Outcome-based Business Models for Enterprise Software
on Nov 16, 2017
A few pioneering enterprise software solution providers offer pricing and business models based on achieving specific outcomes for their clients, rather than just charging for software.
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Buying Results Instead of Buying Things
In the ‘outcome economy,’ people don’t buy things. They buy outcomes. They buy the end results they are looking for. When a manufacturer sells a product-as-a-service, it is a sizeable step towards an outcome-based business model. Examples of this include all three major aircraft engine manufacturers selling power-by-the hour instead of selling engines; Philips customers can pay-per-lux with their light-as-a-service instead of buying light bulbs; Schaeffler Industrial Services offers bearings-as-a-service for large complex machines like wind turbines or cruise ships with a multi-year, pay-per-rotation contract; Evergreen Lease from Interface who offered to own, install, clean, replace, and recycle their carpet squares so their client’s carpet is perpetually new; Contract Air service from Atlas Copco provides compressed air at specified pressure, dew point, and purity—the customer pays by the cubic meter; Philips Healthcare offers pay-per-use programs for their whole technology portfolio. Additional value-add services are wrapped around many of these programs.
There has also been a lot of interest in moving our healthcare system from a fee-for-service approach (which just encourages more procedures and tests, regardless of their value) to outcome-based healthcare. Instead of getting paid just for ‘doing stuff,’ doctors and hospitals would get paid for making us better and keeping us healthy.1 Moving to this model is not easy. It requires restructuring payments, accurate ways of measuring and analyzing outcomes, and major changes to organizational/team structures and incentives.
Hello … Any Outcome-based Enterprise Solution Providers Out There?
So, what about enterprise software. Why do most enterprises still keep paying for the ‘thing’ (i.e. the software) rather than the outcome that they desire? Or to flip the question around, are there any enterprise solution providers offering outcome-based payment models? Some people argue that Software-as-a-Service is an outcome-based model, because instead of paying for hardware, and running a data center, the customer only pays for the software when it is up and running,2 with all of the infrastructure taken care of by the provider. While SaaS is a step in the right direction, it is a fairly small step and we don’t consider it a true outcome-based model by itself. This is because companies don’t buy software just to get it up and running, but rather they buy software in order to achieve certain end goals and results. So, back to our question: do any enterprise software companies actually sell results rather than software?
The answer is yes, a few do … a very few, especially if we set the bar high, where 100% of revenue depends on outcomes being achieved. However, there are various gradients and flavors of outcome-based approaches, as we explore below.
i2 Technologies (now part of JDA) used to offer value-based pricing. During presales, they would conduct a two-week ‘Strategic Opportunity Assessment’ (SOA) to develop "as is" and "to be" solution processes and a business case for transformation. As part of this, they created a value/ROI model that defined which KPIs they would impact and by how much, such as inventory reduction, E&O3 reductions, decreased expediting charges, and so forth. The delivery team developed a method to measure improvements, to be used in post-deployment audits. However, there was no contractual guarantee of meeting these KPIs, in part because of the complexities of isolating i2’s impact from the numerous other factors affecting the various KPIs. Nevertheless, i2 offered a discount in exchange for additional payments if certain KPI goals were met over time. This was an early example of partial outcome-based compensation.
Isolating the Impact of Other Factors
This highlights a perpetual challenge for providers of outcome-based software approaches: how to isolate the impact of your solution or service on any given metric from other factors. For example, suppose a sourcing solution provider promises a 10% reduction in the cost of specific parts. Is that good or bad? For starters, one would want to look at what kind of year-over-year savings the client has been achieving prior to implementing the solution. If they are already getting 10%, that’s not an improvement. There are also external factors such as supply and demand or the cost of input materials or fuel that might have a huge impact on what the expected savings could be. Zero savings from the previous year might be an amazing accomplishment in one circumstance (say everyone else saw a 15% increase), whereas a 10% reduction might be a real disappointment in another circumstance (if others realized 25% savings on average).
Trying to isolate the effects of the solution from other factors can be quite challenging. However, we have seen clever approaches being used. For example, one retailer was adopting RFID tags on their apparel lines, to improve inventory accuracy with the expectation of getting an uplift in sales. To isolate the portion of sales uplift caused by the RFID tags, they conducted an experiment. They created pairs of ‘like’ stores—i.e. stores with similar characteristics, whose sales had historically closely tracked one another. Then they implemented RFID in one store but not the other for each pair. By doing this, they convincingly showed that RFID was resulting in a sales uplift averaging about 10%.4
The Chain of Goals—Connecting the Dots from the Most Granular KPIs Up to the Broadest Corporate Goals
Another question for companies moving to an outcome-based model is which goals and metrics to focus on. Companies usually have KPIs and goals that range from very granular, low-level metrics all the way up to their corporate mission statement. Between a company’s missions statement and their lowest level metrics are various levels of intermediate metrics and goals. In the example below, on the right are higher-level goals and KPIs taken directly from GSK’s mission statement on their website. On the left are increasingly granular goals and KPIs5 that might be used to measure progress towards the higher-level goals. An individual contributor’s personal goals and metrics should connect up to departmental goals and ultimately to an organization’s balanced scorecard. Many companies are not quite that well organized in maintaining a connected chain of KPIs and strategy. Still, alignment of goals and KPIs up and down is a worthwhile ideal to strive for.
Figure 1 - Example of 'Chain of Goals and KPIs,' From Most Granular to Most Encompassing
For outcome-based software, a provider would like to measure impacts at the highest levels. However, often it is much more practical to measure more granular impacts. Picking the right metrics that can be solidly attributed, easily measured and agreed, and provide the most value can be challenging.
Coupa’s Focus on Measurable Results
Coupa has been one of the fastest growing and most successful spend management/sourcing and procurement solution providers in recent times. When I attended Coupa Inspire (their annual use conference) earlier this year, I was struck by the overwhelming number of references to precise, measured results achieved by their clients. There is a similar abundance of specific measured results on their website. Most enterprise solution providers have a smattering of quantitative metrics improvements mixed in with qualitative descriptions in their case studies. The reason Coupa has so many more of these stats is because of how they engage with prospects and clients.
What Are We Trying to Achieve? How Will We Measure Success?
Coupa starts presales with ‘value discovery,’ working together with the prospect to define the goals of the initial implementation. They ask ‘what problem are we trying to solve’ and ‘how will we measure success’? The goals are diverse—some companies are looking to lower transactions costs and increase procurement productivity. Others may be looking to reduce data entry errors. Almost everyone is looking for hard dollar savings through reduction of spend, but in different ways. Some are looking to consolidate spend, others to bring more spend under management, or capture early payment discounts. Some look to reduce procurement or product cycle times, or standardize processes, or improve regulatory compliance.
Defining Goals Upfront and Continually Driving to Achieve Them
Coupa insists that the business goals, objectives, and success metrics for the project are defined up front. Some prospects ask ‘can’t we just get started and figure that out later,’ but Coupa told me they won’t move forward until the customer, with Coupa, defines what they are trying to achieve and exactly how they will measure success. The folks from Coupa said, “Go live is not the finish line, it is the starting line.” They do periodic ‘value reviews’ to check progress against the original goals, and set additional goals when ready. This results in expanding Coupa’s solution footprint at each client, not by asking ‘what else can I sell them,’ but by focusing on the client’s desired outcomes first. One manufacturer of industrial and aerospace control systems that I heard at Inspire set the following five objectives:
Increase spend under management—they increased it by 17%, exceeding their goals
Consolidate suppliers—reduced the number of suppliers by 30%
Increase visibility of spend—moved $105M of spend from two different ERP systems onto Coupa, to get line item details for orders and invoice, and custom reporting
Improve contract compliance—improved by 30%
Increase electronic invoices—89% of invoices now received electronically
Although there is no specific financial payment at stake for achieving the defined metric, all parties understand the goals and what constitutes success. Coupa takes an outcome-centric approach to client engagements, making it much likelier that goals will be understood and met, and thereby the customer will feel confident about the value they are receiving.
LevaData provides a Cognitive Sourcing Platform that ingests internal company information (such as the forecast, BOMs, materials master data, and other master data) to provide much better visibility into current spend. It then combines that with a rich variety of external data (such as news feeds, weather, commodity indices, economic data, etc.) and uses AI and machine learning to provide automated market intelligence and identify opportunities. The platform provides specific recommendations for sourcing and negotiation strategies. They can do sophisticated ‘should-cost’ analysis. For example, if the price of copper goes up, the platform will know which components and product should be impacted and by how much. They also provide anonymized community benchmarking. LevaData recently released an AI-based sourcing advisor called Leva.
The purest form of outcome-based software that I’ve encountered comes from LevaData. Normally they price their software based on an expected amount of incremental cost savings. That is the most important KPI for most procurement groups—year-over-year cost reductions. In creating these savings targets, LevaData looks at the prospect’s historical spend: the last year or two of what the prospect actually sourced, contract prices, and prices paid. From this, they create a baseline and use their tools to calculate what kinds of additional savings the customer would have achieved if they had used the LevaData platform—e.g. “You left $27M on the table across these four commodities.” They will look at the prospect’s current savings goals for the year and predict how much better LevaData will do. “We can add an additional 2% to your cost reduction goals” or “We can increase your savings by 25%.”
But LevaData goes further and puts their money where their mouth is. They are willing to put 100% of their revenue at risk if they don’t meet the goals. They create a baseline cost reduction from the mutually verified historical 3-year average cost savings. The gainsharing formula is: for each incremental hard dollar cost savings realized above and beyond that historical baseline, LevaData earns 33%.6 They are essentially saying, “we can help you reduce costs better than you have historically, and if we can’t, you don’t owe us a cent.” That requires a very high level of confidence in the ability to meet the goals, and a large incentive to work hard on behalf of the client to meet those goals. They are the only software vendor I know of that is willing to offer an outcome-based model at this complete level of commitment.
Polycom Takes Advantage of LevaData’s Gainsharing Model
This approach is not just for new prospects. One of LevaData’s clients, Polycom, manufactures and sells video-conferencing and related products. They started using LevaData about a year and a half ago. Prior to adopting LevaData, their commodity managers did a lot of manual monitoring of market data and prices, industry capacity and demand, identifying alternatives, with basic analysis using their home-grown Excel spreadsheets. Adopting LevaData’s Market Intelligence capabilities saved their commodity managers a lot of time and has enabled them to become much more effective at finding alternative parts and identifying opportunities for cost savings.
Building on this success, Polycom wanted to expand their use of the platform to include LevaData’s SmartRFQ solution, which generates negotiation strategies and single-click creation of playbooks, telling the commodity managers which levers to pull and when during the negotiation cycle, to achieve optimal results. However, larger forces were at play, making it difficult to get the budget approved for this. In April last year, Mitel announced it would acquire Polycom. However, three months later, Polycom announced that deal was being cancelled and they were being acquired by Siris Capital instead (that acquisition was completed in September). All of this complicated internal budgeting. So, Polycom opted to bypass the need to budget funds altogether, by taking advantage of LevaData’s offer to get paid strictly via gainshare. They are in the process of working through how the savings will be measured, which things LevaData should get credit for, when those savings are actually being realized (since they use contract manufacturers and it takes time to consume the existing inventory of components), and how to account for market fluctuations. This has allowed an existing client of LevaData’s to expand their footprint without risk, at a time when they were unable to get budget approval.
Good Things Happen When the Solution Provider Has Skin in the Game
There are very few examples of solution providers offering true outcome-based software models in the market today. Those that do are inherently much more aligned with their customers’ goals and become more embedded, like an extension of their client’s internal teams. By having skin in the game, they make a powerful statement about their commitment to success and confidence in achieving the goals. This approach does add complexity to the pricing schemes, in order to isolate the impact that the solution provider has from other factors. However, this can be well worth the effort, as it forces the client to think more deeply about their goals and to more precisely define what it is they are trying to accomplish. In the end, this creates solution providers with a very strong vested interest in the success of their clients, resulting in far fewer failed projects and much better end results. As more software solution buyers become aware of these options, we expect them to start to demand it, and the use of outcome-based models will expand beyond the current pioneers.
1 It would seem important to provide incentives for patients as well, to encourage them to adopt healthy lifestyles and comply with treatment regimes, since those are such critical factors for achieving and maintaining good health. -- Return to article text above 2 This is usually not strictly true, since most SaaS providers charge startup and integration fees before the software is actually up and running. They also typically require a 1-3 year commitment with penalties for cancellation. -- Return to article text above 3 E&O = Excess & Obsolete inventory -- Return to article text above 4 The sales uplift from RFID varied a lot, depending on the category. For men’s suits, it was about 5%-6%. For lingerie, about 25%. Overall the average was 10%-12%. Many retailers have come to a similar conclusion for RFID tagging of apparel and footwear. Last year, globally about 6-7 billion apparel and footwear items were tagged with RFID, driven almost exclusively by the sales uplift they were seeing. -- Return to article text above 5 In Figure 1, the goals and KPIs on the left are hypothetical ones that we made up for illustrative purposes, not necessarily actual KPIs that GSK uses. -- Return to article text above 6 LevaData also offers a shared risk option, where they put 50% of Year 1 subscription fees at risk in exchange for a smaller percentage of incremental savings going to LevaData. -- Return to article text above
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