HOW TO SERIES OUTSOURCING: Derive the Maximum Value from Outsourcing

After years of outsourcing to cut costs, a global telecom service firm we'll

call GiantTel launched a bold new agenda. It partnered with a large telecom

equipment firm to transform its entire business. Under the deal, GiantTel

outsourced its world-class, circuit-switched voice operations to InfraCom (not

its real name) and additionally signed up the telecommunications equipment firm

to build the infrastructure powering GiantTel's new strategy-wholesale

migration to Internet Protocol (IP) transmission services. How could GiantTel

manage this critical relationship to make sure it fulfilled its ambitious

business agenda?

GiantTel understood its voice operations intimately. It would have been easy

for the firm to drive the outsource relationship by laying out clear performance

measures and awarding InfraCom cash bonuses for hitting them. But this would

have been a mistake. GiantTel recognized that managing a transformational agenda

required a categorically different kind of relationship- and a different way

of using metrics and incentives. The partners rolled up their sleeves and spent

months envisioning their future and the potential paths to success. The result?

A committed plan and a set of metrics to gauge their progress toward the

ultimate goal: generating wholly new revenue streams from IP offerings. To share

its risk, GiantTel wouldn't pay InfraCom for the new network until it was

"ready for



revenue."

Until recently, most companies locked outsourcing in the back room-using it

to pass off unimportant functions and processes to competent specialists so

managers could focus on more critical activities. But that's all changing.

Outsourcing is increasingly making its way into executives' strategic toolkit.

In an earlier research study, we identified three types of outsourcing

relationships: conventional, collaborative, and transformational. Executives use

conventional outsourcing to generate cost efficiencies in support processes.

They use collaborative outsourcing both to upgrade business processes and to

provide flexibility to respond to changing business needs. Business

transformation outsourcing holds a higher standard. It's a comprehensive

approach to both create new capabilities and to use them to achieve a clear

strategic objective.

Metrics and incentives are an important component of all three types of

relationships, but as executives use outsourcing more strategically, these

become more critical than ever. In this research study, we found that each type

of outsourcing relationship calls for different metrics and incentives to some

extent. More importantly, executives also use the same metrics and incentives in

different ways to shape the outsourcing relationship they need. Based on our

in-depth conversations with executives, we conclude:

Conventional outsourcing can't generate incremental savings forever.

Despite rigorous measurement and tough penalties for failure, the stream of

incremental savings that conventional outsourcing delivers ultimately reaches

its limit.

Driving additional value means moving toward a more sophisticated

relationship. Many firms have migrated toward more collaborative outsourcing

relationships in order to create value beyond simple cost cutting.

It also means relaxing the tight linkage between accountability and control.

Tapping new sources of value means sharing ownership for results with an

outsource partner. The more transformational the outsourcing agenda is, the more

blurred the lines of accountability.

Effective firms use metrics and incentives in a whole new way to manage

transformational relationships successfully. Executives who operate at this

cutting edge have loosened their white-knuckle grip on control and use metrics

and incentives to foster commitment.

Conventional Outsourcing



Metrics and incentives are staples of today's large-scale outsourcing

relationships. All of the executives we spoke with have barometers in place for

tracking their progress toward the goals of the deal.

Although they pick from a broad menu of metrics, executives with conventional

outsourcing relationships generally rely on a short list of approaches. Most

contracts spell out service levels-such as computer availability, call-center

phone response time, and transactions processed per hour-and cost reduction

targets. Vendors are compensated by fixed fees with penalties for missing

"guaranteed" service levels and, in some case, bonuses for beating

savings bogies.

Over time, as companies gain outsourcing experience, they learn what works

and what doesn't. They revisit their initial sets of metrics and make

adjustments that boost performance. Best practices they related to us include

making sure objectives are clear at the outset, paring the performance measures

down to a small number of critical ones, shifting from input to output metrics

where possible, and making sure these are developed early in the relationship.

Armed with these best practices, executives do achieve cost savings from

conventional outsourcing-to a point. Firms report a 20 to 50 percent average

cost savings over the course of a long-term contract. However, the results they

achieve depend heavily on the efficiency of the operation to start with. And

once it has been tuned up to industry standard performance, the ability to

generate substantial year-over-year cost improvements drops markedly. What do

executives do to keep up the momentum? Some peg their improvement targets to

industry benchmarks. Using outside experts to measure, they aim to keep costs

and service levels in the top quartile, as compared to similar operations.

Annual incremental savings may be flat or small, but at least the firm maintains

parity with the most efficient organizations.

Other firms stoke up market incentives. These companies keep multiple vendors

in the mix to foster better performance through competition. A

telecommunications executive points out, "We have four or five main

providers and hundreds of people asking for support. If a vendor demonstrates

good service at the ground level, it's more likely to get follow-on

work."

A smaller group of companies go for scale with multi-firm service centers.

There's a limit to how much improvement even the best outsource vendor can

achieve with your operations. To drive cost reductions even further, some

organizations press their vendors to bring other firms' work into the same

facility.

The architect of extensive business process outsourcing at a major resources

firm explains, "We had accounting organizations dotted all over the place.

When we consolidated to a single location through outsourcing, we achieved a

significant cost reduction. To get the benefit of another scale change, we

worked with our



vendor to pull the operations of six of our competitors into the same
center."

These approaches to continuous improvement satisfy some of the firms we

interviewed, but 74 percent have taken a different tack. They have shifted their

outsourcing relationships to a more collaborative footing in order to expand

their opportunities for value creation. One CIO on the cusp of this decision

lamented, "Every month there's a metrics meeting with our IT outsource

vendor. We rate them; they rate us. But when I walk the halls, everyone's

really pretty unhappy with the service. I want to make IT a key strategic focus

for the company, but I need all the arms and legs rowing in the same direction

to accomplish this. That's just how our outsourcing works today."

Collaborative Outsourcing



A conventional outsourcing relationship gets you what you asked for;

collaboration gets you what you want. Companies looking for more value from

their outsourced business processes-from supply chain management to human

resources-strike collaborative relationships. Unlike conventional outsourcing

relationships, these can offer significant upside in the form of customer

delight or an edge in efficiency.

Outsourcing complex processes with substantial upside potential means using

metrics and incentives to promote collaboration. In the absence of tight

controls on performance, parties in these deals go one step further. They create

and document shared principles that guide the way they will jointly deal with

each other-what Trevor Nagel, a partner at Shaw Pittman, calls a

"constitution, not a contract." These principles not only set forth

the work approach, they capture the key business goals and thought processes

behind it, as well as the methodology for achieving it. The goal: to ensure the

principles set the correct tone for the relationship as it evolves, regardless

of the individuals involved at any time. Explains outsourcing expert Harry

Glasspiegel, CEO of Glasspiegel Ventures, LLC and formerly of Shaw Pittman and

CNA Insurance, "The original parties can help the relationship succeed over

time by giving later participants a gift-context."

Business Transformation Outsourcing



Many organizations have pushed outsourcing beyond a conventional

relationship. A few bold leaders have gone even further. They are using

outsourcing to transform their businesses. Companies undertaking business

transformation outsourcing (BTO) seek radical change that can rock an industry.

It requires unflinching commitment to an outcome that may be years away and a

partner to share the journey. Although the potential rewards are enormous,

unexpected shifts in technology or the competitive landscape could call for

mid-course corrections at any moment. Executives forge strong relationships to

see them through this white water ride. One CEO told us, "I work side by

side with my counterpart at to ensure that we anticipate and

confront change as it happens."

If

a conventional relationship gets you what you ask for, and a collaborative one

gets you what you want, a transformational relationship gets you what you need.

Business transformation requires commitment because of its bet-the-ranch

character. In it, both parties forsake the comfort and security of clear scope

of work, defined outputs, and structured roles and responsibilities to pursue

dramatic improvements in enterprise performance. They use metrics and incentives

to keep their interests tightly aligned and to support deep, continuing

commitment on both sides to reach their aspirations. This is a whole new game.

It means establishing some new enterpriselevel metrics, crafting a gripping new

set of incentives, and changing the way lower-level metrics are used.

When the goal is business transformation, the only relevant metric is

business value created. Architects of BTO relationships measure:

Enterprise-level outcomes... And they set their sights on dramatic

improvements in business value. Companies aim to double revenue, achieve market

dominance, or completely reposition the firm. For example, Archer Financial

Group, a disguised global financial services firm, doubled both operating

margins and stock price through business transformation outsourcing.

...for both partners. Unlike more conventional outsourcing arrangements, BTO

must create enterprise-level value for the outsourcer as well as the client

company. Otherwise, it wouldn't be worth the risk. By building and running a

new infrastructure for GiantTel, for example, InfraCom hopes to launch a

promising new line of business for itself.

Extracted from a report by Accenture, a global leader in outsourcing,

prepared by Jan C Linder, Joseph Sawyer, and Alice Hartley, based on a research

by Accenture. Reprinted with permission.

Best Practices in Outsourcing Metrics and Incentives

Veteran outsourcers shared some of their hard-won lessons with us:

Clarify objectives at the start to align for success: Many companies learned

the hard way that they had to understand their own objectives before they could

invite an outsourcer to the party. Communicating your goals broadly throughout

the organization helps set clear expectations. As one executive notes,

"Business leaders on our side thought they were getting improved service,

but the negotiating team gave that away in favor of reduced price. The result

wasn't pretty."

Choose fewer metrics with higher stakes: Outsourcing veterans have

significantly narrowed the number of metrics they track over time-and

increased the accompanying rewards and penalties-in order to boost focus,

minimize administrative demands, and improve their relationships. The first to

go: metrics that proved too difficult and time-consuming to measure. After

several attempts, the senior vice president of procurement at a UK

transportation equipment firm removed engineering efficiency from his outsourcer's

list of target metrics for business process improvement. It simply proved

impossible to quantify the result.

Shift from input to output metrics where possible: Instead of counting how

many hours it took to complete each order, a photographic firm asked its

outsourcer to count how many orders it completed each hour. This small change in

the way they kept score helped focus the vendor on speeding up throughput.

Similarly, Family Christian Stores stopped tracking the uptime of store computer

systems in favor of getting the weekly replenishment orders delivered to stores

by 8 a.m. every Monday.

Define metrics early in the relationship: Some of the firms we talked to

signed their outsourcing contracts long before they identified the metrics they'd

use to manage performance. At least one executive identified this as a problem,

saying, "It took us more than a year to build the set of metrics we would

use to evaluate performance. Things would have gone much more smoothly if those

were in place sooner."