The Downside of Performance Based Contracts

The promise of a “performance-based” contract or a “risk sharing” agreement sounds so appealing on the surface but does it really live up to its lofty billing? Do customers really only “pay for performance”? And/or get what they are paying and if so, what does it take to make that contract work?

The Promise 
The concept has been around for many years and has been used successfully in the Public Sector and Health Care industries. Additionally, it has also been a very successful way to sell certain commodity products. More recently it has caught on with companies providing web and tele services.

Research on the prevalence of this pricing model shows that in marketing, online marketing services are dominated by “pay for performance,” especially in the area of search and advertising.

This trend is also carrying over to non-web based lead generation services like teleprospecting. With companies offering performance-based or risk sharing models, it seems like a good business decision when spending precise and sometimes hard to track marketing dollars.

But not so quick! It does sound good on the surface but read on to find out how it can go wrong.

At Risk” Contracts 
I recently had the opportunity to assess an outsourced lead generation program for a Fortune 500 company. The CMO of the organization was frustrated with the performance of the vendor and was close to terminating what had been a relatively successful 5 year relationship. Before that occurred, she asked me to assess the operation and the performance of the vendor, including the new Performance-Based Contract with an “At Risk” clause… recently forced on the vendor.

After visiting the operation and evaluating the program I concluded that:

  1. the vendor was actually performing exceptionally well given the situation
  2. the performance-based clause in the contract was causing counter productive business practices,
  3. the reason the vendor was not hitting their lead targets was actually the client’s fault and not the vendors.

The interesting part of the story that the CMO didn’t realize was that the vendor had 5 years of response data (by campaign, tactic and channel) including lead conversion rates by campaign type. The vendor also had very precise and predictable conversion rates for each stage of the pipeline. It was only a matter of flowing the right volume of responses from campaign activities into the top of the pipeline to create the number of leads needed to meet the target. All very predictable and a perfect set up for a performance-based contract, right?

Except there was one major problem…guess who was supposed to create the responses? That’s right, the CMO’s marketing team.  

This tele-qualification program was an inbound group that qualified responses coming from the client’s marketing efforts. Unfortunately, the client was not producing enough response for many reasons: under performing campaigns, inconsistent campaign activity with some months being totally dark, etc.

What is a vendor to do?
They start running their own campaigns to fill the gap because they don’t want to see their fees get hit. Here’s the not so funny part — their marketing campaigns start outperforming those of the client. Ha, Ha …the client is paying the vendor to follow up on their campaigns’, the only problem is that when they do the vendor loses productivity.

The vendor now doesn’t want to follow up on certain campaigns that it knows will be produce less than 10% response rates (because its own programs are producing 14%). Keep in mind the vendor owns 5 years of campaign response rate data it also can predict the lead yield from the client’s campaigns and so it begin to decline to participate in certain campaigns.

The vendor has now turned the tables on the client and is actually holding the client to its own version of a “performance-based” metric for campaigns, except it doesn’t tell the client that and it appears to the client that the vendor is now not only underperforming but also hard to work with because it doesn’t want to do certain things it knows are of low value.

Are you starting to see the mess?

Making it Work
First, create a real partnership with your vendor. Don’t put them in a situation where the performance clause of risking fees is used as a threat. A true “At Risk” model can be very appealing to senior management but may make the day-to-day vendor managers life a living nightmare.

If you decide to create an “At Risk” clause, be willing to add the “At Reward” clause as well. I’ve seen plenty of companies go for the fees at risk but balk at paying for performance that exceed targets. If you’re not willing to pay for the upside then don’t bother with the downside.

Finally, performance-based contracts can be a win for everyone just know that a vendor can’t do it all by themselves. It takes two to dance “the high performance dance” and if you’re not willing to do the “Tango” the dance can turn ugly. You start stepping on toes, tripping over each other and dancing to a different tune. I’m talking real ugly…think Jerry Springer on Dancing with the Stars.

How a Marketing Dashboard Can Bring Down Your Kingdom

Once upon a time there was a Prince named CMO and he lived in the magic kingdom of Marketing. The kingdom of Marketing was under attack from the kingdoms of Sales & Finance. The kingdoms were fighting over the “holy grail” of performance and ROI. So the Prince decided that he would build a Marketing Dashboard that would lead him to the Holy Grail.

The Prince commissioned a band of Knights called Consultants to lead the crusade and help him search the world for information. This journey was difficult and exhausted much of the Prince’s fortune but finally, the Knights built the Prince a magnificent and magical Dashboard…and the Prince was happy.

The Prince showed the Kingdoms of Sales & Finance his Dashboard and they were impressed. He told them that he was close to discovering where the Holy Gail of performance and ROI was hidden. Every month the Prince met with his people to talk about the Dashboard, and ogle at its magnificence but then, one day, something happened. The Dashboard started to lose its magic. The Prince and his people could not make it better and it steadily got worse; the Prince and the Kingdom of Marketing were very concerned and unhappy.

The Prince of Sales started to question the magnificence of the Dashboard and the power of Prince CMO. Prince Finance believed that the magic Dashboard was showing him how Prince CMO was squandering the wealth of his people. The Prince was under attack and eventually lost his kingdom.

The moral of the story is that a Dashboard is not the “holy grail” of performance and ROI. CMO’s are under a tremendous amount of pressure to show the organization how they are providing value and producing a positive return on what can be very sizeable investments (3-6% of revenues). CMO’s believe that they need to have the data to prove their case…and they are right. The difficult part is knowing what to do with the data once they have it, and how to move the numbers in the right direction. Although the story above is written as a fairy tale, it is based on a true story.

The most important thing that a CMO can do to improve the performance of marketing is teach/train country marketing managers the basics of pipeline management because it is their results that show up on the Dashboard. Effective pipeline management is built on four key principals:

  •  Volume – the flow of incoming response, leads, opportunity coming into the pipeline
  •  Conversion – the percent of opportunity that makes its way from one stage to another
  •  Cycle Time – the average time it takes for opportunity to move from one stage to the next
  •  Transaction Size – the average order size of the opportunity closed

If CMO’s can effectively coach their teams on how to manage by these prinicipals then they will have achieve the “Holy Grail”…and they will get to keep their kingdoms.