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Has the time come for outcome based agreements?

Summary:

The time has come for commercial innovation in outsourcing and shared service: three business tsunami that are compelling procurement and commercial executives to explore Outcome Based Agreements.

Content:

In the last two years there has been a confluence of three business forces which are set to transform shared services and outsourcing.  As these forces intensify, so businesses will look to explore new commercial models including the outcome based agreement (OBA).  An OBA is an agreement whereby suppliers are partially remunerated for their contribution to the outcomes of the business.  In return for remunerating when value is added, which requires a greater transfer of risk, suppliers have the freedom to develop solutions which deliver the outcomes in ways which may not have been envisaged by the buyer.  So, what are the issues causing businesses to explore this approach to technology contracting?

These three forces are work acting in concert.  Each one has been seen before but now they have come together in confluence.


The first of these forces is the credit crunch.  Since late in 2008 many businesses are struggling with shrinking markets and credit has become scarce.  Although interest rates are at an historic low, banks are reluctant to lend money.  Cash rich businesses are even more careful about how they invest their capital.  The bar has been raised for investment business cases which are required to deliver benefit early, ‘in year’ if possible.  Traditionally, large IT projects are capitalised but which organisation in the current economic climate would want to burden itself with people, capital and software licence intensive projects?


The second is the advent of cloud computing.  Some say this is the 3rd technological revolution after the client server and Internet.  It offers reduced cost computing power and applications both as a as a commodity.   These new services are maturing rapidly.  New low cost entrants offering infrastructure and software as a service are entering the market every day and when combined with innovative support services it creates a compelling business case to for the business to move from capital projects to revenue based services.  There are risks: CFOs will look to the CIOs to manage those risks as they hunt down the savings.


The final force is the legacy of second generation outsourcing deals.  Just last month I went to see a client with a strategic partnership deal for its ICT infrastructure and corporate applications.  It was signed in early 2008 and based on traditional input driven service level agreements.  My client described a scenario whereby they need to cut costs fast, the CIO sees cloud computing as a way forward but the contract is fixed.  It appears every aspect of the contract is inflexible and the organisation cannot benefit from the falling cost of labour and the emerging changes in technology.  It is as if the technology and business tide has ‘gone out’ leaving the ICT services contract stranded on the beach!  Interestingly, my client has indicated the early termination penalty payments may be worth paying in order to move out of this situation.  This contract is wholly inappropriate for the business in that it is inflexible, deploying old ways of contracting for ICT and excludes the business from accessing new technologies at lower cost.  The contract still has four years to run.  Commercial and procurement specialists have to wake up! 2nd generation outsourcing deals are not appropriate in this revolution.


So how will Outcome Based Agreements help?  OBAs require a completely different commercial strategy.  There are two key differences – commercial agility centred on strong governance and simplified strategic change; the outsourced or shared service contract instead of being fixed on Day 1 for the duration, must recognise technology and business change has to be accommodated.  The second feature is that the buyer does not specify the inputs and through a process of due diligence and innovation the business outcomes are achieved through bespoke solutions, developed together, which fit the buying organisation, with layered remuneration (services, output and outcome payments) based upon the balance of risk between parties.


What are the benefits of an OBA?

  • Unambiguous and effective governance with clear roles for all stakeholders
  • Close working relationships which allows parties to play to their strengths
  • ‘Living contract’ so the buying business can harness new technology and respond to changing business conditions through a portfolio of services and projects
  • Provides objective and comparable performance measures
  • Increased dynamism in the relationship
  • Remuneration as value is added
  • Faster procurements with lower costs.


Procurement and commercial specialists, and lawyers, have got to raise their game and think differently.  New commercial constructs are available and must be deployed if long term, high value contracts are to be future proofed.  OBAs are a clear way forward and can reduce the dependency on people, capital and licence intensive investments thereby releasing businesses from the financial and technology handcuffs of yesterday.  Never again must we be responsible for outsourcing and shared services contracts which risk being left stranded on the beach, like a decaying hulk, when the commercial and economic tide goes out!

This blog was commissioned by SSON and can be found at: