Vested Outsourcing: Game-changing Rules for Outsourcing

Building stronger relationships and gaining greater value from your outsourcing relationships by moving from win-lose to win-win

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.

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

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

Vested Outsourcing is based on a What is in it for We philosophy
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?

Developing a WIIFWe relationship is easier to describe than it is to do. Evolving from a culture of oversight and control to mutual respect is not an easy transition for most companies that outsource. Adversarial relationships often persist, and getting to a true win-win relationship will likely take practice. We frequently suggest assigning a neutral party to the team to act as the "win-lose cop" to point out when organizations slip into conventional win-lose thinking.

The first place to watch for potential adversaries is at the executive leadership level. Vested Outsourcing is not for the faint of heart; it demands committed executive leadership from both organizations, willing to transcend the traditional win-lose approaches most companies take when it comes to procuring goods and services. Unfortunately, some executives often feel they are too senior to be coached by the win-lose cop and have a strong conviction they have to do what they think is right for the company, not what will further the objectives of the Vested Outsourcing partnership.

Even when there is commitment at the most senior levels in both organizations, individuals at the lower levels can succumb to what we term the "Junkyard Dog Factor" and begin to protect their turf. In fact, we have seen this ailment afflict some companies so severely that one or more of the organizations had to fire some of their existing employees to remove "baggage" or get beyond conventional win-lose thinking.

One common place all companies should watch out for adversaries is among the contracting professionals and lawyers at both organizations. Contracting professionals and lawyers can be the kiss of death for Vested Outsourcing because their entire profession is built around the philosophy of "getting the best deal" for their company. Much of our society's business culture and history has been hardwired to play win-lose. The win-lose cop can come in handy to keep the contracts and legal departments in check. If their behavior presents an obstacle, the individuals responsible should be removed and replaced with different mindsets whenever possible.

True win-win requires effort and commitment by both parties. Outsourcing does not mean abdication: it must be a partnership with regular, frequent communication to manage the expectations as well as the work. Although the most pernicious problems that affect outsource arrangements are brought on by micromanagement, a different set of problems can emerge when a company hands over a process completely to the outsource provider, washes their hands and walks away.

True partnerships must often evolve over time as both parties learn to work under a win-win philosophy. For many companies a win-win approach is a learned behavior, and they have to unlearn their conventional approaches and ways of thinking. Human relationships are fundamental to successful Vested Outsourcing. Absent of mutual trust, any attempt to implement Vested Outsourcing will become mired in terms and conditions. In addition, both the company outsourcing and the outsource provider need to make sure they are comfortable in their associated roles. The company outsourcing needs to feel comfortable describing the "what" and delegating the "how" to the outsource provider. The outsource provider must be comfortable signing up to take the risk to deliver the "how." Both organizations must constantly seek to overcome roadblocks in the processes, infrastructure, technology and people that prevent the mutual success.

Most companies that use Vested Outsourcing as an approach for outsourcing do not spend a lot of time talking about how it gives their service providers the opportunity to make more money. They prefer to focus on how it delivers better value or better performance at the same or lower total cost. Nevertheless, service providers who work under Vested Outsourcing partnerships often focus on the higher profit potential of Vested Outsourcing and point to the fact that successfully designed Vested Outsourcing partnerships create happier clients. Because both organizations are working together to achieve their goals, Vested Outsourcing works as a true win-win relationship, which is what partnership is all about.

In our experience, only those organizations that truly challenge the WIIFMe mentality are able to achieve true Vested Outsourcing partnerships that deliver outstanding results. In our opinion, adopting anything less than a WIIFWe philosophy will result in less-than-optimal results.

The five major rules of the What is in it for We philosophy
Illustration 4. The five major rules of the "What's in it for We" philosophy.

Deeply wedded to the WIIFWe philosophy are the following five major rules.

  • Outcome-based versus transaction-based business model
  • Focuses on the "what" not the "how"
  • Clearly defined and measurable desired outcomes
  • Pricing model incentives optimized for cost/service tradeoffs
  • Insight, versus oversight governance structure

How Vested Outsourcing Rules Work Together

In Vested Outsourcing, the organizations work together upon a foundation of trust, with mutual accountability for achieving the outcomes. Through the careful alignment of performance objectives, accountability and control, the service provider, while absorbing additional risk, is empowered to pursue improvements that will deliver improved performance, higher profits and lower total cost of ownership. Vested Outsourcing uses the power of free market innovation to improve the outsourcing relationship. This can be challenging to achieve, but the Vested Outsourcing journey should always strive to arrive at this idealized end state to achieve the performance pyramid where both the company outsourcing and the outsource provider are consistently applying a WIIFWe foundation and applying all five of the Vested Outsourcing rules.

For the service providers, Vested Outsourcing is an opportunity to exercise greater flexibility in deciding how support is provided, to ensure cash flow stability through long-term contracts, and to increase revenue by rewarding the service provider's investment in improving processes. For the company that is outsourcing, it is a chance to obtain improved performance while decreasing costs and assets by partnering with a highly competent and properly motivated firm.

To say that Vested Outsourcing represents a departure from conventional outsourcing practice would be to seriously understate the case. Vested Outsourcing changes the fundamental business constructs of the typical outsourcing approach.

Companies wanting to embark on a Vested Outsourcing partnership will need to deeply understand both the central core of the WIIFWe approach and the five rules. They will need to treat them as rules to live by. In our opinion, a Vested Outsourcing partnership that does not strictly adhere to the entire WIIFWe core and all of the five rules can easily fall victim to one or more of the outsourcing ailments that we have identified in our research. We like to think of a Vested Outsourcing partnership that does not adhere to the rules as a pig with lipstick. You can't simply pretty up something that is essentially ugly!

Once you determine that you are ready to explore Vested Outsourcing, we recommend using a structured framework to help you transform your existing outsourcing relationship to a more productive performance-based approach. The University of Tennessee's research has led to the development of an implementation framework wrapped around the five rules as illustrated in the Vested Outsourcing Implementation Plan diagram in Illustration 5. (Read clockwise starting with "Lay the Groundwork.") We have been piloting the framework with the Air Force and will be working with Intel on transforming their outsourced logistics and transportation to more productive performance-based approaches. We also are actively soliciting other companies to help pilot our implementation framework.

Vested Outsourcing Implementation Plan
Illustration 5. Vested Outsourcing Implementation Plan.
In Conclusion…

While the ailments afflicting many outsourcing arrangements occur as frequently as the common cold, they share a common cure: Vested Outsourcing can and does create an outsourced business model where both the company outsourcing and the service provider make every effort to achieve the elusive win-win. And the risk of catching one of these ailments through outsourcing is more than made up for by the achievement, through a productive Vested Outsourcing partnership, of lower costs by the outsourcing company and higher profits by the service provider, neither of which can be attained by each organization working alone.

Our upcoming book, scheduled to be published by Macmillan early in 2010 (see www.SDCExec.com/VestedOutsourcing), will offer a comprehensive guide for developing successful Vested Outsourcing partnerships. It is designed to help all companies begin their effort to take their outsourcing relationships to the next level. For those wishing to explore Vested Outsourcing further today, we offer three resources:

  • The University of Tennessee offers a three-day open enrollment class at its Center for Executive Education, "Performance-based Outsourcing: Buying Results, Not Activities!" (See http://PBO.utk.edu.) You can contact Bric Wheeler at the University of Tennessee, at BWheeler@utk.edu, for customized, in-house training on PBO for your company. These can be individual companies or a combination of a company outsourcing and their service provider(s).
  • Visit our blog at www.vestedoutsourcing.com and receive additional resources, success stories and insights offered by the authors. You can also request a complimentary e-book that expands on the concepts of this article.
  • Contact the authors at the e-mail addresses with their bios below.

About the Authors: Kate Vitasek is a thought-leader in the area of Supply Chain Management and is a well-recognized authority on performance management and performance-based approaches for business. She is the founder of Supply Chain Visions and has been the lead researcher and faculty for the University of Tennessee's Center for Executive Education Performance-Based Programs. She can be reached at kate@VestedOutsourcing.com.

Mike Ledyard is a veteran of international sourcing, manufacture and importation of product and tooling, especially from China and Eastern Asia. He is an author and frequent speaker on process measurement and improvement, and was selected as one of the Top 20 Logistics & Supply Chain Executives of 2001-2002. Mike is also a co-founder of Supply Chain Visions. He can be reached at Mike@VestedOutsourcing.com.