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Why Focus on the Value of Contract Terms?

Being able to identify, estimate and articulate the business value of the contract terms in an outsourcing agreement can help you to:

• Make smart choices between lower prices and better contract terms.
• Balance the desire to “get it done now” against the value of “doing it right.”
• Invest appropriate amounts of time and resources in drafting and negotiating contract terms.
• Focus negotiating energy on the high-value contract issues.
• Describe to your leadership why it is worth investing in contract terms and how your negotiating success created value for your company.
• Achieve better results for your company.

The value in contract terms is in securing commitments, obtaining options, aligning incentives and supporting a successful relationship.

Securing Commitments

Contract terms can help to secure a commitment to provide specified products and services at firm prices. That commitment may include contract terms such as sweep clauses, service warranties, rights to make immaterial changes without additional charges, continuous improvement obligations, “all-in” pricing, audit rights, and a clear and complete definition of scope.

Without these contract terms, the pricing is more of a forecast than a commitment. Customers without these contract terms often find themselves compelled to sign change orders and pay unexpected charges to avoid going without vital services.

To estimate the value of one of these provisions, multiply your best estimate of the amount that the supplier could increase charges by exploiting its proposed provision by the probability that the supplier would choose to increase its profits in that way.

Obtaining Options

Contract terms can provide the customer options to, for example, obtain out-of-scope services at reasonable prices, in-source or re-source, change technical or operational requirements, impose reasonable rules and restrictions, relocate customer facilities, change customer technology, adjust prices through benchmarking, have services provided to related companies (including divested companies), terminate the agreement or obtain additional services such as M&A support or termination assistance services.

Options are valuable because they reduce the size and risk of charges for changes; their value increases with the volatility of the markets, which seems to be on the rise. Customers’ financial models tend to overlook the value of options because those models assume that all will go as planned—an increasingly unlikely possibility.

A straightforward approach for calculating the direct economic benefit of an option is by estimating the probability of exercising the option and multiplying that by an estimate of the economic benefit achieved by exercising the option. For example, if the supplier agrees that a termination-for-convenience charge will be reduced by $1 million if related to a change of control, and you estimate a one percent probability that you will terminate related to a change of control, this calculation would be 0.01 x $1,000,000 = $10,000. If you can obtain that provision for less than $10,000, it would be worth obtaining. Scenario analysis, Monte Carlo simulations, the Black-Scholes option pricing model and similar tools can provide better estimates, but even a simple estimate provides better guidance to economic decisions than ignoring the economic effect of contract terms or merely calling it out as a risk.

Another approach to looking at the value of options is to look at whether your business can survive without the ability to change the outsourced part of its operations. As Charles Darwin put it: “It is not the strongest of the species that survives, nor the most intelligent that survives. It is the one that is the most adaptable to change.”

Aligning Incentives

Contract terms can increase incentives for the supplier to act in the customer’s best interest. Contract terms such as service level credits, deliverable credits, holdbacks, obligations for the supplier to correct its errors at its cost, and indemnities against harm caused by the supplier support a successful relationship by aligning the interests of the supplier and the customer. These incentive provisions can also mitigate potential losses by requiring the supplier to pay some of the customer’s losses.

The value you place on incentives depends on your estimates of (i) the value of achieving your desired business outcome, (ii) the supplier’s ability to help you achieve that outcome, and (iii) the strength of the incentive. These estimates require judgment, so a good approach is to collect and aggregate estimates from people whose judgment your company trusts.

The strength of the incentive depends on its size relative to the supplier’s cost of achieving the desired result. Like you, the supplier is looking at the cost versus risk. For every $1 that you want the supplier to invest in reducing a risk by one percent, the supplier should have at least $100 at risk. Any less might make the potential liability more of a cost of doing business than an incentive.

Supporting a Successful Relationship

Contract terms can also support a successful outsourcing relationship by:

• Building trust. Trust increases when companies are willing to translate their communications into enforceable legal obligations. It is further increased when the contract terms make the two companies, to a degree, accountable to each other as “partners” in sharing the risks and rewards of operating the outsourced scope. Trust allows companies to work seamlessly together.
• Creating alignment on how to work together. Sourcing contracts create complex, multi- faceted relationships. Agreeing on how to work together allows these relationships to succeed across company boundaries. For example, reporting, governance and information rights simplify the communication process; agreeing on how work will be added or removed reduces the friction at important points in the relationship. Issue management and escalation provisions make it easier to resolve disputes.
• Giving you an understanding of where and how the supplier will provide the products and services. Contract terms can help you understand your entire supply chain. For example, they can help you understand which subcontractors will be assisting the supplier and what new risks have been introduced (location, handoffs, labor type, disruption, publicity, etc.).

These contract terms are important to obtain the benefits of the commitments, options and incentives obtained in other contract terms. Their value can be estimated using the tools and ideas described for commitments, options and incentives.

Summary

• The ability to identify, estimate and articulate the business value of the contract terms in an outsourcing agreement leads to better agreements.
• Contract terms provide value by securing the commitment to defined services for a fixed price, providing options, aligning incentives and supporting a successful relationship.
• You can estimate the economic value of contract terms and in doing so help your contracts and your company be more successful.

I speak at conferences all over the world including world-class events hosted by Sourcing Interests Group (SIG) and IAOP. All three organizations are doing great work for their memberships on both the buy and sell side of the outsourcing transaction.

Here are my observations from this interesting event in New Delhi; they are a guide to today and a prediction for tomorrow.

First, the composition of the attendees at NASSCOM was breathtaking. NASSCOM is all about power networking with provider players who are currently in the glow of 18%+ growth. Almost all India-based providers had their CEOs for BPO in attendance or, in some cases, their CEOs. All stayed for the full event and spent tons of time briefing consultants such as Alsbridge and networking with each other to cross promote and drive the India brand. I never see this type of concentration anywhere else in the world. I think this may be one of the hidden drivers to India, Inc. growing from the force of the invisible hand of NASSCOM.

Also in attendance was an adoring India press that sees outsourcing from the opposite side of the world. They published huge columns all week focusing on NASSCOM predictions and growth issues.

No one seemed to care that no enterprise buyers were in attendance; in fact, the attendees seemed oblivious. If I went to one of the U.S.-based events and it had this attendee mix, the event owner/organizers would be in the restroom committing Seppuku ritual suicide for the shame of it all. Their direct reports would be waiting outside to follow them. At the U.S.-based events, attendance from enterprise buyers is key because provider attendees care for one thing – the opportunity to meet clients. A lack of such attendees would be a death knell for the event. In a surreal contrast, at NASSCOM the provider attendees took no notice – they were there to discuss macroeconomic issues, ways to work together for mutual gain and how they could improve service delivery to their clients. The dynamics of NASSCOM are truly impressive, and western providers would do well to take note.

Focus on Value and Rapid Growth

Industry legend Vikram Talwar (founder of EXL and one of my former E&Y partners) gave an amazing keynote speech. He pointed out a number of issues the sourcing industry must contend with, which included an exhortation to “stop the price wars” and focus on value.

Alsbridge’s analysis is the Indian providers will have trouble doing this because they rely on their own “experience-based” price benchmarks that are flawed and will result in constant low-ball pricing ahead of market need. Buyers, however, will gain from their passion for costly 18% growth.

Matching the current 16-18% growth rate in BPO and slightly lower for ITO was a huge topic for the attendees. Failure here is 12-15% growth. (!!!) Some providers with specialization by industry or function are optimistic that they can beat this year’s market prediction. Those without a specialization seem to be replacing the head of BPO and retrenching their strategies.

Benchmarking 2012 Pricing Changes

Alsbridge was the featured speaker on predictions for price changes in 2012. Our keynote slot was well attended, and everyone took copious notes. Providers were there to get a grip on where prices will be over the next 18 months. Alsbridge, through our ProBenchmark database, has seen FAO prices reduce by five-seven percent on a like-for-like basis over the last 12 months and forecasts this rate to slow to three-five percent over the next 12 months. However, the range of current prices for individual roles varies greatly, reflecting the lack of market standards for labor rates (see the recent ProBenchmark pricing trends webinar for more information). It was clear that Indian-based providers are struggling to control their constant price war mentality due to their reliance on internal price benchmarks. At this point, under pricing is their biggest challenge.

Some niche BPO providers are starting to gain scale in focused segments such as healthcare, analytics and knowledge management. Look for interesting value propositions in 2012 for segments of BPO not fully addressed in the past.

Account leadership gaps were one rumble I heard at NASSCOM. It sounds like many major providers are starting to have trouble staffing leadership positions as fast as they are selling new business. Training the next generation is now a significant problem that they need to address or India, Inc. will run out of steam.

Service management remains a challenge for many providers. With the 800-pound gorilla of growth and an amazing pool of India-based talent, you have to be inept not to make money in BPO. The economics are too overwhelming to not turn a profit. But as costs slowly creep up, providers could be looking at a less rosy picture by 2013, especially if currency exchange rates materially go the other way and there’s real local salary inflation.

How should you prepare for the future?

What does this mean for enterprise buyers? The India-based providers remain high quality and are focused on winning your contract since their business development efforts will remain strong for the foreseeable future. If you engage properly, you can plug into a great wealth of talent at an effective cost point. Fail to engage right and you take unneeded risks.

Western-based providers are facing a determined competitor intent on continuing that 18% growth. Given the western-based locations for your front offices with their infrastructure and sales costs, you need a competition strategy that is focused and differentiated.

India-based providers: It warms my heart to see intensity, passion and commitment result in high growth. But you could be entering an era similar to EDS in 1995, where talent development began to fall behind their years of growth, account management shortages developed quickly and the buzz reputation of über deliver no matter the cost quickly cooled and stalled. Talent growth in complex areas of need and a variety of other factors slowed and then stopped EDS’s unstoppable freight train of growth. HP acquired the provider in 2008. How will you prevent repeating history?

Stay tuned for our next Alsbridge ProBenchmark update.

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Despite the fact that our mothers taught us to take responsibility for our actions, in the complicated relationship pas de deux that is outsourcing, we tend to feel that apologizing and making reparations is not the way to deal with the other party. Despite protestations of partnership between provider and client, our tendency is to frame outsourcing relationships as a constant you win, I lose. If we let the other party have the so-called upper hand in the relationship, we frankly think that we are abdicating terrain, to use a military term.

The prevailing governance structures superimposed on outsourcing relationships don’t foster an admission that sourcing will go wrong from time to time. Governance as we practice it today is predicated on the concept that perfection is a given, and any and all mistakes are a major screw up. The health of the relationship is boiled down to a green-yellow-red scorecard. Obtain as many greens as possible permitting an occasional yellow to demonstrate a degree of humanity is the goal. It’s a game that leaves no room for, and ascribes no value to honestly admitting to a good, old-fashioned screw up.

But in any endeavor, driven by either humans or technology, there is no such thing as perfection. Taking responsibility for a snafu is painful, but it signals that you live your value statement to the injured party and your employees. But it is not enough to apologize when you think sufficient time has passed, waiting until the injured party has moved onto other concerns and has enough perspective to brush the infraction off. It is necessary to act immediately and with sincerity.

Without sincerity and, depending on the context, either a willingness to take on responsibility for the problem or meet the other party at least half way, there is no apology. Unfortunately the concept of amnesia does not exist in a sourcing relationship; the damage caused by empty gestures just festers over time.

A little bit of penance is always helpful. Remediation is good — a bit more “give” than absolutely necessary indicates that the severity and impact of the fault is understood, and that the transgressors take it as a first principle to act in good faith.

Saying we screwed up actually earns the erring party relationship credibility over the long haul. While the short term impact—additional cost or delay, a plethora of sharp emails and calls, perhaps a closer rein on decisions, and greater supervision—is painful, over time, a straightforward admission of responsibility pays off in a better working relationship, deeper trust, and an overarching belief that the parties will always strive to act in the best interest of the partnership. Admission of guilt also builds employees’ faith in the errant company and its leadership, and teaches lessons about customer service and value.

Next time you think that the course of true outsourcing relationship should always run smooth, think again. But saying you’re sorry can go a long way.

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Q. Outsourcing pricing models and contract vehicles have evolved over the past few years. How much change will we encounter in contracts and pricing models in the next few years?

Partha D. Sakar, Global CEO, Hinduja Global Solutions: Over the next five years, it’s likely that traditional outsourcing/sourcing models, services delineation, governance and, most importantly, the expectations of clients will look far different than what we’ve become accustomed to. In fact, we believe new words and concepts will arise in the global sourcing lexicon. These will reframe the discussion, reframe the client/provider relationship, and reframe the idea of what being a good and valuable partner truly means.

Abid Ali Neemuchwala, Global Head, TCS BPO Services: Service providers will have to become strategic partners, or they will fall by the wayside. Strategic partners will start delivering in truly flexible pay-per-use models, leveraging IT and PO synergies from best-in-class technology and processes bundled together. Coupled with this, strategic partners will increasingly need to provide business analytics and insights that buyers can leverage to grow their business.

Angela Hills, Executive Vice President, Pinstripe: We predict that flexible pricing models will become more standard and accepted over the next two years. With the new technologies that providers are developing on a consistent basis (such as the rapid change in the marketplace for social media and related technology tools), BPO providers won’t be able to predict pricing for 12 months out, and buyers will have to be open to considering flexible pricing models. The mindset will have to move from one of a fixed 12-month pricing model to one that is revisited twice a year or perhaps even once a quarter to ensure that clients remain nimble enough to meet changing market conditions.

Q: What is driving the change in pricing and contract models? Is it due more to economics or to the need for agility?

Joanne Olsen, SVP, Oracle Cloud Services: There will continue to be pressure on the providers for lower cost and more flexible pricing contracts as companies come out of the recession.

Gene Byrne, General Manager, F&A and SCM Solutions, North America, IBM: Long-term economics will drive decisions outsourcing buyers make over the next two years. However, buyers signing five- to seven-year agreements need to approach their outsourcing engagements with the consideration of continuous improvement over the term of the contract. The tendency to focus on short-term cost savings and labor arbitrage certainly helps satisfy the immediate need, but a balanced approach that includes an eye toward innovation will deliver considerable additional value over time.

Sharad Sheth, Director, BPO Capabilities and Enterprise Administration Services Leader, HP Enterprise Services: The change in models is due to market conditions that increasingly pressure companies to contain costs and protect capital. As service providers, we need to offer more buying options with greater visibility and control over expenses.

Q. Please describe an example of such an option.

Sheth, HP Enterprise Services: In applications, for example, pricing options for tiered levels of service give companies more control over costs. This flexible pricing enables them to choose higher service levels for critical applications and lower service levels for less-strategic applications. Prices for these scalable services are predictable. This also extends to infrastructure. A suite of managed services, for example, delivers modular, standard packages with predictable pricing and rapid implementation for a faster return on investment.

Joanne Olsen, SVP, Oracle Cloud Services: Another example is the on-demand model. It provides flexibility through annual options to terminate a contract without any termination penalties. This model usually also offers different service/pricing levels from which companies can choose. A service provider with this model can also offer flexibility for scaling up and down the scope of services (such as adding or subtracting compute or storage capacity) or moving between deployment models (such as to remote management of a data center).

Kevin Schatzle, President, Allied Digital Services: Ultimate flexibility in pricing will come with the cloud model. With op-ex monthly subscription-based models, companies can adjust services up or down to respond to their growth and shrinkage. This model also makes it easier to assign costs to the appropriate internal department. Virtualization, remote management tools, and Software as a Service (SaaS) licensing models will drive the change from cap-ex models to cloud-based delivery.

Q. What other possible changes in contracts and pricing will we likely see over the next few years?

Robert Pryor, Executive Vice President of Sales, Business Development and Marketing, Genpact: Organizations will continue demanding more flexibility in terms of resource and pricing variability as well as minimum resource planning and forecasting. They will also demand no/low minimum commitments and easy and low-cost exits from long-term agreements. In essence, service providers will need to address the demand for the pricing and other advantages of long-term arrangements with the ease and flexibility of short-term contracts.

Don Schulman, General Manager, Global F&A and SCM, IBM: In addition to cloud-based platforms and the move toward transaction-based pricing, industry benchmarking for standard pricing will enable additional transparency and add greater flexibility to BPO contracts overall.

Q. Benchmarking to be sure that an existing deal aligns with market offerings is an important activity. Are there enough benchmark data yet on outcome-based pricing and offerings?

Gene Byrne, General Manager, F&A and SCM, North America, IBM: A large portion of the early adopters of outsourcing are coming up for renewal in their existing contracts. These companies, along with new outsourcing buyers, need to spend the time to understand their current cost drivers and how far the outsourcing market has evolved.

These organizations need to recognize that the landscape has changed significantly over the last five years and that many of the drivers and objectives have evolved, especially due to the recent economic climate. Benchmarking at a granular level is now available and offers companies the opportunity to create an “art of the possible” road map towards top best practice adoption, ultimately enabling outcomes-based pricing. Buyers will do themselves an enormous disservice by not investigating recent market developments and the capabilities that now exist to sustain their business in the long term.

Q. Service providers have talked about outcome-based solutions and pricing for a couple of years, but there has been little evidence of success. What is different now that will allow this model to succeed?

Swami Swaminathan, CEO & MD, Infosys BPO: Although providers and clients are keen to move to outcome-based pricing and we will see more of this occurring in the next two years, we believe the journey will be slow. Clients will need to get comfortable that the outcomes are rightly baselined so that they pay the service provider for providing superior results rather than paying for their past inefficiencies.

Rajiv Raghunandan, Practice Head – HRO and Sales & Fulfillment, Infosys BPO: The outcome-based pricing model creates a direct relationship between cost and business results; however, it often implies giving the service provider a very large part of the ownership of the operation and associated technology. For clients not comfortable with doing this, the transaction-based model is preferable to create a linear relationship between cost and revenue.

Abid Ali Neemuchwala, Global Head, TCS BPO Services: Buyers and providers have wanted to mature from the traditional effort-based model to transaction-based pricing as a first step and eventually to an outcome-based model. Lack of baseline data and an ability to define the true cost of a transaction have constrained the adoption of the outcome-based model. The increasing use of the “Process-as-a-Service” model means that buyers and providers can transparently move to a pay-per-use transaction pricing or output-pricing model.

Ritesh Idnani, COO, Infosys BPO: Linked to the demand for outcome-based models is the demand for “skin in the game,” where providers and clients share ownership in success or failure.

Q. Moving forward, are there any changes regarding intellectual property that buyers need to be aware of?

Rajiv Raghunandan, Practice Head, HRO and Sales & Fulfillment, Infosys BPO: We believe that knowledge management and IP is a very important but often underplayed aspect of flexibility in an outsourcing contract. Typically over the duration of a contract, the inherent process knowledge primacy moves from the client to the service provider.

Some providers are now focusing on reverse knowledge transfer (through designated process specialists) periodically to ensure that a certain component of process knowledge continues to reside with clients, thus allowing greater flexibility. Similarly, providers can document the use of tools and macros to aid productivity in order to ensure that any tool or technique that is based on a client’s proprietary knowledge will continue to be the intellectual property of the client.

Q. What will be the impact on currently existing contracts from the adoption of more flexible pricing models during the next two years?

Yugal Joshi, Senior Analyst, Everest Group: Service providers realized years back that they lost pricing power. Today, there is hardly any pricing differential when it comes to delivering pure outsourcing services. Therefore, the flexible pricing model may make the environment even tougher for the providers. The buyers may ask for a change of pricing as they gradually become comfortable with the pay-per-use model. However, this development will take significantly more time; hence, in the next two years, there may not be any material impact on existing contracts.

The buyer of outsourced services can achieve a comfort level that it’s getting what it pays for if it regularly monitors the provider’s performance against SLA specifications for such factors as accuracy, timeliness, regulatory compliance, customer satisfaction, etc.

Establishing SLAs in an outsourcing arrangement is critical, as it helps the buyer eliminate risks in outsourcing.

However, the fact is there are times in outsourcing relationships where the parties choose to proceed with a new initiative without tying it to SLAs. Is there an advantage to doing this that outweighs the risk?

We asked this question of the buyers participating in Outsourcing Center’s 2010 Outsourcing Excellence Awards program. Their responses provide insights into when it might be acceptable to move forward without SLAs as well as factors that lead to a comfort level in proceeding without SLAs.

Types of initiatives entered into without SLAs

The surveyed buyers stated there were types of situations that led to starting new initiatives or a new scope of services without SLA specifications for those services.

1. Side projects. The buyers cited this segment of situations without SLAs more frequently than any others. In these instances, the initiative was a small “side” project that was not part of the process already outsourced. Examples include testing a theory, helping to eliminate backlogged work in a function related to the outsourced process, or experimenting with a potential opportunity that arose from brainstorming.

In some of the side projects, the buyer and provider both discussed at the outset that they could potentially transition to pilot projects or to long-term services, but that was not necessarily a goal in lot of these projects.

One buyer addressed the risk factor stating that essentially there was not much risk in moving forward without an SLA in these initiatives because the buyer would “be in no worse situation” if the initiative didn’t produce the hoped-for outcomes.

2. Time to market. Coming in second place for most frequently mentioned, the buyers in this second group believed they had a unique opportunity and a great risk in not starting the initiative quickly; they felt it was too risky to delay it by taking the time necessary to negotiate SLAs. These initiatives were not for short-term services. They were usually something completely new and not associated with the outsourced process yet were similar to the work already outsourced. In each case, they intended to establish SLAs at a later point in time.

Several buyers commented that these kinds of initiatives were intended as “something we could partner on.”

3. Impact on the relationship. Similarly to the partnering aspect in the instances in #2 (time to market), the buyers in these situations chose to move forward without SLAs because they “didn’t want to be unfair” to their service providers.

In most of these cases, the initiative involved a new process with which neither the buyer nor provider had experience, nor were there industry benchmarks. As one buyer put it, “We didn’t think it was fair to ask our provider to commit to a service level blindly with no data points to back it up.”

A few were situations where the buyer had a mindset that SLAs imply a penalty approach to services and are associated with “managing a vendor” rather than taking a partnering approach and, therefore, should not be used in an initiative designed to enhance a partnering relationship.

Factors leading to comfort with not having SLAs

Without exception, trust was at the heart of the surveyed buyers’ comfort level in starting initiatives or a new scope of services without SLAs in place. Their responses included such statements as:

• “We are confident they are a partner with us and are working for our mutual benefit.”
• “We really understand each other and know we can trust each other.”
• “Our experience with them to date shows we can trust them.”
• “We know that they understand the quality we expect, so we know we can trust them.”
• “We trust them because we know they recognize it is in their best interest and their reputation to meet our targets and ensure we are satisfied with their service.”
• “They always take a long-term approach to our relationship, and they’re going to execute the way they always have, even if there’s not a piece of paper dictating what they have to do.”

However, trust is not blind faith, and in outsourcing it extends only to the level at which the providers have demonstrated their trustworthiness. Among the surveyed buyers, this characteristic was the same for long-term relationships as for relationships that had just completed their transition phase.

Despite their statements that they knew they could trust their providers, the surveyed buyers’ responses revealed their level of trust had limitations. Most also mentioned additional accountability factors that helped bolster their trust in moving forward without SLAs in place. For example, a buyer stated it put in place an audit process to validate all decisions the provider makes on the buyer’s behalf. Several established a base period for the initiative with a deadline beyond which they will cease operating without establishing SLAs.

Lack of SLAs should not mean lack of structure

When is an SLA not necessary in an outsourcing relationship? The answer from a buyer’s risk perspective is “never.” However, as pointed out in the examples described above, there are other perspectives and various contributing factors that lead some buyers to veer from that answer.

Negotiating SLAs can be an inhibiting factor. Several surveyed buyers related this happened in their relationships. In one case, they “stopped the SLA conversation in mid-stream” and decided they would work through the SLA later. This ended the constraints and enabled them to turn the conversation back to figuring out what they needed to do to meet their objectives.

Undertaking initiatives without SLAs can also yield some unwanted outcomes. In one situation, the buyer explained that there were several “exhausting” improvement projects that didn’t lead to any anticipated long-term results. “Since then, we don’t do anything that doesn’t have measures around it. What gets measured gets done,” said the executive.

Another buyer found that undertaking a project without SLAs resulted in unwanted outcomes and commented: “It was a stupid thing to do. It didn’t work out well. We certainly have had SLAs since then.”

One buyer executive spoke of the importance of having SLAs because there are a lot of initiatives and large scope in his company’s relationship, and the SLAs help ensure they still focus on areas that aren’t right at the forefront at a given time.

The bottom line? It’s important to note that, despite the lack of SLAs, the parties in the side-project, time-to-market, and relationship-mindset situations described earlier in this article wrapped some structure around their initiatives. They established roles, responsibilities, target milestones, and feedback/review sessions. In addition, some also established key performance indicators (KPIs) to measure their success.

John Funk, Partner, Morgan, Lewis & Bockius LLP; Doug Lippert, SVP, Operations Director, PNC Bank; Chris Hyland, Enterprise Operations Manager, OcÈ Business Services; Tom Moore, Enterprise Account Manager, OcÈ Business Services; Debra Floyd, COO, Outsourcing Center

Best Communication: PNC Bank and Océ Business Services

Awards Criteria: Both parties communicate proactively, honestly, candidly, and transparently, enabling them to work collaboratively to resolve issues, take advantage of opportunities, and ensure their interests remain aligned.

Talk about an outsourcing service provider going the extra mile.

Last year Pittsburgh, Pennsylvania, hosted the G-20 summit. Barbed wire defense barriers sprouted downtown. Armed guards patrolled the city. PNC, a bank holding company that currently has assets of $265.4 billion, has five branches downtown that had to remain open. “We had concerns that our internal part-time staff would not be able to overcome the transportation obstacles,” reports Doug Lippert, PNC Operations Manager. So PNC worked to develop proper incentives to ensure it had the proper staffing levels to service its customers.

PNC outsources its mail operations to OcÈ Business Services, whose employees are primarily full time but also include some part-time personnel. OcÈ’s staff, however, agreed to come to work at their regular wages. OcÈ brought in air mattresses for its staff so they could stay the night in case they couldn’t get home. “We wanted to make sure we could consistently meet and strive to exceed our service level agreements,” says Chris Hyland, Enterprise Operations Manager for the OcÈ/PNC relationship.

“We admire OcÈ’s relationship with its employees,” says Lippert. “The combination of quality management and developmental training was evident to all those at PNC Bank who interacted with their staff. It’s a good feeling their staff cares enough to be here to service PNC.”

The situation before outsourcing to OcÈ

Prior to this contract, PNC outsourced the mail function to one of OcÈ’s competitors. “Like any relationship that warrants change, there were issues with our existing provider that were negatively impacting our business. We knew we had to search for an alternative to improve our existing situation,” reports Lippert. “They didn’t manage their staff well, which forced us to manage them. This caused a lot of conflict between their staff and ours,” he recalls. Not meeting their service level agreements (SLAs) did not help either, he adds.

The bank, which has operations in 15 states and the District of Columbia, decided it needed to find a service provider that would bring professionalism and expertise in managing a part-time workforce.

The bank signed its contract with OcÈ in 1999 to do outbound mail processing for bank statements as well as shipping/receiving, distribution, and lockbox functions. Currently, OcÈ processes 110 million transactions per year and handles additional functions for 2,400 branches. OcÈ provides services for approximately 56,000 bank employees.

These seemingly mundane functions can generate a lot of emotion. Lippert says “PNC employees value their incoming mail and rely on its timely delivery. Our vendors need to understand our mail represents business-critical communications, which those who deliver it need to respect.”

Lippert also points out that statement processing is crucial to the bank’s success. “If the service provider does not perform its job well, it impacts us and our shareholders. It’s difficult to acquire new customers, yet it’s very easy to lose them,” he explains.

Why this relationship works: communication and appreciation

Lippert says the two “were partners from day one.” A decade later, he says he doesn’t view them as a service provider. “The OcÈ team is part of us and a valuable resource,” he says. “The gray line between us and them has vanished.”

The teams meet formally four times a year “to make sure we’re aligned and our future directions are still in synch.” That said, Hyland’s team speaks on a daily basis to insure it meets each client need.

When Lippert calls Hyland with a problem, the OcÈ executive “is relentless until he finds the answers for me,” says the PNC executive. Hyland says problems most often occur “because people make decisions they didn’t think out.” But the entire team works to fix them “because they understand that if one person puts this contract in jeopardy, it affects 300 families.”

“There is true transparency between the two teams,” Lippert adds. He regularly asks OcÈ executives to participate in print and mail strategy sessions. “If we are going through a strategic change that our employees are not aware of, I know that I can confide in Hyland and trust him to stay in lockstep with me,” he says.

Lippert brings OcÈ leaders to these strategic meetings “so there are no surprises and no chance for us to get out of sync as we move forward,” he explains.

Lippert says OcÈ has done everything his team has asked them to do, whether it’s in scope or not. “They tell us if they think they can do a process more efficiently. If our request is not a core competency, they tell us to look elsewhere,” he says. “I try to think of ways to keep the entire bank running as efficiently as possible within our areas of expertise,” Hyland explains.

Whenever there is a new technology in the industry, OcÈ executives schedule a meeting to discuss if there is any potential benefit to PNC. Lippert is appreciative that he learns about the possibilities from OcÈ before hearing about them through other industry sources. OcÈ is proactive in letting PNC know what is available.

PNC brings the appropriate subject matter experts to these meetings. “We have an open conversation on why it would or would not work in our environment. They allow us to pick and choose what’s right for us based on the timing and our budget constraints,” Lippert notes.

If the course needs correction, the two communicate about it. Lippert says the relationship was going so well he kept “putting Chris off” because he had larger issues to address. “I inadvertently became a communications barrier, which was hurting the relationship and placing a wall where one should not be,” says Lippert.

The two identified the problem and solved it by allocating a dedicated PNC employee to be the focal point for OcÈ. “We didn’t want to squash communication regarding any of OcÈ’s ideas because I was too busy,” Lippert adds.

Hyland, on his part, tries to get to know everyone on his team, including those working the night shift. “They felt no one paid any attention to them before,” he says of the people who are working at two a.m. “I can’t tell you how appreciative they are when I stop by.”

However, OcÈ doesn’t always win PNC’s new business. The bank wanted to outsource its quick-print centers. OcÈ bid on the work, but the bank chose another vendor because it didn’t think printing was OcÈ’s core competency. “They respected us even though they think we made the wrong decision,” says Lippert.

Once a year, OcÈ management treats PNC’s senior management to a Pittsburgh Pirates game. “For nine innings we all get together and talk about the direction of the company in an informal environment,” says Lippert. He believes fun social events are just as important as the semi-annual meetings to review strategies.

Hyland, who started on a part-time basis with OcÈ’s predecessor while in college, says the relationship works because of leadership’s “constant communication.” Over time, these relationship managers have become friends.

Results

Lippert says this relationship has had a direct impact on the bank’s competitive standing in its marketing because it “allows us to concentrate on what’s important to our customers and focus on our customer service. He adds increasing the bank’s ability to focus on its core business “has been our No. 1 achievement of outsourcing.”

OcÈ has continued to bring cost savings to the table over the 11-year relationship. “They continue to find cost-savings opportunities we would never have found ourselves. They have Six Sigma Black Belts who continue to look for ways to improve our process,” Lippert reports. OcÈ has also worked with the U.S. Post Office and pre-sort vendors to contain costs.

He says he manages many service providers, but OcÈ is the only one to achieve this level of excellence. “OcÈ’s culture is to save money,” he says. The savings go straight to the bottom line and, as a result, the bank has one of the best expense ratios in the industry.

The service provider monitors operations to cut costs. In one case, one of the bank’s major business customers was using a business reply envelope that did not qualify for a reduced bulk rate. OcÈ realized this oversight and found a solution that resulted in $365,000 in annual savings.

Outsourcing has also allowed the bank to avoid capital expenditures.

Lippert says the bank has been actively pursuing new business acquisitions to enhance the PNC brand and drive revenue over the last five years. Recently, PNC purchased another bank which effectively doubled its size. The bank brought in OcÈ’s senior management as soon as it made the announcement. “We shared our due diligence and asked them to assess the acquisition’s mail operations,” Lippert says. OcÈ delivered recommendations about reengineering the mailroom at no cost.

Going the extra mile

The weekend after the Pittsburgh Steelers won the Super Bowl, PNC’s president thought it would be a great idea to put a cookie on every employee’s desk to celebrate. “But they forgot to tell us about this and the cookies just showed up on our loading dock,” Lippert recalls.

The OcÈ team worked all weekend to distribute 23,000 cookies so everyone would have a cookie on Monday morning. “OcÈ had a problem but was not going to say no to anyone — especially the president,” he continues.

Another time, OcÈ replaced a piece of equipment that had become obsolete. The service provider negotiated price only after it had the equipment up and running.

Hyland says OcÈ has one business philosophy: ” We do whatever it takes to provide service to our customers.”

Going the extra mile at OcÈ starts at the outset of the relationship. Hyland says he thinks providers should work to start renewing the relationship the day after they sign the deal. “If you rest on your laurels, you are out the window.”

Transition and employee resistance

OcÈ built an employee experience training class that both teams attended. “The class brought to the forefront the fact that the outsourced employees were really a part of our team. It wasn’t us against them. That turned things around,” says the PNC executive.

OcÈ retained 85 percent of PNC’s existing employees because they were already familiar with the bank’s locations. Hyland says OcÈ hired 48 employees in Philadelphia to manage three locations and 68 employees to manage four sites in Pittsburgh. “We went back and forth between the two towns,” he recalls.

“I asked them at the outset to trust me,” Hyland says. Today, 60 percent of those original employees are still on the payroll. “To me that’s like winning the Triple Crown,” he says. He attributes this successful retention to “great communication.”

OcÈ then delivered 13,000 comprehensive site-specific “user guides” to share its message with every employee. “The guide answered questions that OcÈ anticipated PNC employees would ask,” Lippert says.

The phased transition started with taking over the management of the mail processing center in Pittsburgh. OcÈ wanted to move faster, but the bank “forced the team to take longer than they wanted to ensure they truly knew how to handle these transitions,” Lippert says. After two successful transitions, the bank allowed the service provider to move at its own pace. OcÈ currently manages all 10 mail centers from Pittsburgh to the New York metro area.

Lippert says there was virtually no employee resistance. “Our employees met the announcement with joy because they wanted the change,” he says.

However, employees, who had led an unstructured life, now had to do things “by the book” since the OcÈ team instituted its standard operating procedures. “Now we had to make PNC employees accountable,” Lippert explains.

End users had to get used to the changes, too. “We had to educate our internal customer base that the changes we made were actually improving their services,” says Lippert. His team posted a series of articles on the bank’s intranet to explain why the bank was changing the processes. Once they noticed a theme among the complaints, they published the articles online. OcÈ team members also created articles to assist Lippert.

Hyland reports OcÈ’s systems turned around the operations with the same employees. “The secret is that we got everyone on the same page,” he says.

Summing up, Lippert says OcÈ “doesn’t just show up and do a job. They always look to improve a process and find a more effective way. PNC management has come to rely every day on OcÈ’s good judgment, proactive thinking, and excellent service.” Adds Hyland, “We want to keep this relationship forever.”

That would be a good thing for both parties. OcÈ has been able to grow the account into other service areas. More importantly, the two organizations have partnered on a variety of industry awards as well as supporting other business ventures by providing each other with professional recommendations and references.

Lessons from the Outsourcing Journal:

• Buyers should compare prices to insure they are receiving the best cost every time there’s an acquisition and another service provider has been doing the work.
• Buyers need to get to know the service provider’s managers personally to build effective communication.
• Buyers should communicate clear expectations not only up front in negotiations, but also on a continual basis throughout the relationship.
• Buyers get better outsourcing results if they act as partners rather than dictators.

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