Business Model: Partnering For Revenue

The case for outsourcing is dated. The debate has shifted to maximizing

relationships to gain more value. Customers are increasingly beginning to ask

the question: How can we tap the supplier's knowledge base and gain

continuously from the relationship?

But there are no clear-cut answers...only possible strategies. One such

strategy is to engage the service provider by giving it a strategic stake in the

customer's business. The provider gets to partake a bigger pie of the benefit

that is accrued in the form of gain share, revenue share or joint ventures. For

its part, the provider increases its stake in the partnership through financial

investments or resources that enable innovation. Gain sharing has generated the

maximum interest compared to revenue sharing or joint ventures, because it is a

pure incentivizing tool and exists within the realms of ordinary outsourcing.

The others have an element of commercialization.

Gain Sharing



In gain sharing (sometimes known as incentive sharing), the customer

incentivizes the service provider by promising financial gain, if the predefined

metrics and targets are achieved. A well-publicized case of gain sharing is

between the City of Chicago and EDS, where EDS re-engineered the city's method

of parking enforcement, by building a system for collecting parking-ticket

payments. The city had a backlog of $40 mn of uncollected parking tickets, and

since the problem tickets were well defined, gain sharing worked successfully.

The imperative for gain sharing is obvious. Experienced customers find that

providers become complacent once contracts are well underway. Thirty-one percent

of participants of a Deloitte Consulting survey cite complacency as a reason for

the failure of outsourcing initiatives.

Despite the benefits being obvious, few companies adopt gain sharing as a

model. Of the 500 IT deals that TPI has helped broker, only 15 have an element

of gain share, according to Chris Kalnik, partner, TPI. “There is a lot more

talk about gain sharing in IT services than real action on the ground. But it is

a healthy discussion, it is on the right track and will result in some positive

action,” says Kalnik.

The roadblock to the arrangement is the absence of clear-cut measurables and

the customer's lack of trust in the provider's ability to deliver services

that impact its business.

Lack of measurables: Service providers can hope to have an impact on business

processes only when corporations align their outsourcing goals with their

strategies and clearly define the measurables. “It is unlikely that

contractual metrics that focus a provider on cost minimization will lead to the

development of innovative new systems and applications. Implementing new systems

demands management mechanisms that encourage and reward the provider for

undertaking the risks inherent to innovation,” says a report titled Strategic

Intent for Outsourcing by Anthony DiRomualdo, CSC Research Service and Vijay

Gurbaxani, director, Center for Research on IT and Organizations, University of

California.

While a lack of measurables is a reason for the slow adoption of this model

in IT services, it is precisely the capability to define metrics in the case of

CRM outsourcing that has made gain sharing comparatively more successful in BPO.

Lack of trust: Those that practice gain sharing are mature customers with

many years of outsourcing experience. A Fortune 500 company that had been

outsourcing for over 10 years, adopted the gain-sharing model only five years

ago. According to the IT director of the company, the reason was that the

company wanted to understand where the provider's margins were, to be able to

assess the gains.

“Often suppliers are able to streamline processes and park huge margins

after initial investments. Besides, there is a diminishing cost of technology,

all of which the supplier parks as his margin,” he says.

In the case of this particular customer, the provider did not pass on the

benefits of offshoring till they forced a renegotiation. For the same reason,

this IT director advises customers to make it mandatory for suppliers to take

permission before subcontracting work.

Building a rapport is very important because the customer must believe in the

supplier's ability to implement new business processes that will impact the

business. Conversely, the provider must also believe that the customer's

management is receptive to new ways of working. Incentives should always come

from the customer's side, believes MindTree Consulting, which has a

gain-sharing arrangement with a few customers. “We have several gain-sharing

initiatives, and all of them are with old customers - they have been with us

and trust us. Usually they are the ones to initiate discussions on gain

sharing,” says Joseph King, SVP, Marketing, MindTree Consulting. “And that

is the way it should be. Unless customerstrust you completely and think that you

can deliver, gain sharing will not work.” King emphasizes the significance of

the senior management's involvement from the customer's side in gain

sharing. “The push for gain sharing should come from the top,” he says.

On the part of the customer, the trick to succeed is to leave enough margin

on the table for the provider to have a healthy business.

Revenue Sharing



Revenue sharing takes place when the customer of outsourcing services makes

the service provider a stakeholder in the outsourcing project. This could be

either a financial investment by the customer or the payment structure could be

linked to the market performance of the service or product that the provider has

helped design or develop. A percentage of the revenue is shared with the

provider.

In a competitive scenario, the customers can incentivize the outsourcing

provider to innovate and keep ahead of competition. Innovation has ranked among

the top three priorities of 67% of executives according to a survey of over 500

senior executives in December 2004, by the Boston Consulting Group.

Revenue sharing is generally easier to implement in the outsourced

product-development space than in IT-services outsourcing. This is because of

two reasons: One, the provider's contribution to product development is easier

to quantify than in pure IT services, and two, the corporations are increasingly

depending on innovation to accelerate growth.

“To facilitate higher odds, companies are offering fiscal incentives to

providers to compensate for the increased risk, and making significant

investment in resources to achieve the client's demands,” according to a

white paper, New Strategies for Outsourced R&D, by the Outsourcing Center.

“In most incentive models both parties share in the savings achieved by

shortening the development cycle.”

However, that is easier said than done. Not all customers may be comfortable

with this arrangement, because it entails sharing revenue from the customer's

core portfolio. Moreover, it is difficult to assess the impact of the value the

provider has brought into product development, especially when it works in an

embedded environment.

But, companies have managed to work out reward-sharing models. India-based

Wipro, for example, has a riskreward model in which Wipro co-invests in research

and development projects, and offers a reduced cost of service during the

product-development phase. When the product is in the market, the client pays

Wipro additional revenue based on the number of units/licenses sold on a royalty

model. The revenue is shared as per the number that is stated in the contract.

Wipro's VR Venkatesh, SVP and head, Product Engineering Solutions (PES)

Group is quick to point out the risk to service providers in such a model.

“Revenue sharing in the product-development space entails a burden of risk

sharing, because the supplier is investing into a product for which there is no

known acceptability. There is also the possibility of the product not taking off

due to marketing glitches of the customer or compatibility factors, especially

since the product has to work in an embedded environment,” he says.

Wipro earned about half-a-billion dollars in revenue from its PES services

during the fiscal year 2005-06, and hopes to boost revenues from the division to

10% of its total revenue through a combination of strategies, including the

revenuesharing model.

Mindtree Consulting, too, offers outsourced product development on a

revenue-sharing model.

Joint Venture



In the early days of offshoring, large customers opted to partner with

service providers in the commercialization process because they believed they

had enough core competencies to bring to the partnership.

Delta Airline, for example, formed a joint venture called TansQuest with

AT&T to access the provider's state-of-the-art technology to migrate from

the mainframe to distributed environment. Delta had planned to offer similar

services to other airlines wanting to migrate their systems. The joint venture,

however, ran into trouble when senior AT&T executives quit, and soon after

in 1995 AT&T itself was split into three separate companies.

There are just a handful of joint ventures in the outsourcing world

today-the only notable recent one being between TXU and Capgemini, signed in

June 2004. The deal saw TXU outsource its IT, customer care, supply chain,

finance and accounts to Capgemini and HR to Hewitt. TXU transferred 2,700 people

to Capgemini with the aim of dramatically reducing cost, improving customer

experience, reducing its base of third-party providers and creating intellectual

property. The thrust of the first two years was to re-engineer processes by

introducing technology and reducing headcount, while the focus in the later

years was on innovation. Although executives from the joint venture declined to

be interviewed, industry feedback is that the initiative is on track.

Joint ventures are usually serenaded by providers, their aim being winning an

anchor customer and gaining foray into a vertical market. The customer, too,

gains as it can retain control over the project, especially during the

transition. A Deloitte survey in December 2004 found that 30% of the surveyed

participants stated loss of control over outsourced functions as a substantial

threat to ongoing operations.

A joint venture between the Swiss Bank Corporation (SBC) and Perot Systems

gave SBC a nonvoting equity stake in Perot Systems and control over the

transition of processes during the initial phase, while it helped the latter in

gaining a foray into the retail market.

Often the customer does not have any commercial interest in the joint

venture, and it generally exits after ensuring a smooth transition. Deutsche

Bank, for example, exited its joint venture with HCL last year-two years after

the initiative was floated.

Not all joint ventures, however, end on a feeble note. Sometimes customers do

make money when they exit the joint venture, as in the case of British

Petroleum, which made a tidy sum when Exult, its joint-venture partner, went

public.

Balaka Baruah Aggarwal



vadmail@cybermedia.co.in



Republished with permission from Global Services


(www.globalservicesmedia.com)