Date: 11.06.2004

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Conference highlights

Sharing risks and gains = gainsharing

By: Sharon Harmer, Head of Outsourcing & Strategic Procurement, Lloyds TSB

It is all about shared risks and rewards. According to an IDC/Accenture study:

Service providers have the desire to become business partners of customers and share risks and gains

More and more are demanded from service providers

The willingness to share risks is becoming a criteria to select a service provider

What does gain sharing mean? It means that the customer and the supplier share financially the added value created throughout the outsourcing relationship. Beside sharing gains they also share risks associated with the business relationship. In order to properly and fairly share gains the supplier and customer must first align their goals. The level of rewards can then be linked to tangible business results such as lower costs. Realistically set incentives will improve co-operation, service levels, productivity, profitability and commitment on both sides. How and under which conditions the supplier and customer share risks and gains is set forth in a gainsharing plan. The key to success is a fair gainsharing plan which holds advantages for both parties.   

Gainsharing, financially sharing added value, is associated with the pricing model used. There are three basic pricing models usually used:

Cost Plus: payment is based on the actual cost of production plus an agreed-upon fee or rate of profit. This pricing model has a low administrative overhead and provides good transparency. However, the customer must bear most of the risks and the pricing model provides limited cost control which encourages operational inefficiencies.

Fixed Price: the supplier is paid a fixed, pre-agreed amount upon delivery. When this pricing model is used the requirements, scope, services, features, planning and timing, and pretty much everything, is also fixed. For customers it provides greater cost certainty but leaves most of the risks with the supplier. However flexibility is limited and changes can be expensive. It can also have a dramatic negative impact on service delivery and service levels. Fixed pricing is adequate when there are only a few unknown factors and no significant changes are expected.

Time and Material: the supplier is paid based on the time and material used. In principle, when this type of pricing is used the customer pays only for what has been used. The key to success is accountability and transparent administration on the supplier side. However, this type of pricing does not encourage the supplier to increase efficiency and provides limited cost control options for the customer. It can also hide mistakes on the supplier side. An absolute must is a "not to exceed" figure in the contract.

In reality often a mix of the above pricing methods are used. For example in a software project for the design phase Time and Material pricing is used while Fixed Price is applied for the implementation phase. Gainsharing provides a middle road between the different pricing models, creating a win-win environment for both the supplier and customer.

Key elements of success:

Cultural fit and change management capabilities

Communication

Measurable and verifiable gains. Well defined metrics (before the partnership begins)

Risk management

Aligned mutual goals and incentives

Flexibility

Not every process is suitable for gainsharing