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There’s an old adage: “Build a better mousetrap, and the world will beat a path to your door.”
The point is well taken: The market rewards quality. But what if your product is more complicated than a mousetrap? What if it’s a groundbreaking new pharmaceutical treatment? Or what if your “invention” is actually a service you provide to firms, with benefits that extend over years? How do you convince buyers to take a chance on your new product when they know the old mousetrap is working well enough? And how do you tie the number of mice your customers catch with the improved mousetrap to what you charge, allowing you to be vested in your customers’ success for the benefit of both?
Demos, test-drives and money-back guarantees based on performance are all tools to address such questions, each with its own shortcomings.
A solution that has the potential for changing the game is outcome-based pricing (OBP). Outcome-based pricing is a contractual mechanism in which the amount a buyer pays is based on the performance of the product or service. The advantages of OBP are clear: Buyers are sure they won’t pay for a faulty or underperforming product, and producers can more easily enter markets with new solutions without the stigma of an unproven good or service. It also leads to a foundation for some creative pricing models.
A number of industries have experimented with outcome-based pricing:
• Some pharmaceutical companies have signed contracts with insurance companies that anchor payment to a drug’s performance.
• The IT services industry often uses pricing models that tie payments to KPIs like fit for use, software adoption, delivery time, CSAT and uptimes.
• Manufacturers have used OBP based on KPIs like delivery time and ethical sourcing guarantees.
But while OBP is an exciting model, enforcing the terms has been difficult.
The challenge comes down to who gets to decide how a product or service performed. A drug company may tie the cost of its drugs to the health outcomes of patients who take them, yet the drug companies don’t have access to that health data; instead, they must rely on the word of the insurance company they contracted with, creating a conflict of interest that breeds mistrust.
Or in an IT context: It is usually the IT provider itself that reports its uptime. Even if the service provider is completely honest, it is difficult for the counterparty to trust the data since there is a fiduciary incentive tied to it. It is also the fact that interpreting qualitative data fairly sometimes needs third-party expertise. Bringing in a trusted third party to determine commercial outcomes makes this even more complicated to implement on the ground.
These challenges have led some to declare OBP more hype than reality. Yet reports of OBP’s futility are entirely premature, as there is a technology emerging that I believe will make OBP practical and scalable: blockchain.
As I previously wrote, companies must be careful when choosing how to apply blockchain. It is obfuscated by hype, and companies shouldn’t use it for business cases where more straightforward solutions suffice. But outcome-based pricing is a situation where a blockchain (or more generally, a distributed ledger) solution can truly shine.
In a contract context, blockchain allows contract parties to upload documentation without exposing the whole of those documents to the other parties.
Supply chains provide a simple example of why this is important. Often, suppliers to a manufacturer do not want the manufacturer to know where they source their material from, since that information is a competitive advantage. The manufacturer may wish to respect this but might want to know the supplier requires its sub-suppliers to be compliant with corporate mandates (certifying they are not using child labor, are following sustainable sourcing practices, etc.).
With a consortium blockchain, all members of the supply chain could upload their contracts to the blockchain, which then extracts the pertinent information and flows it up to the manufacturer, while keeping other information hidden. It’s a blend of transparency and privacy that is simply impossible to achieve otherwise in a neutral trust environment.
From this example, the jump to outcome-based pricing is small indeed.
Imagine a pharma scenario. A drug manufacturer and the Department of Health of Krakozhia enter into an OBP contract for a new drug. Per the contract, the government will pay a subsidy for the drug only if the drug has a positive outcome for a patient. Of course, the government and the drug manufacturer should not have direct access to patient records, where hospitals include information on the drugs used and their outcomes for the patients. So the drug manufacturer and the government agency join a consortium blockchain with the hospitals, where the hospitals upload patient health records. The contract between the drug manufacturer and the government is implemented as a smart contract, where the patient records that establish positive outcomes for the drug trigger the transfer of subsidy to the drug manufacturer automatically, without the government seeing the underlying health records.
And in an IT context: Per a contract between a service provider and a SaaS vendor, uptime information could be provided directly to the blockchain from a cloud provider like Azure or AWS; the service provider would be paid automatically based on that SLA information.
Outcome-based pricing is a beautifully elegant solution that uses contract parameters and live data to transform the way companies approach risk and reward, minimizing the risk and maximizing the reward. Isn’t that the goal of any contract?
Contracts already have contingencies for changing business conditions; outcome-based pricing adds a layer of secure data intake to monitor those conditions and take transactions to their conclusion.
I predict within three years that OBP will not just remain a common feature in contracts, but will be the standard for creative deals. This is how powerful blockchain is: It will change how we approach and think about contracts, pricing and performance.