The winner of an RFP often suffers what is sometimes known as the winner's curse: overpaying for the object purchased. The consumer either hyped up the value of the item, became too emotional or simply was not as intelligent as they could have been in the process. BPO and ITO Outsourcing share in the buyer behaviors around this problem
This article examines how the winner's curse applies to the outsourcing industry, why it is trouble for both the customer (the company planning to outsource a function) and the service provider, and what the outsourcing buyer ought to do to avoid this pitfall.
The Winner's Curse in Outsourcing
Outsourcing is often the result of a bidding process, in which the potential buyer writes an RFP (Request for Proposal) and then accepts sealed bids from a few service providers. Based on pricing, sub-services offered, and other criteria, the purchaser invites a short list of two or three providers to a round of negotiations in which the buyer of these services, or the buyer's adviser, seeks to extract the desired services at the lowest price. We at the Outsourcing Center have some clear views on how do this more effectively.
At first glance, the three to sixteen percent margins in many areas of outsourcing, and the correspondingly low return on capital employed (ROCE) of most massive service providers, would point out that this process works to perfection - for the buyer of these services at least.
The rest of this article focuses on helping buyers like yourself keep away from the winner's curse. Although it contains many unique recommendations, there are two main points:
- Choose your provider primarily based on a combination of price, best fit, and quality – not just price alone - Be skeptical of the price forecast made by the provider primarily based on an RFP that may be incomplete and not necessarily reveal all opportunities and potential issues. Is it plausible and based on actual expertise? It has been our experience that shopping for based on a very low forecast of costs without additional investigation can be foolhardy.
- Build a sustainable deal - Outsourcing contracts are typically 3-to-5-year deals nowadays. Thus, it is imperative to build a correct deal that is sustainable over time in the face of dynamic changes, both technological and organizational. Transparency is key to lowering risk, aligning interests, and improving adaptability. We have found that a lack of transparency is a leading reason for the winner's curse. The logical first step in building a long-term relationship is to decide which provider has the ability to provide these services also meeting the challenges for buying the outsourcing in the first place. By focusing on the varying strengths any particular provider has, a buyer and service provider can work collectively to shape a mix of services that is both low price and tailored to meet different aims.
Choosing the Right Service Provider
The key to selecting the correct service provider is to put in place a method that stresses collaboration as frequent interaction to leverage its expertise to the benefit of both parties. This implies first setting clear parameters and then evaluating each provider's ability to meet the buyer's needs.
- Building a sustainable deal: Several outside forces (e.g., a sales executive needs the win, or a provider says they do more than they actually provide) can move the industry into a commodity approach that, from time-to-time, is too aggressive and unrealistic in terms of pricing. When this happens, the service company may commence to upcharge the buyer on every little thing that comes through. A sour rapport and a lack of any innovative mentality results. To construct a real relationship, buyers need:
- Alignment of interests: While contracts are essential, they are no longer sufficient. Win/win relationships allow the consumer and provider to work together to enhance the services furnished to the benefit of each. Put economic incentives in place to penalize bad performance or reward results above targets. And know how your provider will evaluate their own economics of delivering your contract.
- Transparency: Outsourcing relationships are by way of nature complex. Additionally, due to the length of most contracts, they should be flexible. Transparency can reduce the dangers for both aspects and provide a foundation for adding/changing services over time.
- Strong governance: There are two regularly neglected elements of governance. First, disciplined adherence to the model. Buyers must measure metrics, shut any performance gaps and have executives oversee the relationship. Second, consider the application of newer technologies like Chat GPT AI and process upgrades to create additional value.
- Understanding the sources of leverage: When the customer and service company jointly structure a solution primarily based on goals and strengths, they set expectations for their relationship at the same time, and a high-level plan for satisfying those objectives.
Focusing on a long-term win/win relationship can ensure that buyers actually seize the benefits they were looking for at contract signing.
Avoiding the winner's curse should not mean buying the cheapest or from the one with the best sales pitch. Instead, we advise buyers to be aware of the complex, long-term nature of outsourcing relationships and the barriers of any contract. Choose your service provider-based leverage points and then build from that a relationship that maximizes value and enables a long-term partnership. And engage a 3rd party like the Outsourcing Center to help you through the process and drive a sustainable outcome that drives real value.
About the Author: Ben Trowbridge is an accomplished Outsourcing Advisor with extensive experience in outsourcing and managed services. As a former EY Partner and CEO of Alsbridge, he built successful practices in Transformational Outsourcing, BPO, IT Outsourcing, and Cybersecurity Managed Services. Throughout his career, Ben has advised a broad range of clients on outsourcing and global business services strategy and transactions. As the current CEO of the Outsourcing Center, he provides valuable insights and guidance to buyers and managed services executives. Contact him at [email protected].