CHAPTER 3
MANAGING THE CONTRACT
Contract management was not specifically included in the committee's reference. However
the success or otherwise of a contract will depend heavily on its efficient and effective
management and submissions to the committee did raise some issues which need to be
considered.
The Commonwealth publication, Before You Sign on the Dotted Line, is part of an
ever-expanding array of publications designed to assist managers to `select, prepare and
manage contracts more effectively'. It identifies contract management as the key to
realising the potential benefits of contracting out:
If managed unwisely, [competitive tendering and contracting] can result in financial
losses and decreases in productivity and/or quality. To ensure that contract outcomes are
achieved on time, an effective contract management regime needs to be established. [1]
The general theme of this publication is that agencies need to prepare very carefully
prior to entering into a contract and that preparation may be time consuming, costly and
involve significant cultural change in the agency. The report quotes the view of the New
South Wales Auditor-General that `planning can occupy 80 per cent of resources applied to
CTC'.
The nature of the contractual relationship is fundamental to the success of contracting
out. The literature on this subject stresses the desirability of a non-adversarial
relationship recognising the mutual dependence and interests of the parties:
Contract administration is often based on an adversarial approach … this can lead
to each party performing at the minimum standard acceptable to the other party…There
has been an increasing tendency in recent times to develop the relationship … so that
the two parties are cooperating to achieve common objectives and optimum performance. [2]
The Department of Veterans' Affairs outsourced part of its IT requirements in 1992.
This is generally held to have been a very successful example of contracting out by a
Commonwealth agency and one of its greatest strengths was in the relationship between the
parties. In a review of the management of the contract the Auditor-General commented on
the absence of disputes between agency and supplier and recognised that:
Having a good relationship with the supplier enabled DVA to readily arrange additional
storage, memory and the permanent and temporary increases in CPU capacity. [3]
This relationship allowed for a flexibility in the day-to-day management of the
contract that enabled the parties to accommodate changes which were not foreshadowed in
the contract with minimum cost or disruption. [4]
It should be noted that DVA and the Auditor-General agreed that the experience with
this contract enabled DVA to improve its request for tender for the second IT outsourcing
contract, reinforcing the committee's view that successful contracting will be a long term
process rather than a short term fix.
Before you sign seeks to promote the non-adversarial contract model by
supporting the development of `extra-contractual' relationships as a means of fostering a
cooperative working arrangement. Partnering, strategic alliances or teaming are among the
terms applied to these arrangements. The report stresses these are not contractual
agreements although it warns that they may have legal implications if relied upon in place
of the contract. Essentially such agreements supplement the formal legal contract by
defining the working relationship between, and the aspirations of, the parties.
Certainly as the DVA example shows, such a relationship is desirable and can benefit
both parties. However the committee retains some concerns in three areas - enforceability
of contracts, the capacity of the public service to manage contracts effectively and the
need to recognise the importance of process as well as outcomes.
Enforceability of contracts
Much of the comment on contract management tends to slide over this issue, relying
instead on somewhat idealised models of the contractual relationship. The Commonwealth
Procurement Guidelines acknowledge the need for proper risk assessment and monitoring
of contract performance particularly with complex services or major capital works
projects. They then outline the preferred contractual relationship in terms very similar
to those used by MAB/MIAC:
The approach to contract management should in general be based on:
- commitment to open communication, trust and mutual support;
- flexibility; and
- working with the supplier to identify possible improvements in the product or service.
- A partnering arrangement can establish the basis for a mutual [sic] beneficial
relationship. [5]
Similarly the then Department of Finance in its submission to the committee stressed
the need for `a flexible approach to contracting arrangements rather than rigid
requirements'. In the department's opinion the ideal relationship is one where:
both parties … recognise their mutual dependence and thus their mutual interest in
developing a cooperative relationship rather than an adversarial one. … The primary
concern in relation to many contracted out services is that the outcomes of the service
are achieved. [6]
However these preferred model relationships, while appealing, sound unlikely to reflect
the reality of many contractual relationships which are, after all, business relationships
in which the parties do not necessarily have common objectives.
Dr Seddon reminds us that:
The whole purpose of a contract is to make a legally enforceable agreement. To the
extent that it lacks enforceability, that purpose is undermined. [7]
Dr Seddon is concerned that the limited range of remedies for non-performance available
in contract law weaken the Commonwealth's position.. He argues that specific performance,
injunction and money damages are of limited use in complex contracts and that termination
is both a blunt and dangerous implement. The Amann Aviation case referred to in chapter 2
demonstrated the risks of mishandling the termination of a contract. In a highly complex
area of service provision termination may be no help. If there is no other service
provider readily available then the agency has to work with the existing contractor.
The emphasis on remedies may seem to give too much weight to `problem' contracts.
However as Dr Seddon points out:
[although] most contracts are performed and most disputes under a contract are settled
by the parties without going to litigation … the settlement process is influenced by
the ultimate legal remedy which the party not at fault has and if that remedy is
ineffectual then any settlement will be slanted in favour of the other party. [8]
The Attorney-General's Department shared the view that awareness of the `ultimate legal
remedy' was important in encouraging contractors to rely on other dispute resolution
procedures thus avoiding the disruption and cost of litigation. In its submission to the
committee the Department noted that `Commonwealth contracts include standard clauses
relating to dispute resolution procedures where disputes are between the agency and the
contractor.' [9]
Thus the real extent to which a contract can be enforced will influence the whole
contractual relationship. Dr Seddon favours the use of liquidated damages as a `stick' in
dealing with contractors or structured payments which are linked closely to performance
measures. Under such a system the contract would specify certain targets which had to be
met and, if they were not, payment would not be made or penalty payments would
automatically apply. This approach is not new. It is widely used in the building industry
and the committee sees merit in its wider application.
A recent report by the Auditor-General on the new submarine project demonstrates that
these are not hypothetical concerns. A central criticism in the report is of the
Department of Defence's `lack of contractual leverage' over the contractor. In a number of
areas problems have emerged `because payments to contractors have far exceeded the value
of progress achieved, the cost of delay has, in effect, been borne by the Commonwealth'. [10] The report also found that:
The contract provides only modest recourse by the Commonwealth by way of
financial guarantees and liquidated damages for late delivery and under performance….
The Commonwealth should be able to do better in commercially-based contracts. [11]
The report concluded that:
payments should be made only on reliable and objective evidence of real progress.
Payments limited to actual progress are a tangible way of clearly indicating
dissatisfaction with under-performance … While recourse to such action may be seen as
a potential breakdown in contractual relations … it is one of the few effective ways
by which a purchaser can achieve required outcomes. [12]
This report dealt with the acquisition of capital equipment. However the project has
many similarities to the `new contracting' for complex services. It involves a very large
number of suppliers, innovative technology and manufacturing techniques and a degree of
uncertainty in defining successful performance.
An enforceable contract is one in which the service required is properly specified, the
relationship between the parties clearly defined and mechanisms for monitoring
performance, including penalties and incentives, set in place. As contracting out moves
into ever more complex areas the nature of many of the services now being contracted out
or considered for contracting make it difficult to define actual measures of performance.
Particularly in the delivery of community and social services outcomes may be highly
variable between service recipients and therefore unsuited to strict definition in a
contract. As the Industry Commission said:
Where there are problems of specifying quality and in measuring outcomes, as occurs
with many community welfare and emergency services ... it becomes more difficult to
develop comprehensive and unambiguous performance specifications, making it hard to
monitor and correct performance problems ... As a result, the risk of failing to meet the
expectations of the client group increases. [13]
The Alcohol and other Drugs Council of Australia reflected on the same issue from its
immediate experience:
Meeting the needs of individual clients or consumers often involves more than slotting
them into a set program that requires only a set amount of resources. … The ideal
contract is based upon knowing the client group and the service providers, understanding
what needs are being addressed and what outcomes the service provider and client are
seeking to achieve. This form of negotiated outcome contract is desirable from a client
perspective and a service provider perspective. [14]
Managing these types of contract will not be easy. The committee's concern is that if
too much emphasis is given to the informal `partnering' approach agencies may not give
sufficient emphasis to ensuring that the formal contractual relationship which must
underpin it is sound. While the desire to work cooperatively to achieve common objectives
is to be encouraged it carries with it the risk that the agency will find itself in the
situation described by the Auditor-General above, lacking contractual leverage and
unwilling or unable to enforce the terms of the contract.
Before you sign … emphasises that:
There are [sic] a wide variety of circumstances which may require public managers to
migrate or cancel ongoing contracts … It is important to take action when required,
for example, by putting dispute resolution principles into practice. This may involve
terminating the contract and/or seeking another legal remedy for underperformance. [15]
To be able to do this agencies must retain some distance from the contractor and avoid
being drawn, incrementally, into the situation where they are trying to prop up a failing
contract (or contractor).
A further aspect of enforceability is the protection of the rights of the citizen who
may be the recipient of the service. Dr Seddon, the Attorney-General's Department and
MAB/MIAC have all dwelt on this issue. The person receiving a service from a provider
contracted to the Commonwealth is not a party to the contract which is between the
Commonwealth and the contractor. Thus, in the event of suffering loss as a result of the
contractor's actions, that person will not have recourse to remedies under the contract.
The Commonwealth as the other party to the contract may not have suffered any loss or at
least may have difficulty demonstrating it. Thus it will not be able to pursue remedies
either.
The committee believes that because of this it is important that the citizen have
access to the Ombudsman and other administrative law protections when services are
provided by contractors. This is dealt with more fully in chapter 4 of the report.
Can the Public Service do it?
A number of submissions to this committee have raised the issue of the capacity of the
Australian Public Service to manage contracts effectively. For many agencies the move to
contracting out represents a fundamental change in their responsibilities. Individuals
whose whole training and experience have been in developing and implementing programs will
find themselves instead managing contracts with an external service provider. This
function will call on new attitudes and a different range of skills. Dr Seddon states that
contract administration is:
usually beyond their training and experience and the result is that there is an awful
lot of very amateur contract administration taking place – a problem that is on the
increase. [16]
The recent report by the Australian National Audit Office (ANAO) on the new submarine
project [17] dealt at some length with problems that have
arisen with the management of this project. At the outset it is important to note that the
ANAO commented that `the submarines appear to have the potential to achieve the
capabilities specified in the contract' and:
The Project has some significant project management, engineering and construction
achievements which in many ways demonstrate the capacity of Australian industry to produce
to world-class standards. [18]
The ANAO nonetheless concludes that:
The predominant underlying and ongoing issue that requires addressing by Defence is the
need to improve its project management skills … Managers of major Defence capital
equipment projects should have the knowledge and skills in all core business
administration competencies to protect the Commonwealth's interests in negotiating with
major private sector contractors. Defence may in some instances need to contract-in such
skills. [19]
The ANAO argues that `a more business-like and commercial approach by the department to
project management would better protect the Commonwealth's financial and other interests'.
[20]
The Auditor-General's comments are of particular concern because the Defence Department
has a long involvement with the management of large, complex contracts. Yet many of the
criticisms seem to reflect weaknesses in the structure of the contract leading to
management inefficiencies.
The then Joint Committee of Public Accounts (JCPA) in a recent report on the Jindalee
Operational Radar Network Project [21] noted that `project
management in the Defence Organisation has attracted criticism from the ANAO and from
Parliamentary committees' and identified what it described as the `persistent themes' of
that criticism:
- poor project definition;
- inadequate specifications;
- badly drafted contracts;
- poorly enforced contracts;
- poor record keeping and acquittals;
- absence of adequate warranty and penalty provisions; and,
- poor assessment and management of risk. [22]
These criticisms echo the general concern expressed by Dr Seddon about the development
and management of contracts. The JCPA viewed the matter so seriously that it argued that
Defence should consider `contracting in' project management skills:
The Committee recognises that `buying in' project management expertise is expensive but
given the magnitude of projects … Defence cannot afford not to obtain the most
experienced project managers available. [23]
This committee does not cite these examples from defence projects to make any specific
point about the Defence Department. That has been discussed at length in the JCPA report.
It wishes to underline the general point that contracting out is not easy, that poorly
drafted contracts will exacerbate management issues, that contract management is in itself
a particular skill and that problems are not restricted to a few very large contracts. If
an agency such as Defence with a long history of contract management can experience such
problems it is unwise to assume that agencies with limited experience of management of
major contracts will reinvent themselves as effective contract managers in the near term.
Development of new institutional cultures and a different range of skills in the
Australian Public Service will be almost impossible without heavy investment in training
or, where necessary, the recruitment of appropriately experienced persons.
Before you sign … stresses the importance of developing a strategy to deal
with this issue, including training, as part of the overall implementation plan before
outsourcing takes place. It suggests that agencies will take time to accumulate the
experience necessary to manage the whole process successfully and that they must be
willing to face significant cultural change to accommodate this new role. This will
involve the retraining of their staff or indeed acquisition of new staff.
Central to this issue is the extent to which agencies will be able to retain skilled
and experienced staff to undertake this task. When an existing service is contracted out
the private sector provider may offer a new market for the skills of agency officers. In
some cases, for example the provision of some information technology requirements, there
may be a wholesale transfer of staff from the agency to the contractor to ensure
continuity of service provision. Agencies are expected to retain officers with the
knowledge and experience necessary to make the strategic decisions about the agencies'
future use of the services and to manage the actual contract. However, particularly where
the service provider is a significant private sector company in a position to offer more
attractive remuneration than the public sector, it is highly likely that the service
provider will attract the best staff from the agency.
The choice for an IT specialist between managing a contract for a public agency
compared with playing a significant role in the operations of a global IT company with all
the professional rewards and career opportunities that offers may be straightforward and
not to the advantage of the public sector.
A final area of concern which agencies should be aware of and guard against is in
developing relationships with contractors which militate against effective management of
the contract. Such a situation may arise where there is no practical alternative to the
existing supplier either because of the size and complexity of the project, the stage it
has reached or its geographical location, for example. It may be the product of an
excessive focus on a cooperative approach to contracting which creates a culture inimical
to a proper business relationship between the parties. In such circumstances the
purchaser/provider relationship which should impose some discipline can break down as the
agency is committed to keeping the service or project going but has limited effective
leverage on the contractor. Contractual requirements such as reporting on progress or time
deadlines will then take second place.
A subset of this problem is consistency in the treatment of different classes of
contractors. The Auditor-General, in a study of AusAID's management of funding to
non-government organisations (NGOs), found that in some cases AusAID's management of
contracts with commercial organisations was more rigorous than that with NGOs. [24] This appears to reflect in part a view that NGOs should be
treated more leniently than businesses but also a lack of understanding and capacity on
the part of NGOs to understand and meet their contractual obligations. ANAO noted that:
AusAID contracts with NGOs are as binding as those … with commercial contractors.
The ANAO found cases where more emphasis seemed to be placed on management of the latter. [25]
It was found that a very large proportion of NGOs failed to meet their obligations with
regard to progress reporting and that end of project reporting was frequently inadequate
and did not enable the agency to make a judgement as to whether the program objectives had
been achieved. In part the problems reflected an attitude that it would be churlish to be
too strict with not-for-profit organisations delivering humanitarian assistance. However
it is imperative that taxpayers' funds be properly expended irrespective of the nature of
particular projects or of the bodies receiving the funds. It should be noted that the
problems identified by the ANAO had also been identified by AusAID and that remedial
action was being taken.
As contracting out is increasingly applied to community welfare areas and NGOs are
involved in contracted service delivery similar problems can be expected to arise with
regard to those services. AusAID in fact offers training to NGOs to ensure they understand
and have the capacity to discharge their obligations.
Outcome versus process
The committee has commented earlier in this report on the need to recognise that
process is important. While `red tape' as an end in itself is indefensible, there are
important reasons for following proper processes. Unfortunately the current ethos in
public sector management is increasingly focussing on outcomes as the sole measure of the
success of a program. As the then Department of Finance stated:
In most cases, how the contractor undertakes the task would not be a focus of reporting
and monitoring, although in some cases the process itself may be an important part of the
outcome sought, for example, activities where legal challenge based on process is likely. [26]
To be concerned with process principally where the threat of legal action is possible
is not satisfactory. How outcomes are achieved does matter. It is certainly a matter of
concern to this committee and no doubt to the Parliament in general. The agency must
comply with all the legal and regulatory requirements placed on it in managing the
contract and dealing with the contractor. There may also be a general implied obligation
in relation to these dealings. In a report on the Hughes case, the Australian
Government Solicitor commented that:
Hughes may support the proposition that contracts with public bodies are of a
special nature which carry a term implied by law that the public body must deal fairly in
performing its obligations under the contract. [27]
The Commonwealth Procurement Guidelines discussed in chapter 2 above enumerate a
range of obligations on both the agency and contractor which require the agency to be
aware of how the contract is being performed as well as whether the specified service
outcomes are being achieved.
Representatives of the Public Sector Research Centre at the University of New South
Wales also cautioned against relying on general outcomes-based contracts, `relational
contracts' and `strategic partnerships' rather than precise contracts including penalties
for non-performance:
`outcomes based contracts' which do not have detailed service level standards and
methods of work … suffer from the same shortcomings … in that broad outcomes are
too difficult to evaluate and leave too much room for time consuming and costly legal
disputation. In many public and human services, in addition, the process or method for
delivering the service is integral to its effectiveness. [28]
Managing for outcomes may also have a significant practical impact on accountability.
Agencies may not generate the sort of information Parliament requires to satisfy itself
that public money has been properly expended. An exchange between the Director-General of
AusAID and a senator in an estimates hearing demonstrates the potential problem. The
senator was trying to establish how the committee could reassure itself that pricing
contained in contracts was reasonable. Part of the answer went to the question of
commercial-in-confidence but the official also commented that:
I do not believe that an outputs based contract, even if we put the contract on the
table, would provide the sort of information that you are looking for, and neither should
it. That is the nature of an outputs based contract … that market forces will keep
profit margins under a degree of control. [29]
The committee is concerned that relying on market forces in this will deny the
Parliament detailed information to demonstrate that contracts are being properly managed.
It also makes assumptions about the skill of Commonwealth agencies as negotiators and
managers of contracts which may not warranted. The Auditor-General's report on the new
submarine project makes a number of comments to the effect that the Defence Department had
not achieved the best deal for the Commonwealth or shown the necessary business skills in
managing the contract.
Conclusion
The committee is concerned that the whole issue of contract management is receiving
insufficient attention. Despite the volumes of advice on best practice which emphasise the
need to approach contracting out cautiously, to invest heavily in all aspects of the
process and to prepare carefully for the actual implementation, and the substantial body
of comment in reports from the Auditor-General indicating that Commonwealth agencies have
a very mixed record as project and contract managers, the prevailing ethos still seems to
promote contracting out as a management option that will yield inevitable benefits.
Resources must be made available to ensure that contract managers have the skills to carry
out the task.
The Auditor-General's performance audits provide a valuable check on the management of
contracts. The committee believes that the Audit Office should be provided with sufficient
extra resources to enable it to focus on contract management as an issue particularly in
the next few years.
Footnotes
[1] Management Advisory Board/Management Improvement Advisory
Committee (MAB/MIAC) Before you Sign on the Dotted Line, Report No. 23, May 1997,
p. 14.
[2] ibid., Department of Defence case study, quoted at p. 26.
[3] Auditor-General, Management of IT Outsourcing –
Department of Veterans' Affairs, Report No. 21 1996-96, page xi.
[4] The company that developed this good relationship with DVA
was unsuccessful in its tender for the second, expanded, range of IT services DVA put out
to contract. To the extent that the company saw its cooperative attitude as an investment
in a long term relationship with DVA it may question whether it got value for money.
[5] Commonwealth Procurement Guidelines, 1997, p. 165.
[6] Department of Finance, in Submissions, vol. 2, pp.
408-9.
[7] Dr N. Seddon, in Submissions, vol. 3, p. 557.
[8] ibid.
[9] Attorney-General's Department, in Submissions, p.
374.
[10] Auditor-General, New Submarine Project, Audit
Report No. 34, 1997-98, p. xvi.
[11] ibid., p. xviii.
[12] ibid., p. xxii.
[13] Industry Commission, Competitive Tendering
Contracting by Public Sector Agencies, Report No. 48, 1996, p. 352.
[14] Alcohol and other Drugs Council of Australia, July 1997,
in Submissions, vol. 3, pp. 681-682.
[15] MAB/MIAC, op. cit., p. 50.
[16] Seddon, op. cit., p. 560.
[17] Auditor-General, New Submarine Project, Report
No. 34, Canberra, 1998.
[18] ibid., p. xvii.
[19] ibid., p. xvi.
[20] ibid., p. xxiv.
[21] Joint Committee of Public Accounts, The Jindalee
Operational Radar Network Project, Report No. 357, March 1998.
[22] ibid., p. 100.
[23] ibid., p. 121.
[24] Auditor-General, Accounting for Aid, Audit Report
no 5, 1996-97.
[25] ibid., p. 32.
[26] Department of Finance, in Submissions, vol. 2, p.
409.
[27] Australian Government Solicitor, Legal Briefing No.
33, July 1997, p. 3.
[28] Public Sector Research Centre, University of New South
Wales, in Submissions, vol. 2, p. 277.
[29] Senate Foreign Affairs, Defence and Trade Legislation
Committee, Hansard, 11 June 1997, p. 230.
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