, for each performance indicator, the actual performance is calculated against the two targets: Actual Rate (AR) from which is subtracted the target figure, Performance Target (PT). The result is multiplied by the total tonnage of bulky waste collected under the contract (T) to give a “Performance against Target Tonnage” (PATt) as follows:

PATt = ((AR-PT) X T) ÷ 100

Where, AR = Actual performance rate as a percentage for the contract year;
PT = Performance Target as a percentage for the contract year;
T= Tonnes of waste that is in scope for the Actual Rate calculation collected for the contract year.

The resulting “Performance against Target Tonnage” for each performance indicator is then added together to produce a Combined PATt (CPATt). For each contract year where the CPATt calculation produces a positive number and the contractor exceeds the Performance Target, the municipality makes a payment in addition to the annual sum paid to the contractor, the “Performance Payment” (PP), which is calculated as follows:

PP = CPATt X PUV

Where PUV = “Performance Unit Value” (for instance, 60% share of the disposal cost per tonne, for the contract year).

This process is summarised in the figure below and an example is available in the table that follows.

Figure: Bulky Waste Performance Payment Process

In the fictional example in the table below the contractor has missed the performance target for recycling in year 1 resulting in no performance payment being made for that year. The targets are exceeded in each successive contract year, generating a payment to the contractor.

Municipalities introducing this kind of performance payment mechanism should take some considerations into account.

• First of all, the contract needs to include clear definitions for “preparation for re-use” and “recycling” to avoid ambiguity in the calculation of the contractor’s performance. A good method is to relate to national/industry-recognised definitions, preferably enshrined in legislation or regulations.
• Secondly, there may be competition across levels of the hierarchy. Actually, the more successful the contractor is in material preparation for re-use, the lower the amount for recycling is: different weighting should be applied to encourage preparation for re-use performance over recycling in the performance payment calculation. It might be worth considering a composite index attributing different weights to the two indicators, for instance, by assigning GHG savings per tonne of waste to the various streams.
• Then, a weight-based performance mechanism may incentivise the collection of heavier items, at the expense of lighter ones, such as WEEE. A categorisation of the different bulky waste types within the mechanism could be required.
• There are also some cases when the performance targets and payments should be reviewed. If the municipality retains control of the price charged to the resident for collection, then there should be the possibility to review new performance targets in case the price changes. The same is valid if the municipality decides to significantly alter either the type of material included under the bulky waste scheme, or the collection methodology. This significantly alters the composition of bulky waste set out for collection, and accordingly, there will need to be for amendments to the performance payment mechanism. Furthermore, a similar provision for review should be included when considering CA Sites/container parks and rules relating to the type of bulky waste that is accepted/not accepted there.
• Additionally, when a Producer Responsibility Organisation scheme is already in place and it covers items likely to fall under the scope of both schemes (e.g. WEEE), further provisions are needed.
• The annual sum payment and Performance Unit Value should be subject to annual adjustment to take account of inflation. An appropriate mechanism for this adjustment could refer to a government-set inflation index or to an industry-recognised index.
• In the example above, performance is incentivised via a performance payment payable after the targets set by the municipality are exceeded; this could be extended to include a payment deduction which is imposed when the targets are missed.