Outsourcing is back on the top management agenda. It has taken on renewed urgency as many material handling companies struggle to restructure their operational costs and refocus their critical resources to survive a brutal economic climate. Practically every part of the business—from customer-facing activities like sales and service to back office processing and support services—is under intense scrutiny for potential farming out to third-party providers.
But for many corporations, the payback from outsourcing has been elusive. While numerous studies show increasing growth in the market for outsourcing services, they also show significant disappointment with the benefits delivered from outsourcing relationships. A recent survey of senior executives by Gartner Group found that half of the respondents believed their outsourcing relationships had not delivered the value they anticipated.
Why is the track record of results from outsourcing so mixed? Our research over the past eight years with more than 150 corporations that have pursued major outsourcing initiatives suggests that this disconnect between expectations and results is largely rooted in a set of all-too-common, but deadly mistakes that companies routinely make before their outsourcing relationships even begin. Few companies take the decision to outsource lightly. But many discover, to their ultimate frustration, that hidden traps and difficult-to-maneuver pitfalls await them throughout the entire process. Failing to avoid or neutralize these obstacles can lead to disappointing results and even disastrous consequences. Some present dangers that are not obvious and leave managers wondering what hit them. Others are seemingly clear-cut, yet executives fail to avoid them despite their best efforts. Below we list the ten deadly mistakes that companies make in the outsourcing process and suggest steps that organizations can take to avert them.
Deadly Mistake One: Jumping the Gun
Too often, executives commit prematurely to outsourcing – they jump to the conclusion that outsourcing is the solution without fully understanding the problem. They make an emotional decision that is motivated by dissatisfaction with the internal group responsible for the process under evaluation. Rather than confront and correct the real causes of poor performance, managers instead look to outsourcing as a quick fix. This mistake is often made when support areas such as IT or HR are viewed as inefficient, not customer focused and delivering services of poor quality. Outsourcing is seen as a way to get rid of the culprits responsible for the problem and therefore the problem itself. But this is wishful thinking; companies employing this approach are often disappointed with the inevitable results of decisions made based on emotion rather than careful rational analysis. Indeed, after such thoughtful consideration, outsourcing will often be the best option but the odds of success will be far greater because the problem is better understood and all other possible solutions have been properly vetted.
Or they pursue a major outsourcing initiative based on assumptions about the outsourcing value proposition or the maturity of vendor capabilities and offerings that are theoretical and untested.
Procter and Gamble’s recent failed attempts to outsource its shared services organization suggest that they misread the readiness of the market to handle a multiple process deal and may have “pulled the trigger” too early in moving to negotiate with a provider to take over their back office and administrative operations. After a year-long evaluation of potential providers, a single finalist (EDS) was chosen. After several weeks, the finalist withdrew from the bidding, indicating that the “risk profile was too high.” P&G then invited the runner-up company (ACS) to enter into negotiations. After two months, this provider also withdrew, saying “the financial, operational and cultural risks were too high.” EDS was then invited back for a second try at negotiating a deal. After two months, this round of talks ended after P&G walked out. By this time these failed efforts cost all sides hundreds of thousands, if not millions, of dollars to pursue.
Once the outsourcing bandwagon gets up a head of steam, it can be very difficult to stop. Managers and staff who have invested a great deal of time and expense frequently become emotionally committed to the idea and will find it difficult to give it up in the end, even in the face of strong evidence that outsourcing is not the best way to achieve their objectives. In the case of P&G, after its failure to find a single vendor to take over its shared service unit, the company announced that it would pursue outsourcing different pieces of the group to different vendors. Indeed, it recently signed a long-term deal with a vendor to acquire and manage the IT infrastructure component of the unit. If it continues to unwind its shared service unit by signing individual deals with different vendors, this piecemeal approach would add significant cost and complexity to the tasks of coordinating services and managing the providers, and could turn the entire situation into an outsourcing nightmare.
Deadly Mistake Two: Focusing Too Much on Process and Not Enough on Outcomes
Some companies rely too heavily on methodology in making outsourcing decisions. They believe that a successful outcome can be assured by executing a thorough and rigorous evaluation process and engaging in a comprehensive and meticulous assessment and selection exercise that often takes months to complete. Every imaginable detail about the potential providers is collected and often-complex scoring systems are developed and used to guide the decision-making. Endless presentations and pitches are made to senior business executives who ultimately make the decision regarding which outsourcing vendor to select.
Despite the seeming rigor of these kinds of exercises, companies frequently overlook or fail to validate critical information about the vendor or act on assumptions about vendors that turn out to be wrong. We have had many executives tell us how surprised they were to learn after the fact that vendor service quality, process execution, business domain expertise and ability to keep pace with new technology were not what they thought or expected. “This is their core business, after all—we expected them to be damn good at it,” was an oft-heard lament. These experiences suggest that taking a methodological approach to vendor assessment and selection is a necessary but not entirely sufficient precondition to outsourcing success.
At the heart of this mistake is the disconnection of the strategic intent for outsourcing from the actual process of evaluating and selecting a provider. Somehow, the ultimate goals get lost in the nitty-gritty details of evaluation or in the excitement of the deal process. This happens most often when the motivations for outsourcing go beyond simple cost reduction. Methodological evaluation processes work great when hard data is available and tangible measures of goals and performance can be specified, but how do you measure or evaluate a vendor’s ability to innovate or the degree to which they will be responsive to impossible to predict changes in your business or in their industry?
Divining answers to these tough questions requires more creative and nuanced methods than cookbook type approaches to evaluation. Companies may need to employ non-traditional methods to keep the vendor evaluation process focused on the outcomes they seek. For example, one state agency employed a process of requiring vendors to devise solutions to the operational problems they were experiencing rather than respond to a conventional RFP. The agency worked closely with all the bidders to provide them with the necessary information from which to devise proposed solutions. It then selected the best overall solution to its problems and began negotiations with the provider regarding the contract for services.
Deadly Mistake Three: Mistaking Provider Willingness to Commit for Ability to Deliver
Buyers of outsourcing services often have considerable leverage over providers. They may represent a disproportionate component of their business, or have potential to be a powerful reference account for them or represent revenues that they desperately need to stay in business. The finalists in any significant outsourcing competition may have invested hundred of thousands or even millions of dollars by this point and may be desperate to avoid losing the deal. In these circumstances, it is important to be careful not to push a provider too hard to win the business. Alternatively, companies must be alert against falling for “low ball” proposals that involve proposed prices that are well below the bids of other competitors. In this situation, there is a risk that you may sign an agreement with seemingly wonderful terms that the provider will simply be unable to fulfill. It is important, therefore, to validate as much as possible the vendor’s ability to deliver before making a commitment. Services are much more difficult to validate for effectiveness than products because they are harder to execute consistently and are often delivered differently to individual clients. Successful experiences with other companies may have little bearing on whether the provider will be successful delivering services to your company. It is important, therefore, to find ways to test capabilities before making any major outsourcing commitments. If possible, it is very helpful to have a previously established relationship and experience base with any vendors you are considering, as this can be a reliable indicator of their ability to perform. If you don’t have a track record with the provider, then it may be worthwhile to engage them on a test basis, through a pilot or learning project, to see how they perform before making any major commitment. Ways of doing this include low risk pilots or test projects, farming out small pieces of a process first before outsourcing the entire thing and handing a vendor the keys and letting them test drive the process, i.e., letting them manage your internal process for 3-6 months to see how they manage it and what improvements to the process they identify and suggest.
Don’t rely on vendor references alone – seek out examples of successful and unsuccessful clients. Leverage peer networks of executives in other firms, user associations, research firms, etc. to broaden your base of references. When you visit their other clients or talk with references, be sure to contact them directly rather than let the provider control the circumstances of your conversation.
The more comprehensively potential vendors are assessed, the better the chances of outsourcing success. It is important to evaluate not just the offering and the deal the vendor is willing to make, but their business strategy, market position, work processes, people, financial condition and performance, innovation capability and track record, organizational culture, management team, and governance processes.
Many companies do not sufficiently understand the service provider’s profit model—some fail to sufficiently answer, or even to ask, the simple question of how the provider makes money. Is it through a cheaper cost base or an ability to run the process more efficiently? By reducing the quality and, therefore, its cost to deliver the service? Through continuous innovation of the process to drive down costs or improve quality? This kind of information is essential when evaluating any outsourcing provider. And you need to understand more than the provider’s business model—you also need to know whether or not they will be able to make a profit providing the type and level of service that YOU expect them to deliver. This issue is important because if your provider cannot make money on what you’ve specified, it will not pay sufficient attention to delivering the service for which you’ve contracted. Instead, it will look to cut corners by reducing quality or find other ways to make up for the profit shortfall such as overcharging for any services not initially specified in the contract or constantly attempting to sell you add-on services wherever it can.
Deadly Mistake Four: Obsessing Over the Contract but Ignoring the Relationship
There are two key tasks in any outsourcing deal. One is to negotiate the terms of a contract. The other is to start building a workable relationship between the customer and supplier. Everyone pays a great deal of attention to negotiating the contract but many companies neglect the relationship building part or do it poorly. Ironically, a great relationship will do far more to ensure that an outsourcing arrangement is successful than an iron-clad contract.
There are several reasons why too much attention gets paid to the contract and too little to the relationship. Underlying this problem is the conventional wisdom that the key to successful outsourcing is writing a good contract. This is untrue. A contract is nothing more than an insurance policy that provides legal protection when things go wrong. When written well, it clearly spells out the price of failure to perform. It does very little, however, to ensure that the relationship will succeed. In one government organization we studied, the executive responsible for negotiating its outsourcing relationship proudly displayed the 500-plus page contract that his team created and signed with its service provider. Despite this detail-laden document, the outsourcing provider managed to badly miss its time and budget goals and jeopardized the agency’s operations so severely that hearings were demanded by the lawmakers overseeing the department.
Another reason that relationship building is given short shrift at this point in the process is that it is often treated as the next sequential step after the contract is negotiated. But by then, it may be difficult to shift from adversarial negotiation mode to collaborative relationship mode if that is what’s required. Some companies even wait until after the deal takes effect to begin establishing the working relationship. But this is much too late in the process – fundamental building blocks need to be in place well before this point if the relationship is to have a reasonable chance to succeed.
It is important, therefore, not to put relationship building on hold while negotiations are underway. Once a finalist is selected, there is typically a four-month period of negotiations to agree a deal. This is the time to get delivery teams and leadership on both sides together to begin building the relationship. Some companies have even implemented a process whereby the same group of people involved in contract negotiations in the morning participates in relationship building exercises in the afternoon. This approach is based on the belief that relationship building should not be put on hold just because you are negotiating a contract.
It is also vital to have all of the key players from both sides addressing the question of how they will work together after the deal is done. It is critical to agree on common principles around which the relationship will operate and to flesh out and resolve cultural incompatibilities between the parties. It is often helpful to concentrate first on developing a set of principles to guide and govern the relationship and to prominently display and discuss them during the negotiation process. Some companies have successfully engaged professional facilitators to assist the effort who understand both the deal making and the relationship building processes. These experts bring an understanding of both the customer and supplier points of view and can help to accelerate the contract and relationship building processes as well as keep them on track and in sync. Others have had success by negotiating the basis of the relationship first and then turning the process over to the lawyers and accountants at the eleventh hour to hammer out the details of the contract.
Deadly Mistake Five: Having One Team Negotiate the Deal and Another Manage the Relationship
One of the worst things a company can do in the outsourcing process is to charge a team of people with negotiating a deal that none of them will be responsible for implementing afterwards. In this situation, negotiators will be open to the temptation to engage in relationship debilitating behavior and one-upmanship unless they are held accountable for and made to live with the results of their efforts. This is true for both sides of the negotiation, as many a chagrined buyer has discovered when a clueless group of strangers from the provider show up the day after the contract goes into effect. Not only should you include your own key staff responsible for implementing the deal in the negotiations, but you should also insist that the vendor do likewise.
The implementation team also needs to be deeply grounded in the context of the negotiations and the deal that ultimately transpires from them. This will enable them to understand the underlying motivations for all aspects of the contract and to avoid having to carry out activities or pursue goals that they don’t understand or with which they may not agree. The fewer “hand offs” from one group to another, the fewer opportunities there will be to “drop the ball” and get things wrong. It will also help to ensure a much smoother start to the relationship if both sides don’t have to go through a familiarization and learning curve process. Knowledge transfer, from the user to the provider and vice versa, must not be neglected. Successfully executing any process in an outsourcing context requires a great deal of knowledge sharing between the customer and provider. The customers bring deep understanding of their business and their organization. They have valuable industry and market know-how as well as a strong familiarity with the organization culture and context—how decisions are really made and how things really get done throughout the organization. At minimum, the provider will need to be brought up to speed on this tacit knowledge and plugged into informal networks in order to effectively perform its work. Some of this knowledge may be explicitly embedded in procedures, software and products and will need to be effectively transferred as well. The same is true for formal and informal knowledge that exists on the supplier side, which will need to be shared with the customer. Companies need to put the appropriate mechanisms in place to effect the desired cross transfer of knowledge. For example, training and orientation workshops can help to facilitate the sharing of formal expertise and know-how. Forming joint customer-provider teams and assigning “buddies” and mentors from both sides can help to enable the transfer of tacit knowledge.
Deadly Mistake Six: Underestimating Cultural Incompatibilities
Odd couples make for entertaining TV shows but frustrating outsourcing relationships. Common ground must exist between the two parties in an outsourcing relationship if it is to succeed. It is important, therefore, to pay attention to explicit differences in organizational culture and practices such as how work is organized and how decisions are made in the provider organization and the extent to which these differ from your own. One critical area of organizational compatibility to address is decision making. For example, is the provider’s organization centralized and are decisions made mostly from the top or is the company decentralized in structure with widely distributed decision authority? If the gap between the two organizations is great and not closed, the ensuing friction will jeopardize the entire relationship. Another vital issue is how people are rewarded for performance. Is individual achievement encouraged or is group and organization success stressed more? Significant differences in how people are measured and rewarded will make transfer of employees from the customer to the provider especially challenging and joint projects and teamwork between the two organizations problematic.
Implicit cultural differences are harder to gauge but can be devastating to a relationship. For example, differences in how the work is viewed by the two respective organizations can lead to difficulties. Is the work of the organization seen as a systematic process requiring standard methods and ways of doing things, or is it viewed as more art than science with an emphasis on creativity and crafting unique solutions to each problem that arises? Bridging the gap between a rule-following culture and a rule-breaking one is often an insurmountable obstacle to implementing a workable outsourcing relationship.
Kodak’s experiences with outsourcing illustrate the importance of culture compatibility. A pioneer in IT outsourcing, the company established a very successful outsourcing relationship with IBM, but failed to do so with Digital (since acquired by Compaq). A key factor in both experiences was cultural compatibility. IBM and Kodak had very similar cultures, values and ways of working. Kodak was very process-oriented and metric-based, as was IBM. They favored standardized ways of doing things and ongoing measurement of performance. The Digital culture, on the other hand, was entrepreneurial and individualistic. Its staff prided itself on creative approaches to problem solving. Doing everything the same way and keeping detailed performance scorecards was viewed as constricting to performance. Kodak and Digital were unable to bridge these differences in culture and the relationship proved problematic throughout its life.
It is critical, therefore, to surface and weigh all the explicit and implicit differences between the cultures of the organizations and to establish enough common ground on which to build a relationship before moving ahead to serious negotiations.
Deadly Mistake Seven: Forgetting About End-Users
It is both strategically and operationally critical to design a workable point of contact for end-users regardless of what process you outsource. A dedicated internal group should be formed to assume responsibility and accountability for the end-user relationship and experience. This will allow the company to maintain its understanding of the drivers of demand throughout the organization for the outsourced services, as well as provide the opportunity for its functional managers to be hands on in managing the day-to-day relationship with the outsourcing provider. In addition, service levels can be more clearly spelled out and delivered when there is direct contact with users and service problems can usually be resolved more effectively.
One effective technique is to assign account or relationship managers or teams to key internal users of the outsourced services. Ideally, a key member of the team, probably the leader, should be responsible for working with users to manage their demand for services and to integrate the capabilities of the outsourcing provider into their planning and strategy making process. It is important that account/relationship managers have deep knowledge of the customer’s business domain as well as the service provider’s offerings and capabilities. Another member of the account/relationship team should assume responsibility for working with the users and the provider to make sure that day-to-day services are being provisioned satisfactorily by the outsourcing provider.
Overall, a single point of accountability can facilitate demand management activities and make service provisioning and allocations more effective. Trouble shooting and problem solving nightmares will be avoided if users are clear about whom to contact with problems and when support teams understand what they are accountable for and how they need to work with each other.
Having a dedicated team will not only help to ensure a smooth transition and ongoing operation of the outsourced service, but it will help to keep the provider focused on delivering to the contract and service level agreements as well as prevent them from trying to encroach into the user groups to sell other kinds of services that may not be needed.
On the supply side, a number of companies have pursued so-called best-of-breed relationships with multiple outsourcing vendors, each with respective competencies and service responsibilities. In these instances, establishing a single point of contact to address and resolve issues on the supplier side is critical. An effective technique is to require the multiple vendors contractually to operate as a single entity through a dedicated combined organization, or with one of the providers acting as the “general contractor” and assuming overall responsibility for trouble shooting and ensuring satisfactory levels of service and performance.
Deadly Mistake Eight: Designing “Snapshot” Contracts
A common trap that many companies fall into when pursuing outsourcing, particularly those looking to reduce their costs, is to create contracts that are based too heavily on present needs and supply and demand factors. The pressure is great for buyers to specify their needs as specifically and as far out into the future as possible; without stable commitments to demand levels and supply preferences, it will not be possible for the provider to commit to cost savings over the long term. A provider won’t be able to reliably quote prices and make service level commitments very far out into the future without turning the contract into one giant revenue and profit gamble for its stakeholders. But a customer who locks in its requirements over the long term is taking a similar gamble. In order for buyers to avoid being locked into unfavorable contracts, they need to build enough flexibility into the contract to allow for changes in demand and supply levels and new bundles of services. On the demand side, inserting a clause into the contract requiring regular reformulation of demand levels can do this. This can also be done on the supply side, though it is advisable to specify systems and technology upgrade and replacement schedules upfront.
Another mistake that many companies make is not factoring in the possibility of changes in their business such as mergers and acquisitions or startups of new businesses into the agreement. While these types of contingencies are difficult to predict or specify in advance, specific clauses can be negotiated upfront in the contract to allow for them to be addressed and negotiated whenever they arise. It is also important for the outsourcing customer not to assume anything regarding what the vendor is or is not able to do with transferred assets or people. If you want key people to remain on your account throughout the term of the contract, for example, then you will need to specify this in the contract. The same is true for training and development or systems and technology refresh requirements and expectations. Procedures for early termination of the contract and for bringing people and assets back in house if necessary should be thought through and incorporated into any agreement with the outsourcing provider.
Deadly Mistake Nine: Relying on the Outsourcing Provider to Impose Behavioral Change
Outsourcing works best when it causes minimal disruption to your business and organization. The mere act of outsourcing usually represents a significant change in the status quo. But some companies make the mistake of using outsourcing as a vehicle to impose drastic changes in how their organization operates and rely on the outsourcing provider to enforce these changes.
The practice of service level management illustrates this mistake. Before outsourcing, a company may have had few formal mechanisms in place to document user requirements, service level expectations, charges for services and so on. When a business process is outsourced, the company expects the provider to implement a more disciplined and controlled type of process. But they fail to consult end-users and get buy-in from them for the changes in the process. End-users quickly see the outsourcing vendor as an enemy trying to impose rules and procedures on them that they neither understand nor want. Soon users may openly revolt or act subversively to undermine the whole outsourcing arrangement.
Expecting outsiders to act alone to change your organization is a recipe for failure. Strong internal leadership and proactive change management interventions need to be employed if behavior change is to be successfully effected. Training and incentives must be offered to users – they need to see a clear benefit for their efforts. Many senior managers may prefer to use the outsourcing provider as a blunt weapon to ram through change but to succeed they will instead need to be involved in a ‘hands on’ fashion to address user concerns, sort out problems and keep the peace internally until the benefits of the new way of operating begin to be realized. The bottom line is that you can use outsourcing as a tool to support organizational change, but you can’t outsource the responsibility for making the change happen.
Deadly Mistake Ten: Falling into the Mutual Deception Trap
The last deadly sin involves turning the contract negotiation into a win-lose contest with the outsourcing provider. Contract negotiation is a process that can easily bring out the competitive and adversarial sides of the participants. Armies of lawyers and accountants from both sides must become involved, and these specialists can take over the process if allowed, turning it into a hostile win-lose exercise. For some opportunistic vendors, the lock-in process begins with the contract negotiation. The customer has already invested a great deal of time and resources in the outsourcing process by this point and a deal-oriented vendor will try to take as much advantage of this situation as they can. And many buyers fall prey to this same kind of asymmetrical behavior.
Instead of open and honest discussion and negotiation of requirements and commitments, the negotiation process devolves into a series of mutual deception tactics. While this can happen in any area of the deliberations, there are a few specific issues around which it is most likely to arise.
One common deception involves costs. This happens when the buyer attempts to get the outsourcing vendor to commit to unreasonably high cost reduction targets or when the seller tries to take advantage of buyer inefficiencies in the process to be outsourced to “low ball” the cost reduction commitments it makes so that it can reap the majority of the cost benefits for itself. Open disclosure of financials and operating costs can help keep the negotiations on a productive track.
Another common deception involves capabilities. The buyer exaggerates the condition and value of the assets and people it will be transferring over to the provider while the seller promises to maintain and improve these assets while having no intention of making any significant investments in them. Using independent third part benchmarking services and advisors can help to keep both sides honest by providing a fair and mutually accepted measure of quality and a realistic assessment of the investments and improvements likely needed to maintain capabilities as the relationship progresses.
A last prevalent deception is the stated desire for partnership, sharing common goals and equitably splitting risks and rewards, that each party earnestly proclaims to the other. But beneath the surface, the buyer tirelessly attempts to negotiate the most favorable terms it can or wields its clout to wring free services from the provider, even to the detriment of its so-called “partner” while the seller does likewise—relentlessly searching for opportunities to price gouge its “partner” for any services not explicitly specified in the contract. Joint ownership and investment and gain sharing relationships can help to enable collaborative behavior during the negotiation process and once the relationship begins.
Outsourcing is a common and accepted part of how companies operate today. But the decision to outsource remains a strategic one, even when what’s being outsourced is not. It is critical, therefore, to pursue outsourcing for the right reasons and in the right ways in order to realize the benefits you anticipate. Make sure you fully understand the problem and have seriously weighed all possible solutions to it, besides outsourcing, before proceeding. Be rigorous in evaluating vendor capabilities; make certain you validate that providers can deliver what you require in your specific context. Give as much attention to building an effective working relationship with your outsourcing provider as you do to negotiating the contract. Avoid deal-making contests and win-lose brinksmanship. Remember that even if you do everything right leading up to signing an agreement, success may still not be ensured. The hardest part—implementation—remains. To succeed you will need to gain acceptance for outsourcing throughout your entire material handling organization, change how you operate, maintain a viable and productive working relationship with your outsourcing provider, and anticipate and respond to unexpected changes in demand for and supply of services throughout the life of your relationship.
With a list of success factors like these, no wonder so many outsourcing relationships fail to deliver to expectations. Still sure you want to outsource?
|Meet the Author
Tony DiRomualdo, a business researcher and advisor, is a partner at Next Generation Consulting located in Jackson, Wisconsin, and on the Web at www.nextgenerationconsulting.com..