The global market for the enterprise software that large companies use to run their businesses reached US$477 billion (393 billion euros) in 2019, Statista reports. But why?
In reality, no business buys software because it wants to own software. It buys software (or rents it on the cloud) because it wants the benefits the software can deliver, from sharper financial insights to improved collaboration among widely dispersed teams. So, instead of selling software, shouldn’t software companies sell the results their software can deliver?
As it turns out, a few innovative firms are doing just that – and finding that the COVID-19 pandemic has made increasingly risk-averse business buyers receptive to the idea.
“We are living in an uncertain world at the moment, and the current pandemic is only amplifying existing pressures,” said Bill McBeath, co-founder and chief research officer at Massachusetts-based analyst firm ChainLink Research. “With traditional software licensing models, whether perpetual license or software-as-a-service subscriptions, the solution provider gives some guarantee that the software will perform and that they will fix bugs that arise. But they provide virtually no guarantee that the software will be adopted effectively, deliver the promised outcomes, or generate the promised return on investment [ROI].
“All of that performance risk is on the buyer and users of the software. As a result, some companies are starting to look for more substantive, financial-consequential assurances from their third-party vendors that the claimed ROI will materialize.”
A new approach
The Global Outsourcing Association reports that 89% of both buyers and service providers increasingly favor software contracts based on outcomes. By shifting responsibility for implementation, maintenance and negotiated results (outcomes) to the software provider, Outcome-Based Engagements (OBEs) increase the likelihood that companies will achieve their targeted business goals. In return, vendors receive a share of the financial benefits that accrue to the buyer — a number that can be significantly larger than the list price of the software licenses and a consulting engagement.
“With an outcome-based approach, value is driven by a joint commitment to achieve a specific outcome,” McBeath said. “Clients and service providers come to agreement on a set of well-defined, measurable outcomes they want to achieve, with financial penalties and/or rewards to motivate the service provider to help deliver on them.”
It’s a win-win scenario.
“The service provider’s interests become much more aligned with the client’s,” McBeath said. “Both parties tend to become more invested in the relationship. Quite apart from a ‘license-and-leave-you-to-it-approach,’ an outcome-based model provides a level of guarantee of the results. By having skin in the game, the vendor is sharing the risk with the client. It’s an approach that, when done correctly, can result in a stickier, more embedded relationship.”
Quite apart from a ‘license-and-leave-you-to-it-approach,’ an outcome-based model provides a level of guarantee of the results.
Bill McBeath
Co-Founder and Chief Research Officer, ChainLink Research
Outcome-Based models come in two basic varieties: Outcome-Based Services, which often involve one-time or short-term projects; and full-scale, longer-term Outcome-Based Engagements.
In the case of Outcome-Based Services, the client prefers not to execute the project itself. Instead, it hires the software supplier to do the work and deliver the results. For example, a client might hire an engineering software company to design a product, process or space, and then to virtually test the results, proving that the design meets the client’s objectives. In such cases, the client buys the results: a proven design that delivers on the client’s goals.
Outcome-Based Services are particularly attractive to clients who have a one-time or short-term need, lack staff trained in using the software, or have more work than its own employees can complete in the available time.
In an Outcome-Based Engagement, the client has an ongoing need for what the software can accomplish but wants guaranteed results. In this case, the client and the software provider analyze the client’s needs and agree to pre-defined, measureable objectives. If the objectives are met the software provider earns a premium fee.
Especially in situations where the client and the software provider have a long and trusting relationship, the client may further incent the software supplier by paying it an amount equal to a pre-determined percentage of the benefits achieved for the client.
Modeling success
For GEA, a German food-processing technology supplier, an outcome-based services approach has proven to be a positive choice.
Following the COVID-19 lockdowns in Germany, GEA hired its software provider’s expert team to model its employee cafeteria as an Outcome-Based Service. The firm wanted to analyze the airflow around the communal space and the safest scenarios for bringing employees back to work.
“The full canteen is modeled,” said Eric Nitzsche, vice president of Engineering Standards & Services at GEA. “Our vendor built a 3D model with all parameters set and then simulated how the virus might spread as people move around. It’s been an incredibly effective tool.”
Having those simulations increased the company’s confidence in its reopening plans. “The simulation we have in our hands is very valuable in how we make decisions,” Nitzsche said. “We know what we need to do now. This is great progress for us.”
The vendor’s experience also improved the outcome. “What I really liked is the agile approach the vendor took,” Nitzsche said. “They asked questions that we wouldn’t have even thought of, which allowed us to tap into innovative new ideas. Ultimately, an outcome-based approach eased our life somewhat dramatically. It allowed us to focus on the most important thing for us: our business.”
Ultimately, an outcome-based approach eased our life somewhat dramatically. It allowed us to focus on the most important thing for us: our business.
Eric Nitzsche
Vice President of Engineering Standards & Services, GEA
Some Outcome-Based Engagements, however, are so vital to a company’s competitiveness that the clients prefer not to be named. One such case: a large vehicle manufacturer that partnered with its software supplier to outsource the manufacturer’s process for complying with the Worldwide Harmonized Light Vehicles Test Procedure (WLTP) certification.
The certification, which gives consumers and regulators consistent information on fuel efficiency and carbon dioxide emissions of traditional, hybrid and fully electric cars and motorcycles worldwide, requires a separate wind tunnel test for each configuration of a vehicle. If a vehicle is available with a dozen different combinations of external features, the standard requires a dozen separate wind tunnel tests. If the vehicle comes in different versions – sedan, wagon and SUV, for example – a total of 36 separate tests would be required.
For every manufacturer to physically test every variant of every vehicle in a wind tunnel would take more time than the world’s available facilities can support. Therefore, regulators are permitting automakers to run simulated tests on their vehicle variants – if they can demonstrate that the simulations are designed and implemented to accurately predict the results of a physical wind tunnel test.
Developing and certifying the simulation process and results requires significant investment, time and specialized staff. Any delay in receiving certification could cost an automaker billions of dollars. Therefore, the automotive manufacturer’s software partner developed a certified process to run the simulations, generate all documentation, and submit results to the regulators. The process can certify an entire vehicle family in days, not weeks, with accuracy comparable to that of physical testing. The turnkey solution eliminates the need for the automaker to build an expensive physical wind tunnel that it might only use a small percentage of each year.
A broader palette of solutions
Outcome-Based Engagements and Outcome-Based Services are not for everyone. The larger the commitment, the more important the ground rules and measurements become. This is especially true when a software vendor takes on the responsibility of implementing and managing business-critical software inside their customer’s business.
“An outcome-based business model requires a deep and trusted relationship between the vendor and the customer,” McBeath said. “Perhaps the biggest challenge, however, is agreeing on the specific business outcomes, how they will be measured, and how rewards will be shared.
“That challenge explains why an outcome-based approach isn’t right in every situation,” McBeath said. “For the right high-value use cases, between customers who are willing to put in the effort to carefully agree on a very well defined set of KPIs and the right vendor willing to share the risk and reward, this can be a very attractive proposition.”
Lindsay James is a senior journalist at Tudor Rose, and a frequent contributor to Dassault Systèmes’ Compass magazine.