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."