Effective incentivisation mechanisms are crucial to the delivery of the desired benefits of any commercial agreement. Implementing certain outcomes of the Strategic Defence and Security Review (SDSR) will require negotiation and re-negotiation of key contracts to ease the budget deficit. It is essential that the resulting agreements incorporate mechanisms to drive the right behaviours within both the UK Ministry of Defence and its suppliers, delivering both the desired outcomes and value for money.
This is not easy. Incentives act and interact in different ways for different organisations, teams and individuals, which can result in contracts that reward the wrong behaviours.
Developing effective incentivisation requires a structured approach that takes account of the outcomes to be delivered, the business drivers, an analysis of incentive interactions and practical management measures.
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Understand the desired outcomes
In any commercial relationship, both parties will seek to derive the maximum possible value; an inclination that will be enabled by the mechanism(s) in the deal. It is therefore essential that the design of an agreement is founded on a clear definition of all of the outcomes (or benefits) that are required and a good understanding of the stated and likely behaviours that will deliver them.
Fundamentally, the desired outcomes should be derived from the organisation’s commercial strategy, which should take account of the business context in which the contract will exist. For example, a defence contractor gains maximum commercial advantage from developing products that can be exported to many countries, rather than developing a highly bespoke product for one national customer. For such a customer, agreeing outcomes which support the contractor’s exporting aims, will keep the cost down. However, if the need is for a world-leading capability, this will necessarily increase the price.
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Identify the most appropriate commercial levers
Business drivers vary by organisation, even in terms of basic measures such as the balance between short-term margin versus long-term growth. Identifying appropriate commercial levers will require analysis of the specific business model. A major pharmaceutical company developing an outsourced service contract gained critical insights when analysing a potential vendor’s proposal by identifying the underlying business model. As a result, some key assumptions were uncovered and discussed, which improved the vendor’s price and resulted in a more balanced apportionment of risk.
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Consider how incentives interact and work together
Effective incentivisation mechanisms include commercial levers that incentivise all of the desired behaviours and reflect the relative importance of desired outcomes. System dynamics modelling (by which all dynamics are plotted to show how they interact) can support identification of the most effective commercial levers for incentivising each objective, and highlight interactions between commercial levers and any associated, unintended consequences. Furthermore, through quantification of such models, the relative weighting to be applied to commercial levers can be assessed with some degree of confidence. For a mobile telecommunications operator, such modelling revealed that five fundamental KPIs drove their business. Such insight helped inform a network service contract, which was based on these key drivers and provided the focus for management effort.
Taking a logical approach to the design of incentivisation mechanisms will help to ensure that the contract drives the right behaviours and ultimately delivers the desired outcomes and improved value for money in defence.
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