Outcome-based contracts – again!
I wrote on this subject just a couple of weeks ago and received a number of interesting replies. Among them was one that pointed to a report by the UK’s Intellect group from 2010, in which they suggested that the main inhibitor to outcome-based contracting is supplier resistance. The paper seemed to imply that resistance is primarily due to risk aversion.
In a conventional sense, it is certainly true that it is risky for a supplier to take responsibility for an outcome since there are many elements over which they have little control. However, intelligent contracting can address those points, not only through the right terms and conditions, but also through an appropriate governance process for the contract and the relationship.
However, I think the bigger issue for a supplier is the fundamental impact that outcome-based contracts have on internal management systems and on cash flow. It is hard to manage outcome-based contracts on an exception basis – they simply do not fit easily with traditional skills, measurements or business systems. But a business transformation to make this a standard offering has massive implications – and of course depends on the readiness of the market to accept that change.
And it is here that we come to what I see as the real inhibitor to outcome-based contracts – the customer. While welcoming the theory and in some cases even issuing bids that request outcome-based proposals, my experience is that most customers then back off from such deals because they are not equipped to manage them and cannot easily calculate the implications. For example, how do you calculate savings? How do you agree incentives or charging levels for over-performance? How do you budget for an uncertain cost? And perhaps most important, how do you oversee and manage performance?
The truth is, for all the challenges that outcome-based contracts may represent for suppliers, the buy-side is generally even worse equipped to manage such contracts, having made virtually no investment in post-award contract and relationship management. So despite all the talk and all the benefits, progress in this area remains painfully slow – but there are at last signs that it is picking up pace (and I will write more about that tomorrow).