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Matti Grönroos
Wanna Get Penalty Money or Service?
Are you a tough customer if you can get as much penalty money as possible to your company?
An outsourcing deal is like a marriage: It works fine only if both parties feel good. If the relationship is based largely due to the digging of mistakes, the divorce is approaching sooner or later.
A penalty driven vendor management is a common practice, and it may lead to good results. Still, it has drawbacks to consider.
The most fruitful vendor-customer relationship is balanced: it supports both parties to success. A very aggressively priced service contract might fascinate the company's bean counting department. However, this often leads to inflexibility, because there is no money to be flexible. If the customer focuses on errors only, the vendor might put the most focus on avoiding them. Those service elements not subject to sanctions might receive less attention. However, those service elements may be critical to the customer's business case. In such cases, the value from the penalty driven vendor management might be negative.
Basically, then the penalty driven vendor management is about looking at the rear mirror. A forward-looking partnership is likely to give more value to both parties.
Everything cannot be subject to penalties. If such an approach were attempted, the service contract would turn out to be far too complicated. The penalties would lose their key mission: to steer and to direct the service. The Service Metrics always are samples only, and irrelevant service elements might be sampled. The quality of the entire service seldom equals the sum of the quality of the service elements. It is good to understand that the penalty model works well on mature services only. Few service providers agree to commit to the quality sanctions of a new service without first gathering experience about it (or adding a risk premium margin into the price tag).
The agreed maximum penalty usually is a fixed percentage of the monthly service fee. It does not cover all the business damages in severe cases. That is why preventing damage is a better way to take than charging for damages. Better to co-operate. Even if sitting on different sides of the table, work together to seek the common good.
If the service provider sees the situation hopeless, it might follow the Minimum Viable Service approach until the end of the contract period to focus on better customers. In the next bid round, it may not submit an offer at all, or it may deliberately price itself beyond the pain line. The customer faces a transition project to a new vendor. The cost of such a project will almost certainly exceed the penalty money received earlier.
In international business cases, the cultural factors may turn significant. Especially in Asian cultures, losing the face is a bad bad thing, and being forces to pay penalties is the same as losing the face. In order to avoid penalties, the service provider may start to hide things or even to cheat. In such cases, service bonuses are usually a better choice than service penalties even if the schemes would have an equal outcome moneywise. Instead of charging 100 EUR penalty from 1000 EUR baseline, better to pay 100 EUR quality bonus on top of 900 EUR baseline if no major errors occurred.