Alternate Strategies for Incomplete Public Contracting - Assessing Cost Effectiveness

Abstract

Incomplete contracts are a core challenge faced by every government buyer. Developing contracts with the right incentives and safeguards so public money is wisely spent and citizens receive quality services, while keeping transaction costs proportionate is a difficult balancing act. One innovation is the use of outcomes-based contracts (OBC). Unlike traditional contracts like fee-for-service (FFS) where payment is based on inputs or outputs, OBCs respond to contract incompleteness by shifting the focus to outcomes which may be more readily verifiable and more congruent with overarching contract objectives. This means that government buyers can focus on outcomes achieved and providers have greater flexibility to adapt service delivery to achieve the public principal’s goals. Despite growing policy interest, empirical evidence on the performance consequences of alternative contracting modalities remains limited (Schepker et al., 2014), particularly with respect to comparative assessments of cost effectiveness. We contribute to this emerging evidence base by empirically comparing the cost effectiveness of a conventional FFS contract against an OBC in the context of a complex human service; housing-related support provision in Kirklees, England. Our ‘cost’ data is collated through systematic analysis of contract data and semi-structured key informant interviews. Our ‘effect’ estimates are derived through a quasi-experimental analysis comparing individuals’ housing and employment outcomes under both contract types, drawing on linked provider management information and UK government administrative data. We find that the OBC delivers lower per-person costs than the FFS contract (£3,236 vs £4,856 cost in real 2024 GBP). We also find greater effectiveness in the OBC, with a significant increase in participants sustaining independence from housing-related benefits (by 6.15 percentage points) and employment entry (6.20 percentage points). The OBC is therefore less costly and more effective than the FFS contract, with an incremental cost effectiveness ratio of -£12 per additional person sustaining independence from housing-related benefits; and -£11 per additional person entering employment.