Procurement Services. white paper. Debunking the myths surrounding the gainshare commercial model. Simon Woodcock Sourcing Solutions Manager

Transcription

1 Procurement Services white paper Debunking the myths surrounding the gainshare commercial model Simon Woodcock Sourcing Solutions Manager

2 It is common for words and phrases to grow and fade in popular usage over time; in the last decade the proliferation of social media and mobile devices has drastically increased that rate of change. One term that has seen a meteoric rise into public consciousness recently is fact-checking. In this paper, we do some fact-checking. Within the realm of sourcing and procurement services, there are two schools of thought regarding effective commercial models; gainshare and fee-for-service. Gainshare sees the provider receive payment as a proportion of and upon successful delivery of realized savings to the customer and is in contrast to feefor-service models, which see customers pay a fixed cost for a pre-defined piece of work or on a time and expenses basis. Both models have their merits and, depending on the circumstance, might be the ideal model to implement as part of a sourcing and procurement outsourcing initiative. Unfortunately, we have recently seen and heard a number of untruths being told in the market relating to this gainshare model. So, taking on the role of fact-checker, here we attempt to debunk the myths that are abound; we have come across ten myths in total: 2012 Xchanging 1

3 Myth 1: Gainshare agreements are high risk Gainshare agreements foster a culture of high risk and high stakes which may not lead to good or sustainable results for the organization. Myth 1: BUSTED This point focuses on the risk of the provider squeezing suppliers to the point that they are unable to adequately provide the services to which they are contracted, thus creating a business continuity risk. Well what about the risk of contracting with and paying a provider on a fee-basis without any incentive for them to actually deliver true value? In reality, both are extreme hypothetical situations engineered to discredit the other model and the key in both instances is to implement robust SLAs that will ensure risk mitigation. Some of the longest procurement outsourcing contracts in the market are based on a gainshare model up to fifteen years quite sustainable in our eyes. Some of the longest procurement outsourcing contracts in the market are based on a gainshare model up to fifteen years quite sustainable in our eyes Myth 2: A provider can get lucky A provider can get lucky and implement large savings on a very easy project. The organization ends up paying a disproportionately large sum of money as fees. Myth 2: BUSTED Of course, with a fee-for-service model, the reverse of this is true. An organization can pay a fee for a project that under-delivers in terms of savings and end up paying a disproportionately large sum of money as fees. Similar to the first myth, the key here is as a good sourcing professional will advise you about entering into a contract with a third-party to ensure you have SLAs that protects you. This discussion relates only to project-based consumption. With a managed services model, the provider will take the rough with the smooth; some projects will deliver more value to the customer and provider, and some will deliver less. Over the course of a three-to-five year contract managing all spend across categories and including value-add services such as spend analytics, compliance managers, sourcing helpdesk and savings tracking, those peaks and troughs really do level out Xchanging

4 Myth 3: Service and quality are ignored in favor of savings Since gainshare agreements are based only on savings, they ignore other important aspects of procurement such as service, quality, customer satisfaction, right solution for the organization. It is not a balanced approach. Myth 3: BUSTED This type of argument seems to rely on the assumption that C-Level executives are signing contracts with service providers that are based only on the commercial aspect of gainshare. Realistically, that is not the case. Service contracts that are based on the commercial principles of gainshare, like any other contract, contain SLAs and KPIs that protect both parties to the engagement and ensure all objectives are addressed properly. Gainshare contracts have been signed for over a billion dollars of spend for terms up to seven years; the implication that this magnitude of contract would not contain service guarantees beyond pure cost savings is a little mis-placed. Myth 4: Quick saving vs. complex projects Gainshare agreements incentivize the provider to deliver quick and easy savings, not large and complex savings. Myth 4: BUSTED Assume that both the quick and easy project and the lengthy and complex project deliver the same quantum of savings but the time and complexity adds cost to deliver for the provider, which in the case of fee-for-service will be passed on to the customer. When paying a third-party to manage projects, gainshare will be relatively more expensive than fee-for-service for quick projects and relatively less expensive for complex projects. So if you are addressing both projects then it makes little difference what the commercial model is. If you are allowing the provider to pick from a choice of the two then, theoretically, the gainshare provider is incentivized to deliver the quick projects and the fee-for-service provider to deliver the complex projects. But there is one more factor to consider and that is the time value of money. There is a financial impact of delaying savings and everybody knows this, which is why, no matter what commercial agreement is in place, quick and easy projects should always be pursued first. Myth 5: Failure is invisible The customer doesn t know which area of spend to target and is guided by the provider, who is incentivized to identify areas of potential success and ignore failure. It s the ultimate dumb buyer versus smart seller. Myth 5: BUSTED Generating savings goes beyond just identifying them - it involves the entire sourcing process (benchmarking, supplier profiling, RFP construction and management), the negotiating (rate negotiation, added value and SLA commitments) and the contracting process (mitigating risk through legal expertise, SLA and KPI writing). Companies hire an external provider precisely because they do not have the firepower to do all these things, or have decided to focus on strategic objectives and let experts undertake this work. Many companies have used this model successfully over the last decade; it would be a little unfair to accuse the blue-chip companies that have signed gainshare agreements of being dumb buyers Xchanging 3

5 Myth 6: Gainshare causes budget challenges There is a separation between procurement and functional budget holders. Allocating savings to a business unit may not be possible and, if it is, would change the dynamic between both parties, turning them from friends to enemies. Myth 6: BUSTED This brings up a fundamental question; what is the purpose of sourcing and procurement? Is it to help derive savings for each individual budget holder so they can spend that money elsewhere or is it to deliver enterprise-wide value that will hit the bottom line and impact organizational profitability. We believe the latter. This point also seems to suggest that tracking of savings to specific budget holders will be a trigger for budget cuts. We would suggest that, given the current economic environment, budget cuts are inevitable and that an ability to track savings to the business P&L where they were realized makes the sourcing function an ally of the business, not an enemy. After all, no finance executive can deny the merits of an arrangement that is self-funding and P&L positive. Myth 7: Savings calculation adds bureaucracy Calculating savings is not a simple task, in many cases it is complex. The infrastructure required to accurately make those calculations can be counter-intuitive to the objectives of the engagement. Myth 7: BUSTED Savings initiatives are not just based on unit cost negotiations they involve demand management, cost avoidance, better requirements, etc. Each of these items can be quantified and calculated at the end of the reporting period and, even if the calculation takes some effort, it is effort well spent in validating that the contracts negotiated by the provider are actually delivering value to the customer. Think of it this way: would you rather have a fee-for-service model where the provider got paid without proving that value had been delivered? Also note that the provider is not charging the customer for this effort; it is the provider s responsibility to prove that savings have been realized and it is in their interest to do it as efficiently as possible. Also note that technology does exist that can validate the value added as efficiently as possible. Myth 8: Gainshare restricts collaboration Successful results come from collaboration and this will be minimized if both parties are constantly ascribing a who did what and when? or whose idea was that? mentality. Myth 8: BUSTED This would appear to be an argument more in favor of the gainshare model. With a fee-for-service model there is risk that the provider charges for an artificially high amount of effort or that scope-creep occurs if the statement of work turns out to be less than comprehensive. The beauty of a gainshare arrangement is the collaboration it fosters. Standard SLAs require a provider address the majority of spend and a road map of projects to achieve that will be created mutually within a governance structure. From then on in, both parties have a vested interest in successful delivery Xchanging

6 Myth 9: Gainshare encourages short-termism Organizations require long-term and sustainable strategic guidance but gainshare encourages first year savings in lieu of long-term service Myth 9: BUSTED This first half of this point is certainly correct; organizations need a long-term and strategic approach but the myth occurs in the second half because gainshare can absolutely be fundamental to a long-term strategy. Gainshare should be used as part of a managed service model that ensures every category is addressed more than once in a deliberate, planned and phased manner so that it can bring in long-term behavioral changes in the management of the category. The ad hoc, point-and-shoot approach of a fee-for-service model is more likely to lack a long-term or holistic outlook. Any fully managed service proposal should plan to address 100% of spend at least once over a three-year contract, which is anything but short-termist. Gainshare should be used as part of a managed service model that ensures every category is addressed more than once in a deliberate, planned and phased manner so that it can bring in long-term behavioral changes in the management of the category Myth 10: A lack of quality, integrity and ethics Commission-only models, such as 1980 s real estate, were long-ago seen as an inefficient way to incentivize people as it leave management unable to manage effectively, quality of efforts and resources extremely patchy and accountability almost non-existent Myth 10: BUSTED In the last thirty years, different industry sectors have switched between various commercial models; fixed-fee, fee-for-consumption, fee-for-service, outcome-based pricing or hybrid model. The moral of the story; industries differ and over time so do the commercial models that are in vogue. It is certainly unfair to compare 1980 s real estate commission culture to modern procurement gainsharing. Today, when many organizations face tightening budgets and a lack of investment capital, the gainshare model allows customers to access technology and expertise to derive value without up-front investment. As for accountability, here we return to a common theme throughout this article; SLAs. These are important in a fee-for-service model as much as they are in a gainshare model. Without them an organization is always open to risk, no matter what they are purchasing, with who they are engaging and no matter what the commercial model of operation.

7 Procurement Services 200 W. Adams Suite 1175 Chicago IL USA Telephone +1 (312) Facsimile +1 (312) Website Xchanging 2950/1 12/2012