Outsourcing is viewed as a means to reduce costs, improve customer satisfaction, and provide enhanced efficiency and effectiveness. However, many organizations never realize the full benefits of an outsourcing relationship.
Outsourcing relationships fail when they are viewed as short-term or tactical solutions, rather than part of long-term strategic plans. The process of considering and/or implementing an outsourcing solution must be systematic and fully documented to achieve the desired results. A multi-step approach, including planning, analysis, design, implementation, and operations phases, along with a contingency exit strategy, is required to achieve a successful outsourcing implementation.
In part one of this two-part presentation, we will look at the first three phases: planning, analysis, and design.
Phase One: Planning Strategy
Traditionally, outsourcing initiatives focused on headcount or cost reductions, but today, outsourcing is a more strategic decision, focusing on core competencies. Thus, it must have the full support of senior management, and all goals and objectives must be articulated from the top.
Before outsourcing a business function, a strategy and goals document should be drawn up, detailing the organization’s outsourcing intentions, the strategic rationale for outsourcing, and describing:
- Processes to be outsourced
- Objectives for outsourcing
- Relationship of outsourcing to the overall corporate strategy
- Links between the outsourced process and the organization’s core competencies
- Strategic forces driving the organization into an outsourcing relationship
- Scope of coverage
- Critical risks involved
- Expected duration of the relationship
The strategy sessions that result in the formulation of this document should focus on questions of core versus non-core processes. The strategy and goals document then creates a value proposition that outlines the expected benefits customers – both internal and external – will realize because of the outsourcing arrangement.
Core vs. Non-Core Processes
The definition of a non-core competency is any process that does not generate income or help your organization increase its market share. Non-core processes should be outsourced, allowing the organization to realize financial and competitive advantages by reallocating internal resources to focus on core competencies.
To help identify business functions that are core competencies, ask:
- Does this process create or defend a unique competitive advantage for the organization?
- Is this process contributing directly to business growth or expansion?
- If the organization were a start-up, would we build this capability internally?
- Would other companies hire us to do this for them?
Information technology and human resources are non-core business competencies that have blazed the outsourcing trail. As the outsourcing of IT and HR has matured, other business competencies have jumped on the outsourcing bandwagon. Forecasts show that outsourcing the finance or accounting function is the fastest growing outsourcing trend.
Expected Benefits of Outsourcing
Typically, organizations can expect to realize the following benefits from a strategic outsourcing initiative:
- Improved company focus, leaving operational details to the outside experts.
- Reduced operating costs.
- Increased customer satisfaction.
- Re-allocation of internal resources to core activities.
- Access to world class capabilities and services, without the need to build from the bottom up.
- Reduced risk. Markets, competition, government regulations, financial conditions and technologies all change extremely quickly. Outsourcing is a vehicle that enables the organization to share these risks with the outsourcing provider.
- Improved cost, quality, service and cycle times.
- Cash infusion. In some cases, outsourcing involves a transfer or sale of company assets to the provider.
- Increased capital funds availability. Resources can be acquired through alternate methods rather than capital expenditures.
Phase Two: Analysis
Phase two involves preparing and delivering a request for proposal (RFP), examining proposals, evaluating outsourcing providers, and determining required service levels.
Request For Proposal (RFP)
Before writing a request for proposal (RFP), the organization should prepare a list of possible outsourcing providers. This list should not include the entire universe of organizations providing the service, but typically those 10-15 companies that would appear to have the greatest compatibility with your organization.
The request for proposal itself should provide a complete picture of every aspect of the business function to be outsourced. Vagueness in the content of an RFP results in outsourcing providers submitting proposals based on assumptions about deliverables, which could quite possibly result in increased costs over the life of the outsourcing agreement.
A well written RFP contains twelve basic elements:
- Statement of purpose. The nature and extent of the services to be outsourced and the overall objectives of the contract.
- Background information. An overview of the process as it is performed now, including relevant statistics, relationships with other outsourcing providers, facilities, and automated systems, along with an honest accounting of current problems and strengths.
- Scope of work. Specific duties to be performed by the outsourcing provider versus those to be performed by the contracting organization and/or other parties.
- Term of contract. Length and options for renewal.
- Deliverables. A list and schedule of all products, reports, and plans to be delivered to the contracting organization.
- Outcome and performance standards. Outcome targets and minimum performance standards expected of the outsourcing provider, as well as methods for monitoring performance and the process for implementing corrective actions.
- Payments, incentives, and penalties. Terms of payment for adequate performance, the basis for incentives for superior performance, and penalties for inadequate performance or lack of compliance.
- General contractual conditions. Standard government contracting forms, certifications, and assurances.
- Special contractual conditions. Requirements unique to this contract.
- Requirements for proposal preparation. Required format and content of the response to the RFP, including information to be submitted on outsourcing provider’s personnel, technical and corporate qualifications.
- Agency contacts and RFP schedule. Persons to contact with questions regarding the RFP, along with any contact restrictions, dates for submitting questions, pre-proposal conferences, submission of proposal, etc.
- Evaluation and award process. Procedures and criteria for evaluating the technical proposals and bids, and for making the contract award.
Finding the Right Outsourcing Partner
In the ideal relationship, both the organization and outsourcing provider share a similar vision and contribute equally to the success of the project. The right partner can help the outsourcer define realistic expectations and articulate benefits of moving the process outside.
Finding an outsourcing partner that can share your vision and merge seamlessly into your organization’s culture requires significant up-front effort. Several formal and informal meetings will be required to get to know one another, to achieve a complete understanding of the scope of the project, and to fully discuss the specifics of the processes and procedures.
During the selection process, tough questions need to be asked, like:
- Is there strategic synergy between the two organizations? Can they work together to achieve a high level of benefits?
- Is there opportunity for growth? Can the relationship – and its benefits – be expanded?
- Does the relationship reduce the level of risk for your organization? Is the vendor financially viable?
- Is there good chemistry between your organization and the provider? Are your corporate cultures compatible?
- Is there clarity of purpose? Are the goals and benefits explicit and clear?
- Does each party benefit fairly from the relationship? Is this a win-win situation?
- Does the outsourcing provider have in place a management team capable of delivering best-in-class services?
- Does the outsourcing provider have the technology environment needed to support world-class service? Is there a strategy in place for maintaining state-of-the-art technology and the updated skills to operate it?
- Can the outsourcing provider leverage industry experience to devise improved solutions?
Determining Financial Benefits of Outsourcing
In evaluating the financial ramifications of outsourcing a business process, organizations often employ a simple ‘straight dollar’ methodology, comparing the bid of one outsourcing provider to the bid of another. Then comparing the winning bid to the straight costs of performing the process internally.
This method fails to consider the true impact of outsourcing. Instead, more sophisticated methods of evaluation, like the impact on cash flow, or on efficiency (return on equity and return on assets) and value creation (total business return and economic value), will provide a complete picture of the potential benefits the provider and/or the outsourcing strategy can bring.
Phase Three: Design
The Contract
A sound agreement is critical to the success or failure of an outsourcing engagement. It allows the organization to maximize the rewards of outsourcing, while minimizing the risk. Each party must understand the reasons for the outsourcing decision and approach the contracting process with a give and take philosophy.
It is essential that the outsourcing contract reflect all the critical issues, specifically the scope, performance, and pricing. Important contractual considerations include:
- Terms of agreement. Today’s trend is toward a shorter-term, renewable option (2-5 years).
- Scope of project. The contract should specify the services to be provided in as much detail as possible. If this description is absent, disputes may arise as to whether particular requests are within or outside the scope of the project. It is in the best interests of both parties to have a complete listing of all services to be performed, service levels, and deliverables detailed in the agreement.
- Confidentiality. The agreement must specify that the organization owns the information it submits to the outsourcing provider and that the information is to be kept strictly confidential.
- Service level agreements. A contract should include service level agreements (see more on SLAs below). Without them, there are no objective criteria for managing the outsourcing relationship. Performance measures should be easy to understand, relatively few in number, and reasonable/possible.
- Force majeure . Provisions that excuse the vendor from performance under certain conditions.
- Warranty. The vendor warrants that it will provide the services as defined in the agreement and will accommodate a specified increase in requirements.
- Change management. The contract should spell out the cost/fee implications of changes to the original agreement, and the personnel authorized to request and accept changes. Planning for change is critical to the success of any outsourcing agreement.
- Pricing. Pricing is an area where flexibility can be used to reward both the organization and the outsourcing provider. A new trend involves spreading business risk by adding a quality or performance bonus tied to service level agreements. This is meant to guarantee that the outsourcing provider has a significant interest in the organization’s business performance.
- Termination plan. How the decision to terminate the relationship will be executed in a fair and equitable manner, without resulting in disruption in services.
Service Level Agreements (SLAs)
Properly structured performance incentives and penalties enable the outsourcing provider to work with your organization as a partner, be accountable for their performance, and tangibly demonstrate the value they bring to your organization. The most successful outsourcing relationships involve the outsourcing provider and the organization participating in continuous process improvements.
Performance incentives should focus on:
- Clearly understanding the areas impacted by the outsourcing relationship.
- Identifying the key performance indicators (KPIs).
- Defining the handoff between the internal organization and the outsourcing provider.
- Putting substance behind the attainment of service levels.
When establishing the performance indicators or SLAs, a defined structure like the one outlined below will eliminate ambiguity.
SLA Structure
- Objective: The business reason for measuring the service level
- Definition: A specific definition of the service level
- Method: A description of how performance will be measured
- Period: The time through which the performance will be measured
- Action: What happens when service levels are and are not met.
If developed in detail, service level agreements will provide you with the information needed to fully understand the quality of service your outsourcing provider is delivering.
Outsourcing agreements should always be living documents. The organization should monitor and evaluate the performance of their outsourcing provider in relation to the agreement on an ongoing basis.
Part Two of Managing the Outsourcing Process will deal with Implementation and Operations.
Originally distributed through ABC-Amega’s Credit-to-Cash Advisor April 2004 e-newsletter