Enabling Incentive Based Contracting

The growth in cloud and infrastructure technologies has given companies the ability to store, analyse and make decisions using advanced tools and drawing from huge data lakes. As emerging businesses enter their respective marketplaces, they are no longer needing to be digitally transformed as they are already digitally enabled. This gives them the edge in building scalable business systems, processes and infrastructure to support their operations.

 

There has been little development, however, in the way companies’ contract and price their goods and services. There are innovative mechanisms available, such as Incentive Based Contracting which has been in use in the MOD since the 1960s, but such contracts are typically very complex to manage with onerous contract frameworks, the burden of maintaining financial models and the need to report against delivery of requirements.

 

There has been some application with varying results across the public sector; Open Book and Incentive Based Contracts are commonplace for large defence, nuclear and construction contracts. Due to the highly regulated and safety-critical nature of these markets, notwithstanding the huge physical and financial risks, business operations are arranged so to collect and retain granular operational and financial data. This data then provides a ready-made platform for the operation of more complex contracting models which rely on transparency of such data.

 

Incentive Based Contracting rewards the Supplier for delivering measurable outcomes e.g. performance improvements or total cost of ownership (TCO) reduction. It provides a commercial and contractual framework where relationships are vested. This paves the way for effective commercial management and operations, stimulating partnered behaviours and driving future innovation.

 

To implement, Incentive Based Contracting requires skilled staff, accurate cost collection systems and appropriate contracting vehicles. In order to accurately track value metrics, businesses should look to leverage available technologies allowing them to accurately shape and manage contracts, and in turn develop their infrastructure to accurately share and optimise costing data. This facilitates extant contract management and has the benefit of also informing future contracts in the context of pricing.

 

Oft-quoted is the saying, “buyers are searching for the hole not the hammer and nail”. Both parties should strive for a culture of mutual trust, and be willing to share information in a transparent manner; getting to know their business partner as truly understanding their objectives is a much more effective basis for contracting.

 

The days of locking a contract in the drawer are over. We believe that there will be a rise in transparent Incentive-Based Contracts as critical commercial information becomes easier to store, analyse, validate and share.

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Athena Commercial December 13, 2019 0 Comments

Our Approach to Contracts Transformation

We have delivered a number of Contracts Transformation projects for our clients, showcasing the tangible benefits that can be achieved from this process including cost savings, improved efficiency and risk mitigation. See our graphic below for an overview of how we approach contracts transformation projects.

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Athena Commercial October 30, 2019 0 Comments

Don’t issue an RFP unless…

Your business stakeholders are bought into the process.

For an RFP to be effective and to support eventual implementation and management of the goods or service you are looking to procure; it is essential to have your business stakeholders bought into the process and the value you are looking to deliver.

Rightly or wrongly, the procurement process can be perceived as a blocker by internal stakeholders who often (and usually for the right reasons) want to “get stuff done”. It is therefore important that the procurement function acts as a business partner and works with the business to integrate the differing functional constraints into a consolidated procurement plan.

If you don’t have buy in to your procurement process, you may discover internal blockers within your organisation including a technical or operation bias to an existing supplier which may present a risk to the process, either by unwittingly providing sensitive tender information or via encouraging a supplier arrogance towards the process.

Depending on where you are with your procurement process, if you are looking to move quickly against a procurement project, it is important to either have your budget cleared, or to at least understand the key financial parameters your business is looking to operate under (i.e. position on Cap-Ex / Op-Ex) and ensure you understand your route to business case / budget approval.

 

You understand your business capabilities & requirements.

Not all businesses understand their requirements at RFP, and this can present issues in the procurement process and in overall contract delivery. There are numerous high-profile examples of government contract failures, which whilst typically blame is attributed to the Supplier where in fact a failure to articulate and manage requirements was also a key factor.

Where an organisation has limited information on the technical solution required, the RFP should be structured clearly around the business capabilities that an organisation is looking to deliver through the project. In essence the RFP process will be delivering those requirements through the tender responses. In this example though, it is important to assess whether an RFP is the right process to run, and whether you need to issue an RFI to provide more technical maturity internally.

On larger scale Managed Service contracts, it is advisable that organisations invest appropriately in the necessary capability to fully capture and map internal requirements before contract award and preferably before RFP. This enables a sharper RFP process and contract negotiations and allows for effective change management against that existing baseline. Tender teams should also ensure they engage with their business stakeholders to ensure they are consulted and input where necessary into the requirements, all to often a tender or project team issues an RFP and contracts a solution that then turns out to not be suitable with end-user requirements.

Ensure that your business differentiates between:

  • Business Capabilities – Organisational objectives that the solution will achieve
  • Functional Requirements – Something the solution needs to do
  • Non-Functional Requirements – How the solution will work

There is an excellent blog post on Business Capabilities and Resource Based View (RBV) by leading Solution Architect Tim Manning of Design4Services:

http://design4services.com/methods/business-capability-modelling/

 

Your RFP process is efficient.

You should clearly understand your procurement plan, and structure your RFP process and documentation around those areas you have already identified, including ensuring you have key internal resources lined up where required which is especially important during RFP drafting, CQ’s, supplier evaluations and contract negotiations.

Your RFP documentation should be appropriate to the project you are procuring for, and there is often a risk of procurement departments recycling legacy RFP documentation which is packed with unnecessary and onerous compliance questions. Whilst there is of course a place for compliance questions within the process, it is the job of the tender team to determine the appropriate questions to fit the nature of that project. This is also important to build the right “tender” environment and be respectful of your suppliers bid team resources and phase your RFP appropriately to maximise value and impact.

As Mark Twain once said “I didn’t have time to write a short letter, so I wrote a long one instead.”.

You should ensure that you identify the tender plan with the RFP, including key dates for launch, clarification questions (and response dates), key evaluation and decision dates and dates for contract negotiations. You must ensure you have your internal resources lined up the maximise (and document) the outputs from these sessions. Remember, the RFP process may be your first interaction with a potential new supplier or strategic partner, so you want to represent your organisation in the best light.

 

You can leverage the process.

As part of your pre-RFP business engagement, it is important to identify the value you are looking to drive and the objectives of the tender. There may be examples where procurement has insisted on an RFP process, however the business is fixed on a specific sole source requirement. In a valid application of this scenario, then a tailored RFP (or commercial dialogue) must be consider. Procurement professionals must conduct the right due diligence internal to ascertain whether the sole source requirement is valid (or consistent with policies, if you have them) or whether it is being used as a lever to circumvent the procurement process.

You must understand the market position, and your internal constraints and BATNA. If you are issuing an RFP to an existing strategic partner, you should have the necessary levers within your contract to ensure you can optimise value for increased contract spend (whether through spend-level discount mechanism, reduced rates or enhanced discounts).

 

You know your contract baseline.

A common sticking point within RFP processes can be the negotiation of the actual contract and the time this can take if your tender process doesn’t appropriately address this key area. A common misconception is that the lawyers will “sort the contract”, and if this is the case, at the very minimum you need to ensure you have engaged them in the RFP process.

A more appropriate approach is to ensure that you have the necessary resources to draft an appropriate contract framework prior to RFP. This is of course dependent on the maturity of your requirements and you must ensure the framework is flexible and adjustable as you mature through the process.

You then must understand your organisations willingness and capability to negotiate the contract. It can be very effective to issue a fixed set of terms and conditions, which are (or you at least declare) none negotiable. It is advisable that you are pragmatic through your negotiations and operate in good faith with your supplier should they present valid commercial risks and suggested mitigations which would be more appropriate. Also, organisations must be careful that they don’t default into sending onerous and “meaty” terms and conditions full of bear traps to tenderers. The public sector has examples of these contracts which effectively just push risk on to the supply chain (and bidders should ensure they price these contracts appropriately). Ultimately risk best lies where it can be reasonable controlled, and therefore the contract should be structured accordingly.

If you are using standard templates, you should also ensure you understand your deal type, as contract structures clearly differ for different procurements such as Hardware, Support & Maintenance, Software, SaaS etc. You do not want to use a standard support and maintenance (or Services) template where it is not appropriate, i.e. for a SaaS deal.

You know your commercial model.

It is essential that you understand your commercial model before entering the RFP process, and how you will financially evaluate the tender responses and ensure the contracted solution can be financially managed within your budget.

You must first understand your price type. It is recommended that except in rare circumstances you avoid Time and Materials contracts. If the necessary investment in resources and time prior to an RFP, then you should have clearly defined requirements and desired outputs. A stronger position would be to have well understand framework for contract deliverables, milestone and your associated payment criteria. These principles can be applied regardless of deal size.

If operating under a Fixed Price model, it is essential that you are doing it for the right reasons and that this model will drive the necessary value and you have the right market mix to support that approach (i.e. leverage items, non-critical items). If you are going Fixed Price, then you must define the evaluation criteria for value for money and understand the commercial risk you are transferring. It is important to “know” what risk you are paying for as part of a considered business decision, rather than allow being led by the Supplier.

If you have a mature set of requirements and business outcomes, you have a strong bid team and your organisation is commercially mature you may wish to consider contracting to business outcomes, possibly through a TCIF (Target Cost Incentive Fee) mechanism or via a Gain-Share (or alternative commercial models). To deliver and manage this effectively you need to ensure you have a tender team sophisticated enough to execute and manage a model of this complexity.

 

You can manage the contract.

For a contract to be truly successful, you must ensure you have the capabilities internally to deliver both your project and contact management responsibilities to enable your supplier to deliver the goods or services you are paying for.

It is advisable that you extract key information through the RFP process such as required internal resources and your internal dependencies, and if you really want to put skin in the game you should ensure you contract against these.

You then must meet your contractual obligations and ensure you support the supplier through any change management activities, and you dedicate the necessary resources to conduct supplier management and value for money assurance.

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