Benefit sharing – no gain, some pain

Benefit sharing is one way to try to turn promised cost savings into bottom line contract savings, in effect locking a vendor into its promises. It goes by various names. In the States, it can be called “gain-sharing”, and in US “E-Government Act” enacted last year, it’s called “Share-in-Savings", but the underlying notion is the same. Advantages realized by the new project can be shared by both parties.

These advantages can come in various forms. One variant is that, in addition to the amount paid to the vendor for performing the “normal” contract specifications, it is also paid a percentage of the savings that have resulted from the work in the course of the project.

Another variant provides an opportunity during the project for the vendor to come forward with further ideas for cost savings. Then, to the extent that these ideas results in measurable savings, the parties share.

Sounds straightforward, but it is not a walk in the park. Questions arise.

How do you measure cost savings? This may be the most obvious question. At least it was obvious to the US lawmakers when they passed the E-Government Act. The law requires "a quantifiable baseline" of present costs in order for a project to qualify for “Share-in-Savings”. That means that the customer has to know what its original costs were before anyone can talk about cost savings.

Whose idea was it anyway? The customer might claim that the vendor’s new idea was not new to the customer. Who thought of it first? That problem requires careful draftsmanship to define the concept “new”.

Can the vendor actually carry out its savings idea? More often than not, the realized savings depend upon cooperation from the customer. The customer must act upon the idea, must act effectively and must not kill the possible savings through some other, unrelated customer problem. In short, the vendor may find that it does not have the control it needs to bring its idea to fruition.

Is the vendor keeping its eye on the ball? The incentive aspect of the contract must not be allowed to distract the vendor from the principal job at hand, to carry out the contract specifications.

While on paper the idea of benefit sharing sounds like a fine idea, nevertheless the parties must ensure that, with all the challenges presented by a Utility Computing contract, this new wrinkle does not add more problems than it solves.

Joint Ventures

In this alternative, a customer and vendor would form and own a joint venture entity. The customer would contribute its existing IT systems and assets to the JV, while the vendor would contribute its intellectual property, know-how and experienced service delivery team. The JV would then agree to provide to the customer the IT services previously provided by the people and assets that the customer contributed to the JV. Thus, the JV would have an outsourcing contract with the customer. In addition, the JV would subcontract to the vendor and others for services that it itself could not provide. The vendor would typically provide management-level personnel and services, management training and tools.

The advantages of such an approach are:

Shared ownership services to align the incentives of both parties;

Keeping the customer’s assets and personnel in the JV (instead of in the vendor’s organization), which may make it easier to return them to the customer’s operations if necessary;

As an owner of the JV, the customer would share in the JV’s profits and equity value;

As a part owner, the customer is ideally placed to change the way the JV delivers services and therefore keep the arrangement flexible.

Of course there is always a down-side. Such an arrangement is complex to establish, with higher initial costs. In addition, the JV may not be able to attract the same technical talent that could be sourced by the vendor acting independently.

Other twists to this model include the customer assembling its IT operations into a new operating company and transforming that new company into a subsidiary that provides IT services and that could effectively compete for third party IT business. Alternatively, the customer could buy an entire IT services vendor, and then cause the purchased vendor to take over the customer’s IT operations. Under these models, the customer has complete control of the vendor and provision of IT services to it.

Examples of deal-engineering abound, the number limited only by the deal-makers’ imagination. Since Utility computing is predicted to dominate the outsourcing space, creative deal-shaping as mentioned here can thus only increase. This may well transform the way customers obtain IT services in the future.

Alan Steele-Nicholson is head of the IT-Telecom law department in the Rotterdam, the Netherlands, office of the global law firm Simmons & Simmons, and can be contacted on alan.steelenicholson@simmons-simmons.com. Peter Brudenall is Senior Lawyer in Simmons & Simmons’ London office, and can be contacted on peter.brudenall@simmons-simmons.com. Both are specialists in IT and telecom outsourcing law.