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)