Feature Article

Performance-Based Compensation: Getting Paid for Good Design

High-quality, energy-efficient buildings seem like a win-win opportunity, with lower life cycle costs for the building owner and a better, more productive environment for the occupants. The environmental benefits from reduced energy use are icing on the cake. In practice, however, such buildings are rare. Why? It’s not for lack of the right technologies or know-how within the design community.

Truly state-of-the-art, energy-efficient buildings are rarely built today for many reasons, including budget limitations, reluctance to change design and construction practices, and a general lack of awareness of the possibilities among clients. For architects, engineers, and contractors there is another reason: an outmoded way of doing business. Contractual arrangements prevalent today generally do not acknowledge the fact that good, energy-efficient buildings require substantially more design work than conventional buildings, and they do not compensate designers for that additional work. Recognizing this predicament, some architects and engineers have proposed a system that would encourage—rather than penalize—designers for producing energy-efficient buildings.

Performance-based compensation is a model that is eminently sensible and deceptively simple in theory. In practice, it has proven remarkably elusive. A round-table discussion on the topic, organized by architect Donald Watson, FAIA and the American Institute of Architects’ Committee on the Environment, was held in January 1994. Round-table participants were able to clarify many of the underlying issues but were hampered by the scarcity of real-world examples to learn from. Here we look at some examples approaching the model of performance-based compensation, explore why it hasn’t been used more, and provide some suggestions for designers and builders interested in pursuing this approach.

Defining the Problem

The current interest in performance-based compensation was sparked in part by a 1992 Amory Lovins paper entitled “Energy-Efficient Buildings: Institutional Barriers and Opportunities,” published by E-Source, Inc. of Boulder, Colorado. Lovins’ paper clearly documents the many aspects of contemporary design and construction practice that obstruct energy efficiency in buildings. His executive summary begins:

“Buildings are rarely built to use energy efficiently, despite the sizeable costs that inefficient designs impose on building owners, occupants, and the utility companies that serve them. The reasons for this massive market failure have to do with the institutional framework within which buildings are financed, designed, constructed, and operated: many of the roughly two dozen actors who play a role in this process have perverse incentives that reward inefficient practice. Fragmented and commoditized design, false price signals, and substitution of obsolete rules-of-thumb for true engineering optimization have yielded buildings that cost more to build, are less comfortable, and use more energy than they should.”

Some Models to

Work From

The basic principles of performance-based compensation for energy efficiency are not new. In fact, they have become common practice for a number of energy service companies. Energy service or energy management companies frequently contract to retrofit existing buildings with energy-conserving measures, and they receive payment on the basis of documented savings.

Certificate from Bigelow Homes guaranteeing energy performance. Payment has only been required in one instance.

Building owners have nothing to lose with such contracts, because they accumulate a portion of the energy savings (the part not paid to the energy service company) without taking on any of the risk. When significant capital investments are involved, financing arrangements with specialized institutions can ensure that all costs are paid for out of the energy savings. With President Clinton’s Executive Order 12902, all federal facilities are mandated to reduce energy consumption through such “Energy Savings Performance Contracting” measures.

Energy savings contracts for existing facilities are inherently simpler than contracts for new buildings, primarily because the facility already has a history of energy use against which improvements can be measured. Even so, there are many variables that must be adjusted for when measuring the results of energy-efficiency retrofits, according to Blake Ross, vice president of The Catalyst Group, a Vermont company specializing in arranging such contracts. These factors include hours of building operation, significant changes in equipment not covered by the retrofit (such as increased plug loads from additional computers in an office building), and even weather patterns.

How the building is managed on a day-to-day basis is also important. Energy-performance contracts sometimes include building management as part of the contracted services. When they don’t, the energy service company will at least monitor building operation to ensure maximum savings. If the contract is well written, both the building owner and the energy services company will work together to promote maximum savings, since they will share in the profits.

A variation on the energy service company model in new residential construction can be found in the many utility demand-side management programs aimed at increasing the energy efficiency of new construction. Programs such as Bonneville Power’s Super Good Cents program in the Northwest and the Energy Crafted Homes program in New England recognize homes built to specific, above-code standards with certifications and, in some cases, incentive payments. Certification is intended to increase the home’s value to potential buyers, who are, in effect, buying better performance than the norm.

Louisiana-Pacific (L-P) has taken this model one step further, offering actual warranties of energy performance for homes air-sealed and insulated by certified contractors using L-P’s Nature Guard® cellulose insulation. (All participating homes are also tested for air-tightness with a blower door.)

Homeowners can opt for the SnugHome™ warranty for about five cents per square foot extra, according to Rick Davenport, who directs the SnugHome program for L-P.

While the number of warranties purchased is relatively small, Davenport claims that, by offering and promoting the program, L-P has significantly increased sales of insulation jobs by SnugHome-certified contractors. Installers offering the warranty have increased credibility with homeowners, who may then see little need to spend extra for the warranty itself.

Along similar lines, homebuilder Perry Bigelow of Palatine, Illinois has been very successful in marketing his tightly built, well-insulated homes with a guarantee that heating bills won’t exceed $200 per heating season (see certificate). These residential performance warranties only require generally “sensible” operation and are not corrected for extreme weather, which the companies expect will remain within their built-in safety margin. Bigelow’s warranty isn’t even adjusted for natural gas price fluctuations. By limiting the warranty to heating energy use, more occupant-dependent energy uses, such as hot water and plug loads, are not involved.

Performance Contracting for Commercial Buildings

Sensible though it may be, performance contracting for new commercial building design and construction has rarely been undertaken. “There are significant technical and legal obstacles that one must overcome first,” says Gregg Ander, who directs design services for Southern California Edison. Dealing with these obstacles adds to the cost of arranging performance-based contracts. Due to the complexity of predicting and then monitoring the energy use of a large building, independent contractors are generally needed to help negotiate and oversee the contract. In theory, the additional cost for these services could also be paid for out of the energy savings. In practice, however, the tab for this service has usually been picked up by other parties interested in promoting energy conservation, such as state energy offices or utility demand-side management (DSM) programs.

Ontario Hydro’s Incentive Program

Recognizing the opportunity to significantly influence building efficiency at relatively little cost, Ontario Hydro instituted a “Savings By Design” program in 1992 for the developers and designers of energy-efficient commercial buildings. This program contained various incentives for efficient design choices, including payments equal to the value of three years’ energy savings, shared among the developer, architect, and consulting engineers. The incentive was later reduced to a flat rate of 4¢ per kWh saved. At its peak the program received incentive payment applications from design teams representing 30% of the new construction market, according to Mike Jacobs, senior program design specialist at Ontario Hydro. This program represented an instance in which design teams were rewarded based upon the performance of their buildings, albeit not by the client who commissioned the design.

In spite of these successes, the program has since been discontinued, a casualty of drastic cut-backs in demand-side management because of new government policies covering electricity distribution. Traditional DSM programs are now an endangered species throughout North America, due to regulatory changes that are creating open competition in place of regulated monopolies. As a result, utility companies that in the past might have provided incentive payments or covered the monitoring costs for performance contracts are no longer pursuing that route. Instead, some are gearing up to offer design and consulting services directly to clients as part of an overall energy services package.

Oakland’s New Offices

One of the very few real-world examples of performance-based compensation for commercial building construction is now underway in Oakland, California. As part of the California Energy Commission’s (CEC) Energy Partnership Program to help local governments reduce their energy bills, Charles Eley of Eley Associates in San Francisco has been retained to ensure optimal energy performance of a new office complex planned for the City of Oakland. Working with City and CEC officials, Eley has devised a design competition and performance-based compensation strategy for the project.

Projected breakdown of energy use in the future Oakland office complex. The performance contract frees the design/build team from responsibility for equipment and elevator loads, and adjusts for hot water use by occupants.

Based on energy performance modeling for the City’s space requirements and the building site, Eley Associates have established an energy target of $450,000 per year, about 25% below state code. A design/build contract will be awarded with this energy target as a requirement. During the second year of occupancy, actual building performance will be monitored (allowing the contractor time to debug and fine-tune the building systems). If energy cost exceeds the target by more than $10,000, the contractor will compensate the City an amount based on the net present value of the additional energy cost over the building’s projected 50-year life. If the energy cost is significantly less than the target, the City will reward the contractor by the same formula.

The Oakland contract is greatly simplified by the City’s prior commitment to working with a single design/build contract, as opposed to requiring separate contracts for design, for construction, and for other services.

In designing this contract, Eley has taken great pains to make the design/build team responsible only for energy components over which they have direct control. As with most of the energy service contracts described above, adjustments will be made for weather deviations from the norm, hours of building operation, and changes in the cost of gas or electricity. Likewise, the energy performance target will be adjusted to account for any discrepancies between projected and actual energy use for miscellaneous office equipment, elevators, and hot water (see pie chart). Additionally, energy use in retail spaces included within the building is excluded from the contract target because tenants, not the design/build team, will install lighting and other services in these spaces.

The Oakland contract arrangement is structured to place all burdens and benefits with the design/build team, rather than using a shared savings approach. Doing so effectively frees the City of Oakland from any risk concerning the building’s energy use, but it also removes any financial incentive the City might have to ensure that the building is operated in the most efficient manner. Although City officials are clearly interested in promoting the building’s energy efficiency and will likely cooperate fully, they have nothing to gain financially regardless of how it performs.

Client Concerns

One concern that has been raised with design contracts written to maximize energy efficiency is that they will do so at the expense of occupant comfort and well-being. Past experience with poor indoor air quality or uncomfortable temperatures is the basis for these concerns. In energy-efficiency retrofits such concerns are less severe because there is a baseline for comfort and air quality levels; noticeable changes for the worse can be specifically prohibited. In new buildings, however, the client may need to be convinced that a contract that rewards the designers for energy efficiency will not compromise other building qualities.

Proponents of performance-based compensation for designers argue that such reductions in the quality of the indoor environment only result when energy conservation measures are carelessly added into a building that wasn’t designed for efficiency from the ground up. In fact, performance-based compensation should actually result in an improved indoor environment, rather than a degraded one, by offering a way to pay for the additional work required to thoroughly integrate energy efficiency into the design.

Minimal requirements based on accepted standards can be incorporated in a contract for services such as lighting, ventilation rates, and thermal control. Care should be taken to specify actual illumination levels, rather than energy use for illumination (lumens per unit area, rather than lighting watts per unit area), to avoid undermining the energy efficiency program. Finally, the client should be made aware that with adequate compensation for energy-efficient design work, the actual quality of lighting, fresh-air distribution, and thermal control can be expected to far exceed those in conventional, less carefully designed, and less efficient buildings.

Performance Contracting Beyond Energy Efficiency

Participants at the AIA round-table on performance-based compensation suggested that it should be possible to extend the principle beyond energy efficiency. They proposed adding other building performance issues, including those affecting worker productivity. After his efforts coordinating the Oakland project, consultant Eley is skeptical of such efforts. He argues that it is hard enough to negotiate a contract around energy use, which is clearly measurable and has specific monetary value. Other building performance criteria have neither of these traits, so contracting for them may be impossible.

At some point, a client’s interest in a high-quality building may be manifested simply in the choice of a design team with a track record in such buildings. With a strong enough reputation, these designers may be able to charge enough to cover the extra work entailed in designing such buildings.

Architects’ Concerns

Architects at the round-table and elsewhere have expressed concern about taking on the additional liability implicit in promising to meet a given energy target. Don Watson argues that by taking responsibility for the results of their work, architects will minimize the liability concerns. Further, he sees such responsibility as critical to creating markets for better buildings: “Essentially, if architects take responsibility for a statement about their building, regarding energy, air quality, or whatever, only then will clients start demanding it.”

In theory, performance-based compensation offers a mechanism by which architects and engineers can sell energy-efficient buildings to even the most skeptical client—the client won’t pay any extra for the design efforts if they don’t pan out. In practice, however, only enlightened clients may be willing to add this whole new layer to an already complicated and sensitive contractual relationship. Below are some suggestions for architects, engineers, and their clients.

Making It Work

•Bring together as many parties as possible under one contract (i.e., design/build contract). A unified contract greatly simplifies the contract process and prevents the shunting of responsibility for shortcomings from one party to another. Such a contract also greatly reduces the relative risk to the contractor, as the energy budget for a large building represents a huge cost compared with the design alone, but much less when compared with combined design and construction costs.

•With a more typical multiple contract project, one party, generally the architect, should have responsibility for the energy performance. In their paper “New Building Energy Performance Contracting,” Eley and his coauthors suggest that the responsible party’s scope of services be expanded to include building commissioning and field verification of building systems.

•Always bring in a third party to help negotiate the contract and monitor the building’s performance. This party should clearly spell out all engineering assumptions to be used when monitoring and modeling the building’s performance, and exactly how adjustments for variables, such as weather or hours of use, will take place. Ideally, this party should have the trust of both the client and the design team, and be able to mediate any disputes that might arise.

•Alternately, Eley et al. suggest that a building’s design could be evaluated using computer simulations, and the architect’s compensation be based on those simulations. The general contractor, after reviewing the simulations, would then take on responsibility for constructing and commissioning the building to meet the performance target.

•Develop contracts to share savings, as much as possible, between all parties involved, to promote maximum cooperation in making the building energy efficient.

•Savvy clients can require performance-based contracts to weed out unscrupulous contenders from a bid process. As the City of Oakland is doing, requiring this type of contract is one way clients can help ensure that the firm they hire is well qualified to provide quality design and construction services.

•Offer to base your compensation on performance, even if actually contracting to do so is unlikely. Like the SnugHome insulation contractors, designers may find that by offering to tie their compensation to actual performance, their standing with a client will improve, regardless of whether or not such a contract is actually used.

Resources on performance-based compensation:

AIA Committee on the Environment Round Table

“Performance-Based A&E Compensation,”

Donald Watson, FAIA, Chair

Documents include Roundtable Discussion, Background Paper, and Commentary

Contact: Chris Gribbs

American Institute of Architects

1735 New York Ave, NW

Washington, DC 20006-5292


202/626-7508 (fax)

Eley, Charles, Ann Peterson, and Scott Wentworth

“New Building Performance Contracting”

Presented March 1995 at the Third National New Construction Programs for Demand-Side Management Conference, Boston, Massachusetts.

Lovins, Amory

“Energy-Efficient Buildings: Institutional Barriers and Opportunities”

E-Source Strategic Issues paper, 1992 (reprinted, January, 1994)

E-Source, Inc.

1033 Walnut Street

Boulder, CO 80302-5140


303/440-8502 (fax)

Published March 1, 1995

(1995, March 1). Performance-Based Compensation: Getting Paid for Good Design. Retrieved from https://www.buildinggreen.com/feature/performance-based-compensation-getting-paid-good-design