Unlocking Pay for Success for Environmental Outcomes: Answering the Top FAQs
Written by Grace Edinger, EPIC’s Procurement Policy Strategy Lead
Picture yourself buying a loaf of bread. You meander through the grocery store, perusing the different types, and settle on a sourdough loaf that’ll be great with tonight’s dinner. You head to the cashier. They scan the loaf and say, “That’ll be $3.50.” You pay, get your receipt which simply has, 1 loaf of sourdough bread plus taxes on it, and head out the door. This is how Pay for Success contracts work. You pay for the unit(s) that you purchase with all costs rolled up into one outcome.
Now let’s try buying a loaf of bread the same way that government agencies normally pay for environmental projects.
You meander through the grocery store, but there aren’t any loaves of bread on the shelf. Confused, you walk up to the bakery counter and ask the baker for a loaf of bread. Instead, he points to a list of names and phone numbers of recipe developers who offer their services to write a recipe just for you. He needs a recipe to bake bread and doesn’t do that himself. You look at a few recipe developers’ names and choose one to work with. In the next few days, the recipe developer does what they promise, and delivers to you a special recipe along with an invoice for their time, charging an hourly rate. You pay their invoice.
Then you return to the grocery store, hand the baker your new recipe, and ask him to bake you this loaf of bread. He takes a look at your recipe and agrees to do the job. “You’re lucky all of these ingredients are in stock. If not, you would need to bring me a different recipe.” That’s right, depending on the baker’s available tools, ingredients, expertise, or other factors, this baker might not have been able to use this recipe.
He bakes you the bread, which he says will take 4 hours to complete. Each hour, he hands you an invoice for one hour of his time and the ingredients he used. You pay each invoice as you receive them, hourly.
Call us crazy, but we think these inefficiencies can be cut out of environmental projects by shifting toward a procurement process that looks closer to how we normally buy a loaf of bread.
As we discuss Pay for Success procurement for environmentally beneficial projects more and more, we often come across the following questions and points of skepticism. These contracts, while becoming more common for state environmental agencies, are still fairly new. We appreciate the skepticism and understand the importance of spending public money responsibly.
Let’s start by explaining what Pay for Success is (beyond bakery terminology). Pay for Success contracting (PFS), also known as pay for performance or outcomes-based contracting, is a procurement strategy that defines desired outcomes and requires the contractor to deliver those in advance of payment to ensure outcomes are achieved. A significant amount of the total payment for Pay for Success contracts is paid only when the project has been completed and verified outcomes have been measured or modeled, often by a 3rd party evaluator.
We have clear answers for some of these questions, while others are still open questions that we’re continually investigating. If you’d like to discuss any of these further or have additional questions you’d like us to add to this list, please reach out.
These are listed in no particular order. Let’s crack into it.
Question 1: How does Pay for Success differ from traditional government grant programs?
Major differences are listed in this table.
| Traditional Grant-Making | Pay for Success | |
|---|---|---|
| Calculation of payments | Itemized financial reporting of time and materials is required, and payments are either made on a regular reimbursement schedule or given upfront | All costs are rolled into one per-unit fee and paid at milestones or solely upon delivery of outcomes as laid out in the contract |
| Paperwork and administrative requirements | Substantial reporting on time spent, details on activities, and receipts are usually required | Simple, per-unit invoicing. Receipts not required |
| Consequences to the grantee or contactor if the project fails | None | The contractor does not receive a significant portion of the payment. They may also be required to pay a daily fee for each week past the contract end if outcomes are not achieved. |
| Who carries the majority of the risk of project failure? | Funder (e.g., the government agency, state, county, etc.) | Private-sector / contractor |
| General timeframes | Grants are on fixed cycles, sometimes with only 1 year to complete a project, sometimes longer. Generally short timeframes | Contracts range depending on the project but can be 20+ years long. |
Question 2: Doesn’t Pay for Success incentivize the contractor or private-sector partner to cut corners?
The short answer is no, it actually holds them to a higher standard. Pay for Success requires contractors to hit certain performance standards. If they fail, they don't get paid. This creates a huge incentive to perform to the desired standards, which are outlined and agreed upon in the contract. We'd argue that traditional procurement's lack of financial incentive to succeed would be more conducive to cutting corners over a Pay for Success model.
Question 3: It doesn’t seem right to “line the pockets” of for-profit businesses for environmental projects. It’s better to give money to nonprofits through traditional government grants.
We really don't see an ethical dilemma with this and have a few reasons why:
Governments (e.g., federal agencies, counties, cities, and states) buy directly from the private sector all of the time. Think about vehicles, computer hardware and software, paper products, the list goes on. The Pay for Success contract structure is the same–the private sector delivers a good or service, and the federal government pays for that good or service in a unit-based way (just like they pay a set price per car, price per computer, etc.)
Focusing on the tax status of the organization is putting unnecessary emphasis on the beginning, rather than the end of the project. The private sector, in the Pay for Success agreement structure, guarantees the successful delivery of outcomes. If they don't, the funder is not obligated to pay the bill. An NGO grantee paid on a reimbursement or upfront basis receives the money regardless of project outcomes, which is risky in comparison. We'd argue that the most responsible use of government funding comes with a guarantee of success. Additionally, NGOs are tax-exempt entities, which cost the state and federal government in uncollected taxes. Private firms’ profits are taxed at corporate tax rates, so that seems like a fair deal. See question 8 for more on NGOs.
Question 4: How does Pay for Success inject more private capital into the environment compared to traditional grants or design-bid-build funded projects? How can this help scale private capital investment?
While the contract structure is a little new in the environmental sector, without a large enough sample size to calculate, we do know it has the potential to be substantial. A reliable, recurring Pay for Success solicitation for desired outcomes creates the positive signaling needed to create a pipeline of projects ahead of time, in anticipation of the next RFP. Having a reliable end payor helps jumpstart the restoration economy in a certain geography and allows the purchasing capacity to be the funding cap, not a lack of high-quality project proposals.
For example, Anne Arundel County’s Bureau of Watershed Protection & Restoration implemented its Pay for Success program in 2018 to expedite the process of restoring local waterways. This program has become a pillar in the County’s progress toward the goals of its NPDES MS-4 permit, the Chesapeake Bay TMDL, and the EPA Clean Water Act.
Over the last six years, the County has realized a drop in the average cost of BMPs for water quality by almost half. The County has continued to improve the Request for Proposal structure over the years and has shown consistency to the private sector, resulting in a competitive bid process that drives down the price.
Additionally, Pay for Success requires the contractor to secure upfront capital. Traditional contracts pay out on regular intervals (30 days, monthly, quarterly, annually) that don't require the contractor to float debt for very long. Pay for Success contracts do not get paid for much longer time periods, which require return-seeking investment or other creative solutions.
Question 5: What kind of environmental outcomes work well for Pay for Success?
Each ecosystem, and government agency, is different. EPIC staff are happy to consult for individual projects and programs to determine if Pay for Success is a good fit, and what unit makes the most sense to be the specific outcome. That being said, a few factors are important to consider across the board:
Ability to quantify: Models or inexpensive monitoring methods need to be available
Unit-based: Pay for Success works best when the outcome is unit-based (e.g., pounds of nitrogen reduced or miles of stream restored) rather than broad deliverables (e.g. restore the river).
Flexible best management practices (BMPs): Pay for Success shifts risk away from the government payor and onto the private sector contractor. To take on that risk, contractors need the flexibility to deliver the outcome in a way that works for them to achieve the promised success.
Timescale: While it is acceptable for outcomes to take years to achieve, Pay for Success is not for project outcomes that are decades into the future. Generally speaking, we’re in favor of outcomes that take less than 8-10 years for final verification, although specific cases may have other considerations.
Question 6: How much money is actually saved using Pay for Success compared to design-bid-build contracts?
To some degree, the jury is still out. However, based on an early analysis in partnership with the UCLA Luskin School of Public Affairs, we estimate that switching to Pay for Success can save government agencies approximately 63% over 5 years compared to traditional procurement. Certain programs have been able to save even more than that after iterating and improving their contracts and solicitations. Contracting agencies become more comfortable with Pay for Success over time, and realize they can find efficiencies in reducing bonding requirements and build in more flexibility for how projects get done.
If you have additional data points we can add to this analysis, please shoot us a message!
Question 7: What if the models or measurements used to determine outcomes aren’t right?
This is a genuine concern, and we should continue to find ways to improve payment triggers for outcomes. In many cases, it’s not yet feasible (financially or scientifically) to directly measure the outcomes being paid for. There’s a real need to model what we can expect those outcomes to be, given a particular land management decision in a particular location (in addition to other information, like soil testing or remote monitoring).
However, it’s helpful here to distinguish between inaccuracy and imprecision. We don’t worry too much about models being imprecise because they’re more precise than not using a model at all. But it’s crucial to ensure models don’t have some sort of widespread bias that leads to inaccuracy. For instance, if a model is across the board ascribing fewer nitrogen reductions to riparian forest buffer plantings than is genuinely warranted, that would lead to fewer effective solutions being implemented and thus fewer real outcomes for the dollars spent.
There’s something of a chicken and egg situation here where improved models drive our ability to pay for outcomes and increased use of outcomes-based contracting drives demand for better models. The solution is not to wait around until we have perfect models; our environmental problems are too urgent.
Question 8: Doesn’t this exclude or cut out nonprofits?
Nonprofits are still eligible contractors under Pay for Success models. Also, it's important to note that we’re not suggesting that every grant award be converted to a Pay for Success contract. Nonprofits are valuable, and grants are totally appropriate in many use cases. That being said, there are certain project types where Pay for Success makes more sense than grant awards. In these instances, we think that at the heart of this exclusion question are two main concerns:
The inability of a small nonprofit to float debt
This is a viable concern. Small Nonprofits may not be able to secure the financing needed to carry out a Pay for Success contract. For large-scale projects, these entities may be better suited to be subcontractors under a larger nonprofit or private-sector entity.
The inability or unwillingness of nonprofits to take on the risk shift that comes with Pay for Success.
Currently, grant money is either given upfront or on a regular, reimbursement-based schedule regardless of how the project fares. If a nonprofit doesn’t feel comfortable taking on the risk of project success, perhaps they aren’t the right contractor for that project. In the end, we need public funding to pay for projects that work. If NGOs aren’t sure that they can produce environmental benefits that are on par with what the private sector can, shouldn’t we give the money to those who can deliver the best outcome for the environment?
A benefit of Pay for Success funding is that the flexibility it provides the contractor often results in them subcontracting with local nonprofits in a way where they can bring genuine help and local expertise.
Question 9: What’s the history of Pay for Success in the United States? Where does it come from?
Pay for Success originated in the social services sector. Projects aimed at outcomes like reduced recidivism, early childhood education, or reducing homelessness are the first instances of Pay for Success contracts used in the United States. The very first project was in the state of New York, aiming at reducing recidivism that began in 2012. The state of Minnesota was the first to enact legislation on Pay for Success pilot programs, but after it passed the effort was unable to move past the planning stages.