Executive Summary
Outsourcing today does not offer the same cost reduction opportunities that once were achieved through simple labor arbitrage. Things have changed, the rupee is stronger and the dollar is weaker. Geopolitical pressures like the recent events in Mumbai are causing companies to rethink their offshore strategies in traditional locations. In addition to economics and geopolitical pressures, companies are facing diminishing returns due to increased provider costs, decreased productivity, or a combination of uncontrollable events.
Getting to the next level of cost efficiency requires a change in how organizations contract with and manage their vendor relationships. Buyers will need to move from relationships based on a price for service to relationships based on performance to results. The formula has changed from:
The definition of value is now defined in terms of price, deliverables, and service levels. The key is in the ability of clients to take advantage of their suppliers technical prowess, innovations, processes, and tools to achieve savings through more value added results.
But how do you focus on value creation while minimizing risk during contracting and vendor management?
Achieving Mutual Benefit from Vendor Managed Relationships
To achieve higher levels of value, clients are turning to managing vendor results rather than managing IT processes. They see the future of their outsourcing relationship based on results, including service levels and delivery milestones, rather than level of effort. To realize greater value, clients are implementing Vendor Management Organizations (VMO) (See Figure 1) and focusing their efforts on managing results with their providers while transitioning existing capacity-based relationships to outcome-based models.
Figure 1
While most organizations initially established their VMOs to fix troubled relationships and improve results, they did not realize improved outcomes with their providers until they changed their focus to managing for results (See Figure 2).
Figure 2
Clients have had to turn project management responsibility over to their providers through a managed results and delivery-based arrangement. Providers will not sign up for a deal that does not put them in control of their own destiny. The managed results relationship is structured to deliver target results, and therefore unlocks the potential for higher order of value exchange beyond cost savings. The results focus allows the provider greater freedom to bring tools, processes, innovation and other points of leverage to the relationship that under the traditional contract were seen as added provider costs.
Managed Results Relationships Demonstrate Tangible Benefits for Both Parties
Managing results allows providers to offer differentiated services by competing on value creation rather than on rate competitiveness. Because clients are not micromanaging their providers, they can improve margins by applying their own processes and tools to do what they do best and operate efficiently. Under the traditional model, clients get in the way. Under a managed results relationship, suppliers spend less time managing the account relationship and more time managing for results.
Clients are moving to change their contracting strategies and vendor management practices for a variety of reasons:
Improved Value Exchange Per Dollar Spent: Capacity-based relationships fail to take advantage of the providers process discipline and tools. Clients report that successful transition to a managed outcome relationship typically yields an additional 25 percent savings improvement over their traditional resource cost labor arbitrage contracts.
Improved Application of Intellectual Capital: Traditional staff augmentation relationships motivate providers to hold knowledge in reserve as leverage for contract continuance. Results-focused relationships motivate providers to leverage intellectual capital on the clients behalf. This exchange of knowledge has long-term benefits for both parties and is key to leverage provider capabilities over the life of the contract and beyond, regardless of whether the relationship is terminated at some future date.
Improved Ability to Get to Yes: Negotiations are simplified as both parties true interests surface earlier in the negotiations. Use incentives for improved service and make penalties a natural consequence for non-performance rather than a punishment for failed performance against service level agreements.
Improved Risk to Reward Profile: Risk for achieving results remains shared between the provider and the client, but the rewards for both parties are considerably enhanced by shifting the IT function to more strategic endeavors and ensuring the provider gets rewarded for innovation in service delivery. The managed results strategy results in higher levels of partnership, which can ultimately extend to relationships based on risk/reward structures and business-relevant drivers of economic value, not merely IT-relevant results.
Making Results Matter
To make results matter, clients need to follow a few basic rules:
- Establish a governance structure that eliminates complexity and focuses on provider interactions that drive measures of progress. Suppliers need latitude to perform while keeping their customer well-informed.
- Start with simple measures or SLAs that can be tracked and verified. Take the time to develop a baseline of performance to ensure the targeted performance requirements are reasonable and achievable.
- Structure results-based payments so that they coincide with business performance reporting. Align rewards with the strategic business drivers, not just with IT drivers.
- Where performance metrics are insufficient, put measures in place to adequately evaluate and reward the providers efforts that result in economic benefit to the client organization. Rush to reward, be slow to penalize.
- Measure results early and often to start. Allow both parties to calibrate the reward formula such that both parties have early visibility into managed results relationships that are not yet mature.
- Last of all, be patient. Providers will be suspicious of your intentions. Client professionals are not typically willing to give up project control. Help staff let go of their traditional roles and responsibilities and assist them to see the value in managing results rather than people and projects.
