How can an outsourcing supplier differentiate itself during the selection process? Price is one way. Building incentives into the proposal is another.
Jeff Kelly, vice president for EDS in the America’s delivery, Information Solutions line of business, says EDS typically competes with Tier 1 suppliers for the nation’s large outsourcing contracts. The Plano, Texas supplier has to be in the competitive range to make the short list. Kelly says the inclusion of incentives can help EDS win the final run-off between the top two contenders. “We try to find a way to create value over and above pricing and delivery,” says Kelly.
Currently, about 25 percent of EDS’ outsourcing contracts have relationship incentives. Kelly says this percentage has increased over time.
Kelly says there are typically three types of incentives EDS employs in its outsourcing arrangements. Reciprocal businesses are the first form of relationship incentive. Kelly says EDS tries to structure these around a specific asset or particular technology. In these instances the two companies pool their core competencies to generate revenue. Typically these are contractual agreements between the supplier and the buyer although they could be joint ventures.
A recent example of creating a reciprocal business is EDS’s joint venture with WorldCom. EDS outsourced its network to WorldCom and WorldCom outsourced its IT to EDS. Each side utilized the other’s side leverage to generate revenue for both parties.
Taking A New Product To Market
The second type of incentive is the creation of a joint venture with the idea of going to market with a new idea. EDS joined hands with BellSouth in a joint venture. Both buyer and supplier are using their best people to perform network management and desk side support. Kelly says this is an equity arrangement. When the parties take these services to market, both parties will share the revenues.
Sometimes EDS will assume the risk in a new venture and not charge for its consulting in return for keeping a share of the profits when and if they happen. The outsourcing contract clearly spells out how the parties will measure the profit and divide it up.
The third incentive EDS uses is gain sharing. Here EDS has a relationship with a client. If it can find a way to improve its customer’s business operations by driving down costs that are not related to its IT contract, EDS shares in the savings. An example is one client consolidated four sites down to two, producing a significant operating savings. EDS earned a percentage of the gain.
Gain sharing is a good tool when the buyer is determined to create a change within the company and believes it is impossible to achieve this reengineering internally. The prospect hopes the outsourcing supplier will become its agent of change.
Deal Specific Metrics
†Kelly says the metrics in a relationship incentive contract are very “deal specific.” Sometimes it becomes difficult to sort out the correct cause and effect. The parties have to accurately determine if the positive revenue is the result of EDS’ expertise, the partner’s handiwork or the symbiotic workings of the relationship itself. “It’s often difficult to measure success,” says Kelly.
One solution is to write the high level parameters into the contract. An example might be EDS will earn 50 percent of the savings generated the first year if it assumes some risk for a new venture. It will earn 25 percent of the savings in year 2 and nothing thereafter.
The parties should decide these metrics before the venture begins. Metrics typically center around cost initiatives, service excellence or value creation, Kelly explains.
Kelly says EDS likes relationship incentives because they can transform the original engagement into a long term relationship. Buyers can see the value of an outsourcing arrangement during the first 24 months. That’s when the supplier is consolidating assets and reengineering the buyer’s processes to improve performance. The changes are visible and tangible.
But in a 10 year relationship, a status quo sets in by year three. Then the buyer is only interested in negotiating the cheapest price since the major transformation is complete. Kelly says if incentives are part of the outsourcing structure, the client will see additional value for the entire span of the contract. “I like relationship incentives because they sustain the value created during the first couple of years,” says Kelly.
Requesting Incentives At The RFP Stage
Clients interested in relationship incentives usually seek out EDS during the Request For Proposal (RFP) process and not the other way around. EDS has a harder time trying to talk a prospective into accepting relationship incentives.
Lessons from the Outsourcing Primer:
- Relationship incentives help create a long-term relationship for suppliers because they continue to create value in the latter years of the contract.
- Outsourcing is a good way to bring change to an organization. Usually systemic change is too difficult to accomplish in-house.
- Reciprocal business practices allow both buyer and supplier to pool their talents to create a joint venture that leverages the skills of both.
- Relationship incentives help bring new ideas to market because the outsourcer is willing to shoulder some of the risk for a portion of the profits.
- Gain sharing helps an outsourcer reengineer a company’s business processes and share in the savings.