The pros and cons of output-based contracting

Agreeing key service parameters should bring greater delivery certainty and improved relationships

An output-based contract will describe the required business deliverable or output, rather than how such outputs should be delivered.

A simple example of an input/resource-based contractual requirement could be: “The supplier shall provide 20 Dell Blade servers at its Northampton datacentre, with two web servers, a clustered Microsoft SQL Server database, two firewalls and a load balancer, connecting to the customer with two 20Mbit/s links.”

An output-based contract might express the same requirements as: “The supplier shall provide a web hosting environment, including a database and appropriate connectivity, sufficient to meet the application availability and response service levels set out in the service levels schedule.”

Output-based contracting has a number of perceived benefits. Customers can focus on developing contract requirements that specify the outputs its business needs. The Office of Government Commerce (OGC) notes that an output-based approach to requirements “allows providers scope to propose innovative solutions that might not have occurred to the procurement team”.

Suppliers have more flexibility to provide the best solution for the customer’s requirements, rather than being tied to a specific set of technical specifications. Customers get the supplier’s commitment to the specified business outputs they want, while looking to benefit from supplier innovation and efficiency in its delivery across the life of the contract.

It sounds good, but has output-based contracting proved such a panacea in practice?

Innovation
Having consulted numerous client contacts in IT procurement and delivery, it is apparent that where customers invite bids on output-based requirements, suppliers often propose innovative delivery solutions. But after that there is little direct connection between the use of output-based contracting and innovation.

Dynamic change to delivery solutions under output-based contracts is, in fact, relatively unusual. This is especially so where reasonable service stability has been achieved. Consistent with the findings at the National Outsourcing Association’s recent Innovation in Outsourcing event, real post-procurement innovation – that is, delivering significant cost reduction and/or service improvement – primarily depends not on the approach to expressing contract requirements but other factors, including involvement of an engaged, experienced and skilled customer function.

Certainty of output/delivery
Output-based contracting has too often been used at the cost of a real understanding between the parties of what is being paid for and will be delivered.

Areas exemplifying this are disaster recovery, technology refresh and what are called innovation teams.

Customer requirements for disaster recovery have often been expressed in extremely high-level output-based terms. Many corresponding supplier solutions are scarce on specific delivery detail. It could be argued that it is output-based contracting, so the lack of specification of solutions is OK, as the customer can count on the outputs.

But this leap of faith is a risky strategy for customers and can present ancillary difficulties even if disaster does not strike. For example, what if the customer wishes to accept more risk and downscale their disaster recovery provision? If the output-based description is lacking detail, on what commonly understood delivery and pricing basis do the parties begin discussing changes, impact on costing and so on?

Times of change
Currently, contract renegotiations and extensions are rife, especially in the public sector. This stocktaking of past performance highlights the difference of opinion between the customer’s output-based expectations and actual delivery.

And the lack of a clear and mutually understood contract baseline in many output-based arrangements has undoubtedly led to frustration and mistrust when assessing the impact of service changes required as part of renegotiations.