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Contractual understanding: Manpower vs outcome-based contracts

contracts

GEP’s Deepesh Jethwani talks about when buyers should look to use manpower- or outcome-based contracts

 

While purchasing general or professional services, agreements can generally be categorised as being either manpower-based or outcome-based.

 

What are manpower-based contracts?

Manpower-based contracts provide buyers with clarity on the scope of work to be completed and how it needs to be done. All they buyers need is staff to fulfil their requirements. This is generally the case for a lot of blue-collar jobs. While there will be leaders or supervisors from the supplier’s side to monitor the quality of work, the ultimate ownership of the task resides with the buyer. A supplier calculates a pricing quote by adding workers’ wages, accommodation and logistics costs and, if applicable, any other equipment-related expenses.

What is an outcome-based contract?

From a buyer’s point of view, outcome-based contracts focus more on the deliverables or output than the way in which the project is done. The risk is transferred from buyer to supplier, which is entirely responsible for completing the job. Failure to complete the work on time could result in penalties being imposed. The supplier is given a detailed briefing on the scope of work and an opportunity to visit the job site to understand requirements and come up with a suitable proposal. Buyers will generally ask suppliers to provide an all-in fixed price.

 

When should buyers use which agreement?

When a buyer has complete visibility on how to get a job done, as well as the necessary infrastructure in place to support it, it is preferable to use manpower-based agreements. The service provider quotes a fixed fee for the cost of supplying and managing the labour provided, plus a variable fee based on additional goods (such as chemicals or consumables, as in the case of cleaning services) needed to provide the service.

 

Buying organisations with a new service requirement or need skilled manpower (as in professional services), will find it preferable to go for an outcome-based contract. Experienced service providers, who have been in the industry for a long time and have handled such requirements in the past, propose a working model to fulfil such requests.

 

As pricing is performance-based, it is in the best interests of the supplier to maintain the highest quality standards. Buyers can use these learnings in the future if they intend to move to a manpower-based agreement. However, it is important that the service provider is completely aligned with the scope of work; otherwise, conflicts may arise as to whether the supplier has covered certain undefined expectations.

 

Negotiation strategies

In manpower-based contracts, as a supplier generally provides a breakdown of cost components, the straightforward negotiation strategy is to understand market rates and compare them suppliers’ quotes.

 

Buyers could, for example, check the minimum wages that are applicable for unskilled workers (for, say, cleaning services) and compare them with the supplier’s quote. If there is a major difference, it can be highlighted and discussions can centre on how those costs can be brought down. Similarly, benchmarking of other cost components can be done via a request for proposal (RFP) process and subsequent negotiations could be pursued with the shortlisted suppliers.

 

In outcome-based contracts, since a supplier might not provide a detailed cost breakdown, buyers are left with limited leeway for negotiations and it becomes important to identify other levers.

 

If a quote is not significantly higher than what the buying organisation is paying the incumbent or has obtained from an RFP benchmarking exercise, it makes more sense to negotiate on the additional ad-hoc scope of work. Buyers entering a cleaning services agreement, for example, could negotiate for a fixed percentage discount on any additional ad-hoc scope of work to be awarded to this supplier in future on the same premises. If the supplier is not willing to bring down costs, buyers could try to get them to agree on stretch targets.

 

Whether buyers opt for a manpower-based agreement or an outcome-based agreement, it is advisable to secure a two- to three-year contract to get the cost-benefit, and then launch a benchmarking/RFP exercise at the end of the contract to ensure the organisation is not paying more than the market rate to service providers.

 

Deepesh Jethwani is a senior consultant at GEP

 

This contributed article has been written by a guest writer at the invitation of Procurement Leaders. Procurement Leaders received no payment directly connected with the publishing of this content.

Deepesh Jethwani
Posted by Deepesh Jethwani