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An introduction to outcome based contracting

A basic guide that sets out the key concepts and terms used in outcome based contracting and looking at whether this is a suitable method for you to run your project or service

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Chapter 1

What is outcome based contracting?

2 mins read

Outcome based contracting describes an approach to public service management that seeks to improve value and impact.

When a decision is taken to use external parties to deliver services, a contract is needed to govern the payment from the government to the supplier. Many types of contract exist, and some could be considered to be more ‘outcome based’ than others.

The most open-ended form of agreement is a grant, where money is paid for a very loosely defined set of activities and/or outcomes. Unlike grants, conventional contracts, often referred to as ‘fee for service’ contracts, tend to be highly specific about the activities which are being paid for, or the specific work to be delivered - and payment will depend on a provider adhering to this specification.

Outcome based contracts, by contrast, tend not to specify detailed activities, in which respect they are like grants. They are, however, highly specific about the desired outcomes. These outcomes are what payment is based on, and because outcomes take time to deliver, payments tend to come in arrears of activity, once there is evidence the outcomes have been achieved. The UK National Audit Office gives further detail to this definition.  

Outcome based payment schemes in the UK public sector are often referred to as Payment by Results (PbR) contracts, but the term is inconsistently used. Some schemes are called PbR, but are not outcome based. For example, some NHS tariffs to pay hospitals for clinical procedures are called PbR, even though the payment is for outputs rather than outcomes. Here, we refer only to PbR that has some element of outcome based payment. This includes social impact bonds.

The payment mechanism in an outcome based contract can vary, and many schemes include a proportion of upfront or activity-based payment that is not contingent on the achievement of a specified outcome. Some form of upfront payment or ‘fee for service’ can make the scheme more attractive to potential providers and investors, especially those in the voluntary and community sector, by easing their cash flow and reducing the risk they take on in agreeing to the contract. 

The UK government has increasingly been using outcome based contracting to deliver public services that address complex social challenges, where traditional ways of paying for services might have been deemed ineffective.

Outcome based contracting in the UK

Major UK programmes that have wholly or partly used outcome based contracting include:

  • Work Programme, Department for Work & Pensions
  • Troubled Families, Department for Communities and Local Government
  • Transforming Rehabilitation, Ministry of Justice
  • Payment by Results Aid Projects, Department for International Development
  • Drug and Alcohol Recovery Pilots, Department of Health 
  • Social impact bond programmes such as the DWP Innovation Fund, the Life Chances Fund, and others
In the public sector, PbR tends to be used to address complex social issues for which there are no straightforward solutions: for example, getting people on benefits back into work, and reducing reoffending.
National Audit Office, 2015

While social impact bonds (SIBs) are effectively a sub-set of outcome based contracting, they are distinguished by the use of external social investment capital, with social investors carrying some or all of the financial risk of not achieving the outcomes, and the payments attached to them. Beyond this basic definition, different SIBs vary greatly in their structure and aims – you can learn more about them in our guide: Introduction to social impact bonds (SIBS) 

Some key terms

Definitions of some key terms, as understood by the UK Government, are included below and are based on the Magenta Book published by HM Treasury:

Term Definition Example
Inputs Public sector resources required to achieve the policy objectives. Resources used to deliver the policy.
Activities What is delivered on behalf of the public sector to the recipient. Provision of seminars, training events, consultations etc.
Outputs What the recipient does with the resources, advice/ training received, or intervention relevant to them. The number of completed training courses.
Outcomes The change experienced by the recipient as a result of the service/ intervention received. Move to sustained employment and improved financial stability.
Impacts Wider economic and social outcomes. Number, range and salaries of employment opportunities in a local area improve.

Chapter 2

Why contract for outcomes

2 mins read

Outcome based contracting seeks to improve the productivity of public spending by paying only when specific outcomes are achieved by a service providers. This can be attractive to both commissioners and providers, as it shifts responsibility to providers in determining which inputs will lead to the desired outcomes – and providers may have a better understanding of needs of the target group, and how to engage them. It also transfers financial risk to providers, as they are required to put in upfront financial investment to deliver services with no, or limited, reward if they fail to achieve outcomes.

Moreover, this type of contracting is intended to improve service quality by offering higher payments for better performance, and to encourage innovation by giving greater freedom to providers to determine how to best achieve the required outcomes.

However, as a form of contracting, outcome-based contracting places additional demands on commissioners and providers, and therefore, deciding to use it should be proportionate to the priority of the problem and the complexity of tackling it.  The rewards are that it might create an environment for radical change, provided that the suitability and feasibility of the service are fully considered.

Outcome contracts should be designed to provide better value to commissioners than any available alternative. Commissioners should consider a range of contracting models which they might use to deliver the desired outcomes, and in choosing outcome based contracting, they must be able to articulate a clear rationale for doing so.

Below are some of the conditions cited by commissioners, advisors and providers as the basis for selecting an outcome based contract.

  • Uncertainty around how effective an intervention is. Outcome based contracting may be appropriate if there is a lack of an evidence base for the intervention in a similar context – perhaps because it is innovative or still relatively untested. It might be too risky to use a fee for service approach, so using an outcomes-based approach can help mitigate the risk of the intervention not working. 
  • Significant risk around delivery. Related to, but distinct from the above, is where there is uncertainty around service providers’ ability to deliver improved outcomes. This may be due to concerns around cost or management capacity within the provider market. By paying for outcomes, the provider has a greater incentive to ensure the intervention is well-managed, and delivers on its promises.
  • A galvanising force for change in practice. Defining a single set of outcomes for providers can be an important agent for change, where commissioners are looking to work with a defined cohort, and perhaps build the evidence base for the alternative practice. This can be particularly significant where the contract has several commissioner parties.
  • Lack of effective internal capacity to deliver change. Related to the above, it may be felt that a service provider brings the expertise and management capacity to deliver the changes that will underpin the improvement of outcomes.
  • An important problem to solve. The outcome is a key priority for commissioners, justifying the investment of time to design, business case, procure and manage a new contract and form of service intervention.

Chapter 3

When is it suitable to use outcome based contracting?

2 mins read

Outcome based commissioning is not suited to all public services, and commissioners should carefully consider all their options and be able to justify their selection of an outcome based approach over alternative service provision mechanisms. 

Suitable

The National Audit Office report ‘Payment by results: analytical framework for decision-makers’ provides some useful guidance on the criteria for assessing suitability. We have paraphrased and summarised the key considerations below:

  • the outcomes of the service are clear and measurable 
  • the eligibility of the cohort is clearly and unambiguously defined 
  • there should be a clear attribution between the intervention to be delivered and the outcomes to be measured
  • the commissioner is prepared to grant the provider freedom to operate and is not overly prescriptive about the means by which outcomes are achieved
  • it is considered that outcomes will be improved through financial incentives.
  • the outcomes linked to payment can be achieved within the period of a contract i.e. 3-5 years (other outcomes may be evaluated longer term).

Not suitable 

There are also cases where using an outcome based contract may not be appropriate. These could be when:  

  • the form of contracting results in additional costs. For example, the same outcomes could be achieved through a less expensive form of contracting relationship
  • the commissioner is unable to pay a sufficient amount to incentivise the achievement of outcomes
  • it is not possible to assess the value of “deadweight” or the outcomes that would have been achieved without the new service and therefore, commissioners may not be confident about the value of the service
  • it is not possible to agree between commissioners where the liability for payment of outcomes sits.  For example, interventions to deter young people joining gangs are hard to incentivise because there is a lack of evidence about which government entities benefit
  • commissioners are not sufficiently confident that external service providers are able to deliver the service without exposing the authority and service users to unacceptable technical, professional or reputational risk
  • there is a significant risk of perverse incentives, i.e. that the service provider has a way of receiving remuneration without achieving the outcomes or, for example, of using inappropriate practices to select service users.
We recommend that commissioners consider the pros and cons of different contracting approaches in relation to the problem being tackled. 

To read more specifically about when it might be suitable to commission a social impact bond please see our section on 'is your SIB feasible?' in our Introduction to social impact bonds (SIBs)

Outcome based commissioning: top tips from a local commissioner