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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.