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BUSINESS MODELS

What to Know Before You Sign a


Payment-by-Results Contract
by David Lanceeld and Carlo Gagliardi
SEPTEMBER 05, 2016

Samuel Castro

Paying for results is in vogue. The concept is fairly straightforward: The parties dene the result
up front, agree on a baseline, work out how condent the organization is in delivering the result,
and then specify the expectation and payment in the contract. The idea isnt new its 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 UKsDepartment for International Developmentuses results-based aid to


improve the educational outcomes of young girls in Africa and Asia. Pearson, the educational
publisher, measures the ecacy 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 protable company.
Health care.Cignais the rst insurance company to get pharmaceutical companies to agree to
value pricing based on results forcertain cholesterol-lowering drugs. And theHealth 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 by2020.
Water.Severn Trent Water, among other UK water companies, has agreed to outcomesdelivery incentives with the regulatorOfwatthat results in rewards and penalties if itmeets or
fails to meet, respectively, performance commitments.

Its 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 theyre starting to demand that
the companies serving them focus on results. And providers want the exibility to deliver
outcomes in the best, most innovative, and most ecient way possible without being
micromanaged by the customer. This often involves collaboratingwith other organizations to
deliver the whole outcome healthier living, better education, or lower crime rates. But as
appealing as PbR is, it oftengoes o the rails.
What to Know Before You Sign a Payment-by-Results Contract

When PbR Doesnt Work

PbR can turn into a costly, risky exercise that delivers unpredictable results. Customers dont
always get the outcomes they expect, and providers can feel underrewarded for their eorts,
especially when the result is hard to achieve. Another problem weve seen is that some providers,
seeking to t 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 beenachievedand 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 hes 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 ofcompanies
gaming the system. There are plenty of ways to do this:going soft on the resultin order to gain
payment (for example, private probations ocers being told to turn a blind eye to oenders who
violate the terms of their probation); redening the outputs to make it easier to achieve the result
(for example, considering patients admitted when theyre placed on gurneys rather than
assigned beds); adding cost into the contract to mitigate risk; orcherry-pickingthe best
customers in order to achieve the result.

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

Making PbR Work


Weve found that PbR contracts function best when:

The parties dene 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 veried independently without
manipulation for example, throughrandomized control trials, statistical analysis, and
qualitative analysis
The provider has sucient capital and risk appetite to take on the challenge while it waits for
What to Know Before You Sign a Payment-by-Results Contract
the payment
There is enough time to develop innovative solutions to achieve the results
Theres 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 dened after conducting market research andengaging with customers.
Performance is then assessed against a baseline on a regular basis say, quarterly or annually.
However, with the growth of sensors andwearable technology, were seeing more ongoing realtime assessment of product- or service-use and results. The great benets 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 threedierentiating capabilities:

Eective partnering with other organizations involved in the delivery of the outcomes.
Thisincludes 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
eciency, tweaking products and services along the way as required.

At rst 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 specic
circumstances by organizations with the capabilities to deliver them. Otherwise, theyll nd they
will pay for more than they bargained for.

David Lanceeld 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.