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By Kate Vitasek and Mike Ledyard

In Search of a Better Way to Outsource

For the past two years, the authors have participated in a University of Tennessee research program funded by the Air Force to formally study companies that were employing performance-based approaches for outsourcing. This article is based on our research and hands-on experience working with organizations that have adopted symbiotic performance partnerships that truly unlock win-win solutions.

While many believe win-win is a simple buzzword that is theoretical in nature, our research has uncovered there is indeed a set of unwritten rules that companies can use to develop performance partnerships where both parties in the outsourcing relationship go the distance to achieve much higher levels of performance and cost savings than previously thought possible.

We have distilled our lessens and approach into what we call Vested Outsourcing — because it is typified by an outsourcing relationship where both parties have a stake in maintaining the arrangement and work together to create a performance partnership that takes both the company outsourcing and the service provider to levels of cost, service and profitability levels not realized previously.

A Better Approach: The Rise of Vested Outsourcing

After reading many articles that detail all the things that go wrong in outsourcing relationships, you might be asking yourself, "Is there a better way?" The good news is that thought-leading companies have been challenging conventional outsourcing models over the past 10 years. The result has been an evolution to a "next-generation" outsourcing model we call Vested Outsourcing.

In the familiar terms of strategic sourcing, there are basically three types of suppliers:

Transactional — the supplier is effectively kept at "arm's length," and a purchase order is issued for every order.

Preferred Supplier — this supplier is pre-qualified, either by certification or years of experience. The Preferred Supplier is often exempted from certain procedures, given releases against blanket purchase orders, etc.

Strategic Alliances — this is characterized by a C-level relationship between the companies, with shared intelligence and operational tie-ins. The two companies often develop working relationships that more closely resemble divisions of the same company.

Illustration 1. Vested Outsourcing Performance Partnerships take the Preferred Supplier relationship to a whole new level.

Vested Outsourcing creates a new level in between Preferred Suppliers and Strategic Alliances. (See Illustration 1.) The relationship is more focused than a Strategic Alliance, and does not require as much operational infrastructure. But it takes the Preferred Supplier relationship to a whole new level.

While no two Vested Outsourcing partnerships are alike, all good ones achieve a performance partnership based on optimizing for innovation and improved service, reduced cost to the outsourcing company, and improved profits to the outsource provider (see Illustration 2 below). The trend towards performance partnerships has evolved such that companies that outsource and service providers work together to develop a performance-based solution in which both parties interests are aligned — and both parties receive tangible benefits (either through tangible or intangible incentives).

The heart of a Vested Outsourcing contract is an agreement on desired outcomes that explicitly state the results on which both companies will base their outsource contract. A Vested Outsourcing agreement clearly defines financial penalties or rewards for not meeting or exceeding agreed upon desired outcomes. In such an agreement, regardless of what is being outsourced, the outsourcing partner has the ability to earn additional financial value (e.g., more profit) by contractually committing to achieve the desired outcomes. Simply stated, if the outsource provider achieves the desired outcomes (achieves results), they receive a bonus. It is important to understand Vested Outsourcing is not gainsharing. The manner in which Vested Outsourcing agreements work is outlined in more detail later.

Illustration 2. The best Vested Outsourcing partnerships align the interests of both parties and ensure tangible benefits for both partners.

Under this dynamic, the outsource provider is challenged to apply "brain power" and/or investments to solve the company's problem. They also take on risk to do it, in essence putting "skin in the game." The outsource provider looks at how they can best apply world-class processes, technologies and capabilities that will drive value to the company that is outsourcing. This commitment to deliver against projected value for the company outsourcing (such as a commitment to reduce costs or improve service or both) shifts risk to the outsource provider. In exchange, the company outsourcing commits to allow the outsource provider to earn additional profit (above and beyond industry average profits for their service area) for achieving this incremental value. The result is a win-win Vested Outsourcing partnership — a paradigm shift we will explore next.

Changing the Game: Going the Whole Nine Yards with Your Outsource Relationship

It's important to understand that Vested Outsourcing is much more than delivering a higher level of service on a given activity. For example, it is:

• NOT about achieving 99 percent fill rate for your warehouse provider versus 95 percent;
• NOT about answering 95 percent of all calls in 20 seconds versus 30 seconds;
• NOT about going from 3,000 defective parts per million (DPPM) to 3.4 (Six Sigma) DPPMs from your contract manufacturer;
• NOT about ensuring that janitorial service provider cleans the toilets every two hours;
• ... and the list can go on and on.

Unfortunately, many people on both sides of an outsourcing relationship simply do not understand the fundamental business model concepts behind Vested Outsourcing. A common mistake occurs when an organization thinks they have a Vested Outsourcing agreement because they have taken their existing contract and simply added a clause stating that if a service provider achieves the metrics they are paid a bonus. This completely misses the mark. Vested Outsourcing is a fundamental business model paradigm shift in how the outsourcing company and its service providers do business.

WIIFWe versus WIIFMe

While many organizations tout they have "partnerships," our experience and research found that most organizations have an internal desire to optimize their own self interests. This is often known as a "What's in it for Me" approach (WIIFMe). How could they not when we are ingrained with "winning" from early childhood and most business schools and law schools focus on "winning." Procurement and sales professionals are trained in the art of negations to help them "win."

The very word "partner" implies that there are two sides. The progression towards a Vested Outsourcing agreement should focus on creating a culture in which parties are working together to ensure the ultimate success of each other. The mentality should shift from an "us versus them" to a "we" philosophy, or what we call a "What's in it for We" (WIIFWe) philosophy.

Companies that embark on a Vested Outsourcing agreement should approach it as a symbiotic relationship. Only by working together can they succeed. Consider the cartoon at left.

Illustration 3. Vested Outsourcing is based on a "What's in it for We" philosophy.

The goal of a Vested Outsourcing partnership is to focus on first identifying and then aligning the interests of both players. The relationship becomes more collaborative and expands beyond simply meeting requirements.

A WIIFWe philosophy strives to increase the size of the entire pie (unlock a greater opportunity than is currently realized by either party) versus maximizing the size for any one player (e.g., lower costs at the expense of the outsource provider's profits). WIIFWe challenges the conventional win/lose mentality and tosses it out the window. A company that is trying to maximize their piece of the pie instead of growing the whole pie is not playing under Vested Outsourcing rules and will most likely craft an outsourcing agreement that is structured with one or more of the ailments we have identified in our research.

Many of you might be thinking, "Win-win is so fluffy. Is it really possible?" Consider a contract manufacturer that had to "touch" the box 12 times to assemble it, but refrained from saying anything as they were "paid by the touch." Under a performance partnership, that supplier would have substantial incentives to help the customer redesign the packaging to reduce the total cost. Let's say that the supplier helped design a box that cost two cents more to manufacture but reduced the "touches" from 12 to 7. If the "touches" cost two cents each, and the annual quantity was 5 million pieces, the annual net savings would be $400,000. Wouldn't you, as the customer, be willing to share that with your supplier?