Procurement evolves to outcome based contracts

By Charles Nyika | 3h ago

Procurement

Years of conditioning and lessons learnt over the years have taught supply chain professionals that the rate of contract non-performance is gravitating towards the higher side. Contracts that are generally awarded based on the lowest bid principle often result in cost overruns, poor workmanship or late deliveries, and poor back up support services.

Given such challenges, the way supply chain professionals administer contracts has changed significantly over the past couple of years. Procurement professionals are under considerable pressure to deliver agreed contract outcomes within budget and on time.

There is an old adage which says in a period of profound uncertainty, change is the new normal. Because of contract non-performance challenges indicated above, supply chains are slowly moving away from standard prescriptive contracts to outcome-based contracts.

The trend reflects a growing inclination towards contracts that tie payments to measurable outcomes.

Such contracts focus on tying payment of service providers to the results they deliver rather than the resources they expend. Suppliers and contractors will only be paid for a product or service if all the agreed specifications are met to the dot.

The driving ideology behind outcome based contracts is that suppliers, service providers and contractors must focus their undivided attention to selling business outcomes which bring value to the end user rather than just focusing on closing a sale.

Outcome based contracts are slowly becoming the buzzword in procurement.

They seem to represent the best approach to pay-for-performance contracting with a view to stretch the value of the dollar.

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Outcome based contracts give suppliers the opportunity to do things differently, allowing discretionary space to try new approaches to resolving supply chain challenges.

It is believed that focusing on performance outcomes is more important than focusing on delivery mechanisms or focusing on technical specifications.

Benefits associated with outcome based contracts include reduced costs, improved outcomes, greater innovation from the service providers, better responsiveness to customer needs, stronger alignment of goals between supplier and customer and greater motivation for the supplier to excel.

It appears there is more flexibility for the service provider to do what suits the situation best.

Outcome-based contracts ensure that both parties to the transaction are clear on what needs to be achieved.

This will facilitate a closer alignment of objectives between the customer and service providers.

With outcome-based contracts, requirements are agreed in the form of end goals or business outcomes without stipulating the formula to achieve them.

It is underpinned by the underlying emphasis on: ‘Tell me where you want to go but don’t tell me how to get there’. It is therefore about shifting from volume to value.

With clarity of intention and commitment, a properly structured performance based agreement shifts the burden of responsibility from the customer to the supplier. It will generally provide greater flexibility in how performance outcomes will be achieved.

Because supply chain professionals will not have imposed prescriptive specifications, the service provider will have discretionary authority to come up with innovative, cost effective solutions for the benefit of the end user. This will provide a unique opportunity for suppliers to showcase their capabilities and differentiate themselves from competition.

Paying for outcomes allow for operational flexibility.

With outcome-based contracts, nothing is ever said about the methodology and plan for the achievement of outcomes. Such contracts will provide flexible terms and conditions that allow service providers to respond in the best possible manner to uncertainty.

They will be useful in the context of creating agile and responsive supply chain designs. Contracts of this nature will allow for adjustments based on changing circumstances, such as shifts in market conditions, changing customer needs or unforeseen consumer challenges.

They are considered to be more flexible to contextual supply chain risks by adapting to the changing needs and realities of the business landscape.

Outcome-based contracts will allow suppliers and contractors to perform their obligations with the minimum of constraints, it normally creates the freedom for a supplier to leverage existing facilities while adapting to new technologies as the situation demands.

With this type of contract, suppliers will easily position themselves as experts in their respective supply chain categories.

The move towards outcome-based contracts reflects a strong desire for better value, accountability and enhanced performance. By tying payment to results, companies will only pay for what they get, bringing a result-focused approach.

Outcome-based contracts are therefore a good proxy for measurable benefits. The major focus is on business outcomes rather than activities and tasks that bring the results.

There is a considerable shift from focusing on inputs and processes to focusing on measurable outcomes and results.

The use of measurable performance standards tied to required performance outcomes is the way to go.

Such contracts can help to control costs, as suppliers and service providers will only be reimbursed for actual results achieved. In the context of economic constraints, there is need to ensure that every dollar spent has maximum effect on outcomes.

Some of the highly recognised key performance indicators for outcome-based contracts are, but not limited to delivery timeframes, completion cycle time, throughput and overall optimum equipment effectiveness.

Measurable metrics such as uptime or response time will become measures of success and value.

Rewards will be directly tied to the value or results that a customer receives. Such contracts can assist in ensuring the delivery of quality products, as poor performance can result in reduced or no payments at all. Supply chain professionals will not shell out funds for an unsatisfactory outcome forcing suppliers to perform up to the required standard.

Invoices for services rendered will only be paid ex-post and only if outcomes have been delivered to the utmost satisfaction of the customer or end user.

In this new age of business, the outcome-based service model has become the preferred partnership between customers and service teams.

Such contracts are bound to co-create joint identification of performance outcomes and measurable metrics which are generally regarded as hallmarks of progressive success.

Contracts of this nature will be modelled based on a shared vision of success, supported in great detail, by relationships that facilitate shared learning and quick course correction methodologies.

Instead of customers bearing all the risks upfront with fixed-price contracts, both parties are interested in achieving mutually beneficial outcomes, helping to keep the parties’ expectations and interests aligned. By sharing best practices, lessons learned, and industry insights, both parties can benefit from each other’s expertise.

Outcome-based contracts will often include mechanisms such as performance guarantees and moderate penalties in the event of non-performance.

Their use will facilitate a seamlessly collaborative relationship which allows for tracking of key performance milestones.

Outcome based contracts are highly customer centric as they take into account the customer’s barometer for success. They happen to synchronise the objectives of the business with the objectives of the customer. Customers generally do not buy products.

They want to buy the capability that the product delivers.

The more benefits the customer receives regarding cost savings and revenue growth, the more they are prepared to pay. This will obviously reduce the financial burden on customers while ensuring service providers deliver results. Customers will not pay a dime until the performance results are achieved.

Suppliers are therefore seen as drivers for economic value, not regarded as cost centres to be micro-managed.

In conclusion, it would appear after the introduction of outcome-based contracts in the last couple of years, the jury is still to pronounce whether they are achieving the desired results.

Although mainstream adoption has been fairly slow, outcome based contracts have been implemented in a range of contexts around the world with mixed results.

It may be important to have a case history and track record to see where trends are going. Supply chain professionals cannot just keep throwing money at problems.

Supply chain professionals will need to have an incurably curious mind that continues to ask the relevant questions through the use of outcome-based contracts.

It may be important to point out that whatever else we know about the coming years, we can be certain that it is no longer business as usual.

The new normal is still work in progress. The world is not so black and white after all. Outcome based contracts will be useful when organisations come across humps and bumps.

During the bust element of the cycle, there is often volatility and uncertainty. Performance based contracts will assist in navigating the several bends along the supply chain journey of success.

Their use will be as exciting as they will be challenging. There will always be pushbacks and hurdles to overcome.

The boom-and-bust business cycles will be prevalent and outcome-based contracts will become the need of the hour.

It appears such contracts hold great promise in improving performance results. They are viewed as a natural progression in the move towards value creation and value preservation.

Outcome based contracts are considered a potential wave of the future. They should be regarded as pedestals for achieving excellent performance results.

After all, customers are smart enough to see through smoke and mirrors and base their future purchase decisions on previous performance results.