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The Five Rules that will Transform Outsourcing

Changing the business mindset from "me" to "we"

Kate Vitasek | University of Tennessee

vestedIs there a better way to outsource? That is the question the U.S. Air Force asked as it struggled to improve the effectiveness of how to procure strategic services.

To answer this question, the Air Force partnered with the University of Tennessee to study how to better procure outsourced services. As part of the study, researchers set out to study some of the world’s most successful outsourcing relationships.

More important, the researchers were looking not just for outsourcing arrangements that had achieved high marks on a “green scorecard” or some other narrow measure of success – but rather, those relationships that were able to deliver transformational, game-changing and award-winning results.

The researchers found a common thread: the most successful companies had crafted a radically different kind of business relationship, one that transcended traditional buy-sell transactions that focus on one party “winning” while the other “loses.” They found relationships where the parties worked together towards shared goals to drive innovation, create value, and reward success.

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Researchers found the most successful companies had crafted relationships where the parties worked together to drive innovation, create value, and reward success.

While this seemed radical compared to today’s still prevalent transaction-based, “me-first” business relationships, researchers realized that these companies were actually leveraging Nobel Prize concepts from John Nash’s equilibrium theory to Oliver Williamson’s Transaction Cost Economics.

Breaking free of the win/lose mentality

The research found that while no business relationships were alike, the best ones shifted away from that “What’s in it for me?” mindset to “What’s in it for we?” (WIIFWe). This change in mindset strives to unlock a greater opportunity than is currently realized by either party.

Put another way, it increases the size of the whole pie versus maximizing the size of the slice for any one party (i.e., a customer simply extracting a lower price at the expense of a service provider’s profits). Simply put, “What’s in it for we?” effectively tosses the conventional win/lose mentality out the window.

With the primary research concluded, the team (of which I was a member) set out to codify the learnings into a process and customized courseware for the Air Force, now taught by the Defense Acquisition University. The team then shifted their efforts to share their learnings outside of the Air Force into an easy to follow process that could be adopted by any company – regardless of their size or location.   The team went on to name the methodology and business model “Vested Outsourcing,” or, more simply, “Vested.”

The Vested methodology includes five “Rules” for achieving collaborative, outcome-based partnerships. The Rules are essential to help companies not only say a “strategic partnership” but truly create an outsourcing agreement that truly fosters a WIIFWe mindset, allowing organizations to make game-changing outsourcing relationships real.

The rules are as follows:

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Rule 1: Adopt an Outcome-Based versus Transaction-Based Business Model

Most business and outsource arrangements are based on a transaction-based model that’s often coupled with a “cost-plus” or a competitively bid fixed price-per-transaction pricing model to ensure that the buyer is getting the lowest cost per transaction.

Under this conventional method, the service provider is paid for every transaction—whether or not it is needed. The more inefficient the entire process, the more money the service provider can make. It’s a perverse incentive called the “Activity Trap,” and one that rewards inefficiency and unnecessary activity.

Vested, in contrast, operates under an outcome-based model in which the provider aligns its interests to what the company really wants: an efficient, low-cost solution. The Vested business model fundamentally shifts the way a company buys services: the company and its service provider agree together upon desired performance outcomes.

Rule 2: Focus on the WHAT not the HOW

Adopting a Vested business model does not change the nature of the work to be performed. At the operational level, there is still a need for material to be stored, orders to be managed and fulfilled, calls to be answered, and goods to be transported.

What does change is the way in which the company purchases outsourced services: the company specifies “what” it wants; the service provider is responsible for determining “how” it gets done. Isn’t this the basic reason for outsourcing?

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Vested arrangements should reduce the total cost of the process being outsourced — not simply the budget for the outsourced services.

The problem that often arises, however, is the “Outsourcing Paradox.” By outsourcing, companies basically concede that they are not in the best position to do a specific task. Yet when they turn the work over to someone more competent, they just can’t resist the urge to tell the service provider how to do the job.

Rule 3: Clearly Define and Measure the Desired Outcomes

Vested’s third rule directs the parties to clearly define and measure desired outcomes. These outcomes are expressed in terms of a limited set (ideally, no more than five) of high-level metrics. Once these goal are agreed upon and documented, the service provider can propose a solution that will deliver the required level of performance at a pre-determined price.

Rule 4: Pricing Model with Incentives that Optimize the Business

A properly structured pricing model incorporates incentives to enable the company to achieve its desired outcomes, thus avoiding the Penny Wise and Pound Foolish ailment. The pricing model is based on the type of contract—fixed price or cost reimbursement—that will be used to reward the outsource provider.

When establishing the pricing model, businesses should apply two principles:

  • The pricing model must balance risk and reward for the organizations, and the agreement should be structured to ensure that the service provider assumes risk only for decisions within its control. For example, a transportation service provider shouldn’t be penalized for the rising costs of fuel, and a property management service provider should never be penalized for an increase in energy prices.
  • The agreement should specify that the service provider will deliver solutions, not just activities. When properly constructed, a Vested agreement will provide incentives to the service provider to solve the company’s problems.

The better the service provider is at solving problems, the more profits the service provider can make. Service providers are thus encouraged to develop and institute innovative and cost-effective methods of performing work to drive down total cost, while maintaining or improving service.

Vested arrangements should be based on reducing the total cost of the process being outsourced—not simply the budget for the outsourced services.

Rule 5: Governance Structure Should Provide Insight, Not Merely Oversight

An effective Vested partnership outsources processes to service providers that are real experts in those processes, but everyone operates under a governance framework that implements and manages the relationship. And it is vital that this be done in a mindset and culture of insight rather than micromanagement and strict oversight. goldbrown2

Vitasek is also the author of The Vested Outsourcing Manual, Getting to We and Vested: How P&G, McDonald’s and Microsoft are Redefining Winning in Business Relationships.

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Kate Vitasek is a faculty member at the University of Tennessee’s Center for Executive Education and an internationally recognized innovator in the practice of supply chain management. Her insights have been widely published in more than 400 articles and five books including Vested Outsourcing: Five Rules That Will Transform Outsourcing.

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3 Comments

  1. Robert W. Sagerer

    Kate Vitasek: Thank you for your insight and this entry.

    The thread throughout that strikes me in my current role as a Lead Information Technology Process Analyst at UPS is that all five rules would benefit any relationship between a sponsor and the project team assembled to seize an opportunity (or opportunities) or to solve the business problem or business problems at hand.

    In my opinion, if we are diligent at defining what is needed and we are respectful of our collective/common goals as a team, the better chance we all have to succeed in meeting our objectives.

    Thank you!

    – Bob Sagerer
    UPS

  2. Pingback: Longitudes (UPS) — September 2014

  3. Pingback: Pit-bull of Procurement | Longitudes

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