Summary

For organizations looking to gain the benefits and flexibility of agile development, while still maintaining predictability and cost control, shifting to a risk-sharing contract model is a key strategy when sourcing application maintenance and development services from external suppliers.

Introduction

In the evolving landscape of digitalization, agile development has become a preferred approach for delivering high-quality solutions. The flexible and iterative nature of agile makes it an attractive approach in an environment where requirements often evolve over time. However, this flexibility can also introduce uncertainty in delivery timelines, costs, and outcomes for an organization.

Challenges

When sourcing Application Maintenance and Development (AM/AD) services in an agile context, through external suppliers, a common challenge arises. Agile teams and development services are generally sourced on a time and material basis – often without a common supplier strategy. Time and material contracts allow for a great deal of flexibility as suppliers provide resources based on the number of hours worked, and customers adjust priorities as new insights emerge during development. However, this approach places the bulk of the risk on the customer, as they are paying for the supplier’s time, regardless of the quality or functionality delivered. Without a common supplier strategy there is also a risk of misalignment between the suppliers (in situations where they may have different objectives) as well as with the customer’s objective.

Risk-sharing through commitment to results

A more effective approach to outsourcing agile AM/AD services is through contracts focused on risk sharing, clear responsibilities as well as commitment to common ways of working.

Risk should be distributed between the customer and the suppliers, where the supplier should be committed to support the customer’s strategic objectives and incentivized to deliver tangible and predictable results.

These risk-sharing focused contracts can include outcome-based milestones or other mechanisms that align the supplier’s performance with delivery success.

Mechanisms to ensure commitment, shared risk and predictability

Below are some examples of mechanisms that could be introduced to ensure that both predictability and shared risk are built into the agile sourcing agreements:

• Preferred suppliers with a formal responsibility to enable and support the customer’s transformation or innovation agenda
• Agreed team size and cost: The customer and supplier agrees on a baseline for the configuration and size of the agile team(s) – and thus a fixed running cost for the team(s). Changes to team configuration or size, and thus running cost, should be agreed upon between both parties.  

• Handshake agreements at the sprint level: At the beginning of each sprint, both the customer and supplier agree on the scope of functionality to be delivered. These sprint-level handshakes act as micro-call offs, ensuring the supplier commits to delivering within the agreed scope and timeframe
• Increment-level follow-ups: At the end of each increment (typically four to six sprints), both parties conduct a formal follow-up on sprint delivery. These follow-ups serve as checkpoints where committed delivery within the increment is compared with actual delivery. By tying payments to the performance over an increment, the customer can better control costs and ensure predictability.
• Increment delivery precision: An increment delivery precision is a powerful risk-sharing tool. It holds the supplier accountable for delivering to, at least, a pre-agreed percent of the functionality in the sprint handshakes and pre-agreed quality level, as a condition to full payment. If the delivery falls short, a part of the payment could be deducted. The size of the deducted payment could be dependent on both the quality and functionality delivered. e.g quality and delivery performance. On concurrent increment under-performance, an even larger amount could be deducted.
• Earn-back mechanism: the supplier could be given the possibility to recover part of the deducted payment if the supplier’s performance significantly exceeds the committed delivery during an agreed number of increment follow-ups after one follow-up resulting in payment deduction due to under-performance.
• Fixed price bundling of base-services: To achieve a high degree of predictability, base-services such as upgrades, incident management, planning and reporting, could be bundled together as a fixed price commitment for the supplier. This would also put a pressure on the supplier to automate and simplify services within the fixed price scope.

 

The ultimate goal of these mechanisms is to enhance cost efficiency in agile AM/AD sourcing by ensuring predictable delivery and creating a fair distribution of risk between the customer and suppliers. By focusing on agreed team and scope, performance-based payments, and rigorous follow-up mechanisms, customers can limit the financial risk of delays or scope creep while still benefiting from agile’s adaptability.

This shared risk approach motivates suppliers to deliver value while safeguarding the customer from overpaying for underperformance. Additionally, by linking full payment to outcome, organizations can ensure that their investments yield tangible results, promoting both cost efficiency and high-quality results.

Authors

Maria Nelsson, Maria Wennerberg