Caveat Emptor

Analysts say buyers should proceed only with extreme caution on such unconventional funding deals, to avoid inadvertently stepping into areas of unwarranted risk. Gartner's Asia-Pacific vice president for the IT services market, Rolf Jester, warns that not all such deals will stand up to careful scrutiny, however attractive they might superficially appear. Moreover in some cases, service providers can end up making a very great deal of money out of such deals - a situation likely to lead to unwarranted public scrutiny of the funding arrangements.

"These things often seem attractive on the surface, and we hear a lot of talk about them in almost every presentation from a service provider in the marketplace, and many of our discussions with the user enterprises raise this issue of putting payment for performance or risk/reward arrangements into the contract," Jester says. "However, in reality, the number of [such deals] that are actually signed and executed and then carried out is much, much smaller."

Jester says that is because deals that initially look beguiling do not always hold up to careful scrutiny. Paying a developer no money upfront, then a percentage of your profits once the development is done, sounds attractive, he says, because it suggests that you will not have to give anything away unless the development makes a profit, and that all the risk is being carried by the service provider. But in reality even if you can strike an equitable deal - and that can involve "an awful lot of fine print" according to Jester - questions remain about how to measure the success of the project accurately and hence how to assess the payment owed to the service provider, in ways that are fair to both sides.

"But even if you can overcome all of those things, then the buyer begins to say: 'Now hang on a minute, this is my profit here. I'm in the business of making widgets and selling and making a profit out of them. This service provider or this consultant that I've engaged is not in that business, they're in the business of developing IT or whatever it is, and they should be making their profit out of that, not out of me selling my widgets'," Jester says.

"And when people begin to think through the business model implications for themselves as buyer - giving away their profit, giving away their shareholders' profit or the taxpayers' money in some cases - then they begin to think: 'Hang on a minute, that's not really what I want.' And likewise the service provider is saying: 'Well that means my income is going to be dependent on the profits made by somebody I don't entirely control, and . . . my income suddenly becomes dependent on an industry that I'm not really in.' All of which has all sorts of questions about it."

On the other hand, some organisations have happily signed up to such deals, Jester says, with the easiest ones of define and manage being those linked to a percentage of savings. "I think some governments are quite fond of those, even in Australia I think, because as long as you can benchmark your costs, and as long as you then build into the contract periodic benchmarking, you can then link payment partly - usually partly, typically there is a fixed element as well as a variable element - to a percentage of savings."