The Effect of Performance-based Contracting in Public-Private Partnerships - The Japanese Case

Chapter 15

The Effect of Performance-based Contracting

in Public-Private Partnerships - The Japanese Case

Masamitsu Onishi, Kyoto University

Yasuhiro Shoji, Ministry of Land, Infrastructure and Transportations, Japan

Kiyoshi Kobayashi, Kyoto University

Introduction

Public-Private Partnership (PPP) is increasingly pervasive around the world as a method of public acquisition. PPP requires the formation of a corporation called a 'Special Purpose Company (SPC)' to undertake a specific project from design to operation and maintenance. The SPC is responsible for any decisions concerning the method of work to meet the required level of performance stipulated in a contract. In contrast to conventional public procurement, whereby the government specifies the method of work, a contract for a PPP project is inevitably performance-based, with the government specifying not a particular method of work but rather measures of performance. Hereinafter, a contracting scheme with conventional procurement is called method-based contracting. With PPP projects, the contractor is allowed to select a method of work at the contractor's own discretion on the condition that the completed work satisfies the required performance level. Contractors' discretion in selecting a method of work can incentivise them to make technological innovations to gain a competitive advantage over competitors in terms of cost and quality. It is claimed that the rationale for applying PPP to public procurement is to employ the private sector's know-how to achieve higher value-for-money on the project. Performance-based contracting as a feature of PPP may change the outcome of public procurement, as it would seem to have an impact on the contractors' incentive for technological innovation and bidding strategy. However, it has been pointed out that private firms' motive for innovation is dependent on the market environments they face [1]. In various market and technological environments, it may not always be guaranteed that the performance- based contracting characteristic of PPP contributes to motivating contractors to make appropriate technological innovation. Therefore, it is meaningful to analyse the effect of performance-based contracting theoretically by developing a model that explicitly considers behavioural changes in contractors when such contracting is introduced in various market and technological environments.