The fact is, when cost reduction is the primary objective in an outsourcing initiative, the service provider often achieves that goal within the first two years. But outsourcing is a long-term arrangement, with many contracts having a five- or even 10-year term. So what value outcome is the buyer paying for during the remaining years?
Most buyers today recognize that outsourcing is a strategic solution and ensure their arrangement is designed to create continued value over the life of the contract. But what about those who signed long-term contracts more than a decade ago? While some put their work out for re-bid in a competitive marketplace at the end of the contractual term, others are happy with their provider and just need some contractual tweaking to make it more effective in today’s environment.
“From the standpoint of ROI, if you have made the decision to outsource, it becomes incumbent on you to manage that process the best that you possibly can over time in order to make it better and more cost-effective,” says Tom Luszczak, director, Asset Management at Travelers, the Hartford, Connecticut-based property and casualty insurance company.
In the Beginning
When Travelers outsourced its facilities management, property management, and project and construction management processes to commercial real estate provider Trammell Crow Company (TCC) in 1991, cost was the number one concern. In addition to process expertise and resources for continuity of business, Travelers wanted to reduce costs and also move to a fixed-cost structure.
“Outsourcing was just starting to be an in-vogue concept back then,” recalls Luszczak, so their contract was standard for those early days and not focused on value creation.
Travelers houses its operations in both leased and owned facilities around the U.S. Since it deals with third-party management firms in many buildings where it’s the anchor tenant, but also deals with its own tenants (through services provided by TCC), Travelers has continual hands-on benchmarking of real estate/facilities management services and TCC’s competitors across the country. “Good service is more than looking for dust bunnies in the corners of the garages,” states Traveler’s director. Treating real estate tenants well should be simple, he believes; that’s what Dallas, Texas-headquartered TCC does for tenants in Travelers’ buildings. But Travelers finds the opposite to be true; often, service providers are inflexible and don’t place high value on the tenant relationship itself.
This serves as validation for the success of Travelers’ outsourcing relationship with TCC, which manages Travelers’ 12 buildings in Hartford as well as 350 field locations. Nevertheless, cost scenarios changed over the ensuing decade, and Travelers knew its outsourcing arrangement could be made more cost-effective.
Contractual Face Lift
Fast forward to 2002 and a new seven-year contract that includes incentive pricing components. The gainsharing strategy encourages the provider’s value engineering on capital projects (bidding the whole project out before letting a contract) and ensuring the ability to self-perform, rather than subcontracting out to a third party for peak or infrequent requirements. “If the self-perform requires them to add more staff,” explains Luszczak, “that is still more cost-effective for us than some labor costs that can be three or four times higher than the labor costs of a 40-hour TCC employee.”
The new win-win pricing plan aligns their interests. As TCC performs services under the new strategy, Travelers reaps the benefit of lower costs, and TCC receives 50 percent of the initial savings plus five percent going forward.
The Provider’s Trump Card
Both parties approach their relationship with “a give-and-take attitude” to ensure success. Besides incentive pricing, they’ve made another significant change to their outsourcing arrangement over time. The innovative provider suggested that the “specialists,” such as electricians, plumbers, and carpenters on the facilities management staff (many of whom are former Travelers employees) become “generalists.”
The strategy to make people become more multi-faceted was designed to handle the peaks and valleys in staffing needs. Admitting initial reluctance to the plan, Luszczak recalls that Travelers was, for instance, “apprehensive about having a third-generation master electrician installing carpet tiles.” In hindsight, the plan benefited employees with enhanced skills as much as it benefited Travelers and TCC. “We’ve seen the growth in these folks, and this was a good change,” he says.
With pressure to keep expenses down to satisfy tenant needs, the corporate real estate world is a tough business. “The minute you resolve one thing, you have 20 other things right behind it,” explains Travelers’ director. “Yet, there’s really nothing new in this business. And once you’ve done it for 20-50 years, you’ve probably encountered all the situations you’ll face. So, as the business matures, you’re not going to be able to produce big wins, cost-wise.
“That’s why the key to success in providing services is to know best practices and how they’re changing, he states. “That’s the value-add piece that an outsourcer like TCC brings to a mature process.” It’s subtle, but key. What you need to do from a plant standpoint or from a utilities standpoint makes the difference, he believes; and it’s not the core expertise of an insurance company. “So we outsourced to put a process in place that allows us to do our jobs well; and benchmarking shows we’re consistently doing it better than our competitors in Hartford,” claims Luszczak.
Perhaps the best acknowledgment of the effectiveness of this new contract in a longstanding outsourcing arrangement comes from Travelers’ new parent company, Citigroup. Assessing the different models for services performed at each of the companies comprising Citigroup in order to determine a single approach to adopt for the global business, Citigroup selected the Travelers / Trammell Crow outsourcing model as the ideal approach.
Lessons from the Outsourcing Journal:
- Outsourcing is a strategic solution, and buyers should ensure it is designed to create continued value over the life of the contract.
- From the standpoint of ROI, it is incumbent on the buyer to manage the outsourcing relationship over time.
- Tweaking the outsourcing arrangement, where necessary, to produce more value as the environment and needs change is a more effective strategy and less costly than putting the contract out for a competitive re-bid.
- Incentive pricing to motivate a facilities management provider to self-perform and provide value engineering will align the provider’s interests with the buyer’s objective of lowering costs.