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Outsourcing Delivers Value Companies Demand

Compliance: Finance's Bridge to the Enterprise

Is Your Resource Commitment to Outsourcing Governance Sufficient?

In the old days (the Leave It To Beaver years), when a bride got married, she asked her mother to share her secrets to a successful marriage. Hopefully, Mom pointed out the mine fields so the bride could avoid the obvious errors.

Outsourcing poses a similar situation for both partners. The buyers, especially ones who have never outsourced a function before, really don't know what to expect in such an intimate business relationship. But sometimes even experienced suppliers stumble into the pitfalls.

Here at the Everest Group, we have a busy remediation practice. As the "marriage counselor" of souring outsourcing relationships, we've seen some universal mistakes. I'll discuss the 12 most common.

Common Mistakes Suppliers Make

Ignoring the Customer's Unique Needs

Tier 1 suppliers - CSC, EDS and IBM - are outsourcing providers who have repeatedly demonstrated their integrity and ability to get the job done. In many cases, few competitors can do the job if it requires global reach. Tier 1 suppliers know this.

These advantages make them confident about their skills and knowledge. Because of that, Tier 1 suppliers have a tendency not to listen closely when their prospects tell them what they want. Instead, they tell their customers how to do things. Bullying buyers into doing things their way results in higher prices or an inflexible contract structure.

Often, Tier 1 suppliers fail to take the time to understand the nature of this sale because they feel they don't have to. But they do have to. They have to focus on what creates value for each customer.

The behavior of the sales staff sometimes gets in the way. Tier 1 salespeople mistakenly view the sales process as a game that must be won or lost. With this mindset, their salespeople often focus on gamesmanship rather than the unique needs of their prospects. They tend to get lost in their own rhetoric. They forget all the customer wants is an outsourcing provider who can do the process better than they can - and cheaper than everyone else in the selection process.

Some suppliers who are not in the Tier 1 category represent the flip side of this problem. They often feel insecure about not being in that august league. They worry about their size. They fret they don't have global reach. They fixate on their perceived shortcomings which creates a defensive posture and diverts attention from the reasons why they may be the best supplier for the prospect.

Sometimes this results in destructive behavior. A defensive attitude reinforces the customer's view that you are not the supplier for them. We have seen very capable suppliers virtually disqualify themselves because of their insecurities, not their abilities. Remember, the customer has enough of its own insecurities during this highly emotional decision-making process. Adding your own needlessly complicates the transaction.

Ironically, both behaviors have the same effect - focusing on the sales process rather than on the customer's specific needs. The Tier 1 players do it out of arrogance and the others do it due to insecurity. Once a supplier is able to put aside its own baggage and meet the customer on its own terms, it becomes more successful in the sales process.

Ignoring the Importance of Leverage

One of the biggest business benefits of outsourcing is the ability to use leverage. This is where the supplier creates value for the buyer. Suppliers must structure their transactions to accentuate the value they create through leverage.

We see the most successful and prosperous outsourcing relationships occurring when the supplier has clear and unambiguous responsibility for a process. As I explained in detail in my book, Turning Lead into Gold: The Demystification of Outsourcing, suppliers must clearly explain the importance of leverage to their prospects. These advantages include:

• The access to scarce resources.
• The ability to substitute cheaper resources for expensive ones.
• Process expertise.
• Access to capital.

Buyers are the most satisfied and get the best value for their dollars and suppliers are able to make above-average returns when leverage is part of an outsourcing relationship. When suppliers have articulated responsibility, neither side wastes time arguing over disputed areas of the contract. And these are the relationships that grow because they engender trust. Neither side feels the other partner is trying to take advantage of them.

Prospects must understand the value of leverage and how it will help them in their outsourcing relationships.

Avoiding Accountability

Having a supplier responsible for a process is core to my definition of outsourcing. Suppliers stress accountability during their initial negotiations. But in reality the sales contracts and governance documents say, "Trust me."

Suppliers try to shirk responsibility because responsibility means risk. They will do whatever they can to legally remove that risk. Shirking responsibility typically happens when the customer refuses to ink a flexible contract. Examples include contracts with long terms, unclear boundaries or metrics that aren't objective.

That is a short sided view. To paraphrase P.T. Barnum of circus fame, "You can't fool all the customers all the time." The supplier rarely benefits in a manipulative relationship. Without risk, the benefits of an outsourcing relationship are destroyed over time.

Ironically, the vendor increases its risk by avoiding risk. If the buyer remains accountable for the process, it can dictate to the vendor how it wants things done. This is always a recipe for disaster.

It's human nature to attempt to maximize a relationship in your favor. The way to maximize an outsourcing relationship is to have the vendor align its interests with the buyer. That way, when the supplier makes a move to maximize its process, the move helps the buyer, too.

Sending in the "C" Team to Manage the Account

After the "A" sales team inks the sale and goes on to wooing the next prospect, the vendor sends its "C" team to manage the new account. Historically, vendors have rarely invested top resources in account management. This is a mistake because outsourcing is like a marriage. The vendor has to work every day with its customers to make an outsourcing relationship work. Ignore your customers and they will react like a spurned spouse: dissatisfaction and disappointment lead to animosity.

Suppliers also make the mistake of paying the account manager a bonus solely on the profitability of the account. This creates predictably dysfunctional behavior. The manager optimizes the account in the short run at the expense of the long term relationship. The manager can't afford to make investments in the process, for example, because that expenditure will negatively impact his current bottom line.

It's far better to create a more balanced scorecard when determining performance bonuses. Add customer satisfaction and relationship flexibility to profitability to determine if a manager should be rewarded.

Buyer Mistakes

Relying Too Much on Executive Contact

Once they have decided to outsource, buyers are usually in a hurry to get the deal done. To put the transaction on the fast track, the two groups of executives get together, shake hands and let the next level work out the nitty gritty details of the relationship.

At the Everest Group we encourage people to complete their transactions as quickly as possible as long as they are done in a thorough manner. Outsourcing relationships create substantial value for the buyer; months of wrangling over the details eat up the desired cost savings.

But it is imperative for both sides to complete a comprehensive review. Outsourcing is closely akin to mergers and acquisitions. Buyers are divesting a process they currently own which includes the transfer of both assets and people. For this reason, buyers must involve various elements of the company. Top level executives are rarely enough.

My grandfather told me, "Marry in haste. Repent in leisure." I see no need for a year long engagement. If a company is in a hurry, hiring an intermediary like the Everest Group can ensure a quality transaction in a minimal time frame.

Letting the Supplier Lead the Process

This mistake is the most common outsourcing mistake and the most deadly. The essence of outsourcing is the buyer transfers the process and buys results.

The quickest way for a buyer to destroy the value of an outsourcing relationship is to dictate how the process is to be done. By definition, the supplier should be an expert in the outsourced process and better at it than you. When buyers tell their hired experts what to do, they are removing the ability of the supplier to add value to the process. And they are erasing the supplier's accountability. That results in higher costs and lower quality services. All these factors combine to make the relationship bad for both sides.

The best way for a buyer to fix this problem is to know exactly what it wants before it begins the outsourcing negotiation process. The buyer's team must know why it will benefit from outsourcing and what its leverage points are. For example, in an IT deal, is the buyer transferring application support or just the infrastructure to the outsourcing supplier? The buyer must make these decisions, not the supplier.

Intermediaries like the Everest Group can clearly and unemotionally help buying organizations think through the requisite structure of their relationships including:

• The required level of accountability.
• The boundaries and the scope of work.
• Service level agreements to measure the results.
• Guidance in how to govern the relationship.
• Dealing with the transition.
• The pricing structure.

Each of these items has its own idiosyncrasies. Intermediaries ensure buyers lead the discussion. Even more important, they work to align the buyer's interests with the vendors' - the clearest recipe for outsourcing success.

Paying By Problem Resolution

Customers often push to pay their suppliers by problem resolution. While this sounds like an elegant solution, it is really a short-sighted approach. Buyers paying only to fix problems are giving the supplier no economic incentive to correct the systemic, underlying causes of those problems. It's like a physician treating the symptoms but ignoring the disease. We talk to hundreds of thousands of customers through our Outsourcing Exchange and the consensus is: If you pay by the problem, you get more problems.

A better compensation plan is to pay the supplier for specific service; this encourages them to get to the root of the problem. For example, if the problem is old equipment, the supplier will be willing to invest in more up-to-date assets.

Interfering With The Process

Unfortunately, this is a common mistake. Buyers just can't let go and won't transfer the ownership of the process to their outsourcing suppliers. They can't get over this deep cultural change.

To keep the process under control, they tell the supplier how to do things. The tendency to do this becomes overwhelming when the buyer assigns a manager who was responsible for this function to head up the outsourcing governance team. This executive has a great deal of difficulty not dispensing advice.

This, however, is a very slippery slope. Vendors have no opportunity to enjoy leverage or scale, two of the big advantages of outsourcing, if they have to do everything the buyer's way.

Signing A Contract With Too Long A Term

Answer this question: What will the Internet look like five years from now? No one has any idea. But a number of buyers are tempted to sign up for five years of Internet hosting. This is lunacy. It's impossible to create boundaries or service level agreements for an unknown process.

Suppliers prefer long-term contracts because the commitment allows them to invest their own capital in the process. Shorter contracts require shorter amortization periods.

At Everest, we advise our customers to develop long term relationships but sign short term contracts. Make sure the contract duration is appropriate. You do this by matching the term with the life cycle of the process and staying in tune wth the natural changes of the business cycle.

For example, we worked with an insurance company that was a third party administrator. The contract it signed was for seven years because the supplier was administering the claims for a closed group of policies that would expire within seven years. However, a seven year contract would be totally inappropriate for Internet services. There, 12 months is enough!

My book describes in detail how to construct a master terms and conditions contract that will last a long time but allows the service level agreements to change during short time spans. With a master agreement, both parties don't have to renegotiate the contract every time they want to change a service level.

Buyers, if the term becomes a deal breaker, break the deal. This is not a good relationship!

Improper Governance

Buyers new to the process often don't assign the right people to manage the process. They assume since they've outsourced it, they don't have to worry about it any more. Wrong!

There is a tendency to assign the governance job to an employee who has just come out of that function. This can become a problem because these employees can be embittered now that they no longer have line responsibility for the process. They look for ways for the supplier to fail.

The best person in this job is someone who has some understanding of the process but who is primarily a business person who can focus on the results. Buyers must now view this process as a business relationship and use those parameters to judge it. The job now is to provide adequate oversight and responsibility. A different way of thinking must prevail.

Lack of Accountability

Accountability is not about buyers looking for ways to punish suppliers. The purpose of penalties is to ensure that the higher ups in the supplier's organization realize they have a problem that they have to fix.

We once advised a customer that had built up over $500,000 in penalties. The supplier's account manage team never told their top management there was a performance problem. When the head honchos found out about the problem, they were shocked!

The customer, however, had contributed to the problem by waiving the first $300,000 in penalties. This signaled to the supplier's team that they really didn't care about performance. It also allowed them to hide their performance problems from their boss.

Don't let your vendor develop its account structure around your lack of accountability. Once the genie is out of the bottle, it's hard to put it back in. At Everest, we strive to ensure both sides are accountable for their actions.

Sometimes the onus rests completely on the buyers. In these instances, the buyers don't follow through on their assigned tasks. If the buyer is responsible for the telecom segment and it gets the bandwidth requirements wrong, it can't hold the supplier responsible for that mistake.

Forgetting the Supplier is a Business Asset

Far too often, the buyer regards its outsourcing supplier as the provider of a commodity - someone who prepares the payroll or hosts an application. But suppliers have amassed a wealth of knowledge about their industry. Take them into your confidence and let them help you! They can add significant value. if you let them.

And when a supplier creates value, buyers must reward them accordingly. Buyers can compensate their vendors by:

• Helping them win more business in the organization.
• Helping them win business in the marketplace.
• Extending their contract.
• Relaxing a service level that's insignificant to the buyer but is costly to them.
• Reinforcing their value encourages suppliers to do more! Buyers who make these mistakes create strained and difficult outsourcing relationships.

Buyers and suppliers, now you know better.

Lessons from the Outsourcing Primer:

Common mistakes vendors make include:

• Ignoring the customer's unique needs.
• Ignoring the importance of leverage.
• Shirking accountability.
• Sending in the "C" team to manage the account.

Common mistakes buyers make include:

• Relying too much on executive contact.
• Letting the supplier lead the process.
• Paying by problem resolution.
• Interfering with the process.
• Signing a contract with too long a term.
• Governing the relationship improperly.
• Shirking accountability.
• Forgetting the supplier is an asset.

Publish Date: June 2001

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Copyright © 2001 - Everest Partners, L.P.

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