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Many buyers use Performance Based Contracts (PBCs) to contract for outcomes, because they are attracted by the simplicity of using PBCs. But this could be a costly mistake if you do not first carefully plan, set up and execute the  requirements of your PBC.1/2  

Planning and correctly executing starts with defining what result, or outcome, you desire then evaluating the performance measures defined in the PBC specifically relating to inputs, outputs, and outcomes.

A PBC -- being different from a conventional contract -- is designed to reduce overall costs for buyers and provide profitable growth opportunities for sellers.  We tend to view the PBC as the contract model of choice across a range of market sectors.  The ability of organizations to effectively develop, implement and manage PBCs is critical to business success, because failure can often lead to long-term performance, financial and reputational damage.


What follows explains how PBC contracting works and why focusing on outcomes only is a mistake.  Why is it critical for buyers and sellers to first identify and understand all inputs and outputs? Only then can they better define the overall outcome (success) as seen by the end customer.  

The first step is to clarify whose outcome -- the direct outcome of the trading (or partnering) relationship or the outcome as experienced by the final customer.  Will your idea of a successful outcome vary with a change in perspective between – or among -- various trading relationships?

To illustrate how an outcome varies depending on your perspective, picture your grocery store’s online ordering system.  You select, order and have delivered a range of grocery items like fruits and vegetables.  

Delivering your order requires a number of organizations each with individual roles and responsibilities performing as follows:

  • Step 1 – End Customer (you)selecting groceries, defining the delivery date; paying the bill; and being home for the delivery.
  • Step 2 – Information technology organizationensuring the grocery ordering website, including the payment system, is available for the end customer, supermarket staff and transportation staff to document orders and deliveries.
  • Step 3 – Grocery supplierslike farmers suppling all types of groceries to the supermarket based on the orders being placed to ensure there is sufficient stock available.
  • Step 4 – Supermarket selecting the items you order online and loading them into containers for delivery. It’s ready to go!
  • Step 5 – Transportation organization taking groceries from the supermarket and delivering them to you.

Figure 1 shows the organizations and their specific responsibilities involved in delivering your order in good condition for the correct price at the agreed date and time – all to you as the end customer.

Figure 1: Grocery Home Delivery Enterprise

The process can be complicated. Many commercial organizations expected to get the groceries to you on time are not solely accountable for final success of that delivery to you.  So, if you are contracting out the grocery transportation process, what is their outcome?  Is it simply successfully delivering all groceries provided by the supermarket, in full and on-time without breakage?  Or is it the end customer satisfaction, which may also depend on the farmers or the IT organization?  

One method we use to help understand this difference in perspective is to describe the inputs and outcomes to an individual organization, and then compare them to the end customer outcome.  Here I use inputs and outputs to reflect the lower level organization or process activities that as a total make up the end customer outcome.  Indeed, how all these inputs and outputs fit together to deliver the end customer outcome highlights the various interdependencies between the organizations.

One technique to help identify the relationship between inputs and outputs is to consider using the Integration Definition for Function Modelling (IDEF0).  Figure 2 describes a standard functional process block including four elements: input, output, mechanism (resource) and control.

Figure 2: Integration Definition for Function Modelling (IDEF0) Functional Process Block

Like other modelling approaches and tools the intent of IDEF0 is to provide a structured representation of the functions, activities or processes within the modelled system or subject area.  Using the IDEF0 model, we can quickly identify whether we are measuring an input (something that enters the process) or an output (something that exits the process).  

Let’s consider our grocery example again, and specifically the transportation organization, which in this case we will contract out.  Here, Figure 3 describes the inputs and output.

Figure 3: IDEF0 Functional Process Block Representation of Online Grocery Delivery Contract

Notice that Figures 2 and 3 correlate.  Consumer law and Labor law represent Control; Packed grocery items and delivery represent input; Vehicle for delivery and delivery staff represent the mechanism (resource) for delivery and Grocery delivery is the outcome.

However, where is the outcome?  More importantly, can the transportation contractor be held solely accountable for an end customer outcome?  For example, if the supermarket accidently packs oranges instead of apples, and these are delivered, who is at fault?  All will agree that the end customer outcome has not been achieved, but where is the fault?  Importantly, how do we treat this where there are commercial consequences, such as reduction in payment?

Acknowledging the difference in 2012, the Australian Department of Defence created three tiers of performance measures to reflect input, outputs and outcomes with the later named Strategic Performance Measure (SPMs).  Each of the tiers of performance measures are linked to different levels of commercial rewards and remedies reflecting this concept of input, outputs and outcomes.  Figure 4 highlights the relationship among each of these with the definitions provided in Table 1.

Figure 2: Performance Measure Tiers

Item

Definition

Commercial Consequences

Strategic Performance Measure (SPM)

OUTCOME

Performance measures that reflect “enterprise” (end customer) outcomes; that is, the highest-level outcome acknowledging that the seller may not be solely accountable for failure or success of this outcome.

Given the indirect nature of SPMs, they are typically not linked to money, but rather to other non-monetary rewards and remedies.

Key Performance Indicator (KPI)

OUTPUT

Performance measures that are directly related to seller performance against their individual scope of work where they have sole accountability; outputs.

Given the direct linkage of a KPI to Contractor performance KPIs are linked to money resulting in them being quantitative and lag in nature.

System Health Indicator (SHI)

INPUTS

Performance measures that give insight into past and future seller performance by highlighting drivers and constraints to this performance.

Typically, the role of a SHI is to provide confidence in the delivery of the KPIs.

Given the indirect nature of SPMs, they are typically not linked to money, but rather to other non-monetary rewards and remedies

Table 1: Definition of Tiers of Performance Measures

Solution:  Both buyers and sellers need to acknowledge the difference between inputs, outputs and outcomes to ensure the expectations and commercial models are aligned.  It is critical that everyone fully understands the differences in their roles and responsibilities.  However, many organizations, similar to our online grocery delivery example, find it difficult to accept the consequences of holding organizations accountable for a shared, end customer outcome as opposed to individual output.  This is especially true when commercial remedies are involved such as reduced payment or service contracts.  The key is for both buyers and sellers to align their understanding and expectations of their individual contract output with that of the end customer (enterprise) outcome, and how and when the various commercial consequences apply.  Specifically, this includes:

  • what the seller is directly accountable for (e.g. outputs),
  • what shared responsibility all organizations have when delivering outcomes; and
  • aligning the commercial consequences, both positively (rewards) and negatively (remedies) with these different tiers of performance measures.

Our ever increasingly complex, interwoven commercial relationships and supply chains require more clarity of what success looks like and to whom.  Moreover, as stated earlier, although the move to outcomes is laudable, both buyers and sellers need to acknowledge the difference between inputs, outputs and outcomes to ensure the expectations and commercial models are aligned.

So, when next confronted with an “outcomes based contract” asked yourself whether the contract is asking for inputs, outputs or outcomes, and whether the commercial rewards and remedies align with them.  If not, we just may get oranges instead of apples; and who’s fault would that be?

 

END NOTES

  1. Jacopino delivered a presentation on Performance Based Contracting on May 10, 2018to IACCM members.    
  2. See also the author’s Performance Based Contracting (PBC) Training Course (1 day)that defines a performance based contract.

 

ABOUT THE AUTHOR

Dr Andrew “Jacko” Jacopino is one of Australia’s best-known PBC practitioners and trainers, having been involved in over 100 domestic and international PBCs for both buyers and sellers since 2005.  As a Fellow of International Association of Contract and Commercial Management (IACCM) he brings world class insight, skills, and practical experience in working with PBC arrangements from all industries and of all scopes and sizes.

ABOUT NGAMURU ADVISORY

Ngamuru Advisory, Australia, provides strategic advisory and commercial services to the Commonwealth and State/Territory Governments and their related agencies. The primary goal is to inspire and enable clients to deliver superior projects.

Topics: contracting excellence, communication, IACCM

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