Performance Guidebook

A Guide to
Performance Contracting
of Water Service Provision
For Regulatory Agencies, Local Government Units,
Water Districts, and Private Water Service Providers
A Guide to Performance Contracting of Water Service Provision for Regulatory Agencies, Local Government
Units, Water Districts, and Private Water Service Providers
This guide was published with assistance from the USAID Philippine Water Revolving Fund (PWRF) Support
Program.
The views expressed here do not necessarily reflect those of USAID or the United States Government.
The PWRF Support Program is a collaborative undertaking of GOP partners, USAID, Japan International
Cooperation Agency (JICA), LGU Guarantee Corporation (LGUGC), and private financing institutions (PFIs)
through the Bankers Association of the Philippines. The Program’s GOP partners are led by the Department
of Finance and include the Development Bank of the Philippines and the Municipal Development Fund Office.
The PWRF Support Program aims to establish a co-financing facility that combines ODA/JICA resources
with PFI funds for creditworthy water service providers, using a financial structure that allows affordable loan
terms without sacrificing the viability of PFIs. PFIs have access to credit risk guarantees provided by LGUGC
and USAID’s Development Credit Authority.
The PWRF Support Program operates around three main objectives, which are to:
• Establish the co-financing facility and develop a long-term financing strategy and mechanism with
broader private sector participation;
• Strengthen water project financing and enable other conditions necessary for optimizing the PWRF
Support Program’s positive impact on the sector, including corollary regulatory reforms; and
• Assist water districts and local government units in developing a pipeline of bankable water projects.
The PWRF Support Program is implemented by Development Alternatives, Inc. in association with The
Community Group International LLC, Resource Mobilization Advisors, and CEST, Inc.
Month and year of publication: October 2011.
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A Guide to Performance Contracting of Water Service Provision

TABLE OF CONTENTS
1 INTRODUCTION .................................................................................................................................................. 1
2 OVERVIEW OF PERFORMANCE CONTRACTS .......................................................................................... 3
2.1 What is a performance contract? ................................................................................................................................3
2.2 Why use a performance contract? ..............................................................................................................................3
2.3 Types of Performance Contracts ................................................................................................................................4
2.4 The Contracting Parties: Water Utilities and Staff ...................................................................................................6
2.5 Case Studies and Lessons Learned .............................................................................................................................8
3 PREREQUISITES OF PERFORMANCE CONTRACTING ............................................................................. 17

3.1 Ring-fencing of Utility Accounts....................................................................................................................................18
3.2 Development of Performance Improvement Plan/Business Plan ..........................................................................18
3.3 Key Requirements ............................................................................................................................................................21
4 STEPS IN PERFORMANCE CONTRACTING ................................................................................................. 23

Step 1 - Identifi cation of Contracting Parties and Contracting Instrument.............................................................24
Step 2 - Setting the Strategic Goals, Objectives, Scope and Timeframe .....................................................................24
Step 3 - Determining Activities to be Contracted ..........................................................................................................25
Step 4 - Defining the Roles and Responsibilities of the Contracting Parties ...........................................................25
Step 5 - Setting Performance Indicators and Targets ......................................................................................................25
Step 6 - Determining Performance Incentives/Linking Incentives to Performance .................................................27
Step 7 - Setting Penalties, Dispute Resolutionand Modification Provisions...............................................................27
Step 8 - Termination of Performance Contracts..............................................................................................................27
REFERENCES AND LINKS ........................................................................................................................................ 29
ANNEX 1 Institutional Set-Up of Water Service Providers ............................................................................. 32
ANNEX 2 Sample Performance Contracts .......................................................................................................... 35

2-1 Improving Production, Revenue Generation and Quality of Service
of the Jagna Waterworks System ...............................................................................................................................35
2-2 Improvement of the Mahayag Local Waterworks System (MALOWAS)
for Better Service Provision and Revenue Generation..........................................................................................47
2-3 Performance Contracting to Reduce Subsidies
for Water Service Operations in Alburquerque ......................................................................................................55
2-4 Area and Branch Performance Contracts in Uganda, East Africa ........................................................................61
2-5 Contracting with the Utility Management in Lesotho, South Africa ...................................................................65
2-6 Copies of Sangguniang Bayan Resolutions Endorsing Performance Contracts ................................................69
ANNEX 3 System of Incentives for Performance Contracting ....................................................................... 74
APPENDIX A Legal Bases and Types of Outsourced Performance Contracts ............................................. 76
APPENDIX B Some Examples of Outsourced Contractual Arrangements in the Philippines .................. 78

LIST OF TABLES AND FIGURES
Table 1 – Benefits to Contracting Parties and Clients ........................................................................................ 4

Table 2 – Types of Outsourced Contractual Arrangements .............................................................................. 6
Table 3 - NWSC Performance Improvement ........................................................................................................ 15
Table 4 - Example of a Performance Improvement Plan ..................................................................................... 19
Table 5 - Example of a Performance Improvement Plan ..................................................................................... 20
Table 6 - Setting Strategic Goals ............................................................................................................................... 25
Figure 1 – Possible Contracting Arrangement within the LGU......................................................................... 7

Figure 2 – Possible Contracting Arrangements for Water Districts ................................................................ 8
Figure 3 – Utility Reform Glide Path ....................................................................................................................... 18
Figure 4 - Steps in Performance Contracting ........................................................................................................ 24
vi

LIST OF ACRONYMS
BEM business efficiency measures
BOD Board of Directors
BOT build-operate-transfer
BWSI Balibago Water Systems, Inc.
COA Commission on Audit
DBL design-build-lease
DILG Department of Interior and Local Government
GOCC government-owned and controlled corporation
JV joint venture
KPI key performance indicators
LGU local government unit
LWUA Local Water Utilities Administration
MALOWAS Mahayag Local Waterworks System
MPDO Municipal Planning and Development Coordinator
MWSS-RO Metropolitan Waterworks and Sewerage System Regulatory Office
NRW non-revenue water
NWRB National Water Regulatory Board
NWSC National Water and Sewerage Corporation (Uganda)
O&M operation and maintenance
PIP Performance Improvement Plan
PPP public-private partnership
PRAISE Program on Awards and Incentives for Service Excellence
PWRF-SP Philippine Water Revolving Fund Support Program
SB Sangguniang Bayan
SMART specific, measureable, accurate, realistic, and time-bound
USAID United States Agency for International Development
WASA Water and Sewerage Authority (Lesotho)
WD water district
WSP water service provider
WSS waterworks and sewerage system
vii

viii

1. INTRODUCTION
More than 80% of water service providers (WSPs)

in the Philippines are public utilities, owned and
managed by government personnel and subject to
government laws and procedures. These include
water districts (WDs) and the utilities run by local
government units (LGUs). Having been vested with
the power to establish and operate water utilities
as part of their devolved function, the LGUs serve
more than half of the total population. Water
districts, meanwhile, account for about 20%of the
water supply market; and the rest is accounted
for by the private utilities, cooperatives, and other
independent providers.
Despite the sizeable share of LGU water utilities

in the water supply market, their performance
is characterized not only by slow expansion but
also by poor quality of services, high levels of
non-revenue water (NRW), and dependence
on government subsidy. The LGU-run systems,
based on a benchmarking study conducted by the
Department of Interior and Local Government
(DILG) in 20081, are deemed the poorest
performers among the WSPs given that they have
the:
1
Based on the results of the Performance Benchmarking of Small Towns Water Supply: Enhancing Performance in the Delivery of WATSAN Services,
Water Supply and Sanitation Program Management Office, Department of Interior and Local Government, 2008.
1

• lowest average service coverage; underscored utility reform to address ownership,
• shortest water availability per day; governance, and resource issues hindering the
• least amount of water delivered to performance of WSPs particularly the water
consumers; districts and LGU-run utilities. It also emphasized
• lowest average tariffs charged per cubic the need to tie up financing with regulatory,
meter; governance, and performance reform. The reform
• lowest revenue collection efficiency; agenda reinforced institutional, capacity building and
• highest average operating ratio; financing initiatives outlined in the Philippine Water
• highest staff/1000 connection ratio; and Supply and Sanitation Roadmap.
• very low capital per expenditure
connection. Utility reform measures such as ring-fencing,
benchmarking, business planning and performance
contracting have been introduced as part of capacity
The dismal performance of public utilities especially building and performance improvement glide path
LGU-run systems is attributed to lack of technical for WSPs.2 Among these reform measures, internal
and managerial capacity, lack of access to financing performance contracting of service delivery — that
for WSS development, and dependence on subsidies, is, forging of performance contracts involving the
which are often episodic. These problems are internal management of the utility or outsourcing
compounded by the weak regulation in the sector with public or privately owned utilities — has been
characterized by institutional fragmentation and recommended as an option for LGUs or other
lack of performance standards and targets to gauge WSPs to strengthen accountability and motivate
the efficiency and effectiveness of water service excellence.
operations; inadequate guidelines on compliance and
enforcement of performance standards and targets While not an entirely innovative concept,
and dissemination thereof; and insufficient capacity performance contracting has yet to be widely
to enforce regulation and monitor compliance. introduced and implemented in water service
There is also a need for key performance indicators provision. Hence, this guide on performance
to guide the provision of water services and contracting is envisaged to inform and promote the
incentives to promote good performance. implementation of this scheme, primarily targeting
LGUs and water districts with the aim of improving
In August 2008, major stakeholders in the the performance of public-sector entities.
waterworks and sewerage system (WSS) sector
agreed to push for a regulatory reform agenda to The succeeding sections provide an overview of
address these issues. The reform agenda envisioned performance contracting involving public-sector
to promote efficiency, drive service improvements entities; present experiences and lessons from
and coverage expansion and also bring to fore other cases studies; and outline the requirements and
concerns related to lack of information, resource procedures for parties willing to engage in internal
sustainability, health, and sanitation. The agenda also performance contracting.
2
Guidebooks related to ring-fencing, benchmarking and business planning developed with assistance from the World Bank-Water and Sanitation
Program and USAID Philippine Water Revolving Fund Support Program, respectively, are available to aid utilities in adopting and implementing these
measures.

2. OVERVIEW OF
PERFORMANCE
CONTRACTS
2.1 What is a performance contract?
A performance contract is a negotiated

agreement between the owner of a public utility
(for example, a local government unit or a
water district) and another entity to undertake
specific actions, meet targets to improve
performance within a fixed time frame and
provide incentives for achieving the targets.
The utility owner’s contracting party may be

its management or implementing unit (WSS
operator or staff) or an unrelated party
(a private-sector entity or another public-
sector entity). Within the utility, the senior
management may also contract out service
performance to its specific unit, branch, or zone
managers.
2.2 Why use a performance contract?
Public utilities carry out several functions

and have multiple principals and objectives.
Most often, their numerous functions are
not matched with the required capacity and
resources. Hence, they are usually unable
to fully undertake these functions and meet
objectives. Some public utilities are also affected
by changes in the political administration, thus,
have short-term plans and poor governance.

The use of a performance contract is one way
of ensuring stability in the operations of a public
utility and focusing its performance of specific
undertakings. It helps establish a commitment
regarding performance objectives, measurable Performance contracting improves transparency and
targets, aligned incentives and required clarity in operations, fosters better partnership and
resources, especially if important stakeholders, commitment among involved parties, and facilitates
such as the economic regulator, are involved monitoring of performance. A performance contract
during design, and if the agreement is made benefits all involved parties — from owners and to
public. operators, managers and clients of water utilities
— being a tool that improves oversight of service
In the case of water services, performance delivery and pushes for measurable targets and
contracts have been used in developed and time-bound results (See Table 1).
developing countries to improve service levels
and quality, reduce NRW, improve billing and
collections, and extend services to the poor,
among others.
Table 1. Benefits to Contracting Parties and Clients
Utility Owner/Management Implementing Unit Clients/Customers

(Government/LGU) (WSS Operator/ Staff)
effective means to delegate responsibility helps provide clarity and stability to the spells out transparency, responsibility and
and accountability utility’s operations given that objectives accountability in operations of the water
are clearly defined utility
provides the basis for specific time-bound motivates performance since incentives improved water services
results and regular and focused reporting are tied to delivery of outputs
improves oversight of service delivery aligns resources (e.g. personnel, facilitates monitoring of water utility’s
expertise, funds, etc.) with objectives, performance of water utility
ensuring that management has the
resources needed
helps define and align objectives so that facilitates monitoring of activities

both parties work towards the same goals
facilitates monitoring of performance
The processes involved in performance 2.3 Types of Performance Contracts

contracting from conduct of due diligence,
negotiating the contract, defining performance Contracting arrangements vary based on: a)
objectives, setting targets, and identifying risks borne by utility owner and contracting
the resources required to meet the agreed party, b) objectives, c) responsibilities of
objectives put pressure on the concerned parties, and d) features including the terms
parties to improve performance. The contract and conditions of the agreement and have
monitoring process, including required reporting varying degrees of effectiveness. Contracts
and periodic performance measurement, further involving a greater shift of risks from the utility
helps to sustain this pressure. owner to an independent party (outsourced

arrangement), for instance, will have higher • have terms and conditions that can be easily
performance achievement. More results- renewed with revised terms and targets; and
oriented contracts can also lead to better • enable the owner, being the superior
performance improvement. Contracts with party,to easily impose sanctions and
monetary incentives are usually more effective terminate the contract.
than those without monetary incentives. 3
2.3.2 Outsourced, Formal Contractual
Performance contracts can be classified Arrangements 4
into internal or in-sourced and outsourced
agreements based on the nature of the utility An outsourced contractual arrangement,
owner’s contracting party. on the other hand, is a legally enforceable
agreement between unrelated parties
2.3.1 Internal (In-sourced) Contracting where the owner of the utility transfers or
Arrangements delegates service provision responsibility.
An unrelated party may be a private-sector
An internal contracting arrangement entity or another public-sector entity.
involves the owner or board of directors
(BOD) of the water utility and its There are several types of formal
management, or its management and its contractual arrangements for water supply
concerned units or branches. Under most operations, usually involving public-private
circumstances, such an arrangement is partnerships (PPPs). They vary depending
between unequal parties and not necessarily on the nature of responsibility being
legally binding. The utility owner or BOD contracted, agreement on ownership of
may enforce the agreement to improve capital assets, accountability for investment,
oversight, delegate responsibilities, and assumption of risks, and duration of
monitor staff performance. Most often, the contract. Thus, a formal contractual
such contracts form part of a management arrangement can range from short-term
strategy to define responsibilities vis-à-vis simple management contracts (with or
key results, the utility’s incentive or without investment requirements) to
compensation package and monitoring and long-term and very complex, sophisticated
supervision system. BOT form, to concession. These types of
arrangements are based on legal issuances
Internal contracting arrangements: (laws and executive orders). Table 2 sums up
the features of various types of outsourced
• are focused on specified performance contracting arrangements.
targets being contracted;
• are easy to monitor since personnel and
records are within the utility;
3
John Sitton. Using Performance Agreements to Improve Water Sector Performance in the Philippines. Final Report, PWRF-SP, November 2009.
4
For further reference on outsourced contractual arrangements, see laws and issuances in Appendix A; examples of outsourced contractual
arrangements in the Philippines in Appendix B; and the following links: ppp.gov.ph; rru.worldbank.org/Documents/Toolkits/Water/Water_Full.pdf
www.adb.org/.../Handbooks/Public-Private-Partnership/default
5

Table 2. Types of Outsourced Contractual Arrangements
Management Design-Build or Lease Concession

Contract Turnkey
Objective Management of Construction of a Operation and Building, operation and
services facility; turn over facility maintenance of the maintenance (O&M) of
after completion facility assets and financing
and investment
management
Who owns capital LGU/WD LGU/WD LGU/WD LGU/WD ultimately
assets? retains ownership
Who pays for capital LGU/WD Contractor LGU/WD Contractor
investments?
How is the contractor Fixed fee + bonus- Fixed fee- investment Revenues-O&M-lease Revenues-O&M-
paid? operating expenses fee investment cost-
concession fees if any
How are risks shared? LGU/WD bears Contractor bears Contractor bears Contractor bears
commercial risk construction risk; LGU commercial risk construction,
all others commercial risks
Typical contract 5 years 2-5 years 15-30 years 25-50 years
duration
2.4 The Contracting Parties: Water Utilities LGU-run water utilities have no uniform
and Staff organizational structure. The mayor sets
policy direction and directly supervises the
In the Philippines, there are two public entities utility manager who is often the Municipal
that can engage in internal performance Engineer or the Municipal Planning and
contracting for water service provision. Development Coordinator (MPDO). The
These are the local government units (LGUs), Municipal Engineer or MPDO, together
which run their own water systems, and the with other LGU employees such as the
water districts (WDs), which are classified accountant and treasurer who share their
as government-owned and controlled services with the utility, usually comprise
corporations (GOCCs).5 (See Annex 1 for a the water utility staff with contractual or
detailed description of their legal mandates and job-order employees for technical support
governance structure.) and bill collection.
2.4.1 Local Government Units LGUs have legal autonomy that precludes
involuntary control from most national-
The Local Government Code of 1991 level agencies. Thus, a possible internal
vests the responsibility of ensuring water contracting agreement will be between
supply and sanitation service provision to the mayor and the utility staff, subject
the LGUs. LGUs have used various service to approval or endorsement by the
provision models, such as those through Sangguniang Bayan (SB), which is the
third party providers (creation of water legislative body of the LGU. A committee
districts, use of community-based operators, of the SB can also be set up to mediate
and concessions) or through forced account any disputes that might arise between the
or directly managed utilities. The latter contracting parties. If the LGU opts to be
are typically treated as part of the overall regulated by the National Water Regulatory
operation of the city or municipality.
5
As GOCCs, they are covered by COA audit, Civil Service rules and regulations, the Salary Standardization Law and government procurement
guidelines.

Board (NWRB) on consensual basis, the 2.4.2 Water Districts
latter can provide the regulatory guidelines
and performance standards to serve as Presidential Decree 198 or the Provincial
basis of the performance contract. Figure Water Utilities Act of 1973 authorizes the
1 shows the possible internal contracting creation of water districts. By virtue of
arrangement within an LGU involving the the law, WDs are under the supervision of
mayor or its water utility staff. the Local Water Utilities Administration
(LWUA). WDs operate as autonomous
Figure 1. Possible Contracting Arrangement within the LGU
Sangguniang Bayan
(SB Council)
Performance Contract Approval, NWRB
Dispute Mediation
Mayor
Performance contract
Regulatory Guidelines/
Performance Standards
Water Utility
Staff
corporations that rely entirely on their There are two possible performance
revenue stream to leverage capital funding agreement schemes for WDs: one is
and defray operation and maintenance between its BOD and its general manager;
costs.6 the other is between the general manager
and the WD staff. Dispute mediation may be
Most water districts maintain a professional done by an agreed independent adjudicator
staff, with core knowledge of the technical or expert panel for the first scheme or by
aspects of the utility’s operation, accounting, the BOD for the latter scheme. LWUA has
and financial management. The management the authority under PD 198 and EO 279 to
and staff have secure tenure, meaning set regulations or require graduation plans.
their composition does not change with Hence, it requires the implementation of
changes in the political administration. The performance agreements. It also has the
corporatized structure of the Water District authority in its role as financier to require,
lends itself better to internal performance as part of the loan, WDs to adhere to
contracting. There is a clear delineation certain targets. Figure 2 shows possible
of the policy setting and oversight, as well contracting arrangements for WDs.
as of management. There is stability in
the organization structure and there are
dedicated resources.
6
Water districts have no national government equity, nor are they entitled to national government transfers from internal revenues.

Figure 2. Possible Contracting Arrangements for Water Districts
BOD
Performance Contract & Approval,

LWUA
Dispute Mediation
General
Manager
Performance contract
Regulatory Guidelines/
Performance Standards
WD
Staff
2.5 Case Studies and Lessons Learned 2.5.1 Case Study 1 - Improving
Production, Revenue Generation,
Performance contracts involving the internal and Quality of Service of the Jagna
management of the utility have been Waterworks System
recommended as an option of LGUs or
WDs to promote governance and improve Profile of the Utility. The Jagna
water utility performance. Unlike outsourced Waterworks System (JWS) is a water utility
arrangements, performance contracting within established in 1925 and run by the LGU of
the water service utility has yet to be widely Jagna in the Province of Bohol. The utility is
introduced and implemented in the Philippines. registered with the NWRB and is licensed
Such arrangement has been recently tested by to provide water supply services to the
pilot LGUs in the country under the assistance municipality. At present, the utility’s service
of the USAID-Philippine Water Revolving Fund coverage is about 27.7% of the municipality’s
Support Program (PWRF-SP). Developing total population. Water supply services are
countries like Uganda and Lesotho have adopted provided to 11out of 33 barangays.
this scheme and have seen positive results from
it.

Jagna is fortunate to have abundant supplies Although the water utility is able to raise
of water with excellent quality. Most of funds to cover its operations, it remains
the spring sources are naturally located at heavily dependent on subsidies from the
an elevation higher than the service area, LGU’s annual budgetary appropriation
so that water can be distributed to the and internal revenue allotment. Tariff is
consumers by gravity alone, thereby saving set through a municipal ordinance with its
pumping costs. attendant public hearings and consultations.
Current tariff, however, is still the lowest
Problems Faced by the Utility. Being among other municipalities in the province.
one of the municipality’s economic Moreover, while staffmembers are generally
enterprise programs, JWS is expected dedicated, the quality of personnel has
to operate autonomously using its own suffered due to insecurity of tenure, low
organization and resources. An assessment salaries, lack of skills training, and political
of its current situation, however, has interference in hiring practices.
revealed a need for: organizational change;
investments in physical as well as in human Key Terms of the Agreement. Driven
assets, improvements in management by the vision and mission to provide its
systems, securing water resources, population with sufficient potable water
improving provision of services to more and become a self-sustaining water utility,
citizens, and generating adequate revenues JWS agreed to be a pilot for utility reforms
to position itself for long-term operability. with the assistance of the PWRF-SP. After
Aside from the poor service coverage, ring-fencing its water utility accounts, it
the utility lacks basic facilities such as conducted business planning and prepared
filtration and water treatment facilities, its performance improvement program (PIP)
mother meter, leak detection devices, and a to address the utility’s problems. With the
calibration machine for flow meters, among PIP as basis, the utility staff and the mayor
others. Its decrepit pipe network accounts entered into a performance contract to
for its huge non-revenue water (NRW). undertake priority activities to be funded by
During the rainy season, water turbidity the LGU and accomplished within one and
is also experienced due to the uncovered a half years (from July 2011 to December
water channels from the spring source. 2012). The key activities include:
Target/Objective Activities
rehabilitation or replacement of old pipes, rerouting of
a) to upgrade the waterworks system in order to maximize submerged pipes along canals and drainage, expansion of
production capacity and increase service connections spring box and construction of bigger reservoir
b) to account for water consumption in order to increase water installation of water meters and stub-outs in all service
sales and improve billing efficiency connections, including public taps and institutions
installation of chlorinator and disinfection of water throughout
c) to improve water quality and ensure its potability and safety the distribution system
acquisition of a service vehicle, upgrading of tools and
equipment, computerization of customer ledger cards and
d) to improve the quality of customer service database, and establishment of strategic collection centers
implementation of better financial management measures and
e) to improve the utility’s revenue-generating capacity imposition of new water tariff

Annex 2-1 shows the specific targets and recognition, and c) exposure visits or out-of-town
timeframes of the above activities. A mid-year trips based on accomplishment of performance
assessment shall be conducted in August to evaluate targets. Incentives will be funded from the LGU’s
accomplishments vis-à-vis targets. An annual General Fund allotment for training and travels
assessment and business plan review should be and maintenance and other operating expenses
carried out in February. The annual assessment and (MOOE).
review shall be attended by all JWS staff, the LGU
local finance group, the Municipal Water Board, the Results/Benefits. Performance contracting
Sangguniang Bayan, and the Mayor. between the JWS staff and the mayor facilitated
the assessment of the state of the utility and
Incentives. The contract is based on performance identification of specific areas needing reforms
with incentives to be provided for accomplishment and improvement. It has defined and delegated
of defined and agreed milestones. As a government responsibilities to implement planned reforms,
agency, provision of incentives is bound by certain ensured funding for reform initiatives with the
policies and conditions, for example, personnel endorsement of the Sangguniang Bayan (for both
services limitation and availability of funds (see the business plan and the performance contract)
Annex 3). Both parties agreed to the following and provided a transparent basis for monitoring
incentives: a) training of the JWS staff on water activities to improve water utility performance.
utility operation and maintenance (including NRW Performance contracting also incentivized the staff
management) (a big brother type of arrangement to undertake assigned responsibilities.
with another utility will be facilitated); b) awards and
Mayor Fortunato Abrenilla of Jagna, in his latest testimonial, said that: “The reform process has
already delivered beneficial results to the JWS. Key performance indicators monitored showed
that our utility has increased its revenues by 34% due to improved collection effort, which
has shortened collection period from 1.5 months to 0.57 months. Return on assets has also
increased from 2.6% to 7% and average cost per cubic meter has been reduced from PHP4.74
to PHP3.79. We have also substantially reduced our subsidy to the utility by 32%. Currently, the
JWS is still facing challenges in its operation. But with a good performance monitoring scheme
stipulated in our performance contract with the JWS staff, we will be able to further institute
required reforms towards the efficient delivery of water services to the people of Jagna.”
2.5.2 Case Study 2 - Improvement of systems. About 52 level II connections have

the Mahayag Local Waterworks been established with an average of five
System (MALOWAS) for Better households per communal faucet. The
Service Provision and Revenue utility plans to expand its service area to six
Generation more barangays, bringing water services to a
total of 17 barangays.
Profile of the Utility. The Mahayag Local
Waterworks System (MALOWAS) was The LGU secured a PHP28 million loan
established in 1972 through the grant-in-aid in 2007 to rehabilitate and improve the
from the government. While a number of existing waterworks system and another
improvements were made possible by local PHP2 million from a rural bank for the
development funds as well as allocations installation of laterals and stub-outs,
from the Countrywide Development including the transfer of old service
Fund since its establishment, the present connections to the new system.
condition of the waterworks system does
not efficiently serve the needs of the Problems Faced by the Utility. Despite
area’s residents. Although MALOWAS has the loans, the current state of the utility
abundant water supply, only 1,524 (or 21%) is far from ideal. More facilities, such as a
of the total 7,276 households in ten chlorinator and a flow meter, have to be
lowland barangays are covered by level III installed. The water supply system (both
10

old and new facilities) has yet to be fully Key Terms of the Agreement. The
integrated. Worn-out pipes are major need to become a viable and self-sustaining
sources of leaks and make the water supply utility prompted the LGU to improve
prone to coliform contamination. There the operations of MALOWAS in order
are unmetered and unbilled connections to provide better and sustainable water
like public taps in government facilities supply services to its constituents and
(market, schools, barangay halls, health improve revenue generation to pay its debts.
centers, and offices) resulting in a high The LGU took the opportunity of being
volume of unaccounted-for water. While a pilot utility under PWRF-SP to pursue
the utility is manned by mostly regular staff, financial and operational reforms. As a
enhancements are needed in the areas pilot utility, it ring-fenced its water utility
of customer service, billing procedures, accounts, which has allowed it to calculate
and recording systems as evidenced by the financial losses being subsidized by the
consumers’ complaints about billing errors LGU and increased the latter’s resolve to
and slow response to minor repairs. pursue reforms. The utility staff underwent
training in business planning and developed
Customers who are not yet connected to its business plan and performance
the new system continue to be billed the improvement plan (PIP) thereafter. The
flat or old tariff rate while those connected mayor and the utility staff agreed to enter
to the new system are charged new tariff into a performance contract for a period
rates, causing confusion and inconsistencies of two years (July 1, 2011 to June 30, 2013)
in tariff collection. As a consequence, to focus the LGU’s limited resources on
there is a significant volume of accounts performing the following priority activities
receivables and a long collection period in the PIP:
equivalent to nine months. Utility operations
therefore continue to be highly subsidized.
a) to upgrade the distribution network in order to match the pipe- laying in identified barangays
increasing demand for service connections
b) to account for water consumption, increase water sales, and installation of water meters and stub-outs in all service
improve billing efficiency connections including public taps and institutions
c) to improve the efficiency of the water supply system and transfer of all service connections to the new distribution system
assure better service provision
d) to increase revenue generations phase out of the flat- rate and implementation of the approved
new tariff rates
Annex 2-2 shows the performance contract of the Incentives. Both the mayor and the MALOWAS
MALOWAS staff with their mayor. staff agreed to have incentives for performance
of defined tasks within specified timeframes. For
A monitoring and review team was formed accomplishment of targets six months after the
consisting of the Municipal Planning and contract takes effect, the staff will be trained in
Development Officer, the Chairman of the SB technical/capacity building related to the operation
Committee on Ways and Means, the Chairman of and management of a water utility system. The
the SB Committee on Appropriations, the Local LGU will arrange the training with a water district
Finance Committee and two representatives in the country with distinct competence on the
from the Local Development Council. Review of subject. Exposure or study visits to highly specialized
implementation progress and accomplishment WSPs in the country will also be conducted for
of targets by the Mayor and the monitoring and accomplishment of the following year’s target.
review team will be done every six months until the For achievement of targets leading to improved
expiration of the contract in 2013. income generation, staff will be awarded a plaque
11

of appreciation. Funding for all the incentives will the required financial and technical assistance to
be appropriated from the LGU’s General Fund facilitate the performance of the activities indicated
allotment for training and travels and MOOE. in the contract. Aside from ensuring mutual
cooperation between the mayor and the water
Results/Benefits. The performance contract utility staff, performance contracting also provided
forged between the MALOWAS staff and the LGU the platform for information exchange to ensure
management provided both parties a transparent the timely performance of activities agreed upon
guide to the implementation of priority reform under the contract. The provision of incentives also
initiatives in water service provision. The contracting encouraged the staff to strive for the successful
process secured the full support of the mayor for completion of their target activities.
Mayor Lorna S. Espina of Mahayag acknowledged the benefits of the reform initiatives undertaken
by MALOWAS as a pilot utility. She noted that “they now have a basis for financial analysis of water
utility operations and have improved their collection efficiency by 14%. We now have a guide in
pursuing strategies and allocating investment requirements to increase the coverage & and improve
service delivery of our utility. Embarking on performance contracting especially helped us improve
enhance the transparency in our water utility operations and monitor related civil works and financial
transactions. These reforms have paved the way towards our utility’s financial viability.”
2.5.3 Case Study 3 – Performance public facilities such as public markets, the
Contracting to Reduce Subsidies municipal hall, the municipal health office,
for Water Service Operations in and the police station.
Alburquerque
The utility personnel are inadequate. There
Profile of the Utility. The Alburquerque is a lack of full-time staff to manage the
Waterworks System (AWS) was established office. There is also a need to hire more
in the 1940s and is currently run by the job-order workers to serve as support staff
Municipal Government. Through the LGU’s for the Waterworks Supervisor or Manager
initiative, the utility underwent major who is at the same time the Municipal
expansion and rehabilitation in 2004. The Engineer.
AWS is responsible for providing potable
water to all 11 barangays of the municipality. The utility generates income from the
At present, the utility has 1,188 active water tariffs. However, the rates are low
level 3 service connections. Water sources and collection efficiency is only 88%.
include spring sources and groundwater. Income derived is only about PHP1 million
annually compared to the cost of operation
Problems Faced by the Utility. The (covering salaries and wages of personnel,
AWS has suffered major setbacks, especially power cost, and other operating and
during the last three years. All water maintenance cost) that amounts to PHP2.7
samples from each of the 11 barangays million annually. Given the fragile monetary
failed the bacteriological test because of position of the municipality, improving
the absence of water chlorinators. Water the finances of the AWS is one of the top
availability in all barangays averaged only 16 concerns of both the water utility and the
hours per day and there were occasional LGU.
service interruptions particularly in the
upland barangays. The problem is attributed Key Terms of the Agreement. The
to old and worn-out distribution lines LGU envisions having a “well-developed
(some of which were installed in the and managed water utility under an
1960s), the use of substandard diameter effective, efficient governance, sustainably
pipes, and insufficient water sources. The providing safe potable water to its
volume of unaccounted-for water is high citizenry.” Consistent with this vision, the
since there are no water meters installed in LGU agreed to be a pilot utility under the
12

PWRF-SP. As with the other pilot utilities, capacity. The performance contract between
the AWS staff completed the ring-fencing the mayor and the AWS staff is focused
of their water utility accounts, embarked on accomplishing the following priority
on business planning, and proceeded to activities within one and half years from July
performance contracting to improve the 2011:
utility’s operations and revenue-generating
a) to intensify the collection of overdue accounts issuance of disconnection notices to customers with overdue
accounts and disconnection of customers with unpaid overdue
accounts 5 five days after disconnection notices were served
b) to improve the tariff structure categorization of water users, conduct of tariff analysis and
consultations, issuance of ordinance on the new tariff structure,
and implementation of new tariff rates
c) to decrease incidence of water-borne diseases to 50% by 2012 installation of chlorinator, conduct of water testing and analysis,
and regular chlorination
d) to rationalize the use of electric water pumps construction of elevated reservoirs
e) to improve the utility’s water revenue revenue-generating capacity improvement of collection efficiency improved from 88 % to
90%, shortening of collection period from 3.7 to 3 months, and
improvement of operating ratio from 113 % to 100%
The detailed terms and conditions of their Results/Benefits. Part of the performance
performance contract are found in Annex 2-3. contracting process is getting buy-in from the
mayor and the SB to adopt the activities stated
Incentives. The mayor and the AWS staff agreed in the contract. While the process was a tedious
to adopt an incentive system for accomplishment one involving several meetings and workshops, it
of performance targets indicated in the contract. prompted the LGU management and the SB to
The incentives include training or capacity building, pursue the priority PIP activities and provided the
awards and recognition, and exposure visits or basis for budget allocation for these activities. The
out-of-town trips, and will be based on whether performance contract also facilitated the delegation
specific targets have actually been met. and monitoring of activities intended to improve the
operations and revenue-generating capacity of the
AWS.
Mayor Efren Tungol of Alburquerque remarked: “The utility reform process was an eye opener
to us. We realized how big our subsidy to the utility is every year. It was a shock to know that we
have been operating a losing enterprise for almost two decades already. Embarking on utility reform
has strengthened our resolve to improve our water utility operations. Performance contracting has
especially facilitated the move to increase our water tariff to support reforms. It is now on its second
reading at the Sangguniang Bayan and we have conducted the first public hearing on this proposed
increase.”
2.5.4 Case Study 4 - Area and Branch mandate as defined in the National Water
Performance Contracts in Uganda7 and Sewerage Corporation Statute of
1995 is to operate and provide water and
Profile of the Utility. Water supply sewerage services in areas entrusted to it,
services in Uganda, Africa are provided on a sound, commercial, and viable basis.
by the National Water and Sewerage The NWSC operations were initially in
Corporation (NWSC). NWSC is fully three towns. Currently, it serves 22 towns
owned by the Government of Uganda. It encompassing the larger urban centers
was established in 1972. The corporation’s within Uganda.
7
John Sitton. Using Performance Agreements to Improve Water Sector Performance in the Philippines. Final Report, PWRF-SP, November 2009.
13

Problems Faced by the Utility. In 1998, orientation and began focusing on results
the NWSC reported that its water supply and outputs. The contracts were later
operations were dismal, as evidenced by the revised to add incentives to motivate
following facts: the staff. In 2004, the introduction of
in-sourced competition, which invited all
• only three cities were breaking even staff to compete for the management of
financially, NWSC’s subsidiary utilities, showed the
• revenue collections were low and present management that it did not have
customer arrears high, and a monopoly on running its business units.
• volume of unaccounted-for water was This induced better performance among the
60%. managers and eased out poor performers.
The top managers also delegated
Key Terms of the Agreement. To responsibility to branch management in
improve performance, the NWSC began a the larger cities by implementing Branch
series of service and revenue enhancement Performance Contracts, which offered
programs in 1999. In 2000, it introduced rewards based on performance.
Area Performance Contracts between
its headquarters and area managers. Key contractual arrangements between
These increased the autonomy of the the NWSC Headquarters and the area
area managers, encouraged a commercial management team include:
Scope and definition of Operator’s obligations: Operations and maintenance; billing and collection; preparation of a
responsibilities one-year rolling business plan, safeguard, maintain assets; rehabilitation, extension of the
system, recordkeeping and reporting.
Headquarters’ obligations: bulk procurement, major capital works, coordination of area
business plan with company-wide budget and tariffs, provision of strategic support and
guidance, monitoring and performance evaluation, non-interference in area management,
inspection and audit
Performance Measures Water balance indicator, operational indicators, service indicators and financial indicators.
Indicators are weighted with cash operating margin (12), unaccounted-for water (10) and
billing (10), and collections (9) having the highest weightings.
The duration of the contract is two minimum performance standards. Penalties

years, which may be re-negotiated and apply if the performance falls short of the
renewed. Funding is based on a one-year minimum performance standards.
rolling business plan prepared by the area
management team, which the Headquarters Results/Benefits. The contracting scheme
coordinates with company-wide budget and between the NWSC headquarters and
tariffs. its area management units had been very
beneficial. Within 10 years, there were
Fees and Incentives. The area substantial improvements in NWSC’s water
management team receives a management services. Service coverage increased from
fee consisting of a base fee, performance 48% in 1998 to 72% in 2008 (see Table 3).
fee, and incentive fee. The base fee is a The number of connections increased by
pass-through of O&M costs that are outside almost 300% (from 50,826 to 202,559)
the management’s control. The performance with new connections averaging 25,000 per
fee covers performance-related costs: year. Staff efficiency considerably improved
those that management can control, or from 36 per 1,000 connections to seven
those that are discretionary and tied to per 1,000 connections. Collection efficiency
collection efficiency. The incentive fee is paid now stands at 92% and non-revenue water
if management performance exceeds agreed at 32.5%.
14

Table 3. NWSC Performance Improvement
1998 2008
Service Coverage 48% 72%
Connections 50,826 202,559
New connections per year 3,317 25,000
Staff per 1000 connections 36 7
Collection efficiency 60% 92%
A more detailed description of the terms have access to piped sewerage. The tankers
and conditions and incentive structure of the are used to empty septic and conservancy
performance contract are found in Annex 2-4. tanks, including VIP toilets.
2.5.5 Case Study 5 - Contracting Problems of the Utility. In 2004,

with the Utility Management in the utility had financial problems and
Lesotho8 had difficulty expanding its services. The
government availed itself of World Bank
Profile of the Utility. Water and assistance to improve WASA’s operations.
Sewerage Authority (WASA) is owned
by the Government of Lesotho in Africa. Key Terms of the Agreement. WASA
Established in 1992, WASA currently (represented by the Ministry of Finance
delivers potable water to more than and Development Planning), entered into a
300,000 people.It provides safe drinking three-year performance agreement with its
water to approximately 47,000 postpaid management (represented by its Chairman
connections and approximately 400 of the Board and the chief executive), the
public standpipes. There are also more operator, as a loan condition under the
than 2,500 domestic prepaid connections World Bank project. The key objectives of
and more than 2,200 communal prepaid the agreement were to:
card holders. The Authority also serves
many industrial and commercial premises, • establish key financial parameters,
particularly in Maseru, including Nien tariffs and levels of service necessary
Hsing, C&Y, Global Garment, and Lesotho to achieve the agreed level of financial
Brewing Company, which use about 36% sustainability by the end of the period,
of the water produced. In total, 40% of the • identify and register — all WASA assets
water produced is used in industries and and describe their — condition,
commerce. • improve water and wastewater service
levels, including the implementation of
WASA has over 5,000 customers who systems and procedures for proper
are connected to the sewerage system. measurement, and
Over and above the said connections, • establish a mechanism for period
the Authority operates a tanker service reviews of the tariff necessary for
that serves more than 8,000 registered WASA’s long-term sustainability.
customers in all of the country’s urban
centres. The emptying service is provided Key contractual arrangements between the
to households and businesses in areas that government and the WASA management
have a reticulated water supply but do not include:
8
Ibid.
15

Scope and Operator’s obligations: to strive to achieve service levels set by GOL government policy; to improve the utility’s financial health of the
definition of utility; to optimize asset performance of its assets; to improve planning and management of capital works; to improve human resource
responsibilities management; to maintain the appropriate level of staffing; to develop a strategy to implement the Government’s policy on service in
peri-urban areas.
Government’s obligations: to permit full commercial freedom to WASA; to carry out a tariff study, revise regulations and carry out periodic
tariff revisions to enable WASA to recover its operating and financing costs; to revise its water resource strategy to ensure sufficient water
supply and to enable WASA to achieve its performance targets; to permit WASA to disconnect any Government agency for non-payment
without interference from another government agency; to develop a policy for providing services to peri-urban areas and to allocate
funding from World Bank loan to procure services, goods, and equipment needed to achieve the performance targets.
Performance Include targets in the following areas: customer service, water resource management, corporate strategy, operations optimization
Measures and finance. Performance was assessed by a Technical Auditor appointed by the Commissioner of Water within the Ministry of Natural
Resources. (The agreement indicates that this role would have been performed by an economic regulator had one existed.)
The contract’s duration was three years, revenue, and reduced political influence
renewable with revised terms and targets on decisions regarding water service
after the third year based on WASA’s provision. For the managing or implementing
performance. A business plan was prepared parties, performance contracting not only
during the development of the agreement meant getting incentives but also gaining
which was updated annually. Financing from professional mileage and fulfillment in
the World Bank loan was linked to specific serving customers’ interests.
procurements intended to enable WASA to
achieve its objectives. There were also challenges faced in
implementing performance contracts.
Incentives. Management was paid Foremost was the need to generate the
an incentive fee or bonus based on required budget to implement the agreed
performance. The annual incentive fee activities and meet targets. Most often, the
was calculated using a formula, so that any implementing unit’s capacity to implement
individual performance that does not hurdle the activities for improved performance
the passing rate reduced the overall award also required capacity building or staffing
(see Annex 2-5 for details). However, no complement. Some parties were also
penalties were applied. resistant to increases in the cost of service
(tariff) and a certain degree of political
Results/Benefits. Having improved influence affected contracting arrangements.
WASA’s financial standing and increased The key to successful implementation of
services to peri-urban areas, the agreement contracts, however, was the strong political
facilitated improvement in the Authority’s will of the government entity and the
operations. In terms of incentives, the support of the utility’s management and
contract produced mixed results, with other stakeholders. Extensive advocacy on
management receiving 76.8%, 66%, and 80% the advantages and potential benefits of
of their incentive bonus in the first, second, performance contracting also helped.
and third years, respectively.
As regards the contracts, the following
2.5.6 Lessons Learned guidelines helped the utility in presenting
clear activities and targets:
Results from the preceding experiences • The contract should be complete,
attest to the merits of performance simple, and easy to understand;
contracting. Performance contracting has • All key words in the contract should be
improved water supply services through clearly defined;
expanded coverage and better operational • Contracting parties need to take time
and financial systems. It has relieved the to think through the objectives, terms
utility owners (either national or local and conditions and targets; and
government) of the burden in water service • Some flexibility, especially for the first
operations, enabled them to generate more contract (or if initial data is unreliable),
should be allowed.
16

3. PREREQUISITES
OF PERFORMANCE
CONTRACTING
Utility reform involves a series of interventions

(see Figure 3). The last step in these series of
interventions is performance contracting. Two
major activities, ring-fencing (specifically for LGUs)
and business planning, are undertaken prior to
performance contracting to ensure identification of
the performance improvement program.
17

Figure 3. Utility Reform Glide Path
3.1 Ring-fencing of Utility Accounts Ring-fencing involves the following steps:
Ring-fencing entails the segregation or isolation • establishing and maintaining separate books
of the water utility’s transactions from the of accounts and financial statements;
general account of the LGU. The rationale • opening a separate bank account;
behind ring-fencing stems from the lack of • formulating and implementing ring-fencing
reliable financial and operating reports, which financial management guidelines;
makes it difficult to set the appropriate tariffs • realigning and defining duties and
and plan for appropriate service improvements. responsibilities of the water utility staff; and
It is common practice for LGUs to combine the • transferring control and responsibility for
costs of their water and sewerage services with staff and assets.
those of other municipal services. For instance,
staff may work across different departments. For a more detailed discussion of ring-fencing,
Vehicles and other assets may be pooled and please refer to the Guide to Establishing LGU-
used across different services. Revenues also Run Water Utilities as Economic Enterprises,
may flow into a general municipal fund. In PWRF-SP, 2011.
these situations, determining the actual cost
of providing service and monitoring financial 3.2 Development of Perfomance
performance from one period to another can Improvement Plan/Business Plan
be extremely difficult. Thus, it is inappropriate
to enter into performance contracting After ring-fencing, the next step in the utility
without ring-fencing the water utility accounts reform glide path is business planning. It helps
and physically/organizationally ring-fencing water utilities determine the required technical
its operations. Ring-fencing will enable the operations and financing needs, including tariff
concerned parties to have sufficient information levels and collections, and quantify and schedule
to evaluate the agreement during negotiations capital investments in a sustainable manner.
and to monitor performance so that the utility The preparation of a business plan will help
has adequate control over the resources needed the utility management and staff in making
to meet its commitments. rational decisions related to the levels and types
of service provisions. It will also ensure the
effective use of the utility’s resources through
clear financial planning.
18

The business planning process entails a) The PIP will have the following elements:
strategic planning, which quantifies the
strategic goals identified and agreed upon • Statement of Specific Action
by stakeholders, and b) preparation of the • Strategic Goal Addressed
Performance Improvement Plan (PIP), which • Description of Primary Actions
translates these goals into a set of concrete • Schedule of Tasks and Milestones
and measurable actions. The strategic planning • Application of Investment Capital
process defines the utility’s vision, sets long- • Measurable Improvement in Performance
range goals and areas of primary focus to
identify key performance indicators, and spells The PIP is used as the basis for the performance
out the broad actions needed to achieve long- contract to be forged between two concerned
term performance improvement. The process units: the mayor or the general manager and
establishes the utility’s core priorities and sets the operator or implementing unit or staff. (See
the guidelines for future managerial decisions in Tables 4 and 5 for sample PIPs.)
the business planning process. The preparation
of the PIP will set the specific targets for each
broad action agreed upon in strategic planning.
Table 4. Example of a Performance Improvement Plan
19

Table 5. Example of a Performance Improvement Plan
20

In business planning, it is important to involve • Ability to adequately define the scope of
both the a) management team composed of the the agreement. For a performance contract
Water Supervisor and members representing to last, the parties must have a common
the utility’s key units (including operations and understanding of its objectives, the roles
maintenance, customer accounts management, and responsibilities of both parties, the
and general administration and finance), and b) resources required, and the timeframe for
the Policy Governing Body that will ultimately achieving the targets.
approve the business plan and the PIP. • Expertise to understand and evaluate the
obligations accepted under the contract. Both
The “Strategic Business Planning for LGU- parties must have the knowledge and
Run Water Utilities: Guide and Model for experience to understand what they are
Preparation of Business Plans, PWRF-SP, 2011” agreeing to.
provides an instructional process of conducting • Ability to achieve the desired outcomes of the
strategic planning and preparing the PIP for contract. The objectives of the performance
LGUs. For water districts, refer to the “Strategic contract must be achieved solely by the
Business Planning for Water Districts: Guide and parties involved and not depend on the
Model for the Preparation of Business Plans,” actions of others.
PWRF-SP, 2010. • Sufficient information so that each party
can evaluate and monitor the contract. Both
3.3 Key Requirements9 parties must have access to adequate,
relevant, timely, and verifiable information so
Once the water utility’s financial accounts that they can agree on the current situation
have been ring-fenced and the PIP has been and objectives of a contract, evaluate their
prepared, the concerned units are ready to roles and responsibilities, set baselines
enter into performance contracting. There are for monitoring performance and monitor
key requirements for the parties to enter into implementation performance.
performance contracting to ensure that the • Capability to control the resources needed to
contract will be effectively implemented. These honor their commitments. The concerned
key requirements include: parties must have authority and control
over the resources needed to implement
• Trust between parties. The utility owner their parts of the contract.
or management and the utility staff do • Ability of third parties to measure performance.
not enter into performance contracting Dispute resolution mechanisms cannot
negotiations as equal partners. The former function unless those tasked with mediating
has more control over the resources disputes can independently verify (for
required to achieve the target activities. example, through the use of external
In order for both parties to negotiate in auditors) the information presented by the
good faith, there must be a reasonable level parties.
of trust that will prompt each of them to • A legal or institutional framework. There
perform the role agreed upon. must be an adequate legal or institutional
• Ability to enter into an agreement. Both framework that permits the parties to
parties must have the authority to bind enforce the contract and to resolve
the government sufficiently to meet the disputes.
commitments made. • Limiting the contract to two parties. The
• Willingness to enter into an agreement. Both contract will be difficult to enforce if
parties should be genuinely willing to enter there are other individuals and entities
into a performance contract and both that will interfere in its implementation. It
should see some value in the agreement in is necessary to limit outside interference
order to commit to its performance. that would undermine the authority of the
parties involved.
9
Ibid.
21

22

4. STEPS IN
PERFORMANCE
CONTRACTING
Performance contracting involves a series of

activities or steps (see Figure 4).
23

Figure 4. Steps in Performance Contracting
Note: Boxes in broken lines signify prerequisites to performance contracting.
Step 1 - Identification of Contracting Parties Step 2 - Setting the Strategic Goals,

and Contracting Instrument Objectives, Scope and Timeframe
The stakeholders (utility owner represented by With the Performance Improvement Plan (PIP)
the mayor for LGUs or the General Manager/BOD as basis, the contracting parties will agree on
for WDs, management and staff) will first agree to the specific goals and objectives of the contract.
embark on a performance contract. The contracting The goals and objectives should address current
parties will then identify the specific staff to be issues faced by the utility. They should be specific,
involved and the signatories to the contract. As measurable, achievable, realistic and time-bound (see
much as possible, the contract should be just Table 6 for a detailed description).
between two parties to limit interference and
focus roles and repsonsibilities. The contracting
instrument will be in the form of a performance
contract (see Annex 2 for samples) or a
memorandum of agreement between the utility
owner and the utility management and staff.
24

Table 6. Setting Strategic Goals
Characteristic Description
Specific A Strategic Goal must be clearly stated in specific terms, so that there is no confusion as to the meaning and
purpose of the goal.
Measurable A Strategic Goal must be measurable in quantitative terms so that it can be monitored and assessed
objectively, which in turn, facilitates evaluating progress towards achieving the goal.
Example: “Non-revenue water will be reduced from 40 % to 30% by 2013.”
Acceptable If the work force of the utility does not accept a particular Strategic Goal, achieving it will be difficult.
Effective management requires that the work force take ownership for achieving the stated Strategic Goals.
If they do not understand why they are being asked to achieve a particular Strategic Goal, or if they do not
know the possible impact the Strategic Goal will have on them and the utility, once achieved, they will not
pursue it with commitment and determination.
Realistic While a Strategic Goal should be challenging, it must also be realistically possible to achieve the goal as
stated. If a strategic goal is unrealistic, the staff may become unmotivated to work towards it, because they
will never be able to reach it.
Time Bound A Strategic Goal should be stated such that it is accomplished within a specified time frame, say from one to
five years. When stating a longer- term for a strategic goal, it is advisable to state interim target goals to be
met.
For example, if the goal is to increase the bill collection efficiency rate to 95% by the end of Year 4 of the
business plan, and if the collection efficiency rate is currently at 25%, then interim goals could be stated as:
“The interim bill collection goal for end of Year 1 is 35%, end of Year 2 is 50%, end of Year 3 is 70%, and end
of Year 4 is 95%.”
Source: Strategic Business Planning for LGU-Run Water Utilities: Guide and Model for Preparation of Business Plans, PWRF-SP, 2011
The scope of the contract will define the area agree on the current situation and set baselines for
or activities to be covered by the contracting determining the priority activities and monitoring
arrangement. performance. In determining the activities, the
timeframe and budgetary constraints should be
There is no set timeframe for a performance taken into consideration.
contract but it should be realistic and sufficient
to implement the necessary activities, especially Step 4 - Defining the Roles and
when substantial effort and resources are required Responsibilities of the Contracting Parties
to achieve the desired performance goals and
objectives. Performance contracts should be The roles and responsibilities should be well defined
typically short ranging from one to three years (for and within the official mandate or function of each
LGUs in particular, the duration should be within party. In discharging their roles and responsibilities
the term of the mayor) to minimize uncertainties under the contract, both parties have to exercise
and risks such as changes in management and due diligence, efficiency, and economy in accordance
policies. One other important factor to consider with generally accepted professional conduct and
in setting the timeframe is the budgeting process practice. They should also comply with pertinent
affecting the water utility to ensure funding for policies governing civil service and the performance
planned activities. Thereafter, the contract may be of duties of public employees.
re-negotiated and renewed as required and agreed
upon by both parties. Step 5 - Setting Performance Indicators and
Targets
Step 3 - Determining Activities to be
Contracted The performance indicators should be adequate to
measure and gauge progress towards the desired
The activities or actions to be contracted should be objectives. Select indicators that clearly link to
linked to the objectives set by both parties. These objectives, which can be clearly defined by both
are preferably the priority activities from the PIP. parties and readily measured using available and
Both parties must have access to adequate, relevant, verifiable information.
timely and verifiable information so that they can
25

The corresponding targets should be specific to realistic in that the improvements they measure
the performance objectives of the agreement. are achievable considering the time frame and
Just like the goals, performance targets should be availability of resources (skills and financing, among
specific, measureable, accurate, realistic and time- others). Targets must be time-bound to provide the
bound (SMART). The information/targets needed necessary pressure for performance improvement
to monitor them should be available on a timely (see the box below for examples).
basis and auditable. They should be ambitious yet
Examples of Key Performance Indicators and Targets
A) Financial management of the water supply operations improved by (target date)
- Collection efficiency improved from ___ % to ___%

- Collection period shortened from ____ months to ____ months
- Operating ratio improved from ____ to ____
- Cost recovery ratio increased from ___ % to ____%
B) Non-Revenue Water reduced from ___% to ___% /or billed water increased from ___% to ___ % of total connection
by (target date)
- Rehabilitation of old pipes of ____m into PVC or PE pipes of ___m completed by (target date)
- Upgrading of distribution system and installation of stub-outs completed by (target date)
- Leak detecting devices installed in ____ areas by (target date)
- Flow meter at water source facility installed by (target date)
- Metered residential, commercial, and institutional connections and public taps increased from __% to __ % of total
connections by (target date)
- Defective/old water meters calibrated or replaced/changed with more efficient ones by (target date)
C) Billing and collection efficiency of water supply services improved to at least ___% and ___%, respectively by (target
date)
- Metered residential, commercial and institutional connections and public taps increased from __% to __ % of total
connections by (target date)
- 100 % computerization of customer ledger cards and database by (target date)
- ___ strategic collection centers established by (target date)
- ‘Operation Cut-Off’ for delinquents and long overdue accounts undertaken every (target date)
- Discount or rebate system for timely payments in place by (target date)
D) Water quality improved by (target date)
- Construction of slope protection/retaining wall of water source completed by (target date)

- Filtration facility(for systems with surface water sources) installed by (target date)
- Chlorinator installed by(target date)
- Regular chlorination conducted starting ____ and every _______ thereon
- Water testing and analysis conducted starting ____ and every _______ thereon
E) Improved tariff structure for water supply services implemented by (target date)
- Capacity building on tariff setting conducted

- Classification of current water user/customers completed by (target date)
- Tariff analysis conducted by (target date)
- Proposal for new tariff structure completed by (target date)
- Public consultation conducted by (target date)
- Sangguniang Bayan ordinance passed by (target date)
- 100% phase out of flat- rate by (target date)
- New water tariff rates implemented by (target date)
26

Normally, there is no single best practice target but Meanwhile, the setting of dispute resolution
there are industry and technical standards that can mechanisms is highly recommended with the
be used as basis. Having too many targets can make involvement of the economic regulator (such as the
monitoring cumbersome and costly. Also, a large NWRB) or the legislative body (Sangguniang Bayan)
number of targets tend to give equal weight to each for LGUs or third-party adjudicators for WDs.
target and often the least useful are the hardest and
most costly to measure. Performance contracts should be flexible enough
to consider unexpected and fortuitous factors
Step 6 - Determining Performance (including sudden changes in policies or the
Incentives/Linking Incentives to Performance occurrence of major calamities). Modification of
any provision or termination of the contract will
Performance contracts commonly tie incentives to be mutually agreed upon by both parties and will
accomplishment of defined and agreed milestones be recognized only if evidenced in writing signed by
to motivate the utility owner’s contracting party. each party or their authorized representatives.
In the Philippine setting, provision of incentives
is bound by certain policies and conditions, such Step 8 - Termination of Performance
as personnel services limitations and availability Contracts
of funds (see Annex 3 for details). Some possible
incentives include: Performance contracts may be terminated based
on agreed terms and conditions, for example,
• Awards and recognition non-compliance with or violation of the terms
• Exposure visits or trips and conditions provided in the contract, or as
• Training or capacity building determined on probable cause by the designated
• Merit incentives allowed under the Salary dispute mediator or third-party adjudicator.
Standardization Law and Civil Service Law,
such as Program on Awards and Incentives Finally, when designing performance contracts to
for Service Excellence (PRAISE) improve WSS services, consider the following good
practices:
To facilitate monitoring of accomplishment and
provision of incentives, the following can be done: • Ensure that both parties have expertise to
negotiate agreements;
• setting performance targets and weights • Keep contracts simple and easy for both
for performance targets (which amount to parties to understand;
100%) to stress importance; • Ensure that both parties have sufficient
• measuring performance during the period information to set baseline measurements
versus the target to determine the and targets, and to monitor performance
percentage of achievement (for example, over time;
1,000 new connections achieved versus a • Develop a financial model (for example,
target of 2,000 = 50%); and a business plan) to understand the link
• for monetary incentives, calculating the between objectives and resources;
percentage of the maximum agreed bonus • Ensure that both parties have control and
to be paid by comparing with agreed rating authority over the resources needed to
or scoring system with weighted values. meet their commitments;
• Link incentives to performance;
Step 7 - Setting Penalties, Dispute Resolution • Limit the number of performance measures
and Modification Provisions to those needed to measure the desired
improvement;
Penalties, like incentives, can also drive performance. • Use only performance measures that can be
However, like incentives, penalties for public audited by third parties;
utilities are governed by civil service policies. Firing, • Make dispute resolution mechanisms simple
demotions, or salary deductions are not applicable and easy to use;
penalties in public service unless they are based on
justifiable grounds.
27

• Be flexible by allowing adjustments in terms of budgetary appropriation for
or amendments, especially when first the planned activities and for monitoring
introducing internal agreements or when purposes (see Annex 2-6 for copies of SB
available information is unreliable; resolutions);
• Involve key stakeholders, such as the • Make performance contracts and periodic
economic regulator, in the design of the performance reports publicly available on a
performance contracts and in their approval timely basis;
or endorsement by the legislative or policy • Limit outside interference (that is, from
making bodies to ensure full support individuals and entities not party to the
for the implementation of the contract agreement) that would undermine authority;
and achievement of targets. For LGUs, in and
particular, it is strongly recommended that • Encourage competition among several
the performance contract be adopted or potential operators whenever possible,
endorsed by the Sangguniang Bayan to make whether by means of in-sourcing or
it more transparent and binding especially outsourcing.
28

REFERENCES AND LINKS
Alburquerque Waterworks Strategic Business Plan, 2011-2015
Strategic Business Panning Guide for Water Districts: Guide and Model for the Preparation of Business Plans
for Water Districts, PWRF-SP, 2008
Guide to Establishing LGU-Run Water Utilities as Economic Enterprises, PWRF-SP, 2011.
Jagna Waterworks Business Plan, 2011-2015
John Sitton. Using Performance Agreements to Improve Water Sector Performance in the Philippines. Final
Report, PWRF-SP, November 2009.
Mahayag Local Waterworks System Strategic Business Plan, 2011-2015
Strategic Business Planning for LGU-Run Water Utilities: Guide and Model for Preparation of Business Plans,
PWRF-SP, 2011
Asian Development Bank website. www.adb.org/.../Handbooks/Public-Private-Partnership/default
National Water and Sewerage Corporation, Uganda website. www.nwsc.co.ug/about.php
Public-Private Partnership Center website. www.ppp.gov.ph
The World Bank website. www.rru.worldbank.org/Documents/Toolkits/Water/Water_Full.pdf
Water and Sewerage Authority, Lesotho website. www.wasa.co.ls
29

30

ANNEXES AND APPENDICES
1 - Institutional Set-Up of Water Service Providers
2 - Sample Performance Contracts
2.1 Improving Production, Revenue Generation and Quality of Service of the Jagna Waterworks System
2.2 Improvement of the Mahayag Local Waterworks System (MALOWAS) for Better Service Provision
and Revenue Generation
2.3 Performance Contracting to Reduce Subsidies for Water Service Operations in Alburquerque
2.4 Area and Branch Performance Contracts in Uganda, East Africa
2.5 Contracting with the Utility Management in Lesotho, South Africa
2.6 Copies of Sangguniang Bayan Resolutions Endorsing Performance Contracts
3 - System of Incentives for Performance Contracting
APPENDIX A - Legal Bases and Types of Outsourced Performance Contracts
APPENDIX B - Some Examples of Outsourced Contractual Arrangements in the Philippines
31

ANNEX 1 - Institutional Set-Up of Water Service Providers
This section reviews the institutional set up for two types of water service providers: LGUs and water
districts, both public entities and loosely regulated vary widely in size, from 100 to 5,000 service
on service coverage and quality of performance connections.
targets. The Local Government Code vests
economic regulation of LGU-run water utilities Under the Local Government Code, LGUs are
on the Local Sanggunians. Since these Sanggunians entitled to annual block grants from the national
are not bound by national guidelines or subject government. These grants are determined through
to oversight, nor are members trained in sound a formula-based internal revenue allotment (IRA),
economic regulation, utilities are not guided which are automatic appropriations and cannot
or compelled to achieve performance targets. be earmarked by the national government. LGUs
Water Districts, on the other hand, are regulated can use at least 20% of their IRA for development
by a national agency, the Local Water Utilities projects, prioritization of which is at the discretion
Administration (LWUA). However, the LWUA is of the LGUs. They are authorized to generate their
also a specialized lending agency of Water Districts. own revenues through taxes, fees or charges, such
Thus, inherent in its interest as a funding agency, as for water supply services. They can also utilize
the economic regulation exercised focuses on tariff various financing mechanisms, like bank loans and
regulation, motivated by ensuring loan repayments. bonds, provided debt service obligation does not
Regulation of service coverage and performance exceed 20% of the LGU’s regular gross income.
targets is not actually exercised. BOT or joint venture contracts, LGU loans for
water projects or other revenue generating projects
Unlike the contracted utilities, which have for that matter, fall under general obligation, as these
defined targets in their agreements and built-in are backed up by IRA pledges.
incentives and disincentives for performance or
non-performance, the LGUs and WDs do not have Governance Structure
drivers or anyone compelling them to perform.
Hence, internal performance contracting is offered There is no uniform organizational structure for
as a self-propelling mechanism for progressive- LGU-run water utilities. The mayor sets policy
minded Boards and management to improve the direction and directly supervises the utility manager.
quality of water utility services. In many cases, the Municipal Engineer is also the
utility manager. Similarly, other LGU employees such
1. Local Government Units as the accountant and treasurer share their services
with the utility.
Mandate and Jurisdiction
The Mayor is elected every three years, and may
The Local Government Code of 1991 (Republic be re-elected twice. In that case, a mayor can
Act 7160) gave LGUs, particularly cities and potentially be in power for nine years. However,
municipalities the mandate and the responsibility since re-election is not a certainty, the mayor tends
of ensuring water supply and sanitation services to have short-term plans. The LGU staff, on the
to their respective constituents. LGUs have used other hand, has permanent appointments subject to
various service provision models. Some LGUs Civil Service Rules. In theory, they are supposed to
have relied on third-party providers, i.e., creation of provide project continuity. However, in practice, the
water districts, use of community-based operators, mayor can move or “freeze” the personnel and hire
and private contracts, but LGUs mostly operate other staff as consultants or contractuals.
the water utility directly. Water supply service is
typically treated as part of the overall operation It is also important to take note of resource
of a city or municipality. Operation of the utility is constraints. Investments in water supply and
normally part of the task of the municipal engineer. sanitation compete with other services. Only a few
Majority of LGUs do not ring-fence their utilities LGUs leverage their internal revenues with loans or
as independent economic enterprises, hence cost-based tariffs, thus constraining further available
performance is difficult to assess. LGU-run systems resources. Moreover, water supply and sanitation
32

projects take longer to prepare and implement. giving it the privilege to operate the public utility.
Hence, they often rank low in the priority list of By jurisprudence, water districts are qualified as
local chief executives who want highly visible and government-owned and controlled corporations.
quickly implementable projects that they can show As GOCCs, they are covered by COA audit,
off in the next elections. DBM-approved plantilla positions, Civil Service rules
and regulations, the Salary Standardization Law and
All these set a limitation on the scope and government procurement guidelines. The ruling,
timeframe of performance contracts with LGUs. however, fell short of identifying who owns them
Realistically, performance contracting with LGUs will (whether they are LGU-owned or if NG-owned,
tend to focus on short-gestating tactical measures who they will be accountable to). The LWUA is able
more than strategic reforms. to impose key performance and financial indicators
for water districts with loans, but do not do so for
2. Water Districts those without loans.
Mandate and Jurisdiction Water districts are autonomous corporations.

Although their assets came from the LGUs, these
Advocacy for corporatized service providers were paid for over time. They were not provided
grew in the 1970s, which paved the way for the with national government equity, nor are they
promulgation of Presidential Decree 198 or the entitled to national government transfers from
Provincial Water Utilities Act of 1973. PD 198 internal revenues like the LGUs are. Hence, they
authorized the creation of water districts and rely entirely on their revenue stream to leverage
established the Local Water Utilities Administration capital funding and to defray operation and
(LWUA), a financing and regulatory institution for maintenance costs.
water districts. The creation of water districts
is initiated by LGUs. The LGU legislative body Water districts are classified into:Very large, Large,
(Local Sanggunian) enacts a resolution naming the Big, Medium, Average and Small. The classification
district, defining its boundaries, transferring assets is based on the size of resources, financial
of the existing waterworks system, and naming the capability in satisfying operating requirements
initial set of its Board of Directors. Subsequently, and scope/complexity of operation, and service
the appointment of the Board of Directors connections. The table below shows the categories
rests with the municipal mayors or provincial and geographic distribution of water districts in the
governors.10 The resolution is then forwarded country.
to the LWUA for the issuance of the Conditional
Certificate of Conformance (CCC), essentially
Water Districts by Category as of December 2007
Category (service connections) Luzon Visayas Mindanao Total

Very Large (19,000- 135,000) 3 3 3 9
Large (15,000- 58,500) 12 4 2 18
Big (3,500 to 27,000) 38 1 11 50
Medium (2,300 to 14,000) 41 14 9 64
Average (1,500 to 7,500) 22 12 12 46
Small (100 to 4,500) 153 72 61 286
Total Operational Water Districts 269 106 98 473
Non-operational Water Districts 144
Grand Total 617
Source: LWUA Corporate Planning Office and Management Services
10
In case the Water District covers several municipalities, the mayor of the municipality or city with at least 75% of service connections will be the
appointing authority. Otherwise, authority is vested in the provincial governor. 33

Governance Structure beyond one municipality. Hence, in some cases,
political interference by the LGU Executive is
Water districts as corporate entities have better exercised through the Board. However, considering
governance structure. There is a Board that provides the arms-length relationship, the political influence in
policy direction, approves major capital projects policy or management decisions is not as pervasive
and their financing, and approves tariffs endorsed as it is in the case of LGU-run utilities.
to the LWUA. The Board has the authority to set
performance standards, hire and fire management Most water districts maintain a professional staff
within the ambit of Civil Service Rules and with core knowledge of the technical aspects of
Regulations, and (although covered by the Salary the utility’s operation, accounting and financial
Standardization Law) exercise some flexibility in management. The management and staff have
providing incentives to management and staff. The secure tenure. The Figure below shows the typical
governor or mayor appoints the board members organizational structure of a water district.
if the franchise area of the water district extends
Typical Organizational Structure of a Water District
75
General Manager (1)
Administrative Office 3 Engineering and Planning 3

Secretary (1) Section
Cleaning Services (1) Senior Engineer (1)
Driver (1) Junior Engineer (2)
Finance Section 3 Technical Section 55 Customer Service 10

Head of Section (1) Head of Section(1) Head of Section (1)
Accounting 1 Water Production and 12 Equipment/Services 9 Water/Sew age Netw ork 16 Water Reservoirs # Customer Service 9
Treatment Head of Sector (1) (5-Work Teams) Head of Sector (1) Meter Installer (1)
Accountant (1) Head of Sector (1) Welder (1) Head of Sector (1) Workers Res. No.1 (4) Meter Readers (5)
Lead Operator (4) Excavator Operator (1) Supervisor (5) Workers Res. No.2 (4) Billing Clerk (1)
Pump Operator (4) Equipment Operator (2) Netw ork Specialist (10) Workers Res. No.3 (4) Cashier (2)
Electrician (1) Electrician (1) Guard (4)
Supplies 1 Mechanic (1) Driver (3)
Chemist (1)
Supplies Clerk (1)
Source: Strategic Business Panning Guide for Water Districts: Guide and Model for the Preparation of Business Plans for Water Districts, PWRF-SP, 2008
The corporatized structure of Water District lends resources. In addition, relative to the LGUs, Water
itself better to internal performance contracting. Districts leverage their resources more through
There is a clear delineation of policy setting and credit financing, and generally charge cost-based
oversight, as well as management. There is stability in tariffs.
the organizational structure and there are dedicated
34

ANNEX 2 – Sample Performance Contracts
2.1 Improving Production, Revenue Generation and Quality of Service of the Jagna
Waterworks System
2.2 Improvement of the Mahayag Local Waterworks System (MALOWAS) for Better
Service Provision and Revenue Generation

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2.6 Copies of Sangguniang Bayan Resolutions Endorsing Performance Contracts
ANNEX 3 - System of Incentives for Performance Contracting
Two types of incentives for performance In addition to the basic salary, LGUs and Water
contracting have been researched: 1) incentives to Districts can give performance-based awards
the institution, that is, the LGU or Water District; and bonuses based on the Joint Resolution No.
and 2) incentives accruing to the utility managers 4 Authorizing the President of the Philippines
and personnel. The review on available incentives to Modify the Compensation and Position
includes legal basis, types of incentives such as Classification System.11 This Resolution was
recognition or financial reward, and conditions for passed by both Houses of Congress in 2009 to
award. authorize the President to update the government’s
compensation plan and schedule, as well as identify
Institutional Incentives incentives that can be provided to government
personnel to encourage excellent performance and
Currently the institutional incentives are limited to productivity.
recognition or awards for good performance. For
LGUs, the most relevant is the Galing Pook Award, The applicable provisions are:
a prestigious award that promotes best practices
in governance and delivery of public services. Every For Water Districts
year, the Galing Pook Foundation gives awards to
10 outstanding local governance programs. From Water Districts can provide incentives as rewards
time to time, there are special citations based on for exceeding agency financial and operational
key advocacies and Foundation’s development performance targets, and to motivate employee
thrust. The Galing Pook Award is conferred by the efforts toward higher productivity. The incentive
President of the Philippines. has to be identified in the District’s Performance
Management System.
For Water Districts, awards for good performance
are given by the LWUA and by the Philippine For Local Government Units
Association of Water Districts. Good performance
is reckoned by key performance indicators on Section 7 of the Resolution states: “The salaries,
financial and technical grounds. wages, allowances and other emoluments and
benefits of officials and employees of LGUs shall
The Galing Pook and Water District Awards do not be determined by their respective Sanggunians
have cash components. in accordance with the pertinent provisions of
Republic Act 7160: Provided, that LGUs may, if their
Personnel Incentives finances warrant, grant salary or wage adjustments
to their personnel, subject to the personal services
The salaries of water district and LGU personnel limitation in the LGU budgets under Republic Act
are governed by the Philippines’ Compensation and 7160: Provided, further, that the grant of allowances
Position Classification System. Each position in their and other benefits shall be subject to the said
respective plantilla has a corresponding salary grade personal services limitation.”
and within each grade, there are eight steps with
corresponding salary increases. An employee may Further, the salary or wage adjustment, if warranted
progress from Step 1 to Step 8 of the salary grade in by the finances of the LGUs, shall be determined on
recognition of meritorious performance based on a the basis of the income class and financial capability
Performance Management System (PMS) that should of each LGU but shall not exceed the following
be approved by the Civil Service Commission. Each percentages of the rates in the Salary Schedule
WD or LGU is required to submit their PMS to the under item 4(b) of Joint Resolution No. 4.
Commission.
11
See http://www.dbm.gov.ph/index.php?id=1277&pid=87 for a full copy of Joint Resolution No. 4.
74

Income Classes For Provinces and For The PIB may be given to officials and employees of
Cities (%) Municipalities government corporations (including water districts)
(%) and to LGUs. The primary eligibility requirement
Special Cities 100 -- is for the concerned official or employee to
have gotten at least a satisfactory rating for two
1st Class 100 98
consecutive semesters immediately preceding the
2nd Class 95 85
year in which the incentive pay will be given. The
3rd Class 90 80 incentive pay shall be based on individual personnel
4th Class 85 75 productivity and performance as evaluated and
5th Class 80 70 determined by the heads of the respective offices
6th Class 75 65 in accordance with the policies and standards set
by the Civil Service Commission. The amount
Note, however, that as of this writing, the of the incentive may vary for each official or
Implementing Rules and Regulations of Joint employee within an agency depending on individual
Resolution No. 4 have not been promulgated. performance appraisal. However, the total cost
In view thereof, the current applicable basis for of the incentive pay that will be given within any
performance incentives is still the Performance one year shall not exceed an aggregate total of
Incentive Benefit (PIB) allowed by Administrative an average of PHP2, 000 per filled-up position of
Order 161 signed by then President Fidel Ramos on the agency plantilla. The source of the funding for
January 1, 1995. 12 government corporations and LGUs shall come
from their respective corporate or local budgets.
For this purpose, water districts and LGUs are
authorized to appropriate annually an amount to
cover these benefits.
12
See http://www.dbm.gov.ph/index.php?pid=87&id=91 for a full copy of the Administrative Order.
75

APPENDIX A. Legal Bases and Types of Outsourced Performance Contracts
Performance contracting in the Philippines is expertise include but are not limited to: a) advisory
supported by a number of policy issuances in the and review services; b) pre-investment or feasibility
form of laws and executive orders. These guide the studies; c) design; d) construction supervision; e)
nature and determine the terms and conditions management and related services; and f) other
of various types of contracts for performance technical services or special studies. Performance
improvement. contracting follows the bidding process prescribed
by this law.
Republic Act 7160 (The Local Government Code
of 1991) Republic Act 6957 as amended by RA 7718 (The
Build Operate and Transfer Law)
The LGC provides autonomy to the LGUs to meet
the priority needs of and deliver development and The BOT law recognizes the vital role of the private
basic services to their constituents. Under the sector in development and provides incentives (such
Code, LGUs enjoy full autonomy in the exercise of as financial incentives as provided by law, minimum
their proprietary functions and in the management government regulations and procedures and specific
of their economic enterprises. As a corporate entity government undertakings in support of private
(Section 15), LGUs may enter into contracts and sector participation) to mobilize private resources
exercise other powers granted to corporations for the purpose of financing the construction, O&M
within the limits of applicable laws. Article 65 of of infrastructure and development projects normally
the IRR of the Code allows LGUs, through an financed and undertaken by the government. BOT
ordinance, to sell, lease, encumber, or dispose of is defined as a contractual arrangement in which
public economic enterprises owned by them to the the private entity undertakes the construction,
private sector to ensure their active participation in including financing, of a given infrastructure facility,
local governance. Moreover, Section 34 allows LGUs and its operation and maintenance over a fixed
to enter into joint ventures and other cooperative term. During that period, it is allowed to charge
arrangements with people’s and non-governmental facility users appropriate tolls, fees, rentals, and
organizations to engage in the delivery of basic charges to enable the recovery of its investment
services and to develop local enterprises. The aim is and O&M expenses. Water supply is included
to improve levels of productivity and income, and to as one of the private sector infrastructure or
enhance the economic and social well-being of the development projects qualified for the BOT scheme.
people. The law authorizes LGUs and other government
infrastructure agencies, including government-owned
Republic Act 9184 (Government Procurement and controlled corporations (GOCCs) such as
Reform Act) Water Districts to enter into contract with any duly
pre-qualified private sector proponent (individuals,
The GPRA law promotes the principles of good groups, or corporations) with extensive experience
governance and accountability and provides or expertise in undertaking infrastructure or
a transparent and systematic process for the development projects allowed under the law. The
procurement of goods and services by public law further allows LGUs to formulate additional
entities. Contracts for goods and services entered guidelines/procedures not in conflict with the BOT
into by LGUs and WDs as the procuring entities law and pertinent provisions of RA 7160 and their
have to comply with the eligibility requirements implementing rules and regulations.
and procurement procedures provided under
this law. Under the law, performance contracting The BOT law describes the various contractual
forms part of consulting services for infrastructure schemes and variants and sets the requirements and
projects and other types of projects or activities of procedures in undertaking BOT contracts. The list
a government entity requiring external technical and of eligible contractual arrangement is exhaustive and
professional expertise that are beyond its capability even includes a catch-all phrase allowing variations
and/or capacity to undertake. These services or on any of the modalities. The list includes, but is not
limited to:
76

Management contract. This is a contractual Lease contract. In lease arrangements, the contractor
arrangement for the management of a part or whole (a private or another public-sector entity) leases the
of a water utility by another entity (contractor), utility from the public utility owner (LGU or Water
which performs the necessary managerial functions District for instance) for an agreed period of time.
in return for a fee that is typically performance- Generally, the owner maintains the responsibility
based. A management contract is often formed for investment and bears the investment risks. The
where there is a lack of local or internal skills to run operational risks are assumed by the operator,
the specified undertaking. which undertakes the management and maintenance
of the utility.
Design-build or turnkey contract. This contractual
arrangement is a traditional public sector Concession. In this type of arrangement, the owner
procurement model for infrastructure facilities (LGU) defines and grants specific rights to a private
involving private sector participation. Generally, a entity (concessionaire), which is responsible not
private contractor is selected through a bidding only for the operation and maintenance of assets
process. The private contractor designs and builds but also for financing and managing investment.
a facility for a fixed fee, rate or total cost, which is The government usually retains ultimate ownership
one of the key criteria in selecting the winning bid. of the assets. Rights to all the assets, including
The contractor assumes risks involved in the design those created by the operator, typically revert to
and construction phases. the government at the end of the contract period
usually ranging from 25 to 50 years. Payments may
be done both ways: the concessionaire pays the
concession rights to the government and the latter
may also pay the concessionaire, which it provides
under the agreement to meet certain specific
conditions.
77

APPENDIX B. Some Examples of Outsourced Contractual Arrangements in the
Philippines
An outsourced contractual arrangement is a contracts include supply, service, operational or
legally enforceable agreement between unrelated maintenance management contracts. It can involve
parties where the owner of the utility transfers a wide range of functions such as operational
or delegates service provision responsibility. An control or technical operation of the water facility,
unrelated party may be a private-sector entity or management of personnel, accounting, marketing
another public-sector entity. Such a relationship services, training and service and equipment
allows either party to walk away during negotiations procurement. The simplest type of contract
if unsatisfied, or to sue in the courts to enforce involves the payment of a fixed fee for performance
performance under the contract. of managerial tasks by the operator. For more
complex contracts, greater incentives for efficiency
There are several types of formal contractual improvement based on defined performance targets
arrangements for water supply operations, usually are provided with the fee, which is partly based on
involving public-private partnerships (PPPs). They their fulfillment. Under this contractual arrangement,
vary depending on the nature of responsibility being the utility retains ownership of the facility and
contracted, agreement on ownership of capital equipment. In terms of risk, the utility bears the loss
assets, accountability for investment, assumption of if it cannot cover its costs. The contract period is
risks and duration of the contract. Thus, a formal usually short, ranging from two to five years.
contractual arrangement can range from short-term
simple management contracts (with or without A management contract has the following
investment requirements) to long-term and very advantages:
complex, sophisticated BOT form, to concession.
• Focused on specified functions being
Management contract. This is a contractual contracted
arrangement for the management of a water utility • Does not involve lumpy investment by both
(or a part of it) by another entity (the operator), parties and can easily be terminated
which performs the necessary managerial functions • Easy to monitor especially if based on
in return for a fee that is typically performance- defined performance targets
based. A management contract is often formed • Has renewable terms and revisable targets
where there is a lack of local or internal skills to run
the specified undertaking.Variants of management
78

Supply and Management Contracts
A Local Cooperative-LGU Contracting Experience
The Cardona MPC and the LGU of Cardona in Rizal Province entered into a contract for the management and
operation of the waterworks system of the municipality servicing 7 seven out of its 18 barangays. The cooperative
provided the personnel and services for the operation of the LGU’s water utility. Now on its third renewal, the current
contract has a duration of five years. The objectives of the arrangement are three-fold: 1a) to improve the delivery
of water services to the community; 2b) to transform the waterworks system into a performing or earning asset; and
3c) to contribute to progress through people empowerment. Provisions of the contract included the regular reporting
requirements on the financial status of the waterworks operation, the 40-60 % sharing arrangement in the net profit in
favor of the cooperative, enforcement of water quality standards and discount on water use of the LGU. There are no
specific performance standards imposed except for the provision of 24/7 water supply to the service areas and regular
remittance of LGU share of the earnings. Though not stipulated in the contract, additional service areas granted to the
cooperative served as an incentive for good performance.
The contracting arrangement benefited the cooperative in terms of providing additional source of income and enabling
the coop to provide community service in consonance with its mandate. On the part of the LGU, aside from generating
a regular income from its water utility, the contracting arrangement provided better water services to its constituents.
The biggest challenge to the cooperative at the moment is the entry of Manila Water, which has a franchise over their
area of operation as part of the latter’s concession agreement with the MWSS.
Bulk Water Contract between a Water District and an LGU
The Metro Cebu Water District (MCWD) located in Cebu City considered several options before entering into a bulk
supply arrangement with the LGU of Danao City. The options included joint venture, BOT and procurement schemes.
They finally settled for a negotiated contract since such an arrangement is legally and administratively feasible in
accordance with RA 9184 (Procurement Law). The terms of the contract focused on performance indicators and
rates as follows: water quality standard, injection point, water rate which is not to exceed PHP 21 per cubic meter,
production/supply schedule, and supply duration. Agreement of both parties on the other terms and conditions,
including on technical aspects and damages and penalties, is still being worked out. The importance of having clear
and transparent provisions of a contract is emphasized to facilitate the achievement and monitoring of targets.
Design-build or turnkey contract. This Lease-affermage contract. In leases or affermage

contractual arrangement is a traditional public arrangements, the operator or leaseholder (a
sector procurement model for infrastructure private or another public-sector entity) leases the
facilities involving private sector participation. utility from the public utility owner (contracting
Generally, a private contractor is selected through authority) for an agreed period of time. Generally,
a bidding process. The private contractor designs the owner maintains the responsibility for
and builds a facility for a fixed fee, rate or total cost, investment and bears the investment risks. The
which is one of the key criteria in selecting the operational risks are assumed by the operator,
winning bid. The contractor assumes risks involved which undertakes the management and maintenance
in the design and construction phases. The scale of the utility. The operator is not expected to
of investment by the private sector is generally make substantial investments since the risks
low and for a short term. Typically, in this type of include the likelihood that tariffs would not yield
arrangement there is no strong incentive for early enough revenue to pay for such investments or
completion of a project. that subsequent governments would renege on
79

previous or original agreements. If the lease model is contract period is generally longer. In such cases, the
adopted in combination with other models such as operator is also required to make a significant level
build-design or build-operate-transfer schemes, the of investment.
Improving the Governance of a Water Utility Through DBL Arrangements
The LGU of Sta. Cruz engaged in a Design, Build and lLease (DBL) arrangement with the SIG Construction
and Industrial Corporation, a private firm, for the implementation of its urban water and sanitation project.
The P44 million project (plus the 10% LGU counterpart) is a loan from the Development Bank of the
Philippines (DBP)’s lending facility, which is funded by the World Bank.
Under the DBL scheme, the private firm builds the system and the following arrangements are enforced: 1a)
the LGU, the debtor of DBP WB Loan, pays DBP a monthly amortization for a period of 15 years using the
rentals paid by the operator; 2b) the SIG Construction and Industrial Corp., the operator, pays LGU Sta. Cruz
an annual lease fee that shall increase every three years and a supervision fee of PHP2.00 per /connection
per /month; and 3c) the operator maintains a Lease Performance Security in favor of the LGU in the form
of a cash bond. The DBL contract spells out the rights and responsibilities of the contracting parties – the
operator and the LGU, provisions for dispute resolution and penalties for failure to meet service obligations.
The DBL arrangement has relieved the LGU of the burden of operating the municipality’s water utility system
and has generated revenues for the LGU. More importantly, the arrangement has improved the standard and
quality of water supply services provided to the LGU’s constituents.
While a lease contract is similar to an affermage, retains ultimate ownership of the assets. Rights
they differ technically. Under a lease, the operator to all the assets, including those created by the
retains the revenue collected from services operator, typically revert to the government at
rendered and pays a specified lease fee to the the end of the contract period, typically ranging
owner. On the other hand, under an affermage, the from 25 to 50 years. Payments may be done both
operator and the owner share the revenue collected ways: the concessionaire pays the concession
from services rendered. Under both affermages and rights to the government and the latter may also
leases, the operator’s profits depend on the utility’s pay the concessionaire, which it provides under
sales and costs, which typically give the operator the agreement to meet certain specific conditions.
an incentive to improve operating efficiency and Usually, such payments by the government may be
increase sales. In both arrangements and as part of necessary to make projects commercially viable
the lease, some assets may be transferred to the and/or to reduce the level of commercial risk taken
operator on a permanent basis for a period that by the private sector, particularly in the initial years
may extend over the assets’ economic life. Fixed of the partnership when the private sector may
facilities and land are usually leased out for a longer not have enough confidence in undertaking such a
period than mobile assets. Land to be developed by commercial venture.
the leaseholder is usually transferred for a period of
15-30 years. There are two types of concession agreements:
1) franchise or 2) BOT type. Under a franchise
Concession. In this type of arrangement, the arrangement, the private sector (concessionaire)
owner (government) defines and grants specific provides services that are fully specified by the
rights to a private entity (concessionaire), which government (owner or franchising authority). In
is responsible not only for the operation and this arrangement, the private sector carries the
maintenance of assets but also for financing and commercial risks and may be required to make
managing investment. The government usually investments. Meanwhile, under a Build-Operate-
80

Transfer or BOT (and its other variants, namely the concessionaire. Under a BOT model, however,
Build-Transfer-Operate, Build-Rehabilitate- the government has explicit and implicit contingent
Operate-Transfer, and Build-Lease-Transfer) type liabilities (due to loan guarantees provided and
of arrangement, the concessionaire undertakes default of a sub-sovereign government and public or
investments and operates the utility for a fixed private entity on non-guaranteed loans). By retaining
period of time, after which the ownership reverts ultimate ownership, the government controls policy
back to the government. The operating and and can allocate risks to those parties best suited to
investment risks may be substantially transferred to bear or remove them.
Private Sector-LGU BOT Experience
Balibago Water Systems , Inc. (BWSI) is a private water utility operating in 31 areas in 9 nine provinces
in Luzon. Its contract with LGUs is for the provision of safe and reliable water supply services through a
modified build-operate-transfer scheme for a period of 35 years. As part of the agreement, BWSI designs,
constructs, manages, and maintains a complete waterworks system and renders water service, which
conforms with standards and regulations set by the National Water Regulatory Board (NWRB). The LGU
assists BWSI in securing all rights of way and easements, local permits and the requisite Sangguniang
Bayan resolutions for its operation. Other provisions of the contract include expiration, termination and
renewal; tariffs based on NWRB’s 5 five-year tariff- setting methodology; warranties and conditions
precedent. Among the issues and challenges which confrontfaced by BWSI in this type of contracting
arrangement include: 1) change in LGU leadership/ signatories; 2) tariff increase and power cost adjustment;
3) commencement date of the 35-year term; 4) employment and other LGU requests; and 5) collection
issues. Despite these challenges, there are significant benefits to the concerned parties. The LGU, for
instance, is able to expand its political mileage; gain revenues from permits, taxes, and fees; and generate
employment for the community. For BWSI, the contracting arrangement facilitated the realization of their
company’s vision and mission and enhancement of stakeholders’ interests.
Regulating Water Supply Concessionaires’ Operations in Metro Manila
The MWSS-Regulatory Office (MWSS-RO) was created by virtue of the concessionaire agreement
between the government and two Metro Manila concessions (Manila Water and Maynilad). The concession
agreement focuses on the provision of water supply and sewerage services in Metro Manila and ensures a
balance between protecting consumers from high prices and poor services and providing incentives to firms
in order for them to invest, be efficient, and earn profit.
As part of its mandate, the MWSS-RO monitors the conduct of service obligations of the two concessionaires
based on a set of key performance indicators (KPIs) focused on water service, sanitation and customer
service and business efficiency measures (BEM) including income, operating expense, capital expenditure
and NRW. The MWSS-RO adopts an incentive regulatory framework that provides for a reward and penalty
system based on NRW reduction. A reward and penalty threshold is set based on the end- of- year target for
NRW. Actual NRW is gauged against this threshold and the resulting NRW savings/deficiency is made as
the basis for the concomitant reward or penalty for the concessionaire and tariff computation/adjustment. It
uses the following success indicators in the application of incentive regulation: 1) no-surprises approach; 2)
full water rates implementation (one time/staggered rates versus. CAPEX roll-out programs); 3) attainment of
enhanced service obligation targets; 4) phase-in period of application; and 5) attainment of efficiency gains.
The MWSS-RO conducts a review, examination, and revalidation of the concession service obligations for
rate rebasing, set KPIs and BEMs and their business plans.
81

Efficiency Gains Resulting from Concessionaire Agreements
BEFORE AFTER PRIVATIZATION

PRIVATIZATION 2nd Quarter 2009
1997
Service Population 7.0M (est) 5.90M 6.90M
Water Sources Angat (97%) Angat (97%) Angat (97%)

+ deepwells (3%) + deepwells (3%) + deepwell (3%)
Water Distributed 3,000mld 1,600mld 2,400mld
Water Availability 67% 99% 60%
Non-Revenue Water 61% 16% 60%
Billed Volume (MCM) 266 227 167
Tariff / cum (Pesos, ave. all-in) P8.78 P 27.76 P 30.85
Staff/1000 Connection 9.8 1.5 2.6
* Selected Indicators
The following regulatory practices adopted by the MWSS-RO have been proven effective in improving water
service performance and coverage, specifically: 1) strengthening accountability of the concessionaires
to accomplish their submitted business plans, align their investment plan with the interests of MWSS and
consumers and ensure that tariffs are commensurate to the required levels of service; 2) establishment of
KPIs and BEMs; 3) implementation of a reward and penalty system; 4) development of CAPEX Monitoring
Manual; 5) flexibility in amending the concession agreement (for example, based on foreign-exchange
losses/gains, water connection charges, rationalization of sewer/sanitation charges); 6) conduct of Public
Assessment for Water Services (PAWS); 7) creation of the Project Management Committee (PMC); 8)
staggering of rates; 9) transparency in the regulatory process; and 10) avoidance of micro-managing the
concessionaires.
Joint venture. This is a contractual arrangement activity, with each party having a right to direct and
between a public entity or group of entities govern the policy in connection therewith, and with
and a private sector entity or group of entities a view of sharing both profits and losses, subject
where both contribute capital, services, assets or to agreement by the parties. A joint venture may
a combination of these and share risks to jointly be contractual (legal and binding agreement under
undertake an investment activity to accomplish a which the partners perform the primary functions
specific and special goal. Joint ventures facilitate and obligations under the agreement without
private sector initiative in a particular industry forming a joint venture company), or corporate
and pave the eventual transfer of ownership of (registered with the Securities and Exchange
the investment activity to the private sector Commission to perform the primary functions and
under competitive market conditions. It involves obligations of the joint venture as stipulated under
a community or pooling of interests in the the JV Agreement).
performance of the service, function, business or
82

The table below contains a summary of examples of outsourced contracting arrangements in the Philippines.
Philippine Contracting Arrangements

Management Bulk Supply Contract Design-Build-Lease Build-Operate-
Contract Transfer
Contracting Parties LGU of Cardona & and Metro Cebu Water LGU of Sta. Cruz and LGU and Balibago
Cardona Multipurpose District and& SIG Co. Waterworks System,
Coop LGU of Danao Inc.
Objective Manage and operate Provision of bulk water Source development, Source development,
the WS system supply construction and O&M construction and O&M
Performance Targets 24/7 supply at DOH Achieves quality, 100% coverage 24/7 @ 16 psi
quality pressure and schedule NRW at most 25%
24/7 @ 5psi
Ownership of Capital LGU of Cardona LGU of Danao LGU of Sta. Cruz; Contractor until
Assets LGU paid for investment turnover to LGU
Role of Contractor Provide WSS service Construct, operate, and Builds, O&M Invest, build, O&M
maintain bulk supply
facility
Payment to Contractor 60% of the water Paid on per cubic Revenues-O&M-lease Revenues- franchise
revenues meterm; has minimum payment taxes and fees
off take volume
Benefits Improved service, Relieves MCWD of Achieves all Improved service, wider
transformed utility to development cost and performance targets coverage
revenue center effort
83

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A Guide to

Month and year of publication: October 2011.

A Guide to Performance Contracting of Water Service Provision

3 PREREQUISITES OF PERFORMANCE CONTRACTING ............................................................................. 17

4 STEPS IN PERFORMANCE CONTRACTING ................................................................................................. 23

REFERENCES AND LINKS ........................................................................................................................................ 29

ANNEX 1 Institutional Set-Up of Water Service Providers ............................................................................. 32

ANNEX 2 Sample Performance Contracts .......................................................................................................... 35

ANNEX 3 System of Incentives for Performance Contracting ....................................................................... 74

APPENDIX A Legal Bases and Types of Outsourced Performance Contracts ............................................. 76

APPENDIX B Some Examples of Outsourced Contractual Arrangements in the Philippines .................. 78

A Guide to Performance Contracting of Water Service Provision

Table 1 – Beneﬁts to Contracting Parties and Clients ........................................................................................ 4

Figure 1 – Possible Contracting Arrangement within the LGU......................................................................... 7

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

More than 80% of water service providers (WSPs)

Despite the sizeable share of LGU water utilities

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

2.1 What is a performance contract?

A performance contract is a negotiated

The utility owner’s contracting party may be

2.2 Why use a performance contract?

Public utilities carry out several functions

A Guide to Performance Contracting of Water Service Provision

Table 1. Beneﬁts to Contracting Parties and Clients

Utility Owner/Management Implementing Unit Clients/Customers

helps deﬁne and align objectives so that facilitates monitoring of activities

facilitates monitoring of performance

The processes involved in performance 2.3 Types of Performance Contracts

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

Management Design-Build or Lease Concession

A Guide to Performance Contracting of Water Service Provision

Figure 1. Possible Contracting Arrangement within the LGU

A Guide to Performance Contracting of Water Service Provision

Performance Contract & Approval,

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

2.5.2 Case Study 2 - Improvement of systems. About 52 level II connections have

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

The duration of the contract is two minimum performance standards. Penalties

A Guide to Performance Contracting of Water Service Provision

2.5.5 Case Study 5 - Contracting Problems of the Utility. In 2004,

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

Utility reform involves a series of interventions

A Guide to Performance Contracting of Water Service Provision

3.1 Ring-fencing of Utility Accounts Ring-fencing involves the following steps:

A Guide to Performance Contracting of Water Service Provision

Table 4. Example of a Performance Improvement Plan

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

A Guide to Performance Contracting of Water Service Provision

Performance contracting involves a series of

A Guide to Performance Contracting of Water Service Provision

Note: Boxes in broken lines signify prerequisites to performance contracting.

Step 1 - Identiﬁcation of Contracting Parties Step 2 - Setting the Strategic Goals,

- Collection efﬁciency improved from _ % to _%

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