Of the countless client’s I’ve supported, while unique in their management style, diverse in their service offering, and varied in their key differentiators within their industry, all share a common challenge when seeking outsourced procurement support: selecting an effective billing structure. There are three main payment options when it comes to selecting a billing arrangement for your procurement initiatives: Contingency, Flat Fee, and Hourly models.
Contingency Fee structures are mutually beneficial if savings can be achieved. If not, both parties come out on the losing end. This fee model relies heavily on an established baseline, recognized by both your organization and sourcing firm. Some sourcing initiatives do not have quality data to produce such a baseline or are being conducted in a new category that does not have an historic baseline. Depending on the terms of the contingency model, your organization may be put in a situation of guaranteeing steady or increasing purchase volumes to suppliers and could be on the hook to pay estimated savings figures if those volumes fall off. At Source One, we utilize this model based on realized, hard-dollar savings and monitor those savings over the length of the engagement.
Flat Fee projects can work for both parties, especially when the sourcing exercise is unique; take near-shoring initiatives for example. This model allows the firm to rely less on an historic baseline and hard-dollar savings, keeping the focus on selecting the best suppliers at the best price. The drawback for the sourcing firm is that time spent working on the project cuts into profitability margins. These projects can be rushed, often resulting in less than ideal situations. In addition to encouraging the least amount of effort, this fee structure doesn't necessarily allow for flexibility in project scope. Through the sourcing process, we discover new challenges and new solutions that can very easily produce "scope creep." Scope Creep can, and often does, cause friction between the client and consulting firm, as well as add unnecessary administrative burden to the project(s). The desire to perform the best-in-class solution may be limited by this constraint.
Finally, there is the Hourly Fee model. This model allows for scope flexibility and ensures a level of profitability. The downside, quoting these projects requires previous experience and familiarity with the client and category-specific characteristics, which can be very unique. Without this in-depth knowledge, quoting is a stab in the dark. You, as the astute client, are incentivized to review hour reports on a regular basis and inquire what might be taking so long or why the initial quote was incorrect. This line of questioning can have a detrimental effect on the project, as well as, the relationship. Often resulting in time wasted on both sides. This model works well in staff-augmentation engagements.
The Solution? In my opinion, the ideal billing structure is a hybrid of the three aforementioned models. Depending on the project and the unique needs of your organization, a fixed fee model with the option to add "hours” will work well. Based on the scope of the project, consider including an ROI "kicker," tied to realized savings. This hybrid model incentivizes the sourcing firm to spend the time needed on a project to achieve the optimal savings solution(s), while ensuring a reasonable level of profitability during the sourcing process and even a chance to receive future income as the savings are realized. By combining the typical billing structures, your organization can benefit by the assurance that the firm has explored all options and is presenting the best possible solution to fit your unique needs. Below is a simplified example of how this model could be structured:
Example: XYZ sourcing initiative with $1,000,000 in annual spend
$10,000 Fixed Fee for the basic scope of the initiative (50 hours of work)
$200 Hourly Fee for additional sourcing activities identified
Contingency Fee ROI Incentive (if no additional hours are utilized):
120% ROI ($12,000 in annual savings) – 10% or $1,200 bonus
150% ROI ($15,000 in annual savings) – 20% or $3,000 bonus
180% ROI ($18,000 in annual savings) – 25% or $4,500 bonus
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