Negotiating a Success-Oriented Contract
Introduction
The sophistication of information systems in health care has grown exponentially over the past decade. Systems now offer great opportunities to solve business problems that health care organizations (HCOs) rarely attempted to remedy with technology in the past. These systems also bring new complications and risks, especially in achieving benefits. Realizing the value of these systems from newly automated processes requires new skills and strategies from management and technical analysts, as well as high usage to achieve success.
One of these strategies should be a new approach to contracting for these systems. In an environment of ever-decreasing margins, HCOs cannot afford to make mistakes on these huge investments. When total costs for systems generally exceed $10 million, it is not surprising that HCOs spend considerable time building business cases for procurements. Major transformation studies define the value propositions of these systems, and organizations restructure governance and processes around these values. Unfortunately, many negotiations don't adequately address these processes or incorporate these goals into contractual agreements.
Traditional Agreements
Most traditional contracts address the issues of business and legal risk-management and payments very effectively. HCOs have successfully addressed the fiduciary aspects of liability issues, confidentiality provisions, assignment of responsibilities, and severance and termination — all important issues in an environment where things do go wrong. Too often, however, contracts have focused on these draconian and financial issues alone and have not addressed areas that are essential to realizing the value of these expensive systems.
Contract negotiations need to also address performance-based issues to ensure successful implementation. The negotiation points below are designed to produce, in effect, "living," value-oriented contracts.
Pricing and Payment
Although pricing is always covered in traditional contracts, pricing and payment terms are often misunderstood.
It is essential that HCOs understand vendor costs as well as vendor prices. Prices should theoretically be subject to competitive market pressures and basic supply-and-demand arguments, but most of the time vendors' economic arguments are based solely on pricing. The information that HCOs need to successfully get to the "right" price begins with the vendors' gross profit models (or cost of sales), which are published quarterly and annually for publicly held companies. Currently, leading industry vendors are reporting 35 to 40 percent gross profit margins. Historically, however, 40 to 45 percent gross profit margin seems a more realistic figure.
A better understanding of equitable pricing can be gained by analyzing the cost of professional individuals, hardware, software delivery (not development), and other vendor deliverables against standard costing models. Clearly, vendors must be profitable to be viable for the long term. In negotiations, however, HCOs should also be able to measure excess profits, as well as profit shortfalls, against the gross profit margin norms. This is a fair issue to bring up in negotiations.
Another fair negotiating item is basing revenue on reaching milestones of all sorts, including benefit-related goals, which may or may not be related to cash. Many negotiators use cash as a key bargaining element. Although cash is obviously important, booking revenue can be more important to public companies. In view of recent corporate scandals and increased scrutiny, publicly traded companies need to be extremely conservative in booking revenue, and relevant contractual milestones can now have increased importance for HCO's to balance payments against performance.
Performance-Based Agreements
Many vendors and HCOs strive for partnership in negotiating system purchases and implementations. Alas, unless both parties are publicly traded, it is nearly impossible to be "part owner" of the other's organization. It is more realistic to negotiate agreements with incentives for all parties to enjoy success and suffer disappointments together. This can be best achieved with contracts that support optimal benefits through positive approaches to:
- Software delivery related to achieving goals, rather than just acceptance.
- Implementation of change and benefits as well as software.
- Usage goals and achievement in addition to training.
- Integration and exchange of information instead of interfaced data.
- Technology strategies that anticipate changes in the environment.
- Customer service that supports the environment and objectives instead of maintenance agreements.
- Payments based on achieving goals and risk/rewards, not just on standard milestones.
- Project cost control instead of vendor payment analysis.
Software Delivery
Given the high cost of systems, and the associated value goals, HCOs should establish milestones for software delivery based on achieving use and value, rather than simply setting a milestone for software acceptance. Goal and objectives recitals in agreements are a start, but clearly more is needed.
- Involve vendors in understanding the organization's value proposition. Conduct detailed value-proposition walk-throughs of each process change with the vendors. Take notes on how the application software will enable the change and what modifications and improvements are necessary. Include the desired results in the contractual agreement.
- Establish the metrics that define success, preferably through reports that already exist, and include them in the contractual agreement.
- Determine ways for vendors to be invested in the organization's success by participating in the rewards of success (This is defined in more detail below in payment terms.)
- Utilize the vendor's professional services, if available, in establishing metrics and processes for achieving benefits. Include these services in the contract (even if you have to pay for them).
Value is not achieved through demonstrations. Solidly designed processes must accompany and support the systems.
Implementation
A successful implementation involves more than workable software and an acceptable go-live experience. In a "speed to solution" approach, vendors traditionally implement software and customize applications in a timely and efficient manner, but they are rarely rewarded for implementing value. To the contrary, payments are made on software acceptance, a standard that has been made even more rigid by recent public accounting policies. Consulting firms can add structured methodologies to support this approach as well as offer experienced analysts to support the implementation.
To further the value proposition, however, HCOs need to negotiate agreements that:
- Incorporate the necessary modifications, improvements, and metrics required for success.
- Clearly define the roles of all parties in achieving this success — for timeliness, budgeted effort, process, and value achievements. This is especially important if third parties (consultants, integration experts, and the like) are involved.
- Agree on a project charter that defines goals, objectives, roles, responsibilities, change management, structure, and governance, as well as a work plan before signing an agreement. If the vendor argues that such a charter should be part of paid deliverables, pay in advance.
- Include all parties and any necessary change issues in the charter or work plan; establish regular value-achievement meetings and map any changes back to incentive-based payments (described below).
- Distinguish between occasional expert personnel priced at a premium and full-time project staff at standard, more economical rates.
Focusing implementation efforts on both software and change is not a simple task. Optimize the individuals assigned to the project and pay fair prices, but don't make economy the key criterion here. If necessary, get the people elsewhere, but get the best people. And remember to treat them well; don't place uncomfortable restrictions on lodging and expenses — the expense portion of your project probably represents less than one percent of your total project budget. Good treatment of support people will pay off tremendously in the long run.
Optimizing System Use
The ultimate value of health care IT relies on the optimal use of the system, particularly use by physicians and other clinicians of advanced clinical systems. Using these systems has become an even more important issue after highly publicized cases of physician rejection of the technology. However, vendors rarely approach this issue in delivering and implementing the systems.
The implications of clinicians not adopting the technology are far-reaching, ranging from a serious impact on financial return to degraded patient safety. As a result, some HCOs have linked payments to usage goals; however, often the incentives are too small to truly influence the vendor activities. Instead, HCOs need to:
- Link major portions of payments and revenue-booking to achieving usage goals.
- Look beyond traditional training and demand strategies to optimize use, such as customization, redesign, and change management.
- Investigate all technology options (such as PDAs and wireless notepads) for end users. Understand which of these end-user appliances are now supported, or will be soon, and any associated costs.
- Involve third-party support and tool kits (training approaches, methodologies, and the like) into the work plan and be prepared to manage the diverse team.
Integration
Few procurements end in a single vendor solution, and integration costs can exceed one $1 million in large environments. Even more costly are delays in integration, including project team costs, reputation of the project, and delays in reaching goals. Be sure that contract agreements go beyond interface specifications and address communication between vendors, the roles of all, and the expectations of system integration, including:
- Goals for integration, including the sources and uses of information.
- A conceptual integration model of the future environment, which incorporates
architecture issues and maps each information touch point and work effort
involved with each vendor, including customization of "off the shelf" products.
- Detailed definition of the work effort for each touch point, including existing
and future interfaces.
- Definition of current architecture.
- Detailed roles of all current and new vendors, consultants, and the HCO.
- Strategies for future technology changes.
The new vendor is the last one in; if they are capable, consider making them responsible for general management of the integration effort.
Technology
Frequently under-negotiated items are technology and architecture. This is further exacerbated because HCOs want long-term value without the risk of stagnancy. Vendors are expected to be up-to-date on server and storage technologies, operating environments, networks, and end-user appliances, while they are also expected to support the current environment for an extended period.
Also, the following are difficult issues, and frankly ones that are not fair to both sides of the table, that HCOs should negotiate:
- "Just-in-time" hardware delivery to avoid receipt of equipment too early in the implementation cycle. Minimal technology is needed during the building and testing phases of the implementation, and delivery should be scheduled to meet the HCO's needs.
- The right to "switch out" hardware elements when delivery is imminent. Total cost commitment is important to the vendor's package; however, HCOs should also enjoy the newest technology and pricing available.
- A map of current architecture from network(s) to PC to ensure the proposed software, hardware, and integration solutions will perform on the completed architecture.
Also, HCOs should consider asking for pricing on continual technology updates and migration, as well as negotiate discounts for future hardware to enable affordable upgrades.
Customer Service
Traditional agreements approach software maintenance on the level of "fixes versus releases," "releases versus version," and so on. These items are critical to the contract, but performance-based agreements should aim for true customer service — not merely a maintenance agreement. Be clear on what you consider appropriate customer service, and ensure there are mechanisms for change. Remember that the government can change your requirements at any time. Negotiations should include:
- Developing a service-level agreement of time for response in minutes, hours, days, and months, depending on the nature of the request (down, broken, or performance-, service-, or product-related).
- Detailed expectations of the vendor's response to future requirements or regulations. (Think of things like Y2K and HIPAA standards — will the HCO be required to pay for such changes, and if so, how will costs be allocated across the vendor's client base?).
- Clarification of integration maintenance. Is the original a product or service?
If it is a product, then maintenance releases should require minimal customization
hours. If each release necessitates considerable hours, the integration should
be considered a service and should not require maintenance fees.
- Scheduled vendor corporate and product reviews.
- Meetings with vendor's senior management on demand when there are serious problems. Expect them to demand the same access.
During the procurement process, an HCO is always the "most important client," and partnering is always a consideration. Careful negotiations toward a performance-based agreement help support this relationship when the next "most important client" comes along.
Payments and Value
Traditional milestones for software, hardware, and service payments are not sufficient to achieve value goals. A clear example that revenue recognition is not value-driven is the idea of time-based payment defaults. Negotiate payments based on achieving goals — usage, integration, and benefits. A performance-based agreement would pay vendors in a segmented approach (based on factors discussed earlier in this paper):
- Cost of delivery for products and services
- Cost of sale based on traditional "acceptance" standards
- Estimated profits — pay vendors profits and rewards based on achieving value
If an HCO chooses to delay payments until value goals are achieved, then rewards seem appropriate. The amount of rewards should be equitably based on the profit rather than the price. For especially higher cost and reward projects, or riskier projects, HCOs should also consider a smaller proof of concept project and should not be afraid to reject that proof of concept.
Project Cost
Vendor-based costs represent 35 percent or less of total project costs, but they directly influence all of the costs. Cost shifting is always possible, but more likely most project cost overruns are from not aligning all the goals and incentives. Understanding the elements of performance-based agreements can help manage, if not eliminate, these overruns.
- Make sure you understand what you choose to buy and also what you choose not to buy. Make a list of those items (current and in development) to resolve any future issues of required purchases.
- Involve the vendor and document all assumptions for costs, labor, and work effort for implementation; training and education; integration; technology and architecture; and annual cost of operation.
- Negotiate remedies for significant overruns, including early termination.
- Plan for major changes to the HCO (future mergers, acquisitions, and downsizing) that may necessitate early termination.
Cost overruns can destroy the credibility of many projects. Vendors have tremendous experience and can offer great support in this area; they can perform ongoing audits, report on what is going right or wrong, list concerns, and suggest adjustments.
Summary
A performance-based agreement should always be open, not stored in a bookcase or drawer. These viable contracts address the complicated issues in implementing advanced systems and ensure that the HCO achieves the strategic goals and associated value of system investments.
Negotiate for incentives tied to value achievement, and both the vendor and the HCO can enjoy the success and rewards of the result.
