Gain-Sharing: Good in Theory…

Gain-sharing, as a concept, appears to be falling out of favour in recent outsourcing transactions. Once considered an innovative concept for sharing saving made by the supplier of outsourcing services, it has proved unworkable, or forgettable, over the years. Gain-sharing clauses started appearing in outsourcing contracts at least as early as a decade ago. The principle is simple: if the supplier finds a way to save costs while providing the same service, it will share those savings with the customer.

Gain-sharing has a fundamental problem: the interests of the supplier and customer are not aligned. The customer is trying to save costs while the supplier is trying to make money. This tension between opposing interests naturally leads to an equilibrium – that point at which both parties feel that they are getting value from the relationship. Once this equilibrium is established, the commercial interests of each party favour maintaining that equilibrium. Gain-sharing can threaten that equilibrium by pressuring the supplier to reduce its costs while undercutting the supplier’s incentive to do so. The supplier will have difficulty stirring up much enthusiasm for gain-sharing when it could threaten its business case for the outsourcing in the first place.

Another issue with gain-sharing is that it may not actually lead to any savings. While a change in a solution, such as a design change or a change in subcontractor, could theoretically save ongoing costs, when that solution is formally brought into the outsourcing agreement between the parties, the implementation costs, including legal costs and other business process costs, may outweigh the savings that the customer would realise. For this reason, the supplier may choose not to perturb an established and working solution for the opportunity of cost savings, reasoning that the long term gain is not worth the short term pain.

Gain-sharing is also easily forgettable. In a longer term outsourcing, with the myriad of day-to-day issues that face both the customer and supplier, someone has to remember to enforce a gain-sharing provision. Typically that burden falls on the customer, it being in its interest to do so. If the customer does ask for an accounting of gain-sharing savings that the supplier has realised, the answer from the supplier may be that there are no such savings. It would be nearly impossible for the customer to prove otherwise.

A gain-sharing provision may make good sense when the incentives of each party can be driven together. One example is where the customer and the supplier have agreed to share certain third party costs. If the supplier is able to realise a savings on those costs, some of those costs could be shared. The supplier and customer together may be able to work together to leverage their combined position in negotiating lower costs with the third party. This can work well when purchasing equipment or licensing off-the-shelf software from third parties.

Gain-sharing is an example of a concept that was good in theory, but rarely worked in practice. It may be time to move this concept out of our outsourcing templates permanently.

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