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Under Secretary of Defense, Logistics Systems Management ERP Implementations and Gain Sharing

Under Secretary of Defense, Logistics Systems Management ERP Implementations and Gain Sharing. Introduction.

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Under Secretary of Defense, Logistics Systems Management ERP Implementations and Gain Sharing

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  1. Under Secretary of Defense, Logistics Systems Management ERP Implementations and Gain Sharing

  2. Introduction This presentation provides a commercial perspective on the contracting alternatives available in an ERP project and explores in greater detail a commercial approach for paying a systems integrator based on improvements achieved. • Contracting Approaches • Why Gain Sharing for ERP • Gain Sharing • Approach • Requirements • Benefits • Risks • Gain Sharing in the Federal Government

  3. Contract TypesDefinitions Certain contracting models are better suited to different engagement types: • Cost plus: Pays the service provider for the actual cost of doing the work, plus a fixed fee for profit or an incentive fee for delivering extra value (i.e., project completed ahead of schedule). • Deliverables-based time and materials: The service provider is paid based on a pre-negotiated hourly or monthly rate, and on meeting pre-specified deliverables/deadlines; the service provider is reimbursed at cost for materials used or for other costs incurred, such as travel expenses. • Fee for service: Payment is based on a unit or transaction volume, such as MIPS used per month or calls answered per month. • Fixed price: Payment is set at a fixed amount to be paid in pre-established, periodic increments or at the completion of the project. • Gain sharing: The service provider and service receiver share in the amount of money saved or accrued as a result of the project, based on negotiated percentages, such as 50 percent to each party. • Shared risk/reward: The service provider and service receiver share in the cost of developing the service or project, and in the subsequent revenue generated by the new product or service. • Business-benefit-based: The service provider is paid in proportion to the business value generated by the project or service, such as a percentage of increased profit or decreased cost.

  4. Contract Type Business Benefits Cost and Performance Risk Enterprise ESP Cost Plus Develop true costs; obtainessential resources Medium Low Deliverables-Based Time and Materials Estimate costs; obtainessential resources Medium Low Fee for Service Stabilize costs; obtainessential resources Medium Medium Fixed Price Control cost and time High Low Lower cost and time, vendor incentive Gain Sharing Medium Medium Shared Risk/ Reward Lower cost/investment;create revenue High High Business- Benefit-Based No investment; pay onlyfor bottom-line results Medium High Determine the Contract Risks

  5. ESP RelationshipsUtility, Enhancement, Transformation Gartner research has shown that three broad types of relationship exist between ESPs and buyers of those services. • Utility: Utility relationships focus primarily on cost reduction, with the goal of maintaining consistency in the delivery of services. • Enhancement: Enhancement relationships have productivity as their goal. • Transformation: A transformation relationship is characterized by a partnership focused on innovation and new business, changing the very nature of the basis on which an enterprise competes. Although it may appear that the goal for an enterprise is always to become a transformation deal, this may not be the correct approach for the particular circumstances. Understanding and choosing which relationship best fits an enterprise’s business strategy, and the “value” it wants from the deal, lays the groundwork for all subsequent decisions on how the deal is managed.

  6. Determine the ‘Right’ Contract Type By Deal Type Contract Type Business Benefits Suitability to Engagement Utility Enhancement Transformation Cost Plus Develop true costs; obtainessential resources Deliverables-Based Time and Materials Estimate costs; obtainessential resources Fee for Service Stabilize costs; obtainessential resources Fixed Price Control cost and time Lower cost and time, vendor incentive Gain Sharing Shared Risk/ Reward Lower cost/investment;create revenue Business- Benefit-Based No investment; pay onlyfor bottom-line results With the Federal Government, Gain Sharing is one of the best contract types for a transformational project, such as an ERP implementation.

  7. Gain SharingOverview • Gain sharing sets up a direct link between the rewards earned by an IT services supplier and the business benefits delivered to the client. It gives both parties real incentives to cooperate and improve the service. • Under gain-sharing agreements, payments to the service provider reflect the business value they add for the client. • Gain-sharing involves tying part of the service provider's payment to business gains generated by a project. Examples include: • reduced cycle times • improved customer satisfaction • improved return on assets • Gain sharing can be applied to projects and to service-level agreements (SLAs) for the ongoing management of IT services. • Gain sharing is not applicable for all situations but, used with care, can be beneficial to both client and external service provider (ESP). • Use of gain sharing requires understanding when to apply gain sharing, how to quantify benefits, allocate benefits between the parties, and realize the benefits that can be achieved.

  8. Gain SharingApproach - Establish Partnership • Steps to implement gain sharing • Define business needs • Outline requirements • Develop and refine requirements and preliminary design based on expertise of ESP • This is an iterative process with changing requirements based on changing possibilities • Incorporate this approach into ESP selection process or create a separate agreement with an established ESP (ex. time and materials basis) • Requires that both parties agree to the final design before it can be applied to an implementation stage

  9. Gain SharingApproach - Quantifying Benefits • Gain sharing requires that the benefits of an IT services deal be quantified, and that they be allocated between the client and the ESP. • When the goal is cost reduction, there are three common approaches: • Agree to the extent of the cost reduction up front • Benefits - Both parties understand the benefits and the risks for both parties • Risks - Lengthy negotiations at the start of a project, and difficulties if changes are required later • Identify the cost drivers that the project will affect. For example, in an ERP implementation this could be the cost reduction that results from reduced cycle time. The benefits could be quantified in terms of the cost-driver improvements that can be attributed to the ESP • Benefits - Works well when cost drivers are easy to identify and overall responsibility for achieving the cost reduction cannot be assigned to the ESP alone • Risks - Provides less certainty for the client and can be costly to administer. • Use third-party benchmarking to quantify the benefits. • Benefits - Works best when benchmarking is an integral part of continuous improvement in a deal. In these circumstances, benchmarking can be used to identify goals and to check that they have been achieved.

  10. Gain SharingRequirements- Address Key Issues Effective gain sharing requires: • Understanding Responsibilities - both parties must understand their responsibilities for realizing the benefits of an IT services contract • Effective Change Management - Educate a successful implementation by educating users to accept and use a new system to reap its benefits • Applying Gain Sharing to Post Implementation - Gain sharing needs to be applied to the project post the technical implementation • Otherwise, an organization could provide an ESP with bonuses for a project that has failed in terms of results but was successfully implemented from a technical perspective • Mitigating Obstacles - Identify potential obstacles to realizing benefits. Examples include: • Resistance to change by government of contract personnel • Internal performance metrics rewarding old ways of working

  11. Gain SharingBenefits • Gain sharing SLAs promote collaborative and cooperative relationships • For the Government, gain sharing SLAs: • Ensure that payments for over-achievement on SLAs are commensurate with the increased business benefit. • Quantify and share risks and benefits with the ESP more equally than traditional SLAs. • Provide a contractual link between business goals and IT functionality. • Provide, at the contract development phase, an additional measure of the ESP's understanding of the client's business and technology issues. • Force them to identify and quantify business metrics, and to understand the impact of IT performance on business. • Define project success in terms of business success. • For ESPs, gain sharing SLAs: • Match business benefits for the client with performance targets. • Highlight value, or the lack of value, by tying increased or reduced payments to specific client business metrics and key performance indicators. • Demonstrate their superior knowledge of the client's business metrics. • Highlight their ability to both measure and improve the client's business metrics.

  12. Gain SharingRisks - Bad Behavior by ESPs • Traditional SLAs can encourage inappropriate behavior • Bait and Switch - The ESP may under-perform for the first half of a month, but meets the SLA by over-performing during the second half. Although the SLA for the month has been met, the adverse business impact in the first half of the month may be significant. • Rock Bottom - Poor performance in the first week of a month may result in the ESP reaching the maximum monthly penalty payable for that SLA, giving it no incentive to improve performance for the rest of the month. • Playing the Spread - Individual SLAs are often set for components of a system (such as the server, network or LAN and desktop) rather than the end-to-end service. Although 99.5 percent availability SLAs may be achieved for each component, a key application may have only 98 percent availability. However, no penalty would be payable because each of the individual SLAs had been met. • Get Out of Jail Card - The ESP may fail to achieve certain SLAs, but ask for the penalty to be waived on grounds such as skills shortages, asserting that it has not adversely affected the client. The client may agree to this request to maintain a good working relationship.

  13. Gain SharingRisks - Bad Behavior by ESPs • Inappropriate behavior (continued) • On the Cheap - The ESP may find that additional resources are required to meet the SLA, but opt to pay the penalty because it is less expensive than drafting in more resources. The client's business suffers as a result. • Selective Performance - The ESP may find that it can exceed SLAs in one area, collecting service credits that offset a below-par performance (and the penalty) in another area. • Paying for No Gain - If SLA targets are set at realistic, necessary and achievable levels, the payment of financial remedies for underachievement should reflect the resulting impact on the client's business. Perversely, rewards for over achievement can often be paid for levels of service that are not necessary for the client, and that add no business value.

  14. Gain Sharing Issues Specific to the Federal Government • Contract Mechanisms • It is more difficult for government agencies to establish a contract that pays an ESP based on shared benefit rather than specific services. - • Build definitions for shared Benefits in your Business Case Analysis (BCA). • Competitive Outsourcing Schedule • Gain Sharing requires involving an ESP early in the project development stages in order to determine the potential benefits and value the project might yield. This is difficult when agencies are required to define project scope, justify the cost benefit, and establish a budget before even competing the contract to obtain a vendor. • Often, the government cannot utilize the expertise of the ESP in defining the potential benefits until the ESP is in contract negotiations or even hired. • Gain sharing must be embedded in the procurement process. • Budgetary Planning Predictability • It is very difficult to accurately predict the expected gain sharing “payments” will be made to a vendor in future years. This makes budgetary planning very difficult and requires a certain amount of budgetary flexibility that agencies don’t have. • Integrate Gain Sharing with the budgetary planning process

  15. Gain Sharing Issues Specific to the Federal Government (continued) • Project Planning and Alignment • Successful gain sharing requires that the first steps in a project be well executed project so that the shared benefits are aligned with and further the project objectives. Government projects often evolve, forcing government managers to spend more time actively monitor projects and adapting the gain sharing mechanism to align with changing objectives. • Proactive monitoring and management of gain sharing throughout project cycle is required • Resources • Gain sharing agreements require greater government monitoring and oversight to ensure that relationship is working and that the rewards are aligned with the expected benefits. This is difficult when the government is increasing forced to “do more with less.” • Business Case Analysis (BCA) and project plan must account for resources to execute gain sharing. • Expertise • Gain sharing is a contract approach is more difficult, time sharing then typical government contracting. • Working with a progressive contracting office will be required.

  16. Gain SharingSummary Facts • Gain sharing will increasingly be used in IT and business process services agreements. • Gain sharing benefits organization by aligning the contractor with a project’s business value • Gain sharing is well aligned with a transformation service type, such as an ERP implementation • If not used carefully, gain sharing can do more harm than good by promoting poor ESP behavior • Successful gain sharing requires that the initial steps of a project be well executed. Typically, by the final-design stage of a project, 80 percent of the costs and benefits have been locked in.

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