I often get the question, "Is Vested Outsourcing really gainsharing in a new dress?"
The answer is no. On the surface, gainsharing, a performance-based agreement, and a Vested sourcing business model all have a common goal: creating incentives (or penalties) designed to share value with suppliers for achieving lower costs or better performance.
The concept of sharing value is a solid one. In fact, "Creating Shared Value" was espoused by management gurus Michael Porter and Mark R. Kramer as the "big idea" in their highly influential Harvard Business Review article in 2011.
As companies look for ways to reduce costs, improve performance, or drive innovation with suppliers, they are turning to gainsharing, performance-based and Vested sourcing business models with the hope of kick-starting supplier collaboration with incentives. Unfortunately, many often get frustrated. A case in point is that I have seen many gainsharing provisions in contracts where the supplier was never paid an incentive. In my experience, this happens not because the supplier is bad, but rather because the concept is applied incorrectly.
Or consider the success (and failure) of performance-based agreements (also known as managed services deals). In our research at the University of Tennessee, we did a deep dive into why some of the Department of Defense's performance-based deals were wildly successful, while others failed. The question was so perplexing it spawned nearly a decade of research at the University of Tennessee that ultimately led to the development of Sourcing Business Model theory and the Vested sourcing business model.
So what's the key to success when picking approaches to incentivize a supplier? The secret sauce is identifying the differences of each approach - and when and how to apply each in the appropriate environment.
Gainsharing, which first entered the business lexicon in the 1930s, was created as an incentive for suppliers to drive down costs. It typically is based on productivity associated with reducing the cost of services for a specified range of transactions. Gainshare is essentially a monetary bonus tied to cost savings. The more a supplier drives down costs, the more the gainshare payment.
Gainsharing works best when it is applied to transactional agreements (e.g., the payments are tied per unit). Typically gainsharing is used for "cost plus" arrangements versus fixed price deals where the buyer sees the costs the supplier is charging. For example, a supplier that saves one dollar per unit in costs would get a gainshare payment of 50 cents; their profit would go up for reducing their costs - a win-win. Gainsharing is most effective when the scope is limited to what is in the supplier's control and it can see the direct impact of its efforts to reduce costs.
The gainsharing concept has spread to other spend categories outside of manufacturing, but has had mixed results. For example, it rarely works in a fixed price deal because the economics are such the supplier simply keeps all of the savings. Another reason for the lack of success is not the lack of ideas from the supplier, but because the improvement effort is not solely within the control of the supplier. Suppliers get fatigued at offering up ideas when buyers say "great idea" followed by "but..."
Pay-for-Performance as a concept dates as far back as the early 1900s with Frederick W. Taylor's writings on "scientific management" and reward systems. Taylor is credited with developing the moving assembly line for Henry Ford. A large portion of Taylor's book, Shop Management, is devoted to the subject of wage incentive plans. He discussed the need for these plans to offer high wages to the worker and low labor costs to the employer, and to promote individual pay for performance. One of his main goals was to ensure a mutuality of interests between employee and employer in order to increase rewards for increased output.
The concept of a "performance-based agreement" with a supplier first emerged in the 1960s with Rolls Royce and its "Power by the Hour" innovation. Customers would pay Rolls Royce for achieving a success against mutually defined key performance indicators such as hitting availability and reliability targets aimed at keeping aircraft flying.
Performance-based agreements work best in situations that begin to shift the thinking away from activities to supplier outputs; however they often still pay a supplier using transaction-based pricing triggers. These contracts are often also called "pay for performance" because they often have an incentive or a penalty tied to specific service level agreements (SLAs) outlined in the contract. Performance-based agreements usually require a higher level of interaction between a service provider and a buying company in order to review performance against objectives and determine the reward or penalty options that are typically embedded in a contract.
Vested Sourcing Business Model
The Vested sourcing business model is best used when a company has transformational or innovation objectives that it cannot achieve by itself or by using conventional transaction-based or performance-based approaches. These transformational or innovation objectives are referred to as desired outcomes; they form the basis of the agreement. A desired outcome is a measurable business objective that focuses on what will be accomplished as a result of the work performed. It is not a task-oriented service-level agreement (SLA) that often is mentioned in a conventional statement of work or performance-based agreements; rather it is a mutually agreed upon, objective, and measurable business outcome for which the service provider will be rewarded.
A Vested sourcing business model is somewhat analogous to an employee profit sharing plan - but is designed as a way to share wealth with suppliers. Why share wealth with suppliers? Don't you want just the best price? In some cases that answer is YES. In that case you should use a gainsharing approach.
The reason for shifting to a Vested sourcing business model is to motivate the supplier to make investments designed to achieve mutually defined desired outcomes. For example, when P&G chose to outsource its facilities and real estate management services, it wanted to build a strategic partnership that would focus on working with a supplier to achieve transformation - not just perform transactions.
William Reeves, P&G's Director of Employee & Workplace Design & Delivery Services at the time, summed it up nicely in a case study profiled in Vested: How P&G, McDonald's and Microsoft are Redefining Winning in Business Relationships. "We wanted a supplier to take charge of our buildings, not just take care of them."
The P&G outsourcing partnership with Jones Lang LaSalle (JLL) has gone on to win numerous awards, including the International Association for Outsource Professionals (IAOP) GEO award for innovation. JLL has delivered on transformation initiatives that are linked directly to P&G's business goals. One example of a transformation initiative is the investment in "Smart Buildings," which led to a 14 percent reduction in energy consumption.
To answer the initial question, the performance-based and Vested sourcing business models are not simply gainsharing in a new dress. Rather, gainsharing is a simplistic incentive for a job well done in reducing cost against a tangible transaction.
As organizations seek to work more collaboratively and strategically with their suppliers, they should think about performance-based and Vested sourcing business models. They are different - but equally powerful - when the agreements are structured properly.
Kate Vitasek is an international authority for her award-winning research and the Vested business model for highly collaborative relationships. She is the author of six books on Vested and a faculty member at the University of Tennessee. She has been lauded by World Trade Magazine as one of the "Fabulous 50+1" most influential people impacting global commerce and has shared her insights on CNN International, Fox Business News and NPR.