An Obsession For Skin In The Game (Part I)
How does “skin in the game” promote client learning?
In 2004, Forbes ran a story that talked about how consultants, keen to demonstrate their commitment to delivering results, were increasingly electing to enter into fee arrangements tied to performance. These typically involved setting aside a portion of the overall fees and tying their payment to the achievement of stated benefits for the client, and even providing for “gain share” arrangement for sharing in a portion of results delivered over the target.
Arrangements like this were designed, in part, to avoid situations where client and consultant incentives for performance were misaligned (the venerable principal-agent problem), for example:
A project that continues to barrel along toward a contractual outcome (e.g., ERP installation, strategic analysis, development of maintenance procedures and routines for new assets) without care or attention to whether the results from such efforts will be delivered; this might be described as an “obsession for outcomes over results”. While the client has to live in a world of ever-changing demands and imperatives, the consulting firm gets to work in on a set of deliverables “sequestered” from the real world.
Consulting projects that fall behind schedule and end up running over budget because they were structured on a time and materials basis. Given that the firm in question continues to bill for resources at a significant margin, I would call this an “obsession for billing.” The client has to deal with the difficult internal conversations about why their $4MM project has ballooned to over $7MM, but the consultants merely pass along the cost without any incentive to address the underlying reasons for over-running the project budget.
Client engagements that drift into temporary staffing for the client organization to fulfill critical roles they can’t fill themselves; this might be called an “obsession for staff augmentation”. This is perhaps one of the more difficult challenges for clients. Where is the incentive for the consulting firm to help the client fill these roles with permanent hires when doing so eliminates the opportunity for fees?
These are serious considerations; putting fees at risk to ensure that the consultants are sitting in the same boat as the client (to mix our metaphors), is a rational alignment of incentives and value delivered. Or is it?
Although both arrangements seek to align interests, a “fees at risk” structure differs significantly from one focused on “fees for performance”, especially when there is upside in the contract for delivering above the targeted results. A highly incentivized consulting firm focused on cost reduction will demand extreme headcount reductions, and maximize short-term asset performance by any means necessary. Cutting maintenance staff levels, for instance, may increase the risk of equipment failure, a long-term nightmare. We see analogous unintended consequences from comparable approaches to incentivize quantitative performance outside of the world of business as well. Nonetheless, these schemes mostly do what they were designed to do, whether or not the design is conscious or the consequences positive. The big question clients need to ask about consultant contracts is do they promote learning and engagement in the client team, or do they promote doing (at the expense of client learning) by the consultants.
What sort of contractual arrangements have you seen work and what others fail?
John Norcross
Though Canada is a long way from Antarctica, both places offer vast terrain for exploration. Inspired by the great 20th Century Antarctic explorer Ernest Shackleton, Evolve Partners’ John Norcross leads the firm’s efforts to expand our presence in Canada’s exciting, and rapidly growing, energy industry.