“If you look at most traditional outsourcing contracts,” says Ben Trowbridge of Ernst & Young, “there are a number of built-in conflicts of interest in how they are priced and how they are structured.” Trowbridge, who is responsible for the Services Market within Ernst & Young’s Operate Practice, says that equal sharing is not always possible in a typical outsourcing relationship.
One way to align risk and reward with the authority and accountability for achieving the risk and reward, he explains, is to use a joint venture structure for the client/vendor relationship. This outsourcing variant is a unique partnership where both parties share risk equally and both receive simultaneous rewards. It usually involves a world-class, best-of-breed supplier who spins out a buyer’s non-core infrastructure and/or processes to form a new company, which then provides services back to the client (which is also a joint venture partner) as a vendor rather than an internal department.
OneSystem Group LLC, formed in 1997, is a joint venture formed by Farmland Industries Inc. and Ernst & Young (E&Y). Although ownership in OneSystem Group is 50/50, a joint venture ownership of an outsourcer can be structured in a variety of ways to achieve the parties’ objectives. The first of five such E&Y joint ventures, OneSystem Group has reengineered operational and business processes at Farmland and remains the prime example of this unique structure.
How OneSystem Group Was Born
Prior to the joint venture, Farmland, which is the largest farmer-owned cooperative in North America (comprised then of 1,400 local co-ops), had a fairly traditional IT department. E&Y began working as a consultant on Farmland’s strategic transformation, by implementing an SAP platform. The organization lacked access to traditional capital markets, due to its co-op structure and the vast number of non-integrated computer systems among the various business units. Trowbridge comments, “Kent Nunn, the CIO of Farmland (who became president of One System Group), had built an efficient organization. This was not an organization in trouble. They just wanted to go to the next level in gaining leading edge technology and expertise over the long term, yet control IT costs.”
E&Y had determined that it differentiates itself in providing outsourcing services by taking the best of the behaviors of the consulting environment and the best of the outsourcing world and blending them together. That blend, the company believes, gives it a competitive advantage. When it then began looking for a structure to use in actually doing business with a customer, the joint venture legal model was determined to be preferable “because we share the management of an operation with the client,” Trowbridge explains. “Fundamentally we, like the client, are betting that it will work, because the way E&Y makes money is through the dividends created out of the joint venture.” Since the client recognizes its savings through the dividends at the same time, the client and vendor’s interests stay aligned.
When Farmland decided to form a strategic relationship with E&Y, the first step was to consolidate the IT functions and form a consolidated management team for the new company. There are two types of legal agreements involved in forming OneSystem Group. The first is a series of documents that forms the company, including an operating agreement. The joint venture company that was formed then signed a services contract that provides services back to Farmland. Farmland signed two sets of documents–one as an investor in the joint venture, and another as a customer of the joint venture company. “That document looks a lot like an outsourcing agreement,” Trowbridge says. “It has service level agreements and penalties and all those sorts of things. But in a joint venture, you don’t worry as much about penalties and some of those elements because you are not just a client–you have equal control over the joint venture.”
Another big benefit of using the joint venture structure is that an entirely new company–with an entirely new culture–is created. Often, a buyer’s and supplier’s corporate cultures do not match well. In creating OneSystem Group, world-class services would be delivered to Farmland, yet the culture would be designed for Farmland’s needs.
Collaboration Instead of Gridlock
Trowbridge says E&Y now uses the joint venture structure in about half of its outsourcing relationships. “This structure makes sense in a collaborative environment where the client understands that they and we are probably strongest when we share and collaborate in the way we approach the relationship,” he says.
A joint venture’s board of directors is a far more efficient way to manage a relationship, he says. He contrasts this structure–where both parties’ goal is to achieve dividends of the joint venture (through successful delivery of services to the client)–with the management structure of a traditional outsourcing relationship. “In that case, the buyer has somebody managing the contract, and the supplier has somebody managing the contract. They are on opposite sides of the table, and they have separate incentives and separate bonus programs,” explains Trowbridge. “They often work at cross purposes, trying to manipulate each other a little bit to achieve goals.”
“But,” he adds, “if you take those two same people, put them inside the same company, give them the same bonus and the same set of goals, and a board of directors that decides what they are doing and whether or not they get their bonuses,” he says, “it is amazing how a lot of walls of communication are broken down. They are no longer on separate sides of the table. With a joint venture structure, everyone is focused on the same issues.”
In the traditional contracting process, parties often spend a lot of time trying to contract around the fundamental issue of the buyer trying to offload the risk onto the supplier and still wanting a lot of control. It creates conflict that often results in gridlock. To give the risk away, he says, “you have to say, ‘Here is the wheel of our ship. It’s your call.’ The joint venture structure, on the other hand, is a way to offload the risk–to a certain degree–and yet keep some measure of control.”