The Future’s Bright…
This article originally appeared in Outsource Magazine Issue #24 Summer 2011
…the future’s outcome-based, as the need to avoid “detail confusion syndrome” drives innovation in contracting and the increasing adoption of
outcome-based agreements. John Buyers explains more…
Typically lawyers are a granular bunch and love to get into the detail. After all, as the saying goes, that’s where the devil resides. Managed services contracts are usually, in this context, a detail-oriented person’s delight.
Traditionally structured agreements are often composed of multiple schedules, multiple SLAs and front-end terms and conditions that often run to a couple of hundred pages, and that is without reference to external project plans, specifications and methodologies that can increase this volume considerably.
Not unsurprisingly, it can become difficult to see the wood for the trees and determine on a strategic level what exactly a vendor has been contracted to perform. In a similar vein, it can paradoxically become easy for vendors (who have often been hired on the basis of a strategic reason enumerated in a supporting business case) to hide behind the detailed service metrics that traditional outsourcing contracts promote.
For many sophisticated purchasers, this “detail confusion syndrome” as I like to refer to it has become an increasingly frustrating side-effect of contracting for managed services. Innovative purchasers are now avoiding it by use of “outcome-based” agreements.
What is an outcome-based agreement? Well, the concept is not new. This type of agreement had a brief heyday back in the early 1990s. They are now enjoying a renaissance. Typically, as the name suggests, they measure success by reference to outcomes rather than outputs. The industry group Intellect has defined these agreements as:
“…an agreement between a customer and supplier in which the supplier is contracted to directly achieve business outcomes for and with the customer – rather than being contracted in terms of delivery of the supplier’s inputs, outputs or deliverables.”
To give a very simple example, an airline contracts with an IT provider to build and manage a passenger ticketing system. Under a traditional agreement, the IT supplier will have a fairly detailed specification, build plan and SLA to conform to in the steady-state period. Typically the SLA might be structured around availability, so that it will be penalised if the system becomes unavailable or goes down for a greater period than the agreed metrics allow. All well and good right? Well no. What if the airline is more concerned about passenger contentment levels and whether its planes take off on time – i.e. the underlying reason why that vendor was hired in the first place? That is precisely the scenario the outcome-based agreement is designed to fit. Under an outcome-based contracting structure, it is these outcomes (or indeed similar ones) that the vendor will be measured against.
It does not take an IT specialist to work out what the potential pitfalls might be in adopting an outcome-based contracting scenario. The first really concerns cause and effect. In a traditional style outputs-based contract, it is comparatively easy to determine whether the vendor has failed to perform in relation to the defined service metrics that have been agreed between the parties. It becomes far more difficult to determine this in an outcomes-based scenario.
So the planes took off late, or the passengers were delayed in line waiting for their tickets. But these outcomes could have been driven by any number of circumstances not necessarily connected to a failure on the part of the vendor to provide a functioning ticketed system. You can see it becomes critical in framing measurable outcomes to take account of those extraneous events which are outside the control of the vendor. It is a delicate balancing act, however. To simply exclude them would be manifestly unfair to the suppler and would cause any reasonably prudent vendor to run a mile. However, conversely, to allow the vendor too much leeway has the potential to run a proverbial coach and horses through the whole arrangement and undermine it completely.
The second pitfall is that outcome based agreements generally demand a much deeper level of understanding in relation to the customer’s business on the part of the vendor. Simply “flying blind” into service provision will not cut it – whereas in a traditional commoditised managed service, it is comparatively easy to do this. The real concern here is that if the vendor does not intimately understand the customer’s business, they are not going to be in a position to judge what the relevant critical extraneous factors impacting on the customer’s business are. How then can they be in a position to judge whether the relevant outcomes are fair or not? Hopefully you can see that deploying a flawed or imperfect understanding in this context has the potential to translate directly into profitability issues when running an outcomes-based deal.
Advocates of outcome-based agreements, however, argue that the advantages of such arrangements clearly outweigh the disadvantages. The major advantage they argue is the end result of one of the pitfalls I mention above.
The deeper level of understanding that is demanded by outcome-based arrangements promotes a much closer and trusting working relationship between counterparties. It becomes practically much more difficult for either party to withdraw into their respective bunkers and adopt traditionally defensive (and often highly contentious) contracting practices. Could it be that the parties in such arrangements are actually closer to the IT contracting nirvana (and oft misused concept) of “partnership”?
What then are the key factors to bear in mind when drafting an outcome-based agreement? The initial exercise unsurprisingly is to determine what the key outcomes are for the commissioning business. This due diligence exercise needs to establish the extent to which the outcomes are dependent upon extraneous factors that are outside the control of the supplier. The wider the outcome, the more extraneous factors come into play. It is also vital that the supplier buys into the concept. They will do this more readily if they can see that it is their work which influences the chosen outcomes, and the potential disconnect between “cause” and “effect” is minimised.
Additional factors to bear in mind are that (depending upon the outcomes chosen), external benchmarking and evaluation services may become much more critical than a traditionally structured arrangement. To take an example, if customer satisfaction is a key outcome, then “mystery shopper”-type evaluation exercises will become essential to determine the extent of actual outcome attainment.
Governance is also likely to be critical. In an outcome-based arrangement, the parties will need to step away from traditional governance structures which typically involve only the IT and legal departments and enfranchise those company stakeholders that have vested interests in the success of the chosen outcomes.
Finally, those customers who are interested in the outcomes-based approach need to understand that they cannot simply adopt a “black box” contracting mentality with the supplier. There needs to be significant customer investment in terms of time and commitment and a shared accountability to ensure that the desired outcomes are actually attained.
Provided these not insignificant hurdles are cleared, there is no doubt that the outcome-based approach can be a very effective way to facilitate a managed services project.
About the Author
John Buyers is a partner and head of commercial, outsourcing and technology at international law firm Stephenson Harwood. He specialises in ITO/BPO, large-scale managed services projects and regulatory compliance.