Outcome-based Contracts – Towards Concurrently Designing Products and Contracts

Outcome-based contracts that pay for effectiveness and penalize performance shortcomings have been introduced to incentivize cost reduction efforts on the contractor side of product service systems (PSSs). Outcome-based contracting concepts are being used for PSS acquisitions in healthcare, energy, military systems and infrastructure. These contracts allow customers to pay only for the specific outcomes achieved (e.g., availability) rather than the workmanship and materials delivered. Given the rise in interest in outcome-based contracts, it is incumbent upon the through-life engineering services (TES) community to determine how to design systems (including designing the sustainment of systems) to operate under these contract mechanisms, and to ultimately coordinate the system design with the design of the contract terms. Furthermore, sustainment decisions made under outcome-based contracts must target the optimum action for the population of systems managed under the contract, rather than the optimum action for an individual system. Today, outcome-based contract design is always performed separate from the engineering and TES design processes, and provided as a requirement to the design process, an approach that creates significant risks for all parties. For systems managed under outcome-based contracts, contract failure may mean significant money is spent by the customer (potentially the public) for either no outcome or inadequate outcome, or result in the contractor being driven out of business, which can lead to disaster for both parties.