Outcomes-based contracting: Rewarding the result, not the effort

As a result of this compounding financial pressure, outcomes-based contracting (OBC) is one procurement model gaining traction. The model links a service provider’s charges directly to the achievement of defined business outcomes, rather than being based on input costs such as labour costs, cost of equipment, or time spent, which is the traditional practice.

While an OBC model can offer clear benefits over the more traditional resource-based models for both customers and service providers, this new approach represents unchartered waters to both parties and, like any major operational shift, will not happen overnight.

Outcomes-based contracting is a welcome alternative when entering into long-term contractual relationships such as outsourcing contracts. When outsourcing an activity, the objectives are usually clear, but exact and detailed requirements are much harder to articulate at the outset. In addition, the rate of technological change means that the method of service delivery (the “how”) should remain flexible and encourage investment and continuous improvement.

The long-term contract should provide that the benefits of technological, process improvements, and new ideas are passed on to the customer to allow the customer to continue competing in a market where product quality, service requirements and technology are changing.

Given the right conditions, OBC can be successfully crafted to deliver mutually beneficial results. For the service provider, an outcomes-based contracting engagement provides motivation and incentive to innovate in order to make more profit. For the customer, it provides assurance that the services firm shares the risk. A better assurance of the outcome exists by rewarding the result instead of the effort.

As the focus is now placed on the “what”, rather than the “how”, the service provider inherently assumes a greater level of risk. If a service-provider is not performing, outcomes-based contracts may result in the service provider either just breaking-even, or losing money. Of course, neither of these results are sustainable for a service provider, which is why it is essential to ensure an acute understanding of what each party will be held to at the start of the contract.

This highlights one of the greatest challenges involved in implementing an OBC model – defining specific business outcomes at a level that is measurable. If you can’t measure the required “outcome”, you can’t manage performance, and you can’t properly remunerate on the basis of performance. An outcomes-based contracting approach is not always suitable and some services, industries and organisations will be inherently better placed to obtain the full advantage of this contracting model than others.

While the outcomes-based contracting model is undoubtedly gaining traction, particularly among businesses in the private sector, it requires a definitive shift in thinking from customers and service providers alike. In order to be successful, an OBC model demands a high level of trust between customer and service provider – far higher than is demanded by traditional contracting models. This shift in perspective will take time, but it is something that we expect to see happening as businesses continue to fight the ailing economic conditions.

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