As business travelers land at airports in unfamiliar cities they must find a means of travel to get them from the airport to their hotel. But they have an option. They can take a taxi or they can take a car service. The taxi charges a rate per mile, which is clearly marked, but travelers have no idea how many miles it is to the hotel. And if a traveler proposes, because of traffic conditions, that a longer route be taken because it will get her or him to the hotel faster, the traveler will end up paying more. The taxi driver has nothing to lose and benefits from the passenger’s haste. The car service, on the other hand, has a fixed rate to get to the hotel, so if the driver or passenger suggests a quicker route because of traffic, both parties benefit. The traveler gets to the hotel as fast as possible with no concern about price, and the driver is able to unload its passengers quicker so that it can attend to another load of cash-carrying travelers. So the taxi charges for its effort and the car service charges for its results.
Changes occur frequently in outsourcing relationships. And paying for results is one mechanism that can help customers achieve flexibility in the arrangement, says Eugene G. Lukac, CSC’s Principal for Application Value Management. Many outsourcing contracts do not focus on results, but focus on effort. In other words a company pays for hours, days or labor instead of paying for the results of the effort. “If the customer has a contract where it pays for a certain number of hours or skill mix, and then its requirements change, then it is hard to reflect those changes in the contract,” Lukac says. But if the contract specifies the results the customer needs, they can leave the method used to acheive those goals to the outsourcing company.
Along the same lines is having a win-win contract. If the interests of one party are furthered, then the interests of the other are furthered automatically. So if one party takes care of itself the other party benefits. Contracts like these align both companies’ interests and provide for much greater flexibility, Lukac says..”
The Critical Nature of Flexibility
Flexibility is critical to the success of an outsourcing relationship for two reasons. One is that every client is unique and has different needs, and if an outsourcer attempts to treat the arrangement using a cookie-cutter approach the unique needs of the client are not going to be addressed. Hence, the outsourcer will not be successful very long. “Second, whatever the company’s unique needs were on day one are going to be different on day two,” he says. “So a company needs an approach that is designed for change, not an approach that accommodates change, tolerates change or can be adapted to change, but one that anticipates change, welcomes it and is designed to facilitate it, he says.”
Lukac has been personally involved in outsourcing since the late 1980s, and has seen a tremendous change in the way that contracts are written. This change has been driven by several factors. One is that the pace of change has increased. So generally in business, people are more mindful of the need to maintain flexibility and allow the accelerated pace of change to drive through the business. Second, suppliers have learned through experience that the rigid contracts end up going back to negotiation and there is no need to renegotiate contracts, but there is a need to adapt services.
The Changing Business
Renegotiation is not the most expedient way of handling things. A renegotiation says that there is something written that no longer works and new rules need to be established, but if the rules were designed for change, then the companies wouldn’t need to renegotiate. They would only need to determine what the change is and apply it. There is a big difference between renegotiating a change and applying a change. For example, suppose the contract says that the vendor will support 1,000 users, but the client then divests a division and now there are only 900 users. If the contract were set up rigidly then it probably would have to be renegotiated, but if the contract was written to where the number of users becomes a parameter in the contract then the arrangement just changes.
The number of users is only one change that can impact an evolving business’ need for flexibility. Another factor is if the functionality of the application changes. The applications in scope could change, or the applications that are not in scope are brought into scope or vice versa. Third, the workload of the client can change. The client might be processing transactions, invoices or carrying different inventory levels. And when the volume changes then the relationship might need to change. The final factor is the changing environment — the regulatory environment, the technical environment, the competitive environment, etc. This might lead the client to recognize that there are new things to do or old things that don’t need to be done anymore.
The Three Layers of a Contract
These days the typical contract will be done in three layers rather than in a monolithic structure. The three layers are in recognition of the fact that change occurs at different paces, he says. These three layers have become industry standard and enable vendors to manage the flexibility of the contract much easier. ‘Terms and conditions’ is the first layer. This layer is considered the most sustainable layer because it changes the least rapidly. The terms and conditions address things like confidentiality, proprietary rights, insurance, etc. These items typically last years with little change.
The second layer is the work that will be done and at what price. This typically changes every six months, every quarter, or at least once a year. And the third layer is non-contractual. It is procedures like where the calls are received, who is responsible for a certain aspect of the service, how often will the sides meet and where they will meet, etc. Some aspect of these procedures will change every week, so having all of them in one place makes them visible and very easy to change and update. And when they do change it makes it easy to communicate the changes to all the parties that need to know.
Assuring a Flexible Partner
One of the things that customers should recognize is that outsourcing is merely a tool and it is one of the many tools that can provide a solution to a business problem, need or challenge, he says. So the first thing that the organizations should do is examine the business problem that it is trying to address and to what extent outsourcing can help. The company should continue to focus on the problem and on the business because it is not trying to outsource, what it is trying to do is help the business succeed, and outsourcing is a mechanism to help the corporation do that.
“The first step that needs to be taken is to work with companies and providers that recognize that as well, have the same amount of focus, and can bring a variety of tools that will result in a solution to the client’s problems,” he says. “Make sure that the vendor has a reputation for flexibility. Companies do have reputations and a company can check the validity of its reputation by talking to the media, analysts, and references.”
Lessons From the Outsourcing Primer:
- Changes occur frequently in outsourcing relationships and paying for results is one mechanism that can help customers achieve flexibility in the arrangement.
- Flexibility is critical to the success of an outsourcing relationship
- Contracts are composed of layers with some layers more susceptible to change.