Organizations that turn to outsourcing to achieve their business objectives first develop a business case that includes such components as cost savings and avoidance objectives, business value benefits, and risk assessment of potential negative impacts. But what happens when the initial business case stops working because of unanticipated impacts?
Both a Deloitte Consulting study and a PricewaterhouseCoopers study of several hundred executives found that more than 80 percent stated their outsourcing projects achieved their anticipated return on investment (ROI).* For the other 20 percent in each study, one or more components in the business case changed and the parties had to work through the issues or the buyer transferred the work to a different service provider or brought the work back in house.
Outsourcing Center studied how service providers and their clients work through the issues when the business case stops working. The 140 relationships in the study were successful outsourcing deals participating in Outsourcing Center's annual Outsourcing Excellence Awards program during 2009 - 2011. The study focused on these relationships because their origins began before the global economic crisis of the past three years and, presumably, the buyer and/or service provider's economic situation changed during the three years, thus impacting the original business case for one or both parties.
Factors that led to the business case not working and how to resolve the issues
Outsourcing Center found six factors that led to the business case not working. In some cases, it was due to mistaken assumptions at the outset of a relationship; in others, the impact arose from unexpected external events. Here are the factors and how some of the study participants resolved the issues and got back on track with their business case.
1. Resource allocation. The provider did not allocate enough resources to perform at required service levels because the buyer and provider underestimated the workload. This resulted in challenges around the provider being able to deliver the necessary volume of work. In other cases, the parties agreed up front that they wouldn't know the work volume for a period of several months, which might cause them to end up with unit pricing that was too low or too high.
- Discuss – in a constructive, non-blaming manner – how they could have done things differently on both sides to avoid the problem, and agree on how to manage such situations going forward
- Change the contract and pricing model so the business case works for the service provider to add more resources while still making its necessary margins
- Compromise in the current situation and split the cost of adding resources to get the work backlog caught up
- Agree up front (when work volume/resource allocation is unknown at the outset) to preserve the principles of the business case and contract when the time comes to adjust unit pricing
2. The buyer's business model changed. In industries undergoing rapid change (especially healthcare, telecommunications, energy, and financial services), the buyer may need to change its business model in order to stay competitive. Likewise, during difficult economic times, companies often revise their business model, sometimes discontinuing business units, products, and services. To reduce costs when an economy downslides, some relationships also look at process redesign, removing "value-add" components.
- Make sure the contract (up front, or in renegotiation at the point of the business case not working) is structured for flexibility around discontinuing or moving processes (or components/functions) in and out of scope.
- Make sure the governance structure enables quick access to top executives with the capability to revise the deal so the business case numbers work again and the relationship is still based on a win-win approach.
- Make sure the top priority in delivering services in the altered scope does not negatively impact customer satisfaction among the buyer's customers.
3. Multisourcing environment. When some components of a process are outsourced to other vendors, the provider's costs can increase due to not having control over those components when problems arise; and the provider passes the additional costs on to the buyer.
Solution: The buyer needs to remove the obstacles in communication and accountability among the various vendors and providers, allocating ultimate accountability to one provider.
4. Attrition. Attrition among the service provider's ranks can cause cost increases for both the provider and buyer as well as impacts to service level performance.
Solution: The parties need to jointly conduct a root-cause analysis to understand the reasons for the attrition and determine strategies for combating those situations. The solution may involve salary adjustments and different career-path remedies, and the parties need to discuss how to allocate the costs of the solution.
5. Changes to the pricing model. If both the provider and buyer's fiscal years do not match at starting/ending months, changes to the relationship pricing model can impact the provider's compensation and bonus structure.
Solution: Both parties need to collaborate on how to address the issue in a manner that does not hurt either in their fiscal-year results.
6. Changes in IT business-case assumptions. With today's pace of technology development and the impact of disruptive technologies, it is not unusual for the parties to agree up front on the IT systems the outsourcing company will provide but then the buyer change its mind within a matter of months. This obviously has major negative impacts on the provider's business case.
Solution: The parties need to renegotiate their contract, with both being fair and using an open-book and win-win approach.
The trust factor
The Outsourcing Center study also found participants cited mutual trust as being the basis for their ability to restructure their contracts, scope, and pricing model to align to the changed business case. As one study participant stated: "We had to first know we can trust each other before we could discuss things like service line termination without being concerned about the discussion negatively impacting the health and long-term intents for the partnership."
Where that level of mutual trust existed, several participants reported it enabled them to achieve the renegotiation in less time than they anticipated.
* Source: "Vested Outsourcing," by Kate Vitasek; PALGRAVE MACMILLAN 2010; p. 21