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Is outcome-based contracting a trick?

July 31, 2014

“What should I read into the trend from customers to specify that they want an outcome-based contract. Is this just another way they want to load more risk onto the supplier?”

That was the question I faced when meeting with the Commercial Director for a large, international service provider this week. His experience of ‘outcome-based’ has not been good. He cited examples where the customer has been quite specific about the work they want done, but then added a clause that essentially offers them carte-blanche to enforce on-going rework at no cost. They specify requirements, but essentially say that if the outcome they achieve is not in line with whatever they may then need, the supplier must undertake work to deliver that outcome.

Clearly, this is indeed an unacceptable burden of risk. Essentially it abdicating responsibility for defining business needs and saying “I don’t really know what I want, but give me xyz and if I then decide I really wanted abc, you will do the conversion work for free”.

Given the speed of change in today’s markets and technologies, it is quite understandable that customers will struggle to define precise or static requirements. Indeed, in many cases, a key requirement is flexibility and change. It is not reasonable to expect that a supplier can absorb the consequence of that uncertainty. This situation demands a different approach to contracting and contract management.

In IACCM’s view, the first requirement is to undertake an honest and thorough analysis of the potential sources of uncertainty and to assess their severity and impact. We have developed a standard questionnaire to assist in this. Based on those findings, the parties need to review the right contract model – for example, the blending of performance-based, outcome-based or agile. This also predicts the level of collaboration and shared responsibility that will be appropriate.

However, suppliers are not absolved from responsibility in addressing today’s business environment. Few have worked on developing appropriate contract models or assessing the shift in internal competencies needed to negotiate or manage such agreements. Equally, they are reluctant to address the internal measurement and motivation systems that incentivize acceptance of unrealistic commitments and unaffordable risks.

In addition to the questionnaire, IACCM has developed new approaches to negotiation and guidance on producing relational contracts through either internal or multi-party workshops.

Without decisive action, suppliers are indeed right to fear many outcome-based contracts and the risks associated with them. But the answer is to help educate and develop the market because the forces that are driving this need for change will not go away. Ignoring them is an even bigger risk that responding with the wrong solution.

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2 Comments
  1. Eugene P. Grace permalink

    I have worked on many contracts that are looking for a complete solution from a vendor. In fact, in various speeches and in my negotiating seminar, I discuss the difference between contracts for “resources” and those for “results.” A resource contract is essentially saying that the buyer is acquiring a certain commodity and will fashion it into whatever they want. For example, you could have a contract for wood, which could be made into a floor or a fence or could be burned in the fireplace. On the other hand, you could have a contract to buy a house, which is a result oriented approach. Results-oriented contracts require multiple levels of inspection or acceptance testing. The contractor cannot proceed from one element of the project to the next without some form of sign-off accepting the work to date. Fee schedules should be geared to making payments upon acceptance of the various phases of work. On the other hand, the contract should be very specific as to what constitutes acceptance at each phase of the contract. If the work meets the contracted metrics of acceptance, then any re-specification will require additional fees. Frequently, there are change requests in large projects and the fees for such changes should be negotiated in advance. These contracts are typically difficult to draft and there is a lot of back-and-forth as to what constitutes acceptance at each level of the project. The development of these contracts will require significant impact from technical personnel and clear contract drafting. In most cases, a standard contract for the acquisition of goods or services will not be sufficient. These contracts tend to have a higher level of variability. By using the phased approach to “outcome” or “results-oriented” contract, the buyer gets what they wants and the seller is entitled to appropriate additional compensation for changes made to the project. These contracts require a high level of vigilance in contract administration.

  2. This is not an unusual situation, and I agree that suppliers have a clear responsibility to educate their market in sharing contractual risk. I also acknowledge that many suppliers are either reluctant or ill-equipped to undertake such a task, and that may prove expensive – not only will they assume increased risk of uncontrollable scope growth, but they will forego potentially significant opportunity.
    A customer such as the one referred to in the example above, is clearly in need of assistance. He knows in broad terms what we wants done and what he wants to achieve, and knows that there are potentially many other related issues that may need to be addressed but has no idea how to procure that assistance. Quite likely he is heading in a direction which could be expensive, acrimonious, or unsuccessful.
    A smart supplier can, with a little effort, develop an offer package that demonstrates to the customer that (a) unlike the competition, he has a very good grasp of the customer’s business and objectives, and (b) there is a defined commercial solution to (almost) every possibility. The resulting benefits from such an agreement are not limited to the much better working relationship between the parties. The supplier could have a more attractive offer (improved chance of winning), lower risk (a better defined scope) and potentially longer term revenue (helping the customer convert XYZ to ABC or DEF or …). The customer will have lower risk (and pay less for contingency) and a greater chance of success, with a supplier who is incentivized to persist in achieving customer objectives without requiring a blank check.
    While companies continue to seek increased value through outsourcing, supplier competition remains fierce in some market sectors. A versatile supplier who can offer targeted solutions will surely outperform his peers.

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