risk and reward

RISK & REWARD

KEY OBJECTIVES

Following identification of the preferred Contractor i.e. most economically advantageous or lowest price (in accordance with Tendering rules) or by agreement after Contract is in place.

The primary aim is to reshape the deal such that it is constructive in the way that it operates i.e. the underlying commercial framework provides a WIN - WIN and LOSE - LOSE environment.

EXAMPLE 1 - Simple:A Contract was let on “Cost plus a margin” basis even though the Contractor is responsible for negotiating discounts for the Company from third party manufacturers.

Issue - the higher the spend the more money the Contractor receivesi.e. 3% of £1,000,000 = £30,000, 3% of £10,000,000 = £300,000. (Linear deal - WIN - LOSE). No incentive for Contractor to obtain or negotiate the best price for us.

If in the above scenario typical manufacturer discount is 10% for spend of £1,000,000Risk Reward Option: If Contractor obtains 10% Discount for Company he is paid the usual 3% margin.If Contractor only obtains 5% Discount then he only gets a 2% margin.If Contractor obtains a 15% Discount then he gets a 4% margin.

This is a simple structure and can phrased in a different way:-3% margin is fixedTarget discount is set based on benchmarks i.e. 10%Under achievement means a penalty against the 3%Over achievement means a % of the additional saving is given to Contractor.

Copyright Royal Mail 2003

First Published 2000 by: Royal Mail Purchasing Services,

Royal Mail is the trading name of Royal Mail Group plc.

Registered number 4138203

EXAMPLE 2 - Complex - Payment Structure reflects Risk & Reward. : Summary of Agreement.1. Company and Contractor recognise that the relationship to be formed is long term

and needs to deliver both benefits and working solutions. 2. Hence Company requires and Contractor agrees to put a total of 50% of their fees

at risk that the Products delivered work properly and realise the targeted benefits. Benefits realisation can be actual (e.g. legacy switch off) or lead indicators (e.g. process improvements).

3. A Risk Reward environment has been created which provides “improvement” incentives such that the Contractor has the opportunity to obtain returns above the rates originally tendered.

4. The Parties will continue to work together to consider a Benefit Share model (whereby Contractor is paid totally from the benefits realised i.e. no day rates) for improving the business case benefits and for additional benefits.

Key factors in process (See diagram overleaf)

1. An initial Discount of X% from the Tendered Rates is negotiated to create the Day Rates.

2. The Day Rates are fixed for duration of contract or first year and subject to revision thereafter as agreed between the parties.

3. 50% of the Discount is available as the initial Reward for delivering the Project on time, i.e. satisfactory completion of the acceptance tests by the due date with working functionality, and realising the benefits agreed at outset.

4. Further Rewards are achievable through a number of mechanisms: Improvement in efficiency, e.g. time / resource used. Improvement realised in the Benefits agreed for Project. New Benefits identified and realised.

Total value of all rewards is capped at 120% of the Day Rate.5. Higher returns for higher risk by flexing percentages and introduction of Benefit

Share.6. A payment profile is agreed that reflects completion of key stages of the Project

(stated as %’s of the Day Rate):7. “Scorecard” applies to payment i.e. operational delivery, quality, satisfaction, etc.





RISK AND REWARD STRUCTURE

** PART 1 **

Discount & Payment Profile

Discount creation Payment Profile Payment milestones /conditions

Total Cost based on Tendered Rates

n * x% Further Rewards: 1. Improved efficiency, 50/50 share 2. Improvement realised in benefits agreed

(total x’s capped

e.g. 120%)

3. New to business case benefits shareEach reward contributes an x%

Negotiated discount = X%

Total Cost based on agreed Day Rates

a%(10%)

Successful Project Completion:Project Retention e.g. payment made at Project end. Measured by “Final Scorecard” based on Business Case targets.

b%Agreed Benefit Realised:Payable as each is realised (i.e. average is 6 months after Working Functionality sign-off).

c%Release Completion: Deployment of Working Functionality, signed off “operationally”.

d%

Business Deliverables:Products, Work Packages, milestones within Release as agreed with Project. Measured by PRINCE II methodology and ASAP deliverables with update on quality, etc.

e% Monthly plus Expenses:Payment against resource deployed together with expenses.

Note: (I) %’s are of Day Rate, total is 100 + a% e.g.110%, reflecting initial reward pool.

(II) Proportions (a-e %’s) to be agreed





Working Principles

The Contractor is incentivised to be and remain in front of the agreed plan (see Further Rewards, I).

Monthly plus ExpensesResource levels agreed as part of “Work Package” specification. Resource changes agreed at Project Manager level in advance.Contractor is paid for these resources at the “e%” level with no hold-back even if under or over-run on Work Package forecast.

Business Deliverables (Work Packages)Paid against time, cost and quality measures agreed as part of “Work Package”. If any measure missed, remedial actions agreed by Project Managers and payment other than Monthly only when completed. Actual resource used against forecast is monitored such that Contractor has the opportunity to recover any over-run on a milestone or Work Package within the next milestone or Work Package and get back to plan before payment is impacted. Similarly if in advance of plan then this must be maintained through to Release Completion in order to obtain efficiency reward. Issues in dispute regarding under or over-runs are resolved as the Project progresses Issues must be resolved before Release Completion when payment will be adjusted to keep budget on track..

Release CompletionPaid against Scorecard measures agreed as part of Work Package.“Working Functionality sign-off” means when user signs off the Release in the working environment. Realistically, timing will be agreed as part of “Work Package” but will target no later than two months after go live date. Where issues are raised then parties will agree on those to be fixed in order for payment to be made. Payment will be made on resolution of these issues.

Agreed Benefit Realised: Benefits will be delivered over a wide time frame depending on the type, e.g. Legacy system switched off FTE reduction Better use of information providing savings, e.g. manpower planning.The Post Office will target a date as part of “Work Package / Release” for confirmation when payment will be targeted for e.g. 6 months after go-live date. This will be either when: Savings have been realised, or Business Units have accepted (signed off) that they will deliver the benefits.Benefits will be detailed in the Benefits Plan (using Lead indicators).





** PART 2 **

Further Rewards

During the implementation of Work Packages the Contractor is incentivised to:

I. Improvement in efficiency Deliver the Work Package for less total cost / man days than agreed at outset.

The resulting saving will be split equally “50/50” between Contractor and The Post Office as follows: A. 25% will be paid on Release Completion, in effect generating a better

return than the agreed Day Rates.B. 25% will be paid on Successful Project Completion, thus incentivising

delivery of the whole Project including benefits.C. 50% will go to The Post Office and be reserved for contingency, i.e.

additional work.

II. Improvement realised in the Benefits agreed for the Project Deliver benefits of higher value than those agreed in the business case.

III. New Benefits identified and realised. As Work progresses the Contractor is incentivised to identify “NEW” benefits not set

out in the business case and then by agreement of the Benefits Board to deliver these. The Risk Reward structure shall apply.

Work Packages to deliver new benefits will be funded from:A. Savings reserved for potential additional work (item 1C) above.B. Contractor will submit a business case for additional funding from PO.C. Contractor will perform work on a benefit share basis to be agreed and

obtain an enhanced return for success i.e. greater than x%.

Payment Principles in respect to II and III.Benefits in excess of those identified in the business case will contribute x% of the difference towards increasing the return to the vendor.A. 50% of the contribution will be paid on Agreed Benefit Realised, in

effect generating a better return than the contracted day rates.B. 50% of the contribution will be paid on Successful Project

Completion, thus incentivising delivery of the whole Project including original business case benefits.





Balanced Scorecard

Below is detailed the “Operational” scorecard. The scorecard will be used to measure the performance of the Contractor and aid determination of payment.

TimeThe agreed dates by which the milestones, Work Package, Release, or Project will be delivered.

CostThe cost of delivering the milestone, Work Package, or Release. This will be based on agreed plans which are underpinned by the required number of days and the day rate applicable to the necessary skill level to complete each task. Thus it will be possible to quantify this in both cash and man days by skill level, but it must be at a level which is high enough to minimise the bureaucracy of monitoring the contract.

QualityThese measures will vary depending on the milestone or the Release being delivered but will encompass both Working Functionality and Benefits Realised: Customer satisfaction with

usabilitytrainingprocesses

Customer perception and feedback System performance measured before and after any change System outputs/interfaces performing to agreed levels Data reconciliation Knowledge Transfer Internal Audit evaluations Internal quality reviews External quality reviews Benefits achieved

Time and cost will be measures applicable to all milestones, Work Packages and Releases. Quality measures will depend on the nature of the piece of work, i.e. the quality elements to be measured will be relevant to the task(s) being measured.

Business Balanced ScorecardThis scorecard will be developed into a Business Balanced Scorecard, by agreement with the Contractor, during the Contract Term to reflect Strategic Vendor status. The BBS will reflect Operational Performance, Customer Satisfaction, Value / Added Value, and Business Awareness / Benefits.





risk and reward

Documents