5 rules that transform outsourcing outcomes

For organizations seeking a collaborative win-win approach to outsourcing, the Vested sourcing business model is worth consideration. It is the product of nearly 20 years of research at the University of Tennessee, beginning with a deep-dive funded by the United States Air Force on outcome-based outsourcing in 2003.

UT’s ongoing research into the world’s most successful outsourcing relationships, including those from Dell’s and the Canadian government, has uncovered five key rules for establishing win-win strategic partnerships that work collaboratively to achieve business outcomes. When a company and its outsourcing partner follow these rules they become vested in each other’s success: A win for the buying company is a win for the service provider.

The model offers a significant shift away from the transaction-based model commonly used in IT oursourcing arrangements, and its rules resolve several structural flaws that can emerge in transaction-based and managed servicesagreements.

For example, a buying organization might want “outcomes,” but the contract spells out dozens or even hundreds of service level agreement metrics instead. The buying organization might also want “innovation,” but the contract with the supplier has an 800-page Statement of Work with exacting details on how the supplier should perform each of the activities in scope. Or it might want the supplier to implement “efficiencies” while spelling out a transactional pricing scheme that inherently incentivizes the supplier to perform more transactions.

Instead, the Vested sourcing model refocuses business partnerships from a “what’s-in-it-for-me” transactional approach to a highly collaborative “what’s-in-it-for-we” model that promotes (and rewards) the parties when they collaborate. For example, instead of negotiating who will bear the risk of inflation, the parties embrace the fact that inflation is a reality of business and collaborate to identify and invest in operational efficiencies to mitigate the risk of inflation. 

The following five Vested rules might sound simple, but UT research has found that most companies fail to follow them in an effort to the refocus on the outsourcing relationship on mutual success.

1. Pivot to an outcome-based business model

Most outsourcing arrangements are traditionally built around a transactional model. Under this method, the service provider is paid for every transaction — regardless of whether it is needed. The more inefficient the entire process, the more money the service provider can make.

Managed services contracts (e.g., painshare/gainshare contracts often at a fixed scope/fixed price) have emerged to solve the weaknesses of transactional contracts. While most managed services contracts say they partner for outcomes — UT research shows they are almost always focused on supplier outputs — they are not true boundary-spanning business outcomes because the contracts almost always are structured to pit buying organizations and services providers against each other in scope creep battles and hard feelings if performance really deserves a penalty. The more complex and more variable the workscope, the more friction.

The Vested sourcing model, by contrast, operates under a true outcome-based model. Vested uses a formal relational contract coupled with a win-win outcome-based economic model where the buying organization and service provider align interests to what the buying company actually wants — success against strategic business outcomes. A win for the company is a win for the service provider — and vice versa.

2. Focus on what, not how

Adopting a Vested business model does not change the nature of the work to be performed. At the operational level, there is still a need for material to be stored, orders to be managed and fulfilled, calls to be answered, and goods to be delivered. What does change is how the company purchases the outsourced services. Under the Vested model, the buyer specifies “what” they want. It is up to the service provider to figure out “how” to put the supporting pieces together to achieve the company’s goals. This gives the service provider the creative room to challenge the status quo and seek the best solutions to do the job.

3. Clearly define measurable desired outcomes

The third rule of Vested sourcing partnerships is that, to become the beacon for success, desired outcomes must be clearly defined and measured. Desired outcomes are jointly developed by the buyer and supplier and represent boundary-spanning business needs, not simply task-oriented service level measures.

Magnus Kuchler, country managing partner for EY Sweden, explains how organizations make the shift to measuring outcomes under the Vested methodology:

“The conventional approach to measuring success is to have dozens — if not hundreds — of detailed service level measures. But true success is almost defined by more than one process in a networked system. So when you break a process down into small parts, it is easy to fall into measurement minutiae. Real success comes not from ‘did the supplier get the task done’ but from the end-to-end process succeeding. After all, who cares if your services provider processed an invoice for payment if the invoice sat in an employee’s email inbox for five days waiting for approval? The point is that the end-to-end process failed. What I like about Vested is it eliminates the blame game and uses transparent and collaborative end-to-end root cause analysis where business partners are aligned on a common understanding of success.”

4. Choose a  pricing model with incentives that optimize the business

The fourth rule centers on structuring a pricing model with incentives that reward the service provider for optimizing the business. A key goal of the pricing model is to incentivize the service provider to drive continuous improvement and to invest in innovation linked to the parties’ desired outcomes.

There are two principles for establishing a pricing model. First, the model must balance risk and reward for both parties. The agreement should be structured to ensure the service provider assumes risk only for decisions within their control. For example, a transportation service provider should never be penalized (or rewarded) for the changing costs of fuel.

Similarly, a property management service provider should never be penalized for an increase in energy prices. Second, the pricing model needs to link incentives to the desired outcomes. The more effective the service provider is at helping their client achieve desired outcomes, the more incentives (or profits) it can make.  A well-structured pricing model creates a true win-win; a win for the supplier is a win for the buyer — and vice versa.

5. Elect an insight (vs. oversight) governance structure

The Vested model shifts from a culture of oversight to one of insight. Simply put, the buying organization turns its focus to managing the business with the service provider, not just managing the service provider. Why? If you’ve done a good job of selecting the right partner and aligning their interests by using rules one to four, then the service provider will truly have a vested interest in performing because their success depends on achieving success for the buying organization.

While many outsourcing deals rely on governance mechanisms, most do so informally. A key part of creating a Vested agreement is recognizing that you are creating a formal relational contract. This means you must put the relationship front and center and embed formal relationship management and governance constructs into the actual agreement.

Contractually obligating outsourcing parties to sound governance mechanisms obligates the parties to take proper governance seriously. UT researchers advocate embedding a governance schedule into the actual contract written in plain language as opposed to legal-ease. 

David Frydlinger, managing partner at Stockholm-based Cirio Law Firm, explains the rational: “Formally creating a governance schedule in plain language enables the parties to use the schedule more like a ‘playbook.’ Team members can look at the schedule and clearly see how to govern their partnership.”

From research to relevance

Today, more than 100 organizations have applied the Vested methodology in outsourcing deals as diverse as facilities management, reverse logistics, third-party logistics, environmental services, fiber-optic network management, and labor services. UT’s research now includes seven books, 22 white papers, and 20 public case studies that document the success stories of organizations such as Intel (third-party logistics), Dell (reverse logistics), Vancouver Coastal Health (environmental services), and Island Health (labor services/union contract with doctors), and BP (real estate and facilities management).

The Vested movement has become a model for best practices in outsourcing globally — but has yet to get traction for IT outsourcing. In a follow up article we will explore why IT outsourcing has been slow to adopt Vested and how Vested can be a game changer for IT outsourcing. 

For those wanting a deeper dive now, visit the University of Tennessee’s dedicate website and research library at www.vestedway.com.

Outsourcing, Vendor Management