As businesses across all industries realize the need to deliver more value to the customers beyond just low price, they are making changes to their complete business model. Vendors are increasingly seen as partners in value creation. Smarter companies are moving away from cost based transactional relationships to an outcome based partnership model. These companies realize the strategic value that partners bring in areas like process efficiency, continual innovations through the adoption of best-practices, technology and robotic process automation.
The premise of outcome-based pricing is that companies can hold their vendors to greater accountability for business outcomes. Creating successful outcomes requires far more than swapping out the language in contracts. Measurable gains are possible only when both the buyer and vendor are willing to commit to a larger undertaking: namely, making the organizational, cultural, and procedural changes necessary to support a far more symbiotic and strategic relationship.
Successful outcome-based pricing models require a well-planned strategy that elevates providers to trusted advisors. Above all, this means sharing control and accountability as well as risk.
Outcome-based engagement model links fees to a metric directly applicable to the outcome of the business. Customer satisfaction, incremental revenues, and cost savings are some typical examples of the outcomes. Usually, the outcome-based “at-risk” component of the pricing signifies no more than 10 to 20 percent of the full fees.
The defining feature of the above-mentioned models is that they are decoupled from a fixed capacity of FTEs; also, the governance includes managing results and milestones, not service provider resources.
The service provider decides how it will deliver on the business requirements – and thus a degree of both control and risk shifts to the vendor.
Contracts are usually written as a fixed component plus percentage of outcome to arrive at the end of the year/quarter. Both organizations need to invest significant time and energy in ensuring the contracts meet both organizations’ goals. Legalities are important but more critical are the understanding of the terms and conditions of performance between the parties and well-placed trust.
Focus on those components which directly influence business outcomes:
As noted above, outcome-based pricing works well for many business transactions, where the vendor’s performance can directly influence the achievement of pre-defined business benefits. This is not always the case for services as they are often too far removed or where the vendor’s performance is only one of many components. Identifying those services that can directly impact achievement of benefits is crucial to a successful outcome-based model.
Objective performance measurement
The business outcomes should be unambiguously defined in the contract, the objective should allow effortless measurement. If any of these are absent, there is a much larger risk of rigidities and disagreements arising between the parties during the deal’s lifecycle.
Performance measurement can be supported with well-defined metrics across all areas of the operation. Being metric friendly enables easier conversations and fewer challenges in the relationship. Mutually developed and agreed performance dashboards are critical to monitor and review performance.
Better control in service delivery
The stakeholder will typically assume much greater control over how the services are provided including methodologies, tools, and locations so that they can acclimatize their service delivery models relevant to the business outcomes. This renunciation of control requires a mindset change at senior stakeholder and operational levels. This can be a challenge for many such whose roles may undergo change or for those who are very close to managing service delivery.
Understandig the business
Vendors can normally assume risks only when they have a detailed understanding of the clients business. That means having access to accurate, historical data about the performance against the defined business outcomes, including costs and any factors that have influenced the achievement of those outcomes in the past. This places even greater importance on the due diligence that the vendor must carry out pre-contract. This works best where the business and vendor have an existing relationship, history of track records. Another possibility here is a comprehensive study being performed by the vendor of the buyer’s business operations. Such studies are done as consulting projects with findings and improvement opportunities being presented and discussed. Mature companies may leverage powerful business process frameworks including Lean, Six Sigma, DMAIC and SIPOC methodologies. Voice of Stakeholder and Customer surveys are also conducted to understand current business challenges before agreeing on possible outcomes.
A steering board should be formed comprising of CXO teams – leadership needs to be continually involved to review functioning. The frameworks of the relationship should be so built to allow for reasonable flexibility to enable course correction as required.
The vendor will need ongoing information about the strategy, business strategies and product roadmap, and any other influences which may affect the defined business outcomes.
Successful application of an outcome-based model requires practicality and rationality from parties and their advisors, careful preparation and due persistence, open sharing of risk and reward, and transparency and trust between the parties. Though each of these achievement ideologies comes with their particular conventional challenges, outcome-based models, implemented in the right circumstances, can be an operative way of driving value and innovation from an outsourcing relationship.
It is important to integrate the client and vendor operational engines. The services should be governed by well-defined and LIVE standard operating procedures that allow improved communication and collaboration between teams.
Clear communication and escalation protocols would need to be agreed on. Mature vendors have dedicated “Business Excellence” practices to periodically review process, controls, possible automation and improvement opportunities. It is important for the buyer organization to participate in such initiatives and effectively collaborate to bring about proposed changes that are backed by clear business cases.
Driving successful outcomes through outcome-based pricing can only succeed when both the business owner and the vendor view the relationship as strategic and are committed to sharing control and accountability. Control empowers the vendor to have the flexibility to innovate and make decisions that positively impact accomplishment of business goals. Not every association will lend itself to a strategic partnership. There are definite criteria you should consider before you decide to embrace outcome-based pricing with a vendor:
Competency: Does the vendor have the delivery competency to help you realize your business outcomes?
Inclination : Is the vendor willing to pledge to a win-win relationship that aligns client and vendor goals and incentives?
Financial determination : Does the vendor have the financial forte to invest in innovation and change on a global scale?
Flexibility : Does the vendor have the needed scale and agility to support during disasters (technology breakdowns, natural calamities and other disruptions). Vendors, in general, are able to offer some level of flexibility but it is also important for the buyer to support as required during such situations. It is a good practice to evaluate vendors for adequate Business Continuity and Disaster Preparedness in their systems and processes.
Conventionally, contracting for services involved the creation of a complex master services agreement, with statements of work that controlled specific programs. These documents agreed hours of operation, headcount required, reports to be produced, and other requirements the conservative wisdom was that you needed to manage the inputs to the process to arrive at the correct output. This also led to the creation of “shadow management teams,” needed to uphold compliance with contractual terms but whose costs eventually abridged the savings.
Instead of inflexible management of inputs, the outcome-based contract outlines outcomes and measurement indicators. A robust governance model is required to limit exposure to inadvertent consequences, and the underlying economic model of shared value. When created correctly, the outcome-based contract provides a robust framework for a long term relationship.
Mature vendors, as a part of their operating model, capture data at a good level of detail (transactional and business metrics). Such metrics form the basis of an analytics engine that delivers insights and models to enable right decisions and course corrections.
Outcome-based models cannot be fruitful without a sufficient level of investment in data analytics. Insight from analytics allows the ability to intelligently control and tune processes to attain desired outcomes. You only get that insight from collecting the right data and analyzing it by means of proven techniques.
It helps identify the key drivers of the outcome that you are trying to achieve and the extent to which customer service or other functions can influence that outcome. This acceptance is foundational to designing achievable improvement in outcomes and aligning expectations with your business goals.
Conclusion : While an outcome-based model requires a great deal more time, effort, and commitment to define and execute, the potential benefits can far overshadow the disadvantages when it comes to helping organizations transform customer experience and business success.