Contractor Compensation

RT-114 Topic Summary
RT 114

Overview

RT-114 was charged with developing a breakthrough approach to compensate contractors based upon the overall business success of a venture. It is important to note that compensation was interpreted broadly to include reward, recognition, payment, future opportunities, expanded roles, and reduced risk. “Breakthrough approach” was defined as a dramatic improvement, a step change in performance, and/or the fundamental rethinking of concepts.

The team compiled an overview of current industry practices, analyzed survey results, and held a national workshop to explore topics that include:

  • Business objectives of the project
  • Mechanisms used to communicate objectives to project personnel
  • Development of compensation plan
  • Details of compensation plan, including contract terms
  • Impact of compensation scheme on performance
  • Views on compensation method effectiveness and improvements

Traditional engineering and construction contracts perpetuate competing interests between owners and contractors. As such, typical contracting strategies, such as alliances, team autonomy, and incentive contracting, do not always foster a successful project partnership. 

The application of innovative contractor compensation strategies should not be considered an “end all” solution to project performance improvement. Such strategies instead should be considered one more important tool in a project team “tool kit” to be applied in conjunction with other CII best practices such as partnering, team building, team alignment, open communications, setting project objectives, and pre-project planning.

Key Findings and Implementation Tools

1 : 2 Most Important Factors

Two factors are most important in establishing innovative compensation plans and are often the largest barriers to success. These factors are:

  1. A trust-based relationship among project team members
  2. The willingness to develop the compensation plan jointly
(RS114-1, p. v)
Reference: (RS114-1)

2 : Compensation Plans Need To Be Individualized

No single breakthrough strategy or set of metrics was applicable to all projects. The development of contractor compensation plans that lead to owner success is highly individualized to the specific project and the project leaders that create the contract. (RS114-1, p. v)
Reference: (RS114-1)

3 : Compensation Strategies

The 32 innovative contractor compensation strategies, developed through 14 case studies and a national workshop, were grouped into the 10 categories listed below. (RS114-1, p. 3)

  1. Development of Incentive Plans 
    Joint development of the incentive plan promotes sharing of information and leads to more efficient contracting relationships. 
  2. Selection of Performance Measures 
    Performance areas selected for inclusion in an incentive plan should correlate to key results for the owner and must sufficiently span the contractor’s performance so that important aspects of performance are not neglected. 
  3. Application of Performance Measures to Incentive Calculation 
    Incentives can be attached to both objective and subjective performance measures. 
  4. Project Team Member Incentives 
    Incentives paid to individual team members often may be integral to contractor corporate incentive plans.
  5. Incentive Effect Improvement Through Increased Contractor Control 
    Incentive effectiveness is directly proportional to the control that the contractor has over those areas covered by incentives. Therefore, the owner’s choice of project execution strategies is a critical ingredient to the overall effectiveness of an incentive plan. 
  6. Maintenance of Incentive Targets in Long-Term Relationships 
    Long-term relationships, such as partnering arrangements or annual maintenance agreements, permit the use of some innovative contracting methods. 
  7. Promoting Long-Term Contractor Focus on Owner Objectives 
    Traditionally, owner objectives are longer-term than those of the contractor. Some case studies revealed instances where owners, through innovative strategies, attempted to focus contractor’s interest for the longer term. 
  8. Future Work as a Motivator 
    One long-term objective of contractors is to secure repeat work from clients. This objective can provide a useful basis for incentives. 
  9. Alternative Compensation Units 
    Variations in cost-reimbursable units were found to be effective. 
  10. Cash Flow Enhancements 
    Variable cash flow arrangements can be used as an incentive for contractor performance. 
Reference: (RS114-1)

4 : Benefits

Projects employing innovative compensation strategies have realized substantial tangible and intangible benefits including: (RS114-1, p. 11)

  • A 27% underrun relative to budget
  • Three month early completion on a 24-month project
  • 4% improvement in plant production availability
  • A 20% reduction in craft labor hours relative to budget
  • A 22% reduction in overhead charges
  • No lost-time accidents
  • Best contractor resources allocated to the project
  • Reduction in “defensive” paperwork
  • Steadily improving contractor performance over a four-year period
Reference: (RS114-1)

5 : 5 Significant Strategies

The top five innovative compensation strategies identified are: (RS114-1, p. 12)

  1. Incentives developed during project kickoff and teambuilding creates joint ownership.
  2. Benchmarking to set performance targets creates credible yet challenging targets.
  3. Incentives on joint performance of designer and contractor creates alignment with owners goals.
  4. Extensive preliminary engineering reduces risk to contractor and supports stronger incentive contracts.
  5. Future work as a motivator enables savings to be obtained in bidding strategy.
Reference: (RS114-1)

6 : Key Conclusions

Concepts that should be considered by owners and contractors in crafting a compensation strategy include: (RS114-1, p. 20)

  • Conflict between owner and contractor objectives is natural and should be addressed in development of compensation plans. 
  • Translation of owner business objectives to project objectives, and their communication to the project team, is not inherent in the capital project process.
  • Establishing a trust-based relationship among project team members and the willingness to develop the compensation plan jointly are two important factors in establishing innovative compensation plans, but are often the largest barriers to success.
  • Incentive plan contracts currently in use are based on objective performance criteria, subjective criteria, or a mix of the two.
  • Incentives can have a positive effect on contractor’s performance, but the performance gain must be balanced against the costs of shifting related risk to the contractor.
  • Targets should be adjusted if factors beyond the contractor’s control prevent achievement.
  • Aggressive plans are perhaps best suited to parties that have worked together effectively for some length of time in an alliance or partnering relationship.
  • Continuous evaluation of performance provides important feedback to the contractor.
  • Owners are not often aware of the degree to which they constrain contractor performance by the way of work processes, team structure, and decision-making processes.
  • More aggressive plans require more detailed design and better project monitoring.
Reference: (RS114-1)

7 : Implementation Tool #1

RS114-1, Compensation Plan Implementation Process

Some degree of joint development of the compensation plan is preferred because a sense of joint ownership in the plan is created.
Reference: (RS114-1)
rt-114

Key Performance Indicators

Improved cost, Improved schedule, Improved craft productivity

Research Publications

Innovative Contractor Compensation - RS114-1

Publication Date: 09/1998 Type: Research Summary Pages: 27 Status: Tool

Innovative Strategies for Contractor Compensation - RR114-11

Publication Date: 01/1998 Type: Research Report Pages: 326 Status: Reference


Presentations from CII Events

Session - Innovative Contract Incentives

Publication Date: 06/1999 Presenter: Number of Slides: 38 Event Code: AC99


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