Risk & Reward: Examining the models for successful outsourcing contracts
Risk & Reward has become a popular approach to working with Outsourcing Service Providers (OSPs) and at Ember we are often asked what model should be used. Having managed hundreds of outsourced arrangements, our team view is clear: there is no “one size fits all” model. Each contract needs to be treated uniquely, because there are so many variables that may come into play. However, there are generally three underlying approaches: Pay for Performance, Gain Share and non-financial rewards. Each has its own pros and cons.
Pay for Performance
Pay for Performance (PfP) is where the OSP receives a basic rate for delivering the service, but can achieve a higher rate for exceeding set performance thresholds. This is often combined with a penalty element if performance falls below a certain threshold. In short, you pay less for poor service and your OSP is incentivised to hit higher targets. This approach is the foundation of most risk & reward models, though the actual percentages change depending on both parties’ appetite for “risk” and “reward”.
In a PfP model, it’s vital that the “reward” drives the desired results. When a large software company reviewed its PfP model, it found that there was little difference in the performance of the OSPs who had been contracted on a PfP basis, compared to those who hadn’t. The answer: make sure the PfP targets you set are those that promise the greatest ROI.
Gain Share is another popular model. It is typically used where the “gain” can be easily measured – increased sales – or where there is a hard savings target in place for the business and OSP to achieve. The benefits from those sales or savings are shared directly with the OSP at an agreed % split.
With any Gain Share model, the benefits are clear: the OSP is incentivised to achieve results that the client wants. One online travel company took this further still: all the OSP’s remuneration was based on the gain achieved from sales, meaning the client had no upfront costs.
The downside of such models is that OSPs can become so focused on achieving the gain that they lose focus on other important metrics. There are ways to address this: a large FMCG company developed a savings target gain share model that required the OSP to use some of its share to reward agents and invest in new technologies. The client benefited from motivated agents and new systems; the OSP gained incremental margin, while also enjoying lower attrition (and its associated costs) and improved performance.
The third common approach is non-financial rewards – where the client doesn’t have to pay anything more. The reward could be extra work: a games console manufacturer provides its best performing OSP with additional volume at peak times or reallocates work from the worst performer.
A consumer products company rewards agent with product for exceeding performance targets. This not only motivates agents, but also turns them into true brand ambassadors who can engage with consumers as product users and experts. While the OSP receives no direct reward, it benefits from more motivated and engaged workers, lower attrition, higher productivity and ultimately better performance on the programme – leading to improved margins and a thriving partnership.
In our view, all risk and reward models fall into one of these categories. So-called new approaches such as Vested Outsourcing or outcome-based pricing are ultimately based on either PfP or Gain Share, rewarding an OSP for achieving an outcome or sharing benefits.
Adopting your own risk & reward model
As we said at the start, there’s no one right model to use; instead, it needs to fit your business goals. Here are some core factors to consider when designing your own:
- What are the real outcomes you want to drive? Be aware of potential unintended consequences of driving one metric above all others.
- Are the metrics you are planning to reward worth the investment: will you get your investment returned?
- Would it be simpler and more effective to build the metrics you want to achieve directly into your contract, rather than having a risk/reward model?
- How can you incentivise an OSP to use some of its upside in rewarding agents? Everyone benefits from a more engaged and motivated workforce.
- Not all models will work everywhere – for example when working in Financial Services, you must be careful in what you incentivise an agent to achieve.
- Whatever model you look to deploy, transparency with your OSP is crucial. It ensures all parties feel they are getting a fair deal, not only at the outset but through the life of the programme.
For advice on risk & reward models – or any aspect of managing outsourcing – talk to our experts in procurement and partnership optimisation.