Getting the right outcome from outcomes-based contracts

Social innovation consultant Nicolas Ponset, who is CEO of Aleron Group, shares lessons he's learned from working with organisations to manage payment by results contracts.

Outcomes-based commissioning – or payment by results – is a way of paying for services based on delivery of results for beneficiaries – such as improvements in health or better job readiness. By ceasing to pay providers based on outputs, such as hours worked or salary costs, this method incentivises demonstrable impact. Outcomes-based payments also have the potential to drive cost reduction and encourage innovation.

However, while the principle makes sense and the intentions are good, failure to understand the implications of these mechanisms can harm organisations, undermining their sustainability and impact.

Any organisation entering an outcomes-based payment scheme should not rely on traditional costing and pricing models, but must look deeply at the key elements of volumes, success and time.

Failure to understand volumes creates problems

Volumes, or the size of inputs and outputs, determine the complexity and scope of operations. Organisations need to understand how volumes evolve and fluctuate over time. Modelling this will support realistic pricing and help organisations to proactively identify and manage volatility within their operations.

When volumes often fluctuate, organisations must understand drivers of volatility and potential extreme scenarios. For example, a key volume might be walk-in referrals. A cold day might depress demand while warm weather might increase referrals due to increased foot traffic. Stress testing a delivery model with such scenarios demonstrates whether or not there is enough flexibility to account for variations.  

Failure to understand volumes creates problems. One organisation saw a significant drop in the number of referrals but did not analyse the impact this had on payment schedules; while they had useful data, there was not enough analysis to generate the right insights.

Of course, some volume drivers are out of an organisation’s control. If many critical volumes are susceptible to external pressures, there are protective mechanisms to mitigate risk. These include minimum revenue commitments to cover core costs, variable pricing points for different volume bands to cover marginal costs, or renegotiation clauses for volumes outside an agreed band.

The second consideration is how success is defined and calculated. After all, only some activities will deliver successful outcomes. Organisations need to clearly define success and have a robust methodology to calculate it. This can be informed by existing evidence, with statistical analyses helping to estimate the level of risks; these analyses will help assess whether or not success in sufficient volume is probable. 

Having a clearly defined pathway to success can also mitigate risk because success can be broken down into several steps along the path. An organisation can then be paid based on intermediate achievements instead of solely on the end goal. 

As with volumes, it is also important to determine external factors that have an impact on success (such as dependency on other providers). For one organisation, a decision was made not to bid on a major tender because analyses showed that success was heavily dependent on delivery of software by a third party, which was separately commissioned. The software was ultimately delayed by nine months, compromising the delivery of the outcomes.

While value for money and cost effectiveness is important, organisations must always be clear about the full cost of high quality social impact

The final consideration is time. Time is a vital resource, with significant cost implications, and organisations must map out the time needed across the full process, from the start of the activities to the moment payment is received. Linking this time map to costs will ensure that the financial costs are clear. 

Running scenarios against a baseline helps to understand how key cost drivers contribute to performance. For example, what will happen if we only achieve a percentage of our targets? What will happen if we exceed our targets? What will happen if there are delays – how will this affect our cashflow? The results of these analyses, alongside the assessment of delivery risk, should inform the calculation of pricing.

Understanding volumes, success and time are vital during both the negotiation and the delivery phases of any outcomes-based commissioning work. Together with clear internal processes for managing performance and resolving issues, a smooth transition between sales and delivery teams, and continuous self-improvement and assessment, these analytical lenses help organisations to leverage the power of outcomes-based commissioning for social good.

While value for money and cost effectiveness is important, organisations must always be clear about the full cost of high quality social impact.


Photo credit: Oliver Symens