Five Rules — and 10 Steps — to a Healthy Outsource Agreement
November/December 2012, eSide Supply Management Vol. 5, No. 6
A flexible and nuanced outsourcing strategy follows five rules, each with its associated steps.
I often say that "business happens." If your outsourcing strategy isn't flexible and nuanced enough to deal with that fact of life, then it's long past the time for a change in the ways it outsources and its business contracts are negotiated and managed.
It's probably also time for a mind-set change — from "I-win/you-lose" to win-win.
How Do We Get There From Here?
University of Tennessee researchers teamed with the International Association for Contract and Commercial Management to produce The Vested Outsourcing Manual: A Guide for Creating Successful Business and Outsourcing Agreements. The manual is designed to help buyers and suppliers implement the changes needed to bring outsourcing up to speed. Vested outsourcing, or simply "vested," is an outcome-based business model that emphasizes collaboration and innovation between a company and its supplier or service provider to create and share value, and thus achieve a long-term win-win partnership. In a nutshell, vested takes the partners beyond the traditional transaction-based outsourcing model: Companies buy desired outcomes rather than transactions. This process focuses on Vested's five rules, or tenets, that are linked to 10 core elements for developing an effective long-term business partnership based on collaboration — creating and sharing value for mutual success.
Here's how the five rules and 10 elements link together:
Rule 1: Focus on Outcomes, Not Transactions
Element 1: Business Model Map — The first step is to document an outsourcing business model. Describe what your organization wants from the outsource arrangement, and map potential outcomes. This fosters alignment between the parties; they'll know, early on, what the goals are. Jointly mapping a model will pinpoint the transactions of value between the parties, leading logically to collaboration, loyalty and mutual satisfaction, market share and sustainable profit.
Element 2: Shared Vision and Statement of Intent — With the business model understood and mapped, the parties then work together on a joint vision that will guide them for the duration of their vested relationship. The vision and alignment form the basis of a statement of intent drafted by the outsourcing teams.
Rule 2: Focus on the What, Not the How
Element 3: Statement of Objectives/Workload Allocation — This element lays the foundation for those in the developing vested partnership to do what they do best. Depending on the scope of the partnership, the company transfers some or all of the activities needed to accomplish agreement goals to the service provider. Together they develop a statement of objectives (SOO), which describes intended results, not tasks.
Rule 3: Clearly Define and Measure Outcomes
Element 4: Top-Level Desired Outcomes — Desired outcomes are the centerpiece of the agreement. Without mutually defined desired outcomes in place, a vested agreement can't go forward. Outcomes are expressed in terms of a limited set of high-level metrics.
Element 5: Performance Management — A sound agreement will define how the parties manage overall performance of the vested agreement. When the desired outcomes, statements of intent and SOOs are in place and the agreement is implemented, the parties then measure performance to determine what's being achieved.
Rule 4: Ensure Pricing Model Incentives Optimize Cost/Service Trade-offs
Element 6: Pricing Model and Incentives — For the most part, the outsourcing approach of many procurement professionals is stuck on one thing: getting the lowest possible service and labor pricing. The vested movement's strategic paradigm shift is that the service provider's profitably is directly tied to accomplishing the desired outcomes. So, the more successful the service provider, the more money it makes.
Incentives play a key role, because service providers are taking on risk to generate larger returns on investment. Pricing models using margin matching are recommended for use in a vested agreement. The margin matching method is used to adjust pricing points by establishing trigger points that re-set prices when that point is met. For example, the inflation rate might be a trigger point for re-setting inventory carrying cost charges.
Rule 5: Opt for an Insight (Versus Oversight) Governance Structure
Element 7: Relationship Management — A relationship management structure creates joint policies that emphasize the importance of building collaborative working relationships, attitudes and behaviors. The guiding principle is for the parties to manage the business together, rather than the buyer managing the supplier. The agreement is monitored within the framework of a flexible governance structure that provides insights into what's happening.
Element 8: Transformation Management — This is a new relationship model — people and company ecosystems are changing; a degree of discomfort and adjustment is probable. Managing the transformation, including transitioning from old to new — along with change management once the new agreement is up and running — is often difficult and complex to implement. It's imperative to preserve as much continuity as possible among personnel and teams as the transition progresses into day-to-day implementation and operation.
Element 9: Exit Management — Sometimes the best plan simply doesn't work out or is trumped by unexpected events. The parties should have a plan when assumptions or conditions change. An exit management strategy can provide a template to handle future unknowns.
Element 10: Special Concerns and External Requirements — Governance frameworks are not one-size-fits-all, especially in more technical or complex relationships. The last element recognizes that many companies and service providers must understand and adhere to special requirements and regulatory protocols. A governance framework may need to include additional provisions that address specific market, local, regional and national requirements. For instance, in complex international supplier and supply chain relationships involving information technology and intellectual property, security concerns may necessitate special governance provisions outside the normal manufacturer-supplier relationship. Supply chain finance and transportation management are other areas that often require special handling under the governance framework.
Kate Vitasek is a faculty member at the University of Tennessee's Center for Executive Education and is the author of Vested Outsourcing: Five Rules That Will Transform Outsourcing and The Vested Outsourcing Manual, both published by Palgrave Macmillan. A third book, Vested: How P&G, McDonald's and Microsoft are Redefining Winning in Business Relationships, was published in September and shared successful case studies from some of the world's best services contracts. To contact this author, please send an email to firstname.lastname@example.org.
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