Managing the Tools of Government:
Contracting and Contract Management in the New Millennium
Trevor Brown
School of Public Policy and Management
The Ohio State University
Matt Potoski
Department of Political Science
Iowa State University
David Van Slyke
Maxwell School
Syracuse University
Paper for Presentation at the 2005 National Public Management Research Conference,
University of Southern California, Los Angeles
Once a government decides to deliver a service to its citizens, it must then decide whether
to produce the service directly through its own employees or via a contract with a private vendor,
nonprofit organization or another government. Contracting proponents, often with roots in public
sector economics, champion contracting as a way to reduce service costs through competitive
efficiencies and scale economies. Contracting critics, often with roots in traditional public
administration fields, counter that contracting tends to sacrifice key public sector values (e.g.
equality of treatment) and reduce service delivery capacity. Strident ideological debates have
crowded out rigorous, theory-driven analyses of how public managers can effectively manage
contracted service delivery. In academic circles, enough research has identified cases of
successful contracting that few would doubt whether public services can be delivered effectively
through contracts. And yet, research has also uncovered enough cases of failed contracts to
make clear that contracting does not always bear its promised fruits. The current challenge for
academics is to provide theoretically yet practical grounded guidance to help managers capture
the benefits of contracting while avoiding its pitfalls.
In this paper, we develop a strategic framework to guide managers through the contract
process from assessing the feasibility of contracting, to structuring the contract process, to
managing service provision under contract. Our framework brings together the three major
contracting and contract management research traditions. From the research on values and
strategic management, we assess how stakeholder values shape the contracting context.
Managing service delivery requires public managers to balance competing stakeholder values
across varying circumstances: different contracting tools are better equipped for maximizing
different values. From the research on public law and administration, we consider how
institutions shape the service delivery context. The institutional architecture identifies the
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strengths and limitations of service delivery approaches, and defines legal and other resources
available for mangers’ service delivery activities. Finally, we apply transaction cost theory to
identify the market and service features that influence the potential for contract failure and what
managers can do to mitigate these risks. In short, these research streams provide the theoretical
foundation for our strategic approach to managing service delivery via contract.
This paper is divided into four sections beyond this introduction. The first section
identifies the phases of contracting – the “make or buy” decision, contract specification, and
managing service provision under contract – and demonstrates how the three phases are not
simply discrete decision points, but rather are integrated links in a management chain. Decisions
at each phase affect the management imperatives of the other phases. The second section lays
out the theoretical foundation of our framework – values, institutions, and service markets. We
provide a conceptual definition for each factor and describe its influence on the contracting
process. The third section illustratively applies the framework in each contracting phase to show
how the framework can strategically guide managers through key contracting decisions. Finally,
the fourth section concludes the paper by suggesting next steps in research and application.
The Contracting Challenge
Effectively executing core management functions – planning, decision-making,
monitoring, managing fiscal resources and external relations – improves service outcomes (Hill
and Lynn, 2004; Hou, Moynihan, and Ingraham, 2003Knott and Payne, 2004; Meier, O’Toole
and Nicholson-Crotty, 2004; for a review see Boyne 2003), whether services are provided
directly or via contract (Brown and Potoski, 2006; Gansler, 2002; Lawther, 2002; Romzek and
Johnston, 2002). As contracting has become more common and politically palatable, public
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managers have come under increasing pressure to be “smart buyers” and “smart managers” of
contract service provision (Kettl, 1993, Kelman, 2002; and Cooper 2003). Contracting’s
promised fruits – increased efficiency, cost savings, innovation, etc – come more readily to
governments who invest in strong contract management capacity (e.g. Kelman, 2001, 2002a,
2002b; Brown and Potoski, 2003a, 2006; Van Slyke and Hammonds, 2003). A regrettable but
oft-cited presumption is that governments’ contracting may reduce their management capacity in
the same way that they reduce their direct service production capacity (Brown and Brudney,
1998; Van Slyke, 2003). That is, as they eliminate service production personnel and equipment,
contracting governments also eliminate the managers responsible for service quality and
efficiency. Service contracts in such “hollow states” are more likely to fail (e.g. Milward,
Provan and Else, 1993; Milward, 1994).
There are three stages to contract management. The first stage is assessing whether a
situation is suitable for contracting (e.g. Donahue, 1989). Managers must assess whether market
conditions are likely to support a competitive environment for contract service provision (e.g.
Sclar, 2000) and identify which service production and/or management components can be
unbundled for contracting (e.g. Brown and Potoski, 2006). In the second stage, after the decision
has been made to contract, public managers structure and execute a competitive bidding process
(e.g. Lavery, 1999). Contract design is a complex undertaking requiring public managers to
make decisions on many fronts, such as the degree of task specificity, the contract’s renewal
provisions, and the details of incentive systems (e.g. Shetterly, 2000). Finally, after a vendor has
been selected and the contract awarded, public managers must manage service delivery under
contract (e.g. Kelman, 2002a, 2002b). Here the focus shifts to daily management activities such
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as monitoring vendors’ performance and their performance measures, listening to service
recipients, and executing incentive programs.
While these are analytically distinct phases, they are also interrelated. This is because at
its core managing service delivery requires managers to constantly balance competing
stakeholder values, such as between lowering costs and improving service quality, along with
many other decision criteria. Contract management is thus more than specifying tasks and
monitoring vendors’ performance; it is fundamentally about balancing competing values among
a myriad of stakeholders with different goals. Better contract management can improve service
quality without sacrificing efficiency and can lower the costs of producing quality services.
With growing demand for high quality service delivery, declining government budgets,
and an increasingly complex contract environment, public managers need guidance for
strategically managing the contracting process. A variety of prescriptive step-by-step approaches
to contracting and contract management describe the decisions facing public managers, their
different service delivery options (e.g. franchises versus contracts, short-term versus long-term
contracts, performance versus input based contracts), and the management techniques for
delivering them under contract (e.g. Lavery, 1999; O’Looney, 1998). The limitation of such stepby-step approaches, however, is that they do not provide a strategic foundation for managing the
trade-offs inherent in contracting. The contract environment is ever changing and requires
constant rebalancing of competing criteria. Even the most detailed prescriptive text can not fully
prepare public managers for all of the contingencies, outcomes and implications of their
decisions. As Kettl (2001) states “…indirect government is not so much a tactical toolbox as a
strategic approach to governance (p. 508).” Rather than a cookbook, we offer a theoretically
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informed framework for public managers as they analyze key decisions at each phase of the
contracting process.
Values, Institutions, and Service Markets
The strategic framework we propose begins with the assumption that the outcomes of
service delivery through contract reflect the intersection of three factors: values, institutions, and
service markets. Values are the stakeholder preferences that public managers balance and seek to
optimize as they deliver services. Institutions, or the laws and organizational arrangements that
frame service delivery, determine the range of tools resources that public managers can employ
to optimize values. Finally, the services themselves and the character and composition of the
market influence service delivery. Each factor has its roots in different research traditions –
values in public affairs and strategic management, institutions in public law and public
administration, and service markets in economics. In this section we discuss each of these
factors, identify how they influence contracting and contract management, and describe the
manner in which public managers can assess the extent to which they can shape the contracting
environment. We synthesize across these research literatures arguing that, as with the phases of
contracting, values, institutions, and service markets are interconnected. In the section that
follows this discussion of theory, we present several examples from each of the three phases to
illustrate how our framework provides strategic guidance for public managers.
Values
Public managers operate in a crucible of swirling values – effectiveness, efficiency,
accountability, responsiveness, equality of treatment, and service quality to name only a few
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(Frederickson, 1997; Gilmour and Jensen, 1998; Moe, 1996; Posner, 2001; Rainey, 2003; and
Seidman, 1998). Managing service delivery is as much about identifying, balancing, and
targeting shifting stakeholder values as it is about operations management, vendor relations, and
so on. For any service, the list of potential stakeholders is long: interest groups and attentive
segments of the general public, elected officials, the media, public employees, administrative
superiors, collaborators and partners, service recipients, and vendors. Service recipients and
their interest groups may be primarily concerned with equality of treatment. Elected politicians
may focus on political accountability and responsiveness. Administrative superiors may be most
attuned to cost efficiency. Obviously, these values sometimes conflict – ensuring equality of
treatment may reduce cost efficiency – so managers must either frame the trade-offs for key
decision makers, or as is often the case, use their discretion to make these trade-offs as they
implement services (deLeon, 1995; Van Slyke, Horne, and Thomas, 2005).
Stakeholder values are the evaluative yardstick for measuring service delivery.
Contracting may be more cost efficient and better at stimulating innovation (Bennett and
Johnson, 1981; Kettl, 2001; Pack, 1989; Savas, 2000; and Selden, Brewer, and Brudney, 1999).
Direct service provision, on the other hand, is thought to better promote political accountability,
stability, and equality of treatment (DeHoog, 1984; Donahue, 1989; Kettl, 1993; and Morgan and
England, 1992). To some degree these differences are speculative, and the relative strengths of
direct versus contract service delivery appears to vary across circumstances (Brown and Potoski
2006; Morgan and England 1988; and Sclar 2000). Nevertheless, an important first step for
successful contracting is to identify and prioritize the value preferences of key stakeholders so
that public managers can weigh them against one another in their decision making. Because the
contextual setting surrounding service delivery is typically dynamic and often contentious, public
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managers should constantly scan their environment and assess shifts among stakeholders to
better assign weights to different values.
There is a rich literature on how public managers can gauge stakeholder values (Kraft and
Clary, 1991; Serra, 1995; and Thomas, 1995). Surveys can reach large numbers of people,
although they are quite expensive. To reach groups with more intense and deeply held
preferences (e.g. interest groups, service recipients, elected officials), public managers can rely
on public meetings and hearings, requests for comment and information, advisory committees,
and focus groups. Recently, managers have invited stakeholder participation in developing
service delivery goals prior to beginning the contract process (Beinecke and DeFillippi, 1999;
Gooden, 1998). Once values have been identified, the strategic management and planning
literature suggests a number of approaches for prioritizing competing stakeholder values and
preferences, including stakeholder value mapping (e.g. Bryson, 2004), “backward mapping” (e.g.
Elmore, 1979), and balanced scorecards (e.g. Kaplan and Norton, 1996). Synthesizing values is
critical to clarifying program goals and identifying the value trade-offs inherent in different
service delivery practices.
Institutions
As managers identify stakeholder values, they also need to identify the tools, resources
and constraints that define the potential action they might take in delivering services. Institutions
establish the “rules of the game” (North, 1991) and thereby set the parameters for deciding which
alternative service delivery options may be used and the manner in which contractual
relationships can be managed and altered. Two “institutions” are central to the contracting
process – public law and organizational arrangements.
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Public law sets the boundaries within which public managers must operate, thereby
permitting, authorizing or requiring the range of managers’ actions. At its root, a contract is a
legal instrument, an “…agreement by particular parties [that] accept a set of rules to govern their
relationship, whether it is for the purchase of services or for a cooperative working agreement
(Cooper, 1996, 125).” For example, at the federal level, the Office of Management and Budget
circular A-76 establishes the statutory requirements and delineates what federal procurement
officials must do when bidding contracts. As the law establishes what is authorized and
prohibited, it also defines a managers’ zone of discretion, either through legal ambiguity or direct
delegation. In some cases, these grey areas allow for considerable flexibility, creativity and
innovation in the use of contracting tools, or they may restrict discretion to such an extent that
they undermine managers’ ability to manage contracts. Clearly managers need a sound
understanding of the laws, ordinances, and administrative statutes governing the contracting
process in general and their particular services (Rosenbloom and Piotrowski, 2005; Wise, 1990).
Along with legal resources and constraints, organizational arrangements also define the
capacity and resources available for managing service delivery. Contract management capacity
includes physical and financial capital. Perhaps more importantly, management capacity also
includes human capital, such as basic management skills (planning and coordinating service
delivery, negotiating with vendors, monitoring task completion, executing incentives [Brown and
Potoski, 2003a; Romzek and Johnston, 2002; Van Slyke and Hammonds, 2003]) as well as
specific technical skills (e.g. contract drafting). In most circumstances ensuring sufficient
capacity requires assigning these managerial responsibilities to public employees such as
contract managers.1 Weak capacity increases the risk of failed contracts (Brown and Potoski,
2005).
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Service Markets
A final set of factors – service markets – determine whether appropriate conditions exist
which favor contracting. When markets work well, competition for contracts helps overcome
principal agent problems, monopoly inefficiencies, and other ills that can plague service delivery
through government bureaucracies. A competitive market provides information about prices and
service quality across vendors and disciplines vendors who fail to meet market standards. Strong
markets require some fairly strict conditions. Markets need large numbers of buyers and sellers,
participants need to be well informed about products and each others’ preferences, and actors
must be able to enter and exit the market and exchange resources at low costs. Markets can fail
because of high transaction costs, limited information, uncertainty about the future, and the
prospect that people or organizations behave opportunistically in their interactions (Coase, 1937;
Williamson, 1981, 1996, 1997).2 Market failures imply that the win-win outcomes of voluntary
exchanges no longer occur. Of particular importance for our purposes are market and service
characteristics that give rise to transaction costs, or in Williamson’s (1981, p. 552-553) terms the
“comparative costs of planning, adapting, and monitoring task completion under alternative
governing structures.” In the case of contracting, because parties to a transaction cannot fully
predict all possible future scenarios, contracts are underspecified (or incomplete), allowing
vendors to opportunistically exploit ambiguities to their own advantage at the expense of the
contracting government. To minimize such opportunism, the contracting government must incur
transaction costs, such as writing more detailed contracts, implementing performance
measurement systems, monitoring vendors’ performance and executing penalties if necessary.
Asset specificity and ease of measurement are two of the central sources of transaction
costs in public sector contracting. Delivering an asset specific service requires large specialized
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investments in things that cannot be translated to other economically valuable activities. Asset
specificity can refer to physical infrastructure or to the skills and abilities that can only be
acquired through on the job experience. Asset specific services dangerously privilege whoever
wins the first contract because in later rounds vendors without the necessary investments are
unlikely to remain in the market. Losing bidders who have also made specialized investments are
may be unable to market their services elsewhere if the government is the only purchaser. Under
such monopsonistic conditions the winning vendor can opportunistically exploit the government
contracting agency with impunity by raising prices or reducing service quality.
Ease of measurement refers to how well public managers can assess the quality of
delivered services. Easily measured services have identifiable performance metrics that
accurately represent service quantity and quality. If performance outcomes are difficult to
measure and observe, a service may still be easy to measure if it is relatively straightforward to
monitor the activities of the vendor and the activities are reasonable proxies for final outcomes.
A service is difficult to measure when neither the outcomes to be achieved nor the activities to be
performed are easily identifiable. Difficult measurement gives rise to information asymmetries
between contracting governments and vendors; governments cannot assess the quality of services
they are receiving. As with asset specific services, governments contracting for difficult to
measure services are vulnerable to unscrupulous vendors that exploit their information advantage
by lowering service quality and quantity. Of course, difficult to measure services are also prone
to exploitation when delivered internally as well (Jensen and Meckling, 1996; and Milgrom and
Roberts, 1992).
The advantage of internally producing high transaction costs services is managers’
actions can more easily counter the information and principal agent problems that come from
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contracting for high transaction cost services. Mitigating these risks requires deploying
management capacity to address market weaknesses, or avoiding the market altogether through
internal service delivery. If services are difficult to measure, managers can monitor their own
employees more easily than vendors. If services are asset specific, managers can shape
employment incentives (through compensation, promotion possibilities, and other non-pecuniary
rewards) for strong performers. Even strong markets are imperfect, necessitating a minimal
investment in management capacity (Brown and Potoski, 2004).
Taken together, these three streams of factors frame the contracting process. Stakeholder
preferences establish the values to be optimized in the contracting process. The institutions of
public law and organizational arrangements establish what types of contracting tools can be
employed to achieve those values. Characteristics of service markets influence which available
contracting tools and vendors are best suited to achieve stakeholder values.
Managing the Phases of Contracting
In this section we map the three factors to the phases of contracting and begin to develop
a strategic contract management framework. As noted earlier, our approach is not to direct
public managers through a series of proscriptive steps, but rather to illustrate how public
managers can use the lenses of values, institutions and service markets to manage strategically
the contracting process. As our approach is instructive rather than comprehensive, we focus on
only a small subset of the many contracting decisions at each phase of the contracting process.
We first examine the basic “make or buy” decision. For the contract specification phase, we
examine vendor selection. For the post-contract management phase, we examine vendor
monitoring.
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The “Make or Buy” Decision
The central value tension in public sector service delivery is the efficiency versus
effectiveness trade-off.3 Maximizing efficiency means producing each unit of a good or service
at the lowest possible cost, while maximizing effectiveness means producing each unit of a good
or service at the highest level of quality, however quality is defined. Holding external factors
constant, gains along one dimension often require sacrifices along the other, a tradeoff that holds
only under conditions of “ceteris paribus.” More favorable circumstances (such lower transaction
costs), better technology, and management innovations, mean that delivery can be more efficient
or effective (or both). Thus, while public managers seek to take advantage of management
innovations such as “gain-sharing” and benchmarking which promise to reduce costs while
maintaining quality (Osborne and Plastrick, 2000), they must nevertheless balance values against
contracting tools when considering the provision of high and low transaction cost services.
Because the choice of service delivery favors some values over others, debates about the
desirability of contracting are fundamentally grounded in what values public managers should
emphasize. Contracting’s proponents emphasize market competition’s power to lower
production costs while its opponents emphasize service effectiveness and other democratic
values.
Public managers should next map out the range of choices afforded to them by law.
Laws tend to clearly delineate whether contracting is required, permitted or prohibited for a
particular service. At first glance it might appear that contracting is superior to direct service
provision because it offers greater flexibility to manage the efficiency-efficacy trade-off. After
all, federal and state administrative procedure acts mandating whistle blower and other employee
protections, and open records and meetings create both costs and constraints for government
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managers (e.g. Cooper, 1996), precisely the kind of legal and bureaucratic inefficiencies
contracting is designed to counter, particularly if vendors working under contract can skirt the
legal requirements binding governments (Rosenbloom and Piotrowski, 2005). Yet, many laws
restrict contracting practices (DeHoog, 1997), such as those that require special protections or
more heavily weighted preferences to be considered in the contract decision making process.
Such preferences, in an effort to optimize equality, may include awarding extra points in the
proposal evaluation stage for minority-owned firms or small businesses. From the perspective of
the contracting government, onerous legal requirements raise the costs of contracting. Indeed,
many private firms and nonprofits may choose not to compete for public sector contracts because
of such time-consuming and heavy legal requirements (MacManus, 1991; Praeger, 1994)). These
requirements may be less burdensome than those governing internal provision. As such, legal
exigencies lower market competitiveness and thereby dilute the advantages of contracting
relative to internal provision.
Examining the legal arrangements governing service delivery is an important first step in
determining whether to “make or buy”, but other factors – notably characteristics of the service
market – play a more fundamental role in determining the returns from contracting. Low
transaction cost services are prime targets for contracting because of the high potential for
efficiency and cost savings and the low risk of sacrificing service quality. On the other hand,
services with higher transaction costs – those that require asset specific investments or are
difficult to measure – are less attractive contracting candidates because of the higher likelihood
of monopolization and vendor underperformance. Managers should assess whether there are
sufficient vendors to ensure a competitive market, and in the case of asset specific services,
whether there is likely to be a competitive market in subsequent rounds of bidding. Contracting
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in thin markets with few vendors makes contracting costlier because managers must either
counter the lack of information and other problems such markets create or incent and monitor
vendors closely to mitigate opportunism and failed contracts.
Managers need not be hopeless victims to thin markets: in markets with few vendors,
public managers can stimulate competition, for example by recruiting new vendors (Brown and
Potoski, 2004). Another option is for managers to split service delivery into multiple contracts,
allowing public employees to compete against private vendors (Goldsmith, 1997; Osborne and
Plastrick, 2000). Still another is for managers to retain a portion of service delivery in-house to
provide both information on service quality and cost while also ensuring that there is an
alternative provider even in thin markets. However, these activities are costly. When transaction
costs are high and markets are thin, governments need sufficient management capacity to ensure
the desired balance between efficiency and effectiveness. If the management capacity is
expensive, direct service provision may become more attractive.
Taken together, public managers facing the “make or buy” decision should first gauge
stakeholders’ value preferences, particularly along the efficiency versus effectiveness tradeoff.
The nature of the value tradeoff varies across types of services, institutional arrangements and
market conditions. Contracting is more attractive when legal requirements afford public
managers discretion, when service transaction costs are low, and when markets are competitive.
Contracting becomes costlier and thus less attractive to the extent these conditions do not hold.
Contract Specification
Assuming a government elects to “buy” rather than “make”, the next stage in the
contracting process is the contract specification phase. This includes developing and
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implementing a bid process, selecting a vendor, and crafting the contract. Frequently this phase
is analyzed through the lens of principal-agent relations. The contracting government (i.e. the
principal) uses the contract specification phase to constrain the vendor (i.e. the agent) from
exploiting information asymmetries at the expense of the contracting government’s goals. In this
way, the contract is a device to maximally align the vendor’s values and actions with those of the
contracting government. As discussed earlier, legal requirements for contracting constrain how
this process must be implemented, but public managers typically have discretion to shape
important decisions, including task specification (e.g. the scope of work), the use of outcome
measures (e.g. performance based contracts), vendor qualifications (e.g. licensing or
accreditation issues), vendor compensation (e.g. time and materials versus cost-plus-fee),
contract duration (e.g. short versus long) and renewal provisions, payment schedules, the use of
incentives (e.g. punishments versus rewards), and reporting requirements. In this section we
focus on a central contract specification decision: the type of vendor selected.
Contracting governments can choose among three types of vendors: private firms,
nonprofits and other governments. Private firms, whether they are publicly or privately held, are
thought to be motivated to maximize profits, and consequently may focus more on innovation
and efficiency. However, this efficiency may well come at the expense of the contracting
government’s goals (Moe, 1996). For example, in a forced choice between taking steps to
maintain or upgrade service quality and keeping costs low, the fear is that private firms will cut
corners to reduce expenses. In the language of transaction cost theory, private firms are
opportunistic and likely to pursue “self-interest with guile (Williamson, 1985, 45).” Nonprofit
organizations are thought to share similar missions with government, and thus maybe more
reliable contract partners (Hansmann, 1987; Salamon, 1995; Van Slyke and Roch, 2004; and
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Young, 1999). Rather than behaving opportunistically, a nonprofit might draw on its own private
philanthropic resources (e.g. volunteers, endowments) to augment revenue from its government
contract. This distinction, of course, is not without caveats. While nonprofits may be prohibited
from distributing profits, they may in fact use channel government revenue to subsidize noncontract programs. Finally, other governments can also be contract vendors. Like nonprofits,
other vendor governments are thought to have values aligned with the contracting government
because they both share a similar public mission, a workforce committed to public sector values,
and the inability to distribute profits. However, intergovernmental contracts may do less to solve
the weak productivity, inefficiency, lack of innovation and other bureaucratic ills that plague
direct government service provision (e.g. Niskanen, 1971).
Institutional arrangements play an important role in determining the returns from
contracting with each of these three types of vendors. Other governments are subject to the same
legal requirements as the contracting government. These requirements may promote service
quality, but they likely come at the expense of cost efficiency and innovation. Non-profits are
governed as tax-exempt organizations, and as such they are prohibited from distributing profits
to their employees or volunteer boards. Consequently, there may be fewer incentives for them to
engage in opportunistic behavior, at least in comparison to private firms. Finally, while the
profit motive may drive private firms to sacrifice quality for efficiency in a forced choice, private
firms may offer more flexibility and discretion under contract because they are not subject to the
same rule making and transparency requirements as governments.
The type of vendor may be less important for low transaction cost services in competitive
markets because the risk of monopolization is low, performance can be easily measured, and
contracts effectively enforced. Indeed, governments contract more with private vendors in such
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circumstances (Brown and Potoski, 2003b), exploiting their competitive zeal and relatively slim
legal requirements though rigorous contract specification and enforcement (e.g. claw back
provisions or penalty clauses [Brown and Potoski, 2004]). The type of vendor becomes more
relevant when contracting for high transaction cost services in thin markets, for example, when a
small government needs to deliver a service that requires asset specific investments beyond what
it can afford. In these cases, public managers would be wise to solicit bids across the three types
of organizations, and perhaps even favor nonprofits or other governments in selecting a winning
vendor, since value alignment between the contracting government and these vendors may
mitigate the risks of failed contracts. Governments more frequently choose nonprofit and other
governments when contracting for high transaction cost services and in thin markets (Brown and
Potoski, 2003b).
Contracting with vendors that purportedly share the same goals is not without risks. Van
Slyke (2003) finds that governments often establish long-term contract relations for social
services with nonprofits but then neglect oversight and monitoring responsibilities. In
monopsonistic situations (in which the government is the only buyer), nonprofits may become
increasingly reliant on a public sector contract and begin to behave like a conventional
monopolist in order to maintain the resource flow. In the absence of sufficient contract
management capacity, nonprofits are able to exploit the contract in the same way a private firm
might. However, for those governments that invest in sufficient management capacity, long term
contractual relationships can sometimes foster mutual support and sharing, creating a virtuous
cycle of trust begetting more trust, and vendors that do not exploit contractual advantages.
Economists and organizational theorists refer to these types of relationships under the rubric of
relational contracting. In a relational contract public managers work with the vendor toward
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building a long-term relationship based on trust, reciprocity, and joint involvement in the
development and implementation of the contract (Fernandez, 2005). In contracts that are highly
asset specific and where the service does not easily lend itself to measurement, relational
contracting advocates suggest that less detailed specification, less rigidity, and more flexibility
and discretion can lead to greater levels of contractual alignment between government and its
vendors, if based on trust, and frequent communication and coordination (Gazley, 2005). The
success of a relational contracting approach, which has higher transaction costs in the short term
compared to a conventional approach to contract management, can over time lead to lower
transaction costs in the form of reduced bidding, monitoring, and legal costs. The joint
involvement and repeated interactions of government and the vendor are intended to promote
goal alignment between the parties.
Managing Service Delivery under Contract
Once governments select a vendor and turn their attention to contract management,
managers face more decisions centering on the efficiency and efficacy trade-off. Perhaps most
central among these is monitoring and evaluating vendor performance (Behn and Kant, 1999;
Brown and Potoski 2003a; Kettl, 1993; Praeger, 1994). Monitoring and evaluation is the means
by which public managers assess whether service delivery reflects the targeted values. Well
monitored vendors may be more likely to perform according to contract specifications, although
monitoring in turn is costly.
Effective monitoring programs must have a solid legal grounding: in some circumstances,
monitoring activities not covered in a contract may not be used to evaluate vendors (Kelman,
2002). Contracts can authorize the use of several monitoring tools (Brown and Potoski, 2003c).
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First, managers can establish formal systems for tracking and monitoring citizens’ complaints
about service delivery. As direct recipients of contracted goods and services, citizens can serve
as “fire alarms" (McCubbins and Schwartz, 1984), calling attention to occasional transgressions
without requiring governments to constantly monitor vendors’ activities. Second, managers can
proactively gauge public sentiment about service quality through citizen surveys (Miller and
Miller, 1991; Poister and Henry, 1994; and Swindell and Kelly, 2000). Third, managers can
more directly focus on vendors by auditing and analyzing their records and performance data.
This method places the burden on the vendor to produce the performance information and can
therefore lead to higher costs for the vendor. Finally, managers can also conduct field audits – as
they often do in regulatory contexts – in which government employees physically watch as
vendors deliver goods and services. In this way, governments can gain direct information about
service quality, vendor effort, and citizen satisfaction (DeHoog, Lowery, and Lyons, 1990).
These monitoring activities vary in their costs and efficacy depending on the nature of the
service and the broader market conditions. For low transaction cost services, performance
measures are easy to design and implement. For example, public managers might decide that ontime service is a critical performance criteria for the operation of a bus transit system and then
require the vendor to provide periodic reports of how often buses arrive on time at each stop on a
route. Public managers might then spot check performance by randomly riding routes, or they
may set up a call in system to track citizen’s complaints about persistently late routes.
Moderately difficult to measure services may require a more extensive monitoring system, with
overlapping output and outcome performance measures.
Measurement difficulty and the costs associated with designing and implementing a
performance measurement system may exceed the benefits. Contracting in such circumstances
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may require government managers with a deep understanding of the service production process.
This can be an onerous undertaking, beginning with uncovering the logic behind the vendors’
service delivery techniques. Ensuring alignment between government and the vendor may
require that the parties discuss the specific program goals, approach to intervention, and jointly
agree to the types of measures that would best represent successful service delivery.
The goal of any monitoring system is to provide managers with information about
service delivery. The need for monitoring is greatest for higher transaction costs services, but so
too are the costs and difficulty. Equipped with performance information, managers can realign
vendors’ actions with targeted stakeholder values by executing the contracts’ penalty and
clawback provisions. Of course, well functioning markets certainly help impose discipline:
managers can replace underperforming vendors with their more promising competitors.
Conclusion
In this paper, we develop a strategic approach to contract management based on three
central factors: values, institutions, and service markets. Stakeholder preferences establish the
values to be optimized in service delivery. The institutions of public law and organizational
arrangements determine the contracting tools available for balancing among competing values.
The characteristics of service markets influence which contracting tools and vendors are best
suited to achieve stakeholder values. Governance by contract demands a strategic foundation on
which to guide decision making (Cooper, 2003). Our examination of three key decisions –
whether to “make or buy”, what type of vendor to select, and what type of monitoring tools to
employ under contract – illustrates how these heuristic devices can be used to navigate all phases
of the contracting process.
20
We have examined only three of the many decisions involved in contracting, although
our goal is for this framework to guide research. For example, scholars could examine why
governments use different contract incentive and sanction mechanisms and whether their
efficacy varies across different types of vendors and types of service markets. Because of the
varying legal constraints under which they operate, other government, for profit and nonprofit
vendors may respond differently to any particular incentive program. The proof is ultimately
whether public managers find value in our framework for promoting their contract management
capacity.
21
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1
In other circumstances, some of these tasks, like production tasks, may be better performed through contract
(Brown and Potoski, 2006). So long as these managerial tasks can be specified in contract and implemented
properly, governments can procure management activity they might otherwise have performed, or failed to perform,
on their own behalf.
2
There are several ways to view the sources of market failures, including incomplete property rights, information
asymmetries, and transaction costs. Goods may be non-rivalrous or non-excludable so that transferable property
rights cannot be established and enforced without transaction costs swamping gains from trade (Ostrom and Ostrom
1977; Weimer and Vining, 1992). Historical accident may inefficiently lock in path dependent technologies such as
the QWERTY keyboard (David, 1985). Information asymmetries between buyers and sellers may create a “lemon
market” where inferior products keep good products off the market (Akerloff, 1970). A common thread in these
cases is that the market failure is caused by the transaction costs stemming from limited information among
participants, particularly buyers, or from goal incongruence between the buyers and sellers.
3
There are other value tradeoffs that can be considered. For particular types of services, government might be
interested in more or less value representativeness in contract implementation. One example may be that
government managers want to ensure that equity is operationalized in service provision. Depending on the nature of
the service, that might mean the vendor has evening hours on several nights of the week in order to serve those
individuals working during the day. While the evening access is designed to promote greater equity among clients in
need of particular services being provided by government under contract, that value may also lead to increased costs,
in the form of employee overtime pay or lead to lower quality in that evening workers are more difficult to recruit or
those available for evening employment have less knowledge, skills, and abilities in providing this type of service.
Therefore, an inherent tradeoff in ensuring equity and access may result in higher costs or lower service quality.
26