The Emergence of Outcome-Based Engagements

Moving beyond effort towards measuring business outcomes
by Carey Bettencourt, Dave Hofferberth and Jeanne Urich, SPI Research

With the 2008 economic downturn, advent of cloud computing and maturing business process/IT outsourcing market, traditional professional services (PS) engagement models have come under greater scrutiny. No longer are effort-based time and materials, or even output-based fixed-fee engagements, satisfactorily meeting businesses’ need for vendor control and budget management.

As professional services firms develop expertise and choose to share risks, an outcome-based model becomes relevant whereby services compensation is based on the contribution to the outcomes of the client’s business. In fact, Forrester predicts that about 10 percent of the existing contract models will be comprised of outcome-based engagements by 2015.

Outcome-based engagements may not be broadly applicable. But given the right conditions, outcome-based contracts can be successfully crafted to deliver mutually beneficial results. In this article, we explore the benefits and challenges of this model and provide some guiding principles to use when considering an outcome-based contract.

The ideal outcome-based engagement

So, what are the criteria to consider before pursuing an outcome-based contract? Outcome-based models become relevant when the objective of the relationship goes beyond cost to delivering a measurable impact on business results. Further, the client’s and service firm’s interests must align so they can work collaboratively towards the same goal.

A successful partnership in a performance-based engagement depends on many factors. Following are the ideal conditions.

  1. Mature relationship. Services firm has an exceptional working relationship with client, access to its executives, a defined issue escalation path and enjoys trusted advisor status.
  2. Client business insight. Firm maintains insight into client’s business model, operations and industry nuances. Client keeps services firm in the communication loop when making major decisions regarding business direction or response to market conditions.
  3. Engagement impacts business outcome. The scope of work directly affects the business outcome. Client and services firm have a clear understanding of what constitutes a successful outcome. The PS has a well-defined and managed scope and scope change management process.
  4. Process control. Services firm has the ability to control elements of the process that affect the business outcome.
  5. Risk control. Risk involved is at least partially within firm’s control. Risks can be calculated for each stage of the engagement with an acceptable mitigation strategy. External variables affecting outcome must be minimal enough so the firm can influence the outcome.
  6. Accurate baselines. Client provides accurate baselines and historical data.
  7. Measurable outcomes. Service levels and performance goals are clearly defined and measurable. All data, variables, formulas and reports used to compute results and measure outcomes is thoroughly discussed, and easy to develop or readily available.
  8. Defined risk-reward strategy. Reporting to calculate rewards, penalties and pricing is thoroughly discussed and can be documented in contract.
  9. Proven delivery. Firm has proven delivery capabilities for this engagement.

Inherently, an outcome-based contract is a more sophisticated pricing model that requires clear definition of outcomes and assessment of value creation in order to develop an agreement. This model works best in engagements where the outcome is based on meeting service level agreements, deliveries or deadlines.

This model is increasing in use by offshore business process outsourcing and IT managed service firms. Services firms are also beginning to adopt this model for outsourced product engineering services including software maintenance and new product development.

Benefits of outcome-based engagements

For the client, this type of engagement provides assurance that the services firm shares the risk. Thus, a better guarantee of the outcome exists by rewarding the result instead of the effort. Other benefits include cost predictability and reduced total cost of investment, which are critical in lean economic times.

For the services firm, an outcome-based engagement provides great motivation and incentive to innovate to complete the work faster, meet or exceed client’s expected results and deliver profit back to the firm.

Typically, the driver of this type of engagement is the services firm, not the client. Many firms see this model as a way to break out of the linear growth model and unlink pricing from effort and head count. Also, more progressive firms that learn to manage risk effectively can use this approach as a powerful market differentiator.

Challenges of outcome-based engagements

Challenges exist for both the client and the services firm when entering into and managing an outcome-based engagement. Implementing state-of-the-art performance-based contracting requires new evaluation techniques, new management approaches, improved top-level know-how for designing and managing contract relationships, better logistics systems and a whole new set of client skills.

Perhaps most importantly, what is needed is a changed mindset in which clients are rewarded for effectively managing projects and services providers rather than for the number of direct employees under their supervision.

The services firm must comprehensively conduct its due diligence, execute an airtight contract (specifying client obligations) and assign a highly talented and well-assembled team who are prepared to manage to performance commitments.

Engagement evaluation processes (frequency and intensity of oversight, reporting, meetings) should align with the amount of risk undertaken by the project with pre-definitions for how the risks are distributed, planned for, and mitigated between the client and services firm. Conceptually, an outcome-based engagement could have a lower risk than a time and materials or fixed-fee engagement as the services firm has assumed more accountability and responsibility for the integrity of the delivery process.

A services firm must also define the amount of bearable risk given the firm’s process maturity and state of its business before offering an outcome-based model. The ability to accurately calculate process costs is critical to determining risk throughout the engagement.

Outcome-based engagements summary

External economic, technological and outsourcing forces have accelerated the introduction and adoption of outcome-based engagement models. This type of engagement model can be effective and mutually beneficial to the services firm and client with the presence of the right set of conditions. And, most importantly, reaching a common beneficial outcome requires a strong and open relationship between the two parties.