Cost Savings, SLAs, and Supplier Selection Criteria Benchmarks from 2007 Outsourcing Excellence Awards | Article
On an annual basis, Outsourcing Center studies the success factors, trends, and benchmarks of the world’s most outstanding outsourcing relationships, which are nominated in its Outsourcing Excellence Awards program. The awards program recognizes the relationships we studied in 2007 as excellent in the objectives they achieved. Therefore, how they structured their deals serves as valuable insight for future outsourcing relationships.
The study of 86 relationships participating in the 2007 awards program revealed several significant benchmarks. Among the study’s findings are the following:
- While technology innovation was a significant factor among the top supplier selection criteria, the supplier’s capabilities for enabling overall strategic impact on the buyer’s business was not a significant selection factor
- Cultural fit and relationship style–which participants ranked equal in importance–ranked higher as supplier selection decision factors in BPO deals than in ITO deals. Further, in BPO deals, cultural fit and relationship style were also ranked equal in importance with best practices, the supplier’s reputation, and the supplier’s industry expertise.
- BPO deals incorporated incentives in their service level agreements (SLAs) more often than ITO deals
- Aggressive pricing was cited as a significant factor in producing savings in both onshore and offshore deals
- The supplier’s willingness to make a capital investment was cited as an important supplier selection criterion in BPO deals far more than in ITO deals
Factors in Deal Structure that Produced Cost Savings
The relationships in the 2007 awards program achieved cost savings ranging from one percent up to more than 30 percent. Buyers cited five factors as leverage points that produced the savings: offshoring, provider expertise, technology refresh, aggressive pricing, and “miscellaneous other” factors.
As illustrated in Exhibits 1 and 2, offshoring and provider expertise were the primary factors that yielded savings of more than 30 percent.
The study found that in deals with an offshore delivery component, the offshoring was the major influencer of producing savings (at any percentage) and provider expertise was not ranked high as an influencer. However, in onshore arrangements, provider expertise proved to be the biggest influencer of savings.
Fourteen deals had no savings because the outsourced process was not an in-house function prior to this deal; 10 deals did not reveal the amount of savings achieved by outsourcing.
Exhibits 3 (ranking factors in offshore deals) and Exhibit 4 (ranking factors in onshore deals) show the cost savings by combining other influencers with offshoring and provider expertise.
Service Level Agreements
Forty-four percent of the 86 study participants incorporated financial incentives in their SLAs. There were more BPO deals using incentives (58 percent) than ITO deals (42 percent).
Sixty-two percent of the 86 study participants incorporated financial penalties in their SLAs. As shown in Exhibit 6, penalties ranged from one to more than 15 percent.
The study revealed several trends in mind-set toward use of incentives and penalties, as follows:
- Incentives were tied to achieving major milestones, especially where the parties perceived extra effort would be required to achieve them on time and within budget
- Pinning penalties onto too many SLAs is counterproductive because it causes the supplier to focus on achieving a penalty-burdened SLA to the detriment of achieving an SLA without a penalty
- Some deals placed a component of the penalty on both parties, where the supplier’s ability to achieve the SLA was dependent, in part, on information or a process component that was the buyer’s responsibility
- Several deals using penalties did not assess them on a monthly basis, preferring to give the supplier time (usually three months) to resolve issues before paying a penalty
- Some deals had a monthly SLA discussion as part of their governance structure; the parties would agree on what SLAs should be counted “in” or “out” if special circumstances were going on in either party’s company for that period
Supplier Selection Criteria
The number of buyers that included “cultural fit” as a supplier selection criterion is higher in 2007 than in past years of the awards program. Exhibit 6 displays an even more significant finding: where cultural fit is included at all, it is often an extremely important factor.
As Exhibit 6 shows, 58 percent of those who included cultural fit ranked it among the top three supplier selection criteria. In fact, three BPO buyers ranked cultural fit as their second-highest selection criterion.
The study asked participating buyers to rank the importance of 13 supplier selection criteria. Exhibit 7 displays these findings.
In a closer look at the rankings in Exhibit 7, the study revealed that the ranking supplier selection decision factors directly correlated to the buyers’ rankings of their top reasons for outsourcing.
ITO deals. By far, the top driver for outsourcing in ITO deals in the study was a combined objective of reducing operating costs and enabling the buyer to focusing on its core business. Correlating supplier selection criteria were direct cost savings and the supplier’s expertise in the buyer’s industry.
The second most frequently cited driver for outsourcing in ITO deals was a combined objective of upgrading service levels, quality, or production output along with reducing operating costs. In this scenario, the correlating supplier selection criteria were technology innovation and the supplier’s process expertise.
BPO deals. The top driver for outsourcing in BPO deals was a combined objective of reducing operating costs and upgrading service levels, quality, or production output. The correlating top supplier selection criteria were the supplier’s process expertise and expertise in the buyer’s industry.
The second most frequently cited driver for outsourcing in BPO deals was a combined objective of integrating disparate processes and systems, along with reducing operating costs and avoiding needed investment. The correlating top supplier selection criteria were the supplier’s reputation/previous experience and the level of service offered.
Looking at BPO deals further segmented by process, the study found that drivers and selection criteria varied among processes as follows:
- HR deals. The dominant reason for outsourcing was to gain the ability to focus on the core business. Integrating disparate processes and systems followed as the second top driver. The supplier’s reputation and its capability to achieve an overall strategic business impact tied as the top selection criteria. The supplier’s relationship style was cited as the second most important selection criteria.
- Finance & Accounting deals. Cost reduction was the number-one reason for outsourcing, followed by a tie between impact to long-term strategic business objectives and integrating disparate processes and systems. In F&A deals, the supplier selection criteria most often cited was a tie between the supplier’s process expertise and the level of service it offered. In second place among selection criteria was direct cost savings.
- Procurement deals. Impact to the long-term strategic business objective along with business transformation were the top drivers for outsourcing procurement. The top supplier selection criterion was demonstrated best practices, which was followed by the supplier’s expertise in the buyer’s industry.
Lessons from the Outsourcing Journal:
- Evidencing a trend, the 2007 Outsourcing Excellence Awards study in 2007 found that buyers ranked cultural fit and relationship style as equal in importance. Further, the study found that cultural fit and relationship style were ranked higher as supplier selection decision factors in BPO deals than in ITO deals.
- Where cultural fit is included among supplier selection criteria, it is often an extremely important factor and may rank among the top three criteria.
- The study found that BPO deals incorporated incentives in their service level agreements (SLAs) more often than ITO deals.
- Aggressive pricing was cited in the study as a significant factor in producing savings in both onshore and offshore deals
- A good strategy for ensuring the supplier achieves SLAs is to tie financial Incentives to achieving major milestones, especially where the parties perceive extra effort would be required to achieve them on time and within budget.
- Pinning penalties onto too many SLAs is counterproductive because it causes the supplier to focus on achieving a penalty-burdened SLA to the detriment of achieving an SLA without a penalty.
- A good strategy for using penalties in SLAs is to place a component of the penalty on both parties, in cases where the supplier’s ability to achieve the SLA is dependent, in part, on information or a process component that is the buyer’s responsibility.
- SLA penalties that are structured to enhance the relationship rather than punish the supplier do not assess penalties on a monthly basis, preferring to give the supplier time (usually three months) to resolve issues before paying a penalty.
- A best practice in relationship governance procedures is for the parties to hold a joint monthly SLA discussion and agree on what SLAs should be counted “in” or “out” if special circumstances are going on in either party’s company for that period.