Outcome-based contracting sees uptick during pandemic
Contracts that tie service provider payments to results has gained momentum as customers pursue digital transformation projects. Learn about the implications for service providers.
Outcome-based contracting has become more popular during the COVID-19 pandemic as organizations look to share risk with service providers.
Industry executives reported increased interest in this contracting approach, which links some, or all, of a service provider's payment to meeting performance objectives. Outcome-based contracting has existed for decades but appears to be gaining ground in the COVID-19 era. That contracting shift could affect service provider business models.
Forty-seven percent of the 200 senior executives polled by Boston Consulting Group (BCG) expect increased use of outcome-based contracts. The management consulting firm's study, "Postpandemic Outsourcing Trends for CEOs," noted that companies "have to change the nature of contracts so that they share more risks and rewards with service providers."
'Skin in the game'
If partners have yet to encounter outcome-based approaches, they may soon. The BCG report found that 62% of respondents are likely to renegotiate their service provider contracts in 2021.
Business continuity and resiliency are among the outcomes companies look for as they respond to COVID-19 and prepare for future disruptions with adaptive strategies.
"There is a lot more emphasis on how the vendor and service provider can put skin in the game in terms of keeping the lights on," said Hrishi Hrishikesh, partner and director of digital transformation at BCG and one of the report's authors. "That is more important with COVID."
Hrishi HrishikeshPartner and director of digital transformation, BCG
Customers are structuring contracts in a couple of ways to share risk and reward with service providers, Hrishikesh noted. One method puts fees at risk. That is, a portion of the service provider's fees may not be paid if the provider fails to meet or deliver the contract's specified outcomes. The other approach is gain sharing, in which a customer agrees to share a portion of the upside if the provider exceeds the agreed upon outcomes. The gain sharing fee is over and above the provider's fee for satisfying the contract's basic requirements.
In both contract structures, outcomes could be outputs such as the number of user stories delivered per agile sprint or business outcomes such as quicker processing times, Hrishikesh said. Customers often measure outcomes using specific metrics, with targets and thresholds explicitly written into contracts, he added.
At IOpex Technologies, an IT services firm based in San Jose, Calif., the pandemic has led customers to ask for help with improving systems or processes. A call center automation project, in which digital workers are deployed to collaborate with the human workforce, can result in a leaner operation and significant cost savings, IOpex chief digital officer Nagarajan Chakravarthy said.
"Such projects naturally lend themselves to an outcome-based engagement model in which the customer lets IOpex take a share of the cost savings through risk/reward-based contracts," Chakravarthy said.
This approach has emerged in digital transformation engagements, especially as the pandemic accelerated automation- and cloud-based projects, he added.
Due to the push around automation-led transformation, the company launched its OpexWise toolkit. The offering brings together automation, operational platforms and cloud adoption to facilitate digital transformation, according to the company.
IOpex sees many initiatives that involve robotic process automation, chatbots, application modernization and cloud adoption to drive digital transformation, Chakravarthy noted.
Outcomes as a service
Paul Wilkinson, executive vice president at 1901 Group, a Reston, Va., MSP and wholly owned subsidiary of Leidos, equated outcome-based contracting with as-a-service purchasing among public sector customers. Agencies are turning to enterprise IT as a service, divesting themselves of capital expenditures for items such as network infrastructure, endpoint hardware and software, and end-user support, he said.
In this context, public sector customers are buying "outcomes" -- managed desktops, managed storage, managed compute, managed enterprise networks, and managed voice and unified communications, to name several, Wilkinson said.
The public sector as-a-service trend has taken off over the last three years, but COVID-19 fueled its growth. "The pandemic has certainly increased demand for [cloud services providers], with new resources being acquired for data analytics, VPN, collaboration solutions ... and remote support," he noted.
While the as-a-service model is the general direction, buying patterns can vary. For example, agencies may want to use fixed-unit-rate or firm-fixed price contracting, according to Wilkinson. A fixed-unit rate provides elasticity, because the price per unit can increase or decrease based on consumption. A firm-fixed price, meanwhile, generally lacks elasticity. This approach may be used to deliver a defined type and quantity of service where the price doesn't change -- a reserved instance of a cloud service, for example.
"We see a variety of [as-a-service contracting], and it is on the rise," Wilkinson added.