Incentivisation - The Chartered Institute of Purchasing and Supply

CIPS 

Knowledge 

Works 

Contents 

Incentivisation 

1. Introduction pg3 

2. Definition and Background pg4 

3. Why use Incentivisation? pg4 

4. What are the Key Features of Incentivisation? pg5 

5. What are the Rewards and Benefits? pg6 

6. Role of Key Performance Indicators pg7 

7. What are the Disadvantages? pg7 

8. Appraisal of Rewards and Benefits pg7 

9. Putting an Incentivised Contract in Place pg7 

10. Conclusion pg8 

11. References pg8 

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Welcome to a 

guide on 


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CIPS believes that P&SM professionals should be 

knowledgeable about the range of tools and approaches 

relevant for incentivisation. 

1. INTRODUCTION 

The CIPS beliefs on incentivisation, which have been formulated with the role of the more senior Purchasing 

and Supply Management (P&SM) professional in mind, may be summarised as follows: 

• CIPS believes that all P&SM professionals should develop/acquire the relevant tools and competencies 

necessary to manage the incentivisation process effectively 

• CIPS believes that the effect on the bottom line is a key determinant in any decision to apply incentivisation 

principles 

• CIPS encourages P&SM professionals to exercise a ‘what if’ approach in the procurement process 

• CIPS is in favour of incentivisation where a clear business benefit is seen to accrue to the organisation 

• CIPS recommends that P&SM professionals should adopt a proactive and positive approach to the contract 

management process – this encourages innovation and maximises customer satisfaction 

• CIPS believes that P&SM professionals should be knowledgeable about the range of tools and approaches 

relevant for incentivisation.They need not necessarily be experts in the application of all tools, but they 

should know where to obtain that expertise, eg from colleagues in finance. 

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2. DEFINITION AND BACKGROUND 

Incentivisation is defined in CUP (Central Unit on 

Procurement – forerunner of the OGC – Office of 

Government Commerce) Guidance No 58 - 

‘Incentivisation’) as: 

‘A process by which a provider is motivated to 

achieve extra value added services over those specified 

originally and which are of material benefit to the 

user. These should be attainable against pre-defined 

criteria. The process should benefit both parties’ 

Therefore there is some form of enhanced reward 

for the supplier whether it be financial or in some other 

form. 

It involves a process of mutually agreeing targets 

often with respect to cost, schedule, quality and safety 

or other measurable benefits to the client’s business 

such as; 

• inventory reduction 

• increased sales 

• reduced cost 

• improved labour utilisation 

The objective is the achievement of superior 

performance to the benefit of both parties, for which 

the supplier will receive additional reward. The 

outcomes of the superior performance, whether lower 

cost, early delivery, safer or higher quality products are 

of obvious value to the buyer. Incentivisation might in 

some cases also lead to a partnering relationship 

between buyer and supplier. 

There is a close relationship between incentivisation 

and risk management. Both techniques can be applied 

separately or together to ensure that contracts are 

successful. CIPS encourages all P&SM professionals to 

constantly exercise a “what-if”mentality in relation to 

the procurement of goods, services or works.The “whatif”mindset 

will enable P&SM professionals to determine 

the potential outcome of risk management and 

incentivisation by testing the various assumptions, 

propositions and approaches under consideration. 

3. WHY USE INCENTIVISATION? 

From the buyer’s point of view, incentivisation is used 

to foster improvement by binding good suppliers with 

the expectation of even better reward. For the buyer, 

incentivisation offers the possibility of self financing 

benefits from improved supplier performance and it 

also attracts good suppliers who see the potential for 

better rewards for their efforts and capabilities. 

The supplier might expect to gain extra financial 

reward but also an improved reputation as a successful 

supplier (which should lead to more work from the 

original buyer or from other buyers in the market 

place). In some markets, the possibility of a long-term 

multi contract relationship involving some form of 

partnership sourcing is possible. This however is not 

so likely in the construction field where most 

relationships are single-project based. 

The following are examples of influential factors 

which might lead to incentivised contracts: 

Special Circumstances 

Incentivisation may be a product of circumstances 

which act to unite the buyer and supplier into a team 

devoted to the resolution of a particular issue. In such 

cases, the problem is seen as a common enemy which 

can only be overcome by the pooling of buyer and 

supplier resources. It may arise from financial 

difficulty which threatens to overwhelm the existence 

of both parties, or it could be the outcome of a legal 

threat. 

Financial 

Incentivisation may take a purely financial form, for 

example, the buyer could have an earlier need for the 

product of the contract with the supplier than 

previously anticipated. Delivery of the product 

(whether a facility of some sort such as a building or 

an off-shore installation or simply the supply of goods) 

could be financially beneficial to the buyer. Therefore 

the buyer might be prepared to share some of the 

anticipated financial gain with the supplier as a reward 

for the effort needed to make earlier delivery. 

A specific example might be that of an offshore oil 

company finding that it can sell the oil or gas from a 

major development earlier and more profitably than 

previously anticipated (perhaps the price of oil has 

unexpectedly risen significantly). It could now be 

worthwhile for such a company to land the oil earlier 

and to achieve this end, the company is prepared to 

share some of the gain with the suppliers who are 

constructing the platform. 

At the other extreme, it is possible to envisage a 

company which is considering the re-decoration of a 

meeting room. The lead times quoted by the 

decorating suppliers would mean that the buyer would 

have to hire a room elsewhere for some important 

function. If the buyer could strike a deal with the 

supplier whereby the buyer would pay the supplier 

extra for earlier completion of the room, then, 

providing the extra amount paid to the supplier were 

less than the cost of hiring another room, both parties 

would gain. 

Financial incentivisation could also be used to 

stimulate suppliers to beat cost targets embodied in the 

contract. This is appropriate in cases where the target 

cost acts as a cap to the amount which the buyer is 

prepared to pay. If the supplier can deliver the 

requirements of the contract for less cost than the 

target cost, the difference can be divided in some 

agreed proportion between the buyer and the supplier. 


Non- project incentivisation: 

The above examples all suggest that incentivisation may 

only be used for projects or as a component of 

contracts for discrete services. However, this does not 

need to be the case. Incentivisation can be a part of 

contracts to produce goods. In this case, the 

incentivisation could be to reduce cost, improve design, 

reduce stocks, speed delivery etc. 

Non-financial incentivisation: 

While incentivisation can be of a straightforward 

financial nature, ie money, it can also be for money’s 

worth to the supplier. For example, it would be worth 

something to suppliers to be assured of a continuity of 

business and this assurance could be the 

incentivisation. Similarly, some suppliers could gain 

kudos from an association with an outstandingly 

successful contract and this can also act as an incentive. 

4 WHAT ARE THE KEY FEATURES OF 

INCENTIVISATION? 

Incentivisation is contract based that might, but not 

necessarily be based on agreement and trust between 

buyer and supplier. However, without a genuine 

meeting of minds, an incentivised contract is likely to be 

viewed in a negative light, most probably by the 

supplier, who could see it as simply another contractual 

device imposed by the buyer to enforce performance. 

This means that the reward which the supplier receives 

must be commensurate with the extra effort required. 

Conversely, the value of the incentivisation which the 

buyer receives should be commensurate with the 

amount to be paid.The incentivisation must be seen by 

both parties to be win-win, with no hidden agendas. 

Mutual trust and a drive to continuously improve are 

desirable. For example, where the incentives are 

concerned with cost minimisation, there will be a need 

for both parties to practise open book costing. 

Contractual incentive schemes need to reflect the 

business objectives of the buyer and coincide with the 

business objectives of the supplier. They should be 

simple and measurable so as to avoid dispute both 

about their meaning and their attainment. They should 

preferably be based on outputs so that deliverables can 

be easily identified and they should take account of 

what might happen during the life of the contract. 

Incentivisation requires closer and more detailed 

dialogue between the buyer and supplier, both at the 

pre-contract stage and during post-contract 

management. This is because of the greater need to 

attend to performance and its measurement if the 

milestones associated with the incentives are to be 

unequivocally attained, thus clearly justifying payment 

of the incentive. Lack of clarity associated with the 

attainment of a milestone can, of course, breed mistrust 

which will sour relationships. 

Incentivisation arrangements should not be seen as 

an end in themselves and should only be used where 

appropriate. This means that the cultures which exist 

within both the supplier’s and the buyer’s organisations 

must be compatible. Above all, the concept needs wide 

acceptance within many departments and at many 

levels of management in both organisations. It often 

needs to include all stakeholders. Agreement between 

the buyer’s purchasing and contracts department and 

the supplier’s sales department is not sufficient. 

Incentivisation is naturally dependent on the buyer’s 

ability to pay. This requires the buyer to carefully assess 

the likely cost of any incentivisation and to take steps to 

ensure that the purchasing organisation provides the 

funds to make any payment. Where the incentivisation 

does not have some form of cap, or upper limit, ie is 

open-ended, there could be the possibility and risk of 

the amounts of payment exceeding the funds allocated 

for this purpose. This could have severe repercussions, 

particularly if the incentivisation is associated with the 

completion of the project on cost target. 

Incentivisation could be multi-target in nature. This 

means that there could be more than one target for the 

supplier to achieve. The achievement of each target is 

considered individually. So, failure to achieve one target 

does not impact on the supplier’s reward for some 

other target should that target be achieved. The 

supplier is thus not de-motivated by failure and, because 

the overall scheme is fair, it might be that motivation is 

enhanced. 

With respect to projects, the buyer needs to 

consider carefully the implications to all the 

participants (client, contractors, consultants, key 

subcontractors, ultimate customers etc ) of the 

incentivisation process. For example, there is little 

point in independently incentivising some aspect of a 

contractor’s contract if that part is crucially dependent 

upon another party, say a consultant or the client, 

neither of whom are a party to the incentivisation. The 

involvement of the other participants might require 

them to be incentivised themselves, the most likely 

examples being subcontractors and consultants. 

Alternatively, in the case of clients, there is a need for 

an awareness and an understanding of the 

incentivisation and the reasons for it. 

Incentivisation of many contracts within a project 

requires careful management. Multiple incentivisation 

must lead to complementary outcomes if disruption is 

to be avoided. This is because all the parties in a project 

tend to rely on others and the consequence of 

uncoordinated incentivisation can upset this reliance. 

Organisations which have not previously used 

incentivisation need to proceed with caution until a 

level of experience is achieved. A policy of ‘keeping it 

simple’ is advisable. 



Incentivisation can work across a series of contracts. 

This assists in the learning of the buyer and the 

supplier, assuming that the same supplier has been used 

for each of the contracts. This can lead to greater levels 

of efficiency in the later contracts. 

In a study undertaken by the Treasury and other 

government departments some time ago, the following 

were identified as key factors in successfully using 

incentivisation as a technique: 

• a firm and detailed basis for costing a contract both 

for the buyer and the supplier 

• effective measurements and setting of milestones 

and targets for both buyer and supplier, this means 

that a good quality specification is essential and 

there should also be a good audit trail 

• the need for effective contract management within 

an incentivised contract which commences at the 

correct time 

• a requirement for transparent structures in respect 

of cost and performance by both parties operating 

within this sphere 

• good payment procedures to ensure that payment is 

made as agreed 

• willingness on the part of the supplier to participate 

in the incentivisation scheme. 

There can also be an incentive to avoid a negative 

consequence. The most usual form could be liquidated 

damages. Other examples could be loss of reputation, 

or withdrawal of any further business. 

5. WHAT ARE THE REWARDS AND BENEFITS? 

Both buyers and suppliers are able to benefit from 

incentivisation. 

From the buyer’s point of view, the benefits to the 

buying organisation are likely to include: 

• lower cost, faster or more timely delivery of service 

• improved quality or safety 

• earlier delivery with the possibility of an earlier 

revenue stream 

• a more knowledgeable and skilful workforce arising 

from the experience of open book costing 

• additional services from the supplier 

• possibly a longer relationship with a good supplier 

• less time spent resolving contractual disputes 

• better price stability 

• improved management information 

• improved monitoring and control. 

From the supplier’s point of view, the benefits are likely 

to include: 

• faster payment 

• better reputation 

• longer relationships with the buyer possibly 

• less time spent on contractual disputes. 

CIPS defines a “benefit”as that which the buying 

organisation receives as a result of the supplier 

delivering something desirable over and above the basic 

contract requirement. Benefits can be shared with the 

supplier if, for instance, a greater margin is achieved 

through the supplier achieving a target for innovation in 

respect of a particular product. 

CIPS encourages incentivisation where a real 

business benefit accrues to the buying organisation ie 

constructing a contract so that the supplier has an 

incentive to deliver not only what is required by the 

buying organisation, but - as appropriate or necessary – 

exceed those requirements. CIPS believes that if this is 

done correctly it will deliver the best possible contract 

and value for money. 

In practice, incentivisation usually involves the 

employment of rewards, benefits or sometimes 

liquidated damages, or equivalent, in contracting.This 

policy encourages the use of rewards and benefits 

when incentivising contracts. 

CIPS defines a reward as something, usually money, 

which the supplier receives from the buying 

organisation, for achieving an objective, or a desirable 

outcome, which is over and above the basic 

requirements of the contract. 

Financial return is the biggest incentive for most 

suppliers. If the buying organisation would benefit from, 

for example, eg a construction project completed earlier 

than the contract states, then a financial incentive for an 

early finish can encourage suppliers and facilitate a winwin 

situation. However, P&SM professionals should 

ensure that incentives are not introduced too early in a 

negotiation as there is a danger that the original 

contract requirement may get diluted as the supplier 

seizes an opportunity to obtain more from the contract. 

Indeed, CIPS emphasises the fact that negotiators must 

not give away the essence of the deal when negotiating 

incentives. 

CIPS recommends that in the early stages of a 

procurement process the P&SM professional should 

identify, whether or not there are any real business 

benefits to be had from incentivising a contract; this 

should also determine the extent of such incentives. 

If there is little to be gained, over and above that 

which is required from the standard contractual 

arrangement, then there may be no point in pursuing 

incentivisation. CIPS would argue, however, that any 

contract should be subject to proactive contract 

management and continual improvement. It should 

encourage innovation and the delight of customers, and 

so some mechanism to encourage such commitment 

from suppliers should appear in most contracts. 

It is useful to structure the reward package so as to 

align the objectives of the buying organisation and the 

supplier.The first step is to choose an appropriate 

contract form. For example, a lump sum will align the 


parties if the lowest cost is the prime concern, but not 

if the highest quality is what is required from the 

contract. Having set a basic form, the next step is to 

provide further encouragement to align. This can 

facilitate, for instance, the buying organisation paying 

additional fees to the service provider, eg architects, if 

the cost of the total project is reduced or if the faults 

occurring after completion are less than x%. 

6. ROLE OF KEY PERFORMANCE INDICATORS (KPIs) 

KPIs are fundamental to incentivisation.The supplier’s 

profit and possibly overheads and even direct costs 

should be at risk if the contractual KPIs are not met.The 

KPIs can be graduated so that poor, satisfactory, good 

and excellent performance may be determined.The 

supplier earns, for example, a lesser amount of 

profit/overhead (or none at all) for poor performance as 

opposed to excellent performance where the 

contractor might expect to receive their normal margin 

plus the extra amount. So the term ‘risk’ applies to the 

amount of profit/overhead the supplier is prepared to 

risk in the incentivisation scheme and the reward is 

what they actually receive; this will vary depending on 

their performance from a poor rate of return to an 

excellent one. 

It is normal to balance such schemes so that the 

amount the supplier puts at risk (the downside) is equal 

to the amount they could earn over and above the 

normal margin expected for a satisfactory or good 

performance (the upside). 

The KPIs are measures of business-critical 

deliverables such as: 

• Achieving the scope of work within budget 

• Delivering the required amount of production per 

month every month 

• Performing work without any safety and production 

critical maintenance work every month 

KPIs should be easily measurable, tangible and critical 

for the success of the contract and business. 

7. APPRAISAL OF REWARDS/BENEFITS 

CIPS suggests that for any significant contract the P&SM 

professional should produce a strategy for that 

procurement, including a business case as appropriate. 

The business case should include an investment 

appraisal which should illustrate what is required from 

the contract; and what other benefits are required in 

addition, eg working with supplier to reduce costs of 

product X over the contract period. By defining the 

investment in this way at the outset, the management 

and monitoring of the contract should be much easier 

as the buying organisation will have the information 

with which to measure progress. 

When developing a business case, P&SM should seek 

the assistance of their colleagues in finance particularly 

when undertaking the investment appraisal, as financial 

modelling and/or sensitivity analysis may be required. 

The financial modelling and sensitivity analysis may 

identify that a cut-off point is needed in respect of 

rewards to suppliers to prevent super profits being 

generated. Similarly, cost-benefit analysis may be 

appropriate for those benefits which are not an obvious 

advantage. 

CIPS suggests that all benefits/rewards within a 

contract should be: 

• tangible 

• achievable 

• measurable 

• agreed by all parties 

Even softer benefits can be measured such as 

improved communications between supplier and end 

users as evidenced by improved scores on a feedback 

survey. 

If additional incentivisation is required mid-contract, 

then a contract amendment or change order may be 

required. 

8. WHAT ARE THE DISADVANTAGES OF 

INCENTIVISATION? 

It must be stressed that incentivisation should not be 

seen as a panacea for the many problems which can 

impact on large-value, long-term contractual 

arrangements. It is not easy nor is it a quick fix because 

it requires time, considerable thought and planning for 

it to work effectively. It is a co-operative and collective 

approach rather than a unilateral process, which means 

that it cannot be imposed by the purchasing 

department acting independently. Rather, it needs the 

support and active participation of colleagues within 

the buying organisation and of the staff within supplier 

organisations. 

For the supplier, there is the risk of investing this 

time and not winning any business. For the buyer, the 

investment of this time could be with many suppliers of 

which only one will get the business. 

There is also the risk that the effort involved in 

establishing an incentivised arrangement will not equate 

with the extra outcomes from this arrangement. 

9. PUTTING AN INCENTIVISED CONTRACT IN PLACE 

As part of the process of establishing an incentivised 

contract, it has been suggested that the following 

questions should be asked by the party initiating this 

type of relationship:: 



• From the buyer’s point of view, is incentivisation 

worth doing? 

• Can the contract objectives/deliverables be defined 

in such a way that incentivisation is possible? 

• What would the incentives be? 

• Is there sufficient time to develop an incentivised 

contract strategy? 

• Are there any constraints such as culture within the 

buyer’s organisation to the use of incentives? 

• Are the suppliers likely to be receptive to a proposal 

that they undertake an incentivised contract? 

• Will the proposed incentives be of interest to the 

supplier? 

• Can the incentivised targets be measured objectively 

by both parties to the contract and is an audit trail 

possible? 

• What are the risks associated with using 

incentivisation? Are they acceptable? 

• Do both buyer and supplier have the skills to 

manage an incentivised relationship? 

• Are there terms and conditions suitable for an 

incentivised contract and, if not, can they be 

developed? 

For incentivisation to be a realistic tool there must 

be real, achievable and measurable targets and stated 

benefits with both parties being willing to sign up to 

them.There are contracts for which incentivisation 

might not be suitable and there is clearly little point in 

using incentivisation if the desired results can be 

achieved by other means. 

For utilities and for the public sector, incentivisation 

should not conflict with the EU Procurement Directives 

provided the method of awarding a contract is the most 

economically advantageous and provided that the 

method and criteria for assessing which bid is the most 

economically advantageous have been clearly publicised 

in accordance with the requirements of the Directives 

and subsequently adhered to. 

It has been suggested in a review of incentivisation 

undertaken by a Treasury working party some time ago 

that the following can act as constraints to the use of 

incentivisation in the public sector: 

• European procurement legislation: This will affect 

the public sector, utilities and the oil and gas 

exploration and production industries 

• The requirement for public accountability 

• Existing cultures in both the buyer and the supplier 

organisations. There could be opposition from the 

client or the user department within the buyer’s 

organisation who might not like the concept 

• A perception that the process is in some way unfair 

• Insufficient time to plan and to implement the 

processes needed to generate the incentivised 

rewards 

• The scope of the contracts is too limited for 

incentivisation to apply 

• Fear that it will cost too much. This has been partly 

addressed above by the reference to the need to 

ensure that adequate funds are made available 

• A concern that it might not be possible to have 

contracts without incentivisation with a supplier, if 

already involved in incentivised contracts with that 

supplier. The result being a loss of flexibility. 

It is worth noting that many of the above 

considerations could also apply to organisations in the 

private sector. 

10. CONCLUSION 

Incentivisation is a key element in the P&SM 

professional’s toolkit. He or she has an important 

role to play in maximising the benefits of any 

incentivisation process. It is stressed that 

collaboration with other departments (typically, 

finance) is a key factor – the P&SM function cannot 

and should not be expected to operate on a 

standalone basis: ‘CIPS believes that P&SM 

professionals need not necessarily be experts in the 

application of all tools, but should know where to 

obtain that expertise’. 

11. REFERENCES 

Books 

Why Use Standard Forms of Contract 

P Capper FIDIC, (French acronym for ‘International 

Federation of Consulting Engineers) 

Management of Procurement 

D Bower,Thomas Telford Services 

Construction Contract Incentive Schemes – Lessons 

from Experience 

D Richmond-Coggan, CIRIA 

Value Management of Construction Contracts 

John Kelly et al 


CUP Guidance No 58 

Office of Government Commerce 

Articles 

Articles on incentivisation, again with a construction 

industry emphasis, may be found in the CIOB 

(Chartered Institute of Building) publication 

‘Construction Information Quarterly’ (website 

www.extenza.eps.com) 


Websites 

These include: 

• www.rics.org 

• www.ciria.org 

• www.fidic.org 

• www.ogc,gov.uk 

• www.pwcglobal.com 

• www.constructingexcellence.org.uk 

AUTHOR 

CIPS Professional Practice Team

Incentivisation - The Chartered Institute of Purchasing and Supply

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