Outcome-based contracts – Adding value to the contract life-cycle
August 25, 2015
There is growing evidence that an outcome-based contract has substantial impact on the results achieved in a contract life cycle. Outcome-based contracts are results based, focusing on the outputs, quality or outcomes. They typically tie at least a portion of a contractor’s payment, contract extensions or contract renewals to the achievement of specific, measurable performance standards and requirements.
The purpose of an outcome-based contract is to obtain overall better value, better performance and lower costs. Outcome-based contracting requires output based specifications and procedures that require the contractor to devise the most effective and efficient way to perform the work.
The steady move away from traditional product-based sales into a world of solutions and services is changing the emphasis of contracts. Rather than each transaction being driven by specific delivery of input, many agreements now relate to phased activity where completion is rather less precise and success can be gauged only over time and linked to an extended outcome.
Characteristics of outcome-based contracting
Outcome-based contracting is a form of contracting that explicitly includes three characteristics:
- Clear definition of a series of objectives and indicators by which to measure contractor performance.
- Collection of data on the performance indicators to assess the extent to which the contractors are successfully implementing the defined services.
- Performance leading to consequences for the contractors, such as provision of rewards or imposition of performance adjustments.
Importance of key performance indicators
Key performance indicators (KPIs) are used by organisations to gauge their progress towards their goals and play a substantial role in outcome-based contracts. KPIs normally vary from industry to industry as well as organisation to organisation. The use of KPIs are key in the maintenance of an outcome-based contract as they assist in the measurement in relation to strategic goals and objectives. The successful introduction of KPI’s in an outcome-based contract are usually implemented via the STRIPES process below;
- Select – Select the critical KPI business drivers
- Target- Set appropriate, achievable and realistic targets
- Responsibility- Allocate targets to individuals
- Implement- Monitoring of actual performance
- Presentation- Consider most effective reporting format
- Exploit- Opportunities and act on output with proactive management
- Schedule- Agree distribution and reporting cycles
Outcome-based contracting is key to holding the contractor to account for delivery of the contractual services. It requires clearly defined contract performance criteria as outlined above and agreement on the objective measure of the key contract performance criteria. As a result, this generates key outputs and consequently highlights areas for essential corrective action. Lastly it will act a measure in assisting in the identification of trends to support early preventative actions.
To what extent have you used outcome-based contracts? How much value have they added to the life of your contracts? Share your thoughts below or schedule a meeting to discuss your situation in confidence.