What to Know Before You Sign a Payment-by-Results Contract (Harvard Business Review)

By David Lancefield & Carlo Gagliardi

Paying for results is in vogue. The concept is fairly straightforward: The parties define the result up front, agree on a baseline, work out how confident the organization is in delivering the result, and then specify the expectation and payment in the contract. The idea isn’t new — it’s well established in online advertising, for example — but its application is becoming more widespread in the private and public sectors.

Consider these examples:

  • Education. The UK’s Department for International Development uses “results-based” aid to improve the educational outcomes of young girls in Africa and Asia. Pearson, the educational publisher, measures the efficacy of its products to improve educational outcomes. Its CEO, John Fallon, says of this approach, “It is by having a bigger impact on education — measured by expanding access and improving outcomes — that we will make Pearson a faster-growing and more sustainably profitable company.”
  • Health care. Cigna is the first insurance company to get pharmaceutical companies to agree to value pricing based on results for certain cholesterol-lowering drugs. And the Health Care Transformation Task Force, a newly formed coalition of private insurers and provider organizations in the U.S., recently announced that its members are committing to transform 75% of their contracts into pay-for-performance models by 2020.
  • Water. Severn Trent Water, among other UK water companies, has agreed to “outcomes-delivery incentives” with the regulator Ofwat that results in rewards and penalties if it meets or fails to meet, respectively, performance commitments.

It’s no wonder that payment by results (PbR) is gaining traction. Customers and taxpayers want to see more value and accountability for the money they spend, so they’re starting to demand that the companies serving them focus on results. And providers want the flexibility to deliver outcomes in the best, most innovative, and most efficient way possible without being micromanaged by the customer. This often involves collaborating with other organizations to deliver the whole outcome – healthier living, better education, or lower crime rates. But as appealing as PbR is, it often goes off the rails.

When PbR Doesn’t Work

PbR can turn into a costly, risky exercise that delivers unpredictable results. Customers don’t always get the outcomes they expect, and providers can feel underrewarded for their efforts, especially when the result is hard to achieve. Another problem we’ve seen is that some providers, seeking to fit in to a payment cycle, focus on short-term results, losing sight of the end goals.

Sometimes, measuring the results can involve a substantial amount of data collection and analysis, and the measurements are often in dispute. Disagreements focus on whether the result has been achieved and how much of the result was due to the organization under contract or to external factors. Did the patient really become healthier because of the drug in question, or because he’s eating better? Did the student get an A because of the textbook, or because the teacher was inspiring?

Another problem is that badly designed contracts can leave open the possibility of companies gaming the system. There are plenty of ways to do this: going soft on the result in order to gain payment (for example, private probations officers being told to turn a blind eye to offenders who violate the terms of their probation); redefining the outputs to make it easier to achieve the result (for example, considering patients “admitted” when they’re placed on gurneys rather than assigned beds); adding cost into the contract to mitigate risk; or cherry-picking the best customers in order to achieve the result.

Finally, some companies have struggled to finance their activities without payment while they work on delivering the results, limiting their ability to innovate too. As a result, some governments and private foundations have introduced social impact bonds to provide the necessary working capital.

Making PbR Work 

We’ve found that PbR contracts function best when:

  • The parties define the result — and the baseline — without ambiguity and agree to practical approaches to measurement
  • The role of the provider in delivering the result can be verified independently without manipulation — for example, through randomized control trials, statistical analysis, and qualitative analysis
  • The provider has sufficient capital and risk appetite to take on the challenge while it waits for the payment
  • There is enough time to develop innovative solutions to achieve the results
  • There’s trust between the parties and the outcome is not “political.” Too much subjectivity and sensitivity can scupper the scheme.
  • There are management tools and incentives in place to encourage a focus on results and the end goals

Typically, the results are defined after conducting market research and engaging with customers. Performance is then assessed against a baseline on a regular basis — say, quarterly or annually. However, with the growth of sensors and wearable technology, we’re seeing more ongoing real-time assessment of product- or service-use and results. The great benefits of this are improved accuracy and transparency, and therefore accountability.

Required Capabilities

Promising a result creates a greater expectation in the eyes of the customer than simply providing a product or service. It sets a clearer purpose, often in improving the lives of customers and citizens. In our experience, this demands a more agile, higher-performing organization that masters three differentiating capabilities:

  • Effective partnering with other organizations involved in the delivery of the outcomes. This includes the closer alignment of incentives, active performance management, and use of risk-sharing mechanisms for the complex, lower-trust contexts. For example, health and social care providers may work more closely within “integrated care” models.
  • Flexible internal organizational structures. PbR arrangements require more internal collaboration, transcending vertical siloes based on products to organization-wide outcomes in what Sir Martin Sorrell of WPP calls “horizontality.”
  • Use of digital technology. Wearables, sensors, and IoT applications produce real-time insight into the needs, expectations, and behaviors of customers — and, crucially, into their achievement of value outcomes. Companies need to use this digital technology to capture, analyze, and then act on the new insight to deliver the agreed-upon outcomes with the highest efficiency, tweaking products and services along the way as required.

At first sight, results-based payments can be appealing for customers and providers. And digital technology is making it easier to measure the results. But PbR arrangements only work in specific circumstances by organizations with the capabilities to deliver them. Otherwise, they’ll find they will pay for more than they bargained for.

David Lancefield is a partner with PwC Strategy& in London. He advises companies and public sector organizations on strategic transformation.

Carlo Gagliardi is a partner with PwC Strategy&, based in London. His work focuses on helping companies grow in the digital age.