Making sound cost decisions in pay for success

What costs should you consider in establishing a pay for success (PFS) project? How should success payment rates be established? Who bears responsibility for which costs? How can a government protect itself from being stuck with excessive costs?  What cost information is likely to be needed in determining what action to take after the project has ended?

The answers to these questions are particularly important for PFS projects due to the contractual nature of cost responsibilities, and because project cost estimates inform outcome pricing. But identifying the cost of achieving these outcomes can be a significant obstacle during PFS project development. In a new report, we provide a framework for using cost information during PFS planning and development, specifically when calculating success payment rates.

The best-practice recommendations in this report are based on research on existing PFS projects, including interviews with several stakeholders. We identify four key tasks in the cost estimation process, along with specific action recommendations:

1. The government and other project partners make a number of preliminary cost-related decisions. First, stakeholders assess the feasibility of obtaining accurate cost information for the issue area and target population of the proposed project. Next, stakeholders decide if cost savings to government departments—that is, future public costs avoided as a result of the project—will be used to help establish success payment rates to investors. Other important parameters include the length of the project, the maximum success payment the government is willing to pay, and the frequency and timing of success payments.
2. Stakeholders thoroughly define cost-related components of the project. The plan should (1) make clear which project-related costs are the responsibility of the service provider and which the responsibility of the government, (2) define as precisely as possible what outcomes are sought and which beneficiaries will be served, and (3) identify all government programs whose costs will be significantly affected by the intervention. 
3. Project partners estimate specific project costs. To do this, partners identify which costs will be significant based on the nature and context of the intervention. These costs can be grouped into three broad categories: initial PFS project development, one-time or periodic investment, and annual operation and maintenance. Once specific costs are identified, they are estimated using information provided by the government and the service provider. Cost estimates can also be affected by evidence gleaned from other communities’ experience implementing comparable interventions. 
4. Project partners calculate success payment rates. Success payment rates should be fair and clear to all parties and respect the government’s cost ceiling. To the extent the project is successful, payments should reimburse the costs of the intervention, plus a negotiated profit or fee. Calculating the success payment rate requires a number of steps and a variety of information (see graphic below). Rates are based primarily on estimated project costs as well as any bonus payments commensurate with government estimates of the project’s societal benefits, such as reduced crime or improved education access. The derivation of the size of such added payments for societal benefits is not discussed in the report, though our early childhood education toolkit addresses the question in that context.

While every jurisdiction and project has its own unique challenges, it is our hope that the principles and process steps discussed in the report will help guide informed conversations among project partners to enable sound cost decisionmaking.

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As an organization, the Urban Institute does not take positions on issues. Scholars are independent and empowered to share their evidence-based views and recommendations shaped by research. Photo via Shutterstock.