Deloitte’s 2008 report on global outsourcing, “Why Settle for Less?” (Deloitte Consulting 2008 Outsourcing Report), has garnered a large response among many commentators, ranging from the Wall Street Journal to industry blogs. In sum, survey results in the Deloitte report show that 83 percent of global IT outsourcing deals achieve 25 percent cost savings. For two-thirds of outsourcing deals, price is the key driver. Besides identifying the reasons companies outsource, the Deloitte survey revealed widespread disappointment with how outsourcing deals are put together. A whopping three-fourths of respondents feel their outsourcing contracts suffer from poor vendor selection and lack of service levels.
What the report points out is a need for business to not only come up with better ways of outsourcing, but also ways of outsourcing that will garner the best price. The real question many businesses need to answer when outsourcing is not “why” they should outsource – they already know they want to lower costs – but “how” should they outsource.
Sealed-bid Sourcing Model. A price-centered sourcing model does exist for outsourcing. It is called “sealed bidding,” and it can be found in the procurement regulations of the U.S. Government.
Sealed bidding is described in Federal Acquisition Regulation (FAR) Part 14. Part 14 says that when price is the only deciding factor, and there are multiple providers interested in the work, by law Government agencies must contract for services through sealed bidding. Sealed bidding requires the Government to determine all of its work requirements up front and to put them in an invitation for bid (IFB). In response, providers quote a fixed price.
The important point here is not the bit about providers handing in sealed envelopes, but rather how sealed bidding works and why. Its rules are not arbitrary: Sealed bidding represents a well-rationalized commercial trade-off designed to zero in on price and to minimize transaction costs on both sides.
Provider-side Advantages. With sealed bidding, providers are relieved from having to figure out what to propose in order to win the bid; they only need to meet the requirements and do some basic pricing. Sealed bidding makes it clear up front what the planned work is. All providers are asked to do is work the plan. Value-added services like governance, relationship management, knowledge management or innovation are not part of outsourcing by sealed bidding (unless they are somehow specified in the IFB).
Customer-side Advantages. By making it easier for providers to quote a single price for the work, sealed bidding also protects the Government from cost overruns. (The Government requires a fixed price, we can broaden this requirement to include a not-to-exceed, or NTE, amount for labor hours and rates.) Like the provider, with sealed bidding the Government avoids transaction costs like proposal evaluation, negotiation, creating an outsourcing governance structure and transitioning business operations.
Threshold Qualifications. The final requirement in sealed bidding is for providers to affirmatively show in their bids that they are “responsible.” Figure 1 highlights the more streamlined responsibility showing approach to qualifying providers. It shows the procedural differences between managing services by service levels and by threshold qualifications.
Purpose-driven Outsourcing. To many companies, sealed bidding may sound like a good idea in limited circumstances, but not where the company is contemplating longer-term, wholesale outsourcing of business processes. In response, it should be remembered that we are not making the case for streamlined outsourcing models like sealed bidding in all outsourcing. All we are saying is that where the “bottom line” is the sole or primary motivation to outsource, outsourcing providers should be solicited and managed in a way that best achieves a better bottom line. This approach is called “purpose driven outsourcing” (“purpose driven outsourcing” is a service mark of James River Consulting LLC).