Typically, a contract is fulfilled and the supplier is paid upon their delivery of a particular service or product.
In the case of outcome-based contracts (which are also referred to as payment by results) suppliers are paid once they have met pre-determined goals, rather than for their delivery of specified activities or tasks.
Pioneered in the U.S. in the 1960s, this approach isn’t new to procurement professionals, particularly within the public sector, although mainstream adoption has been fairly slow. In Australia, for example, the New South Wales State Government endorsed the trial of outcome-based contracting in procurement for it its procurement reform roadmap back in 2013.
There are several benefits associated with outcome-based contracting, but some key considerations need to be made to establish when it is the right option for an organisation.
What are the benefits of outcome-based contracting?
- Cost savings – When it comes to pricing, outcome-based contracts have the potential to benefit both parties. Suppliers will be better compensated the higher the quality of the services they deliver, whilst procurement won’t need to shell out funds for an unsatisfactory outcome. In addition, the supplier is able, and incentivised, to leverage cost-effective solutions.
- Increased flexibility – this is particularly true for service-based contracts. Suppliers have the autonomy to decide how they deliver on their requirements, which means they could choose to employ additional people or redistribute the budget as they see fit. Ultimately, because outcome-based contracts are less prescriptive, they encourage greater innovation and efficiency.
- Higher-quality output – Suppliers are incentivised to deliver the best possible outcomes and tailor services to their customers.
Key considerations when implementing outcome-based contracts
- Be sure that you have outlined appropriate objectives within the contract. It’s important to incentivise suppliers to deliver results in the best way for your organisation and ensure they have a willingness and ability to address your required outcome.
- Whilst outcome-based contracts mean suppliers are able to take control, this also means they are taking on additional risk. Suppliers will be wary of this and particularly unwilling to take on risks relating to their customers’ business success.
- Suppliers will be under increased pressure to measure and provide evidence of their output. Both parties will need to agree on how this is done.
- In many cases, procurement’s needs can be fully met by a simple deliverables-based contract. Don’t overcomplicate unnecessarily.
- For larger-scale procurement projects, it’s likely to be beneficial to develop hybrid contracts, utilising both outcome and delivery-based approaches for different elements.
- It’s important to establish a clear pricing model. This might include offering incentives for high performance. Some procurement teams might choose to impose penalties for poor performance.
- Moving to an outcome-based contracting model requires a major cultural shift for procurement teams who will be required to hand over a great deal of control to their suppliers. Risk-averse organisations, in particular will struggle with this.
- Outcome-based contracts are likely not appropriate for business-critical goods and services that should not be exposed to the risks of innovative and untested new approaches.
On 13th May PASA Connect is hosting a virtual roundtable on Outcome Based Contracting : How It Works And Why It Works. You can find more information on becoming a PASA Connect member here.