Sourcing Bulletin - July 26, 2006

Companies often talk about implementing risk & reward mechanisms in their IT services or outsourcing

relationships, but what does “risk & reward” really mean in practice and is there really such a thing as a

genuine, balanced “risk & reward” mechanism? Maybe there’s no single magic bullet, but what structures can

be combined in a fair and balanced way?

Customers tend to focus on the risk element – in terms of shifting risk on to a service provider; whilst service

providers are obviously more interested in the reward element and less interested in accepting risks over and

above their standard model. This article looks at a number of risk & reward mechanisms and considers the

pros and cons of those various mechanisms.

Risk & reward can mean different things to many people. Broadly speaking, the mechanisms fall into three

categories:

at the “conventional” level, the risks include a “penalty” payment for underperforming and the rewards

include a cash bonus for over performing;

at the “collaborative” level, the incentive involves a share of the improvement achieved or a percentage

of the revenue achieved by the business; and

at the “transformational” level, the incentive could be a share of a new business venture or the

establishment of a new product line.