One goal of an outsourcing contract is to keep the technology fresh to take advantage of the ever improving price/performance of the next generation. Outsourcing can be an opportunity to free oneself from having to deal with the financial aspects of equipment lifecycles and depreciation concerns by moving the burden onto another party. For outsourced services, such as communications, it is an opportunity to take advantage of the decreasing cost of bandwidth or to control costs driven by the seemingly endless appetite for more. [The service components – necessary trained staff for infrastructure build and support, etc – is a subject for another day]
A gain sharing mechanism is intended to provide incentives for the service provider to monitor and renew the technology during the life of the contract much as is done in an in-house IT shop. Gain sharing sets out a formula that splits the savings, rewarding the service provider with a portion of the savings as increased profit on the existing services and the client, earning credits for purchase of new services, without needing to find additional funds. For gain sharing to work, the provider needs the flexibility to make infrastructure changes without extensive client approvals as would be needed in facilities management arrangements.
Gain sharing should be a win-win. Put gain sharing your contract and sit back – great things will happen. The service provider will be actively looking for ways to save money because they get to keep some of it as profit and extend their services without losing any revenue. Right? Not in the experience of many who have tried gain sharing over the years. Two reasons: money and money.
Outsourcing arrangements are treated as fixed investment portfolios with targeted revenue returns. Like car leases, gain sharing doesn’t lend itself to work well in an environment where purchased or lease equipment might be changed mid-term, with old equipment to be either re-deployed or disposed of. The depreciation and funding issues you outsourced and their costs (plus a profit) are built into the initial contract pricing. The fixed term investment concept can be so embedded, that, in one case, at agreement termination, the supplier called the client to ask what to do with the now obsolete mainframe that had been hosting the services. The client had to tell them that they owned it, and she wouldn’t be paying any bills for deinstallation and disposal.
Another barrier may be in how the provider compensates its staff. Usually, the focus is on new business development and revenue growth. Increased profitability within an existing deal without new revenue coming in may not help the portfolio manager make target.
Lastly, the goals are very different. You are outsourcing for IT services and reduced complexity in-house, and for better cost control. For the service provider, an outsourcing arrangement is first and foremost a financial deal that must be profitable. The CFO in the provider’s organization is just a tough sell as your own.