NEWS ALERT: “No savings – no fee” model fails to deliver. Again.
Oct 1, 2012 7:36:00 AM
The recent news that Somerset County Council is in litigation with the IBM-led Southwest One consortium* has prompted me to dust off a blog I wrote a year ago condemning contingency fees models as a way to engage with a third party.
I hear over and over that organizations run into trouble over contingency fee based engagements, typically two or three years into the deal. And the Somerset Council situation appears to be another example of it. Nothing has changed. Contingency fee models remain an unsustainable model for long term partnerships. They can never be the right approach if you want to engage with a third party in a way that encourages both parties to co-operate, be aligned in their thinking and behaviors, and deliver a long term solution. So here it is again.
Gain share fee models (otherwise known as contingency fee models, or 'no-win no-fee') initially appear attractive to organizations when seeking to engage with a procurement services provider (PSP). However, they are frequently the road to ruin. A closer inspection of such fee models shows why.
But before we look at issues with gain share models, first let's look at some of the positives:
- Gain share fee models incentivize and focus the PSP on achieving savings.
- They de-risk the organization from wasted fees - i.e. paying for non-production work.
- They force organizations to track the actual savings that have been achieved - which is attractive to CFOs who have the perennial problem of being promised savings by the procurement function which never materialize.
- No large budget is required to start the engagement.
These are clearly attractive. However, when deeper consideration is given to the behaviors and restraints gain share encourages, their initial simplicity and attractiveness quickly disappears. In their place, come complex and conflicting pressures which, combined, mean the organization does not get what it initially set out to achieve. As a result, thanks to the "attractive" gain shares model, the relationship between the two parties frequently and rapidly becomes sullied and unsustainable.
- Gain share fees amount to "casino consulting". As we have seen in recent years with "casino banking", a culture of high risk and high stakes gambling does not lead to good or sustainable results for the organization.
- An organization can pay a disproportionately large sum of money for the work undertaken, if the PSP "gets lucky" and finds very large but easy to implement savings.
- As stated in the Pros, gain share models incentivize the PSP to achieve savings. However, that's all they incentivize. It's not a balanced approach. Large issues such as service, quality, the right solution for the organization, customer satisfaction, etc., are all ignored.
- PSPs are incentivized to deliver quick and easy savings, not large and complex savings. Rather than incentivize high levels of savings for the organization, it instead incentivizes the PSP to develop a portfolio of opportunities across multiple clients where it can maximize the return on its own time rather than maximize the savings for the individual organization.
- With gain share arrangements, failure is invisible. Success is visible, but still often appears over-rewarded. If the organization does not know where the savings are it must be guided by the PSP who has no accountability beyond savings. The PSP is only accountable for highlighting savings it is able to identify and knows can be easily delivered. If the organization does know where the savings are, then they should never pay the risk premium associated with delivery - the organization is simply entering into a "gamblers" arena where the opponent (i.e. the PSP) understands the odds of success far better. It's the ultimate "dumb buyer" -v- "smart seller".
- Gain shares often cause budgetary mayhem. The procurement function will rarely if ever own the functional budgets from which savings are to be made. Therefore a retrospective fee based on a portion of that budget (which may legitimately have been subsequently allocated elsewhere by the budget owner) can be very difficult to pay. Many large corporates simply don't have the in-year budgetary mechanisms to allow this and even if they do, it can turn procurement from the budget owners' friend, helping them maximize value, to their enemy - reducing their budget for themselves!
- Savings calculation can become a cottage industry which of itself adds no value to the organization. Furthermore many strategic savings associated with demand management, specification engineering, risk management etc. simply do not lend themselves to a binary savings number which can be perceived as fair by both parties if remuneration is a direct consequence of an exact calculation.
- Collaborative endeavour is made very hard by gain share. Many of the best savings results come from deep and cross functional working between the organization and the PSP. If both parties are constantly ascribing a "who did what and when?" and "whose idea was that?" mentality to minimize / maximize the fees then this will simply never be a fruitful relationship and many great ideas will never see the light of day.
- Even when all other things are equal, aligning the organization and the PSP is often very difficult as gain share encourages short term savings. Yet what the organization actually needs is long term, sustainable, strategic thinking. Indeed, the PSP is incentivized to maximize the first year saving at the expense of long term service to the organization.
- Quality, integrity and ethics: the sales and marketing community have long ago moved on from a belief that the best way to incentivize sales resources is "commission only". They know that this leaves management unable to manage effectively, quality of efforts and resources extremely patchy and accountability almost non-existent. Gain share savings models have all of the same attractions and flaws. Dealing with this business model is akin to a 1980s estate agent's business model and is likely to bring forward a similar type of business partner.
I would be interested to hear your views on and experiences with gain share models - the good, the bad and the ugly.
*Southwest One is an outsourcing shared services joint venture between IBM, Somerset County Council, Somerset Police and Taunton Council. Read more about it over on Spend MattersProxima Group