Feng (2009) states that “Under a gainsharing contract, a vendor and a client originally negotiate a target price and a gainsharing ratio for a particular product.” In the logistics outsourcing context this “product” is often a service or an activity. For instance, if a service provider is managing customer’s warehouse, this activity could be a picking process. Each time the service provider’s employee picks products from the warehouse and sends them forward, the service provider is getting paid. In the end of the month the service provider sends an invoice to its customer (outsourcer) that is comprised of the amount of picks made during that month. Gainsharing steps in when this activity process, for example picking, is being improved. If the picking time is halved due to new innovations, technology or something else, it is obvious that the cost of picking will decrease as well and capacity (amount of deliveries per day) will increase. The sharing of these cost savings depends on the gainsharing agreement that the parties have in the contract.
The painsharing should also be considered in the contract. Ackerman and Van Bodegraven (2011) emphasizes the other side of the gainsharing agreements. The gainsharing will not function correctly if the painsharing is not added in the contract. This means that the service provider will be penalized if they fail to offer the promised savings or development. Sometimes the costs might increase due to external factors such as inflation in prices of electricity, materials or labor. These types of situations should be considered in the gainsharing agreement. The gainsharing price is robust because the price can be changing depending on the savings, innovations and the cost overruns. (Feng 2009) Below is an example of gain/painsharing in a target cost contract created by the Defence Material Organization.
Figure 7. Example of gain/painsharing in a target cost contract. (Defence Material Organisation 2010)
The target cost contract has been introduced previously in this paper. Basically in the Figure 7 the financial and operational performances are integrated. The companies have set a target cost and chosen key performance indexes which they follow periodically. In this example the service provider (contractor) and service receiver share the gains and the pains to a certain limit on an agreed ratio which is 50 %- 50 % in this instance. If the limits are exceeded, the service provider gets the rest of savings or absorbs the exceeded costs or, in other words, cost overruns. (Defence Material Organisation 2010)
Typically, companies need to agree on four common elements when negotiating on gainsharing arrangements. These elements are:
1. Baseline
2. Performance target 3. Reset horizon 4. Sharing mechanism
The baseline is based on the historical data concerning the performance level. The measurements are formed by using this data and desired goals and targets are compared to these measurements. The most suitable measurements are decided and agreed by the both parties in outsourcing relationships. It is vital that the data is visible and available for the both parties. (Charles 2005) An example would be, when a price for picking service in warehouse is calculated. First the average time of one picking activity shall be measured and then the price calculated based on the time and other relevant factors.
The performance targets are also set together. The service receiver should have a clear vision of the desired outcomes and these should be discussed and shared with the service provider. The set goals should be distinct so that the arguments and interpretation issues are avoided. In some gainsharing arrangements the profit is shared when these desired outcomes are achieved. (Charles 2005) The performance target could concern the time needed to execute a picking activity. For example, the outsourcer could set a target to cut the time by 10% from the baseline time in order to execute more picks per day.
Reset horizon means an agreed point of time in future when the service provider and the service receiver re-think the gainsharing arrangement. Often this means changing the conditions, resetting the targets or even abandon the agreement. (Charles, 2005) When considering the previous picking example, it is obvious that the picking time cannot be decreased infinitely.
The fourth element, sharing mechanism, addresses the sharing ratio of the potential gains or losses. In addition, it includes splitting the investment responsibilities. The gains and loses might be divided equally 50-50 or they may be shared based on more complex formula. Often the ratio depends on the investing and innovative party. For example, if the investing and innovative party is the service receiver, they would get the more benefits and bigger share of the achieved savings. On the other hand, if the innovations and investments are made by the service provider, the service provider might get a bigger share of the gains, let’s say 75% for a certain period of time. It’s important to bear in mind that in the gainsharing arrangement, the time period in which the gains are shared are also mutually agreed and ultimately the gains are often moved to the service receiver. (Charles, 2005)
6 DEVELOPING GAINSHARING MODEL PROTOTYPES WITH THE CASE COMPANY
The gainsharing model variations were first created based on the literature and by interviewing the case company’s employees. The model variations were introduced to several customers who shared their opinions, issues and experiences about the gainsharing.
The models were developed further based on customer’s expectations. One of the gainsharing models will be tested with one key customer. The testing itself will be done in future and not within the limits of this thesis. The gainsharing model will be coded to the case company’s extranet where it is usable for the case company and its customers. The further studies and analyzes of its functionality shall be conducted later after the testing, but are not part of this thesis.