Vested Outsourcing: Game Changing Rules for Outsourcing

In Search of a Better Way to Outsource

For the past two years, we have participated in a University of Tennessee research program funded by the Air Force to formally study companies that were employing performance-based approaches for outsourcing. This article is based on our research and hands on experience working with organizations that have adopted mutual symbiotic performance partnerships that truly unlock win-win solutions.

While many believe win-win is a simple buzzword that is theoretical in nature, our research has uncovered a set of unwritten rules that companies can use to develop performance partnerships in which both parties in the outsourcing relationship go the distance to achieve much higher levels of performance and cost savings than previously thought possible. We have distilled our lessons and approach into what we call Vested Outsourcing – because it is typified by an outsourcing relationship in which both parties have a stake in maintaining the arrangement and work together to create a performance partnership that takes both the company outsourcing and the service provider to levels of cost, service and profitability not realized before.

A Better Approach: The Rise of Vested Outsourcing

Knowing the various ways that things can go awry in outsourcing relationships, you might be asking, “Is there a better way?” The good news is that thought leading companies have been challenging conventional outsourcing models over the past ten years. The result has been an evolution to the “next generation” outsourcing model that we call Vested Outsourcing.

In the familiar terms of Strategic Sourcing, there are basically three types of suppliers:

  • Transactional – the supplier is effectively kept at “arm’s length,” and a purchase order (PO) is issued for every order
  • Preferred Supplier – this supplier is pre-qualified, either by certification or years of experience. The Preferred Supplier is often exempted from certain procedures, given releases against blanket POs, etc.
  • Strategic Alliances – this is characterized by a “C” level relationship between the companies, with shared intelligence and operational tie-ins. The two companies often develop working relationships that more closely resemble divisions of the same company.

Vested Outsourcing creates a new level in between Preferred Suppliers and Strategic Alliances. The relationship is more focused than a Strategic Alliance, and does not require as much operational infrastructure. But it takes the Preferred Supplier relationship to a whole new level. (See Exhibit 1.)

Exhibit 1: Supplier Relationships

Supplier Relationships

While no two Vested Outsourcing partnerships are alike, all good ones achieve a performance partnership based on optimizing for innovation and improved service, reduced cost to the company outsourcing and improved profits to outsource providers. (See Exhibit 2.) The trend towards performance partnerships has evolved such that companies that outsource and service providers work together to develop a performance-based solution aligning the interests of both parties—with both parties receiving tangible benefits (either through tangible or intangible incentives).

Exhibit 2: Performance Pyramid

Performance Pyramid

The heart of Vested Outsourcing contract is an agreement on desired outcomes, which explicitly states the results on which both companies will base their outsource contract. A Vested Outsourcing agreement clearly defines financial penalties or rewards for not meeting or exceeding agreed upon desired outcomes. In an agreement, regardless of what is being outsourced, the outsourcing partner has the ability to earn additional financial value (e.g., more profit) by contractually committing to achieve the desired outcomes. Simply stated: if the outsource provider achieves the desired outcomes (results), they receive a bonus. It is important to understand that Vested Outsourcing is NOT gainsharing. The manner in which Vested Outsourcing agreements work is outlined in more detail later.

Under this dynamic, the outsource provider is challenged to apply “brain power” and/or investments to solve the company’s problem. They also take on risk to do it, in essence putting “skin in the game.” The outsource provider looks at how they can best apply world-class processes, technologies and capabilities to drive value to the company that is outsourcing. This commitment to deliver against projected value for the company outsourcing (such as a commitment to reduce costs or improve service or both) shifts risk to the outsource provider. In exchange, the company outsourcing commits to allow the outsource provider to earn additional profit (above and beyond industry average profits for their service area) for achieving this incremental value. The result is a win-win Vested Outsourcing partnership—a paradigm shift we will explore next.


Changing the Game: Going the Whole Nine Yards with Your Outsource Relationship

It’s important to understand that Vested Outsourcing is much more than delivering a higher level of service on a given activity. For example, it is NOT about:

  • achieving 99 percent fill rate for your warehouse provider vs. 95 percent
  • answering 95 percent of all calls in 20 seconds versus 30 seconds
  • achieving quality defects from 3000 DPPM to 3.4 (six sigma) DPPMs from your contract manufacturer

….and the list can go on and on.

Unfortunately, many people on both sides of an outsourcing relationship simply do not understand the fundamental business model concepts behind Vested Outsourcing. A common mistake occurs when an organization THINKS that they have a Vested Outsourcing agreement because they have taken their existing contract and simply added an indication that, if a service provider achieves the metrics, they are paid a bonus. This completely misses the mark. Vested Outsourcing is a fundamental business model paradigm shift in how the outsourcing company and their service providers do business.

To Go the Whole Nine Yards or Not

It is important to keep in mind that just because a company can do Vested Outsourcing for just about anything it might outsource, this does not mean that it should. Some activities still should be outsourced conventionally. Vested Outsourcing is hard and takes time. It should be done only in the areas that will have the largest impact or return for the company.

Companies can evaluate their outsourcing opportunities using the chart in Exhibit 3. If there is high value and expertise to continue to manage a process within the company, do not outsource those activities. However, if there is low expertise but high value, that activity is a good target for Vested Outsourcing. Conventional outsourcing is best used when contracts do not add strategic value to operations. Look for opportunities to decrease cost, increase availability, and thus increase customer satisfaction.

Exhibit 3: Vested Outsourcing Decision Matrix

Vested Outsourcing Decision Matrix

If Vested Outsourcing looks promising for an activity, ask yourself not “What’s in it for me?” but rather “What’s in it for we?” to be successful.

WIIFWe vs. WIIFMe

While many organizations tout that they have “partnerships,” our experience and research found that most have an internal desire to optimize their own self interests. This is often known as a WIIFMe approach (What’s In It For Me). How could they not, when we are ingrained with “winning” from early childhood and most business schools and law schools focus on “winning”? Procurement and sales professionals are trained in the art of negations to help them “win.”

The very word “partner” implies two sides. The progression towards a Vested Outsourcing agreement should focus on creating a culture in which parties work together to ensure the ultimate success of each other. The mentality should shift from an “us vs. them” to a “we” philosophy, or what we call a What’s In It For We (WIIFWe) philosophy.

Companies that embark on a Vested Outsourcing agreement should approach it as a symbiotic relationship. Only by working together can they succeed.

The goal of a Vested Outsourcing partnership is to focus on first identifying and then aligning the interests of both players. The relationship becomes more collaborative and expands beyond simply meeting requirements.

A WIIFWe philosophy strives to increase the size of the entire pie (unlock a greater opportunity than is currently realized by either party) versus maximizing the size for any one player (e.g., lower costs at the expense of the outsource provider’s profits).WIIFWe tosses the conventional win/lose mentality out the window. A company that is trying to maximize their piece of the pie instead of grow the whole is not playing under Vested Outsourcing rules and will most likely craft an outsourcing agreement that is structured with one or more of the ailments we have identified in our research.

Many of you might be thinking, “Win-win is so fluffy. Is it really possible?” Consider a contract manufacturer that had to “touch” the packaging 12 times to assemble it, but refrained from saying anything as they were paid by the touch? Under a performance partnership, that supplier would have substantial incentives to help the customer redesign packaging to reduce the total cost. Let’s say that the supplier helped design a package that cost two cents more to manufacture, but reduced the “touches” from 12 to seven. If the “touches” cost two cents each, and the annual quantity was five million pieces, the annual net savings would be $400K.


Wouldn’t you as the customer be willing to share that with your supplier?

Developing a WIIFWe relationship is easier to describe than it is to do. Evolving from a culture of oversight and control to mutual respect is not an easy transition. Adversarial relationships often persist, and getting to a true win-win relationship will likely take practice. We frequently suggest assigning a neutral party to act as the “win-lose cop” to point out when organizations slip into conventional win-lose thinking.

True win-win requires effort and commitment by both parties. Outsourcing does not mean abdication: it must be a partnership with regular, frequent communication to manage the expectations as well as the work. Although the most pernicious problems that affect outsource arrangements are brought on by micromanagement, a different set of problems can emerge when a company hands over a process completely to the outsource provider, washes their hands and walks away.

True partnerships must often evolve over time as both parties learn to work under a win-win philosophy. For many companies, a win-win approach is a learned behavior, and they have to unlearn conventional approaches and ways of thinking. Human relationships are fundamental to successful Vested Outsourcing. Absent of mutual trust, any attempt to implement Vested Outsourcing will become mired in terms and conditions. In addition, both the company outsourcing and the outsource provider need to make sure they are comfortable in their associated roles. The company outsourcing needs to feel comfortable describing the “what” and delegating the “how” to the outsource provider. The outsource provider must be comfortable signing up to take the risk to deliver the “how.” Both must constantly overcome roadblocks in the processes, infrastructure, technology and people that prevent the mutual success.

In our experience, only those organizations that truly challenged the WIIFMe mentality are able to achieve true Vested Outsourcing partnerships that delivered outstanding results. Adopting anything less that WIIFWe philosophy will result in less than optimal results.

Deeply wedded to the WIIFWe philosophy are the following five major rules, illustrated in Exhibit 4.

1.   Outcome-based vs. transaction-based business model

2.   Focuses on the WHAT, not the HOW

3.   Clearly defined and measurable desired outcomes

4.   Pricing model incentives are optimized for cost/service tradeoffs

5.   Insight vs. oversight governance structure

Exhibit 4: The Five Rules of Vested Outsourcing

The Five Rules of Vested Outsourcing

How Vested Outsourcing Rules Work Together

In Vested Outsourcing, the organizations work together upon a foundation of trust with mutual accountability for achieving the outcomes. Through the careful alignment of performance objectives, accountability and control, the service provider, while absorbing additional risk, is empowered to pursue improvements that will deliver improved performance, higher profits and lower total ownership cost.

Vested Outsourcing uses the power of free market innovation to improve the outsourcing relationship. This can be challenging to achieve, but the Vested Outsourcing journey should always strive to arrive at this idealized end state to achieve the performance pyramid in which both the company outsourcing and the outsource provider are consistently applying a WIIFWe foundation and applying all five of the Vested Outsourcing rules.

For the service providers, Vested Outsourcing is an opportunity to exercise greater flexibility in deciding how support is provided, to ensure cash flow stability through long-term contracts and to increase revenue by rewarding the service provider's investment in improving processes. For the company that is outsourcing, it is a chance to obtain improved performance while decreasing costs and assets by partnering with a highly competent and properly motivated firm.

To say that Vested Outsourcing represents a departure from conventional outsourcing practice would be to seriously understate the case. Vested Outsourcing changes the fundamental business constructs of the typical outsourcing approach.

Companies wanting to embark on a Vested Outsourcing partnership will need to deeply understand both the central core of WIIFWe approach and the five rules. They will need to treat them as rules to live by, as described below. In our opinion, a Vested Outsourcing partnership that does not strictly adhere to the entire WIIFWe core and all of the five rules can easily fall victim to one or more of the outsourcing ailments that we have identified in our research. We like to think of a Vested Outsourcing partnership that does not adhering to the rules as a pig with lipstick.


You can’t simply pretty up something that is essentially ugly!

Once you determine that you are ready to explore Vested Outsourcing, we recommend using a structured framework to help you transform your existing outsourcing relationship to a more productive performance-based approach. The University of Tennessee’s research has led to the development of an implementation framework wrapped around the five Rules as illustrated in the Vested Outsourcing Implementation Plan diagram in Exhibit 5. (Read clockwise, starting with Lay the Foundation.)

Exhibit 5: Vested Outsourcing Implementation Plan

Vested Outsourcing Implementation Plan

Conclusion

The ailments from which many outsourcing arrangements suffer occur as frequently as the common cold, butthey share a common cure: Vested Outsourcing can and does create an outsourced business model in which both the company outsourcing and the service provider give it their all to go the whole nine yards. And the risk of catching one of these ailments through outsourcing is more than made up for by the achievement through a productive Vested Outsourcing partnership of lower costs by the outsourcing company and higher profits by the service provider, neither of which can be attained by each organization working alone.

Kate Vitasek is a thought-leader in the area of Supply Chain Management and is a well-recognized authority on performance management and performance-based approaches for business. She is the lead researcher and faculty for the University of Tennessee's Center for Executive Education work in the area of outsourcing and performance-based approaches. She is also the Founder of Supply Chain Visions, a Top 10 supply chain management boutique consulting firm. Kate can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

Mike Ledyard is a veteran of international sourcing, manufacture and importation of product and tooling, especially from China and Eastern Asia. He is an author and frequent speaker on process measurement and improvement, and was selected as one of the Top 20 Logistics & Supply Chain Executives of 2001-2002. Mike is also a co-founder of Supply Chain Visions. He can be reached at This email address is being protected from spambots. You need JavaScript enabled to view it..

University of Tennessee Center for Executive Education
www.thecenter.utk.edu

OMTEC 2010 Speaker

Kate Vitasek presented the Keynote Breakfast Address on Thursday, June 17 at OMTEC 2010 in Chicago. A 2.5 hour Workshop followed the Keynote, at which attendees obtained:

  • An “assessment framework” for gauging the health of your outsourcing agreement
  • A Vested Outsourcing project plan and model for implementation, along with an eBook to assist in continued learning
     

Detailed abstracts of the Keynote Address and workshop, as well as Ms. Vitasek's presentation, are available online.