Contracting Best Practices: Incentives and Penalties
Many traditional municipal solid waste contracts provide incentives for disposal-based systems by paying contractors incrementally more for additional solid waste collection residences served and/or for higher disposal quantities. Under these contracts, payments decline as more materials are reduced, recycled and composted so they do not support zero waste programs effectively.
Incentives and penalty clauses in contracts can be used to encourage generators, contractors, haulers, processors, landfill operators and government agencies to reduce waste.
Most contractors are incentivized through fair compensation for the services under a cost-plus contract where the contractor is paid for designated expenses plus a profit.
- Pay-As-You-Throw Variable pricing with reduced rates for smaller disposal bins or weights
- Additional payments for achieving targeted waste reduction, recycling and/or composting milestones
- Additional payments for achieving processing facility residual or contamination reductions (i.e., the weight or percentage of materials that are still disposed of after sorting out recyclable and compostable materials)
- Adjust franchise fees based on diversion percentage or for meeting diversion program requirements
- Use of a sliding scale in the contractor's allowable profit based on diversion percentage
- Additional payments for contractor performance related to outreach or other targets (e.g., meeting with business customers, public education, etc.)
- The renewal or extension of contract linked to performance (e.g., achieving diversion milestones)
- Full or more favorable payment-sharing for recyclables or compostable materials marketed
Incentives for achieving specific targets work best when the contractor is compensated separately from customer rates and the local government controls the scales and record-keeping.
Some communities reduce their franchise fees directly proportional to the amount of waste diverted. For example, franchise fees are 16% for contractors diverting 24% or less, 12% if they divert 25% to 49%, and 8% if they divert 50% or more.
One of the most powerful tools communities have is to extend contracts. Contractors are often willing to offer new diversion services to extend contracts so they don't have to spend time and money to go through a competitive procurement and risk losing the contract. An average proposal process costs each hauler about $50,000-100,000 and costs the local government about $100,000-200,000.
Typical term extensions are for one to three years beyond the term of a seven-year base contract. Longer extensions may be designed to replace equipment and stabilize customer rates.
- Liquidated damage payments
- Payment Reductions (e.g., forego a payment increase or reduce payments)
- Not eligible for contract extension
- Require contractor to implement new diversion or outreach program(s) at no additional cost.
Liquidated damages are agreed upon terms regarding penalties associated with the contractor failing to meet contract requirements. They are used to provide a contract management tool that is less onerous than terminating the contract if a particular aspect of the contractor’s performance is unsatisfactory.
- Strong diversion incentives: Tying additional profits or contract extensions to diversion rates give contractors market-based incentives to reduce waste. Liquidated damages are also proven to achieve results.
- Aligns economic drivers: Savings should accrue from waste reduction, recycling and composting if the system and rates are established correctly. Avoided collection and disposal costs can provide economic drivers.
- Time and cost savings: Contract extensions can save the contractor and the local government time and money.
- Generator waste reduction and reuse: Generators can save money by eliminating waste. Waste can be reduced, for example, by using returnable shipping containers and reusable pallets or establishing online document systems. Often 80-90% of costs are for hauling materials off-site, so processing materials on-site through home composting or local reuse can result in significant savings.
- Cost of incentive payments: There may not be enough funding available to cover all of the incentives or the incentives may not be substantial enough to be effective. Contractors taking significant additional risks may require higher base rates as well as bonuses to compensate for the additional risks.
- Local government workload/potential to misrepresent results: Unless there is adequate oversight and funding for audits, contractors can overstate their numbers to receive incentives or avoid penalties.
- Reduced competition: Negotiated extensions may not provide the most innovative proposals or the most competitive results.