Outsourcing After the Honeymoon
-Making Relationships Work Over the Long Term
By Leslie Willcocks and Geraldine Fox, Compass America
Many outsourcing relationships begin with mutual goodwill and high expectations. By the time the first contract renegotiation takes place, however, it’s not uncommon for one of the two parties comes to the table with a grievance. In some cases, the vendor is unhappy with a low profit margin and seeks an adjustment to terms. In others, the client feels the services delivered do not warrant the fees being paid.
Whichever side enjoys the contractual advantage should avoid the temptation to press it too strongly.
The idea that clients should “squeeze” struggling suppliers on cost is short-sighted and counterproductive. Similarly, outsourcers should be wary of deals tilted too sharply in their favour.
Allowing the vendor to earn a reasonable profit is essential to the long-term success of an outsourcing relationship. The incentive of profit – and of additional reward for outstanding work – motivates a vendor to commit resources and key talent to improve service levels, identify new opportunities, and address the client’s business problems. Contracts focused exclusively on cost reduction will inevitably encourage a status quo mentality, in which the outsourcer delivers services to the bare minimum necessary to justify the monthly invoice.
The common practice of “backloading” contracts has complicated the role of profit in outsourcing relationships. Backloading refers to the practice of structuring the deal to deliver unsustainably low margins in the early years (so as to attract the client into the relationship), and then compensating with higher margins towards the end of the contract term. The problem for many client organizations today is that they are entering into the high-margin back end of their contract terms, precisely at a time when economic circumstances dictate cost reduction.
One approach to addressing this problem is to negotiate the insourcing of various functions handled by the vendor. If some low-margin services can be brought back in-house, the outcome can potentially be mutually beneficial. Other options could include bringing in an offshore outsourcer to reduce costs, or implementing technology upgrades that are stipulated but haven’t been completed.
Benchmark Clauses
Exercising the benchmarking clause in an existing outsourcing contract often provides the best opportunity to baseline existing services, repair a damaged relationship, and adjust terms to new conditions.
Compass recently analysed 72 outsourcing contracts for IT services in North America, Europe, and Australia in which a benchmark clause was exercised. The initiatives were successful in 68 percent of the cases, in that both parties accepted the outcome of the benchmark review and contract terms were adjusted. In the 32 percent of instances where the review was unsuccessful, the initiative was either cancelled or the client changed vendors.
Compass observed a wide degree of variance between vendors in completing benchmark review initiatives. Specifically, major outsourcing vendors with mature global capabilities were more successful; in the contracts analysed, these players completed and implemented between 80 percent to 100 percent of benchmark reviews they were involved in. Several smaller vendors with a local or national focus, meanwhile, completed 0 percent of the initiatives they were involved in.
A benchmarking review can benefit both parties by establishing objective, fact-based performance criteria. By validating the price and quality of outsourced services and facilitating a successful resulting negotiation, the process can enhance client/vendor cooperation and communication and help to build trust over the long term.
Leslie Willcocks is Professor of Information Management and e-business at the Warwick Business School in the UK, and associate fellow of Templeton College Oxford, visiting Professor of Erasmus University Rotterdam, Professorial Associate University of Melbourne, and distinguished visitor of the Australian Graduate School of Management. Geraldine Fox is Global Outsourcing Service Line Leader for Compass.
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