Performance based contracts seek to focus upon the output required from the contractor, and create measures and remuneration mechanisms which align the contractor’s performance with the outcomes desired.  This contrasts with traditional approaches in that the specifications focus less on the ‘how’ and more on the ‘what’ through a clear statement of expected work outcomes.  The statement of work shows the detailed work elements including a performance standard, acceptable quality levels, how performance will be measured and monitored, and the percentage of the contract price each service represents.  Performance based contracts require clear definition of what is needed and measurement processes which relate directly to actual performance levels.

For example, supposing a buyer pays a maintenance provider for supporting a pump.  The fees are 15% of the initial acquisition cost, and the fee is paid annually.  The fee structure is unrelated to the actual cost expended by the supplier, and the supplier may or may not focus on achieving the required uptime levels - assuming that these are specified and measured.  A performance-based contract might reward the provider for uptime, the provider will only be paid if the pump is functional, and the provider will be paid less - or not at all - if the pump reliability is less than specified.  This would be a performance-based contract, and align the contractor to delivering the required pump availability.  See also Risk and Reward.