Ancient navigators found their way by following the Little Dipper. The constellation’s polestar, Polaris, always conspicuous and very near the north celestial pole, was used as a guide in traveling the seas. Outsourcing, often undertaken by buyers who have no prior experience navigating the depths of this intricate business relationship model, can end up in a shipwreck. Ted Williams, Vice President of Business Development for Compass America, reminds companies considering embarking on an outsourcing journey to make sure they are well represented by a neutral third party. “Outsourcers write a lot more contracts than buyers. They are better at it than you are,” he says.
Compass America, a Polaris-type guide for many wise buyers, believes accountability is key to effective outsourcing relationships. Often called upon to remediate deteriorating relationships between parties, Williams know the shipwreck hazards. He explains what buyers should do to be accountable for the success of their outsourcing agreements.
The Titan and the Dwarf
“The biggest hazard is not knowing true market rates for services – not knowing what it should cost to run your operation,” says Williams. He tells the story of what all too often happens. “It occurs on the golf course. The buyer’s CEO golfs with a partner from the outsourcing company and says his company is spending $100 million on IT. The outsourcer partner says, ‘We’ll do it for $95 million!’ The CEO thinks it’s tremendous that he has just saved $5 million. But what if the true cost was $80 million? He just gave away $15 million.”
Suppliers are rather like Titan — the largest satellite of Saturn and the largest satellite in the solar system; buyers resemble the “dwarf,” a small star of low luminosity. Williams says that suppliers usually have the ability to find out what a buyer’s current costs are. Since they also know who else is bidding on the work, suppliers are not incented to lower the price. He recommends establishing true costs before putting an RFP out for bid. This evaluation process can take six to eight weeks if it’s performed by a services company. It starts with understanding the buyer’s environment and then drawing together a reference group of top performing operations of similar size and magnitude. An exact comparison is then made between what the buyer and the top performers are paying for the same services. He points out that, although there are several great reasons to outsource, cost is not usually one of them. Still, it’s important to negotiate with the supplier from the point of what true costs are; otherwise, a buyer cannot know what it should pay for services.
In the galaxies, a fireball is a brilliant meteor that often trails bright sparks. In outsourcing, a buyer needs to be accountable for sparks — the additional resources it allows to be written into the contract. “Take care that the additions don’t outnumber the reductions,” warns Williams. “For example, an outage at a remote center might cause a need for 24×7 help desk support for that location; so the supplier writes an ARC (additional resource cost) into the contract. Conversely, you want to make sure you get rid of that support if you don’t really need it.” He says suppliers are very adept at writing ARCs in such a way to benefit their companies.
The key is for the buyer to be accountable enough to know its business better than the supplier. “The outsourcers put a lot of time into figuring out where and how you are going to grow so that they can fix the contract to best benefit the outsourcer on where your growth will be,” he explains. “If the outsourcer knows that you are moving into eCommerce, for example, it will write more expensive ARCs around the services pertaining to eCommerce.” Williams says that buyers have the ability to minimize those prices. A buyer who lets the supplier know the magnitude to which it is going into a particular growth area is “a company that is going to be damned by its mistakes,” he says. “They are opening themselves to exposure over the term of the contract.”
The third area where buyers need to take steps for accountability is the management of the ongoing relationship. “Marriage counselors always say never go to bed mad but, instead, talk it out,” he says. “Otherwise, small problems become bigger problems. In outsourcing relationships, things that start to go bad just get worse unless you at some point make the effort to level the relationship.” No matter whether the problem is a buyer who is unhappy because it is not getting the service levels it expected, or whether the supplier is overcharging for one service but charging below market on another service, or what the problems may be, there must be some give and take. Both sides need to make concessions to get the relationship back on track and moving forward again.
Williams says that a buyer who doesn’t structure its contractual agreement carefully, to allow for true-up sessions and regular discussions about the relationships, will have a “decreased ability to fix it when it goes awry.” Once a year or every other year is frequent enough for true-up sessions (with input from both sides), he advises, but discussions between both parties at all levels need to take place on an ongoing basis.
Even so, there is a common trap that buyers can fall into when structuring for true-up sessions, he cautions. Outsourcers like to play the shell game – insisting that only one process be examined each year, thus being able to hide expenses under different shells. “You really need to measure it all at once if you want a true assessment of the relationship; otherwise, it will be ineffective and the money will be misguided,” he says.
Lessons from the Outsourcing Primer
- The biggest pitfall is for a buyer not to know the true market rates for the services it wants to buy.
- Buyers must not fall into the trap of letting their additions in resources outnumber their reductions in resources.
- Buyers must structure true-up sessions into the contract.