Organisations often embark on outsourcing with the aim of improving service performance and driving innovation. During the sales phase, service providers will often boast of their "transformational" outsourcing services, and will describe how they can deliver improvements and facilitate innovation, resulting in better service levels.
In practice, once the contract is signed users all too often find that obtaining performance improvements and generating innovation for the business remains an uphill struggle.
So, what mechanisms can be built into an outsourcing relationship to drive the right behaviour from a service provider and help the user achieve that all-important business case?
Examine your service levels
As a precursor to any proposed outsourcing deal, the service provider is likely to carry out due-diligence procedures. This will involve considering existing levels of service expectation and recent performance against those expectations.
Particularly in cases where the service provider takes on facilities, assets and employees from the user, there may well be some reluctance from the service provider to agree to service levels higher than those currently achieved.
However, there are various reasons why the user could reasonably expect a higher level of service:
● The service provider is an expert in delivering the outsourced services, the user is not.
● Any proposed outsourcing deal is likely to affect staff morale, and this is likely to negatively affect service levels shortly before and after an outsourcing deal.
● One of the reasons for outsourcing is to improve the efficiency of service. Without guaranteeing this, how will the organisation meet its business case?
In any event, users should not have their expectations for service levels lowered by existing levels, the service provider's proposed levels, or by "industry standard" levels. The user should make whatever plans are necessary to ensure that the service levels they require are attained.
An organisation may be tempted to agree that the outsourcing supplier has a grace period, during which they will not be liable for any service targets not met in relation to the outsourced services. However, the user should consider very carefully before agreeing to any such provision. The first few months of a new contract should prove telling, and the onus is on the service provider to meet expectations.
Whatever service levels are agreed, the contract should build in a mechanism for making improvements to those service levels over the term of the contract.
Wherever possible, the user should try to agree in advance a programme of service-level improvement. For example, they may agree to the outsourcing supplier's suggested service level, provided it is improved on by an agreed amount by the end of the first year.
In addition, the contract should include a ratcheting or baseline-renewing mechanism to ensure that service levels are always challenging, but remain achievable.
For example, if the target service level is 95% and the service provider's average performance for a year is 97%, then the contract could include a mechanism that mandates that the target service level would automatically ratchet upwards towards 97% from the beginning of the following year.
Governance mechanisms should include regular meetings for both sides to focus on service performance and improvement. The user should decide whether they are prepared to financially reward the service provider to improve performance. Is there a business benefit to be had paying pre-agreed service bonuses if the service provider manages to achieve higher performance levels?
Measure your productivity
Productivity improvements can be assessed in different ways. For example, in an application development context they can be linked to an increased number of "function points" achieved per day.
The productivity of staff can be measured before the outsourcing agreement and then regularly reviewed to monitor productivity. If the improvements have not been achieved then the user could require the service provider to credit them the cost of staff time that would not have been incurred had the productivity improvements been achieved.
Alternatively, an agreed level of productivity improvements could be built into the service charges, with the risk borne by the service provider if the productivity improvements are not achieved.
Whatever measuring system is used, it must be appropriate for the needs of the business. In 2006 Sprint sued IBM, claiming that IBM had failed to achieve the productivity improvements it was committed to in its contract.
Sprint also claimed that IBM had failed to adhere to the agreed methodology for measuring productivity and that it had failed to provide the data required by the contract to back up its productivity claims. IBM claimed that the productivity formula was incomplete.
The case was eventually settled, but it demonstrates the importance of getting the mechanism right before the contract begins.
Aim for ongoing improvement
Over the contract term, outsourcing services and technology may change, allowing business to be conducted more efficiently. The user should ensure that the service provider has an obligation to keep it informed of any such improvements, as well as any opportunities to increase the user's revenue.
Such reporting could be done through regular meetings. To ensure that the outsourcing supplier has an incentive to come up with improvement proposals, the user should require the provider to submit a certain number of improvement proposals per year.
The user could also consider requiring the service provider to build a certain number of improvement man-days into the services charges.
Finally, users could consider including some sort of gain sharing mechanism, which deals with how any reduction in costs or increase in revenues can be shared between both parties.
If both parties derive some benefit from improvements it is more likely that the service provider will suggest them in the first place.
Transform business processes
However useful the mechanisms detailed above may be, achieving real business improvement will sometimes require the user to think about outsourcing in a different light.
Transformational outsourcing aims to re-engineer a process or function so that performance improves and cost decreases. Transformational outsourcing may well involve making changes to the user's internal processes and procedures, as well as to the services being outsourced.
Accordingly, transformational outsourcing needs significant planning and extensive collaboration between parties to ensure that the transformation and subsequent improvements can be delivered.
Innovate to survive
Most users want and expect their service provider to bring innovation to the services they provide. However, measuring innovation is notoriously difficult.
If innovation is a key factor in selecting an outsourcing supplier, the user should consider the provider's track record, take references and speak to its existing users to evaluate how innovative that service provider has been in practice.
The user could even consider giving each service provider a small project during the evaluation process to test the service provider's capacity for innovation. In the contract itself, the user should include specific mechanisms to ensure that innovation is regularly proposed, considered and tracked.
As with any continuous improvement process, the user could consider requiring the service provider to build a certain level of innovation requirement into the original contract.
The user could also consider softer methods of incentivising improvements. One way of doing this is insisting that a proportion of the service provider's account managers' bonuses are tied to the results of an improvements-focused user-satisfaction survey.
It is often taken as read that outsourcing will bring performance improvements and innovation. However, for outsourcing arrangements to deliver real business benefits users need to ensure that contracts include the right mechanisms for measuring business improvement.
Moreover, users need to take a proactive approach to drive the right behaviour. For any outsourcing contract to be successful, good contract management is vital.
Ultimately, the user has to be realistic. If it truly wants improvement and innovation from a service provider, it may need to bite the bullet and make the investment. This might mean financial commitment or contributing towards strategic planning.
● Susan Mclean is a member of the Global Sourcing Group with Morrison & Foerster
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