[With special contribution by Jim Eckler]

In this article, I follow up on the statement made in my last column in which I said “I’d seek to bust the myth that what’s good for a vendor must be bad for a customer and vice versa.” In writing those words, what I had in mind was to explore a newly developing genre of outsourcing known as “Vested Outsourcing”^fn. To help with this undertaking, I’ve turned to the colleague who first introduced me to this outsourcing model – Jim Eckler, President of Eckler Associates and a leading expert in outsourcing with over 35 years of experience in the supply chain management field, specifically in business strategy development, operations productivity improvement, and logistics information technology strategy.

Vested Outsourcing – What is It?

The key thing about a vested outsourcing arrangement is the radical redefinition of success. The objective, Jim explains, is to structure the deal so that the measurement of success for the vendor is aligned with the achievement of success for the client’s business. In Jim’s experience, this realignment has a profound impact on the deal and the parties’ relation with one another. The typical measurement of success in an outsourcing lies in the combination of two deal ingredients: is the vendor, for the expected fees, meeting or exceeding the expected service levels? The new model repositions success for the vendor as residing in the achievement by the client of a goal. On this new model, the vendor has a vested interest in the success of the client’s business, as opposed to a narrower perspective in terms of the success of the outsourcing contract relationship, which may well be derivative to the client’s overall business success.

There are several implications to this approach, Jim advises.

The first is that these deals are not negotiated in the same way traditional outsourcing deals are. Specifically, what seems not to work in order to accomplish the desired alignment of goals in a vested outsourcing, is the conduct of a traditional, multi-party, competitive procurement process. As a lawyer well versed in such procurements, I must say that I am partial to them and have seen clients derive great value from them. However, I am also sympathetic to Jim’s point. This type of procurement process is undertaken with each party fixed on its own interests, and is, as a consequence, by necessity adversarial where those interests do not align. Jim’s point is that a negotiation process that is structured on an inherently adversarial basis is unlikely to be one that results in the desired alignment of interests.

So, a different approach is needed. When giving advice to vendors approaching a vested outsourcing, Jim recommends the vendor begin by reviewing the annual report of the client and the CEO’s message to begin to assess the client’s priorities and determine opportunities for alignment. This step is the first in a broader context to conduct interest-based negotiations for the development of an outsourcing agreement. Jim also advocates the use of a mediator as part of this process, whereby each of the parties and its respective counsel would present their interests and a mediator would assist the parties in finding alignment. The introduction of a third party mediator seems to be a key ingredient in objectively identifying opportunities for alignment, just a mediator might be used as part of a settlement process for the same reason.
The next key implication to vested outsourcing is that this alignment of interests is complicated. Vendors are expected to put “skin in the game” with each party assuming real business risk, but where a “win-win” outcome is sought. This creates an incentive on the part of the vendor to apply brain-power or investments in its technology or service delivery model to solve the client’s problem. If a specified business outcome is achieved that results in success for the client, then the vendor is accordingly remunerated; conversely, if the outcome is not achieved, the vendor carries the risk of financial penalties.

Why Adopt It?

Jim’s view is that vested outsourcing solves a current problem in the outsourcing market. The perceived problem stems from the result of traditional outsourcing negotiations and the sense that these deals have always been one-sided in favour of the party with greatest bargaining power. Historically, the vendor was perceived as having greatest bargaining power because it was in the business of doing these outsourcing deals regularly, and accordingly had the most refined business intelligence on how to make money doing them. Pity the poor client. In recent years though, clients have become increasingly sophisticated in both procurement techniques as well as the ins and outs of structuring outsourcing deals. The market place for vendors has also become more competitive. The effect is that the pendulum has swung increasingly to the client side, as the party having greatest bargaining power. Most recently, vendors have begun resisting this pendulum swing, and legal practitioners like me can see it, for example, in the evolution over the past five years or so on the allocation of risk between parties expressed in indemnities, limitation of liability provisions, and carve-outs to limitations of liability. In Jim’s view, the way to untangle this Gordian Knot is to embrace a different measure of success and a different negotiation process to discover it.

So is it right for everyone in all circumstances? It’s difficult to answer that question, in my view, and one that has implications for customers in terms of their short-term and long-term vendor strategies. What I do think is clear, and what has always appealed to me about outsourcing, is that the outsourcing business model is continuing to evolve, and the newest entrant to this portfolio is vested outsourcing. Look for it as part of deal on your street corner, coming soon!

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fn
The origin for the thinking on vested outsourcing lies with Kate Vitasek, who is the author of “Vested Outsourcing”, a book in which she explores how to negotiate, structure, and manage an outsourcing in alignment with “win-win” principles.

My kids watch a popular TV show called Mythbusters in which the hosts seek to uncover the truth behind popular myths. While watching it with them the other night, it struck me that outsourcing has its own share of myths. One that I think deserves having a light shined on it is benchmarking. In this article, I’ll discuss the myth around benchmarking, its impact on an outsourcing agreement, what I take to be benchmarking’s proper role, and I’ll endeavor to do it all with the same “gleeful curiosity and plain old-fashioned ingenuity” that the hosts of Mythbusters are described by the Discovery Channel as possessing. Ready?

The Myth

Benchmarking refers to a process whereby a customer engages the services of a third party expert to review the services in the outsourcing deal with its vendor. The third party expert (the benchmarker) then compares those results against other comparable deals to determine whether the customer is realizing good value. Sounds straightforward; so, what is the myth surrounding benchmarking?

To my mind, there are misconceptions about benchmarking. And, the most significant of those misconceptions is that benchmarking is a substitute for the running of a competitive RFP process. This myth most often materializes in the context of a deal in circumstances in which the customer is under time pressure. A decision is made to sole-source the negotiation with a single vendor, and then rely on benchmarking in order to ensure that “market based” pricing is achieved. Myth #1: benchmarking is not a proxy for the conduct of a competitive RFP process (which by its nature does disclose market pricing).

The Normalization Process

The first thing to understand about benchmarking is that it is equal parts art and science. The straightforward description above of this process belies the difficult exercise of “normalization” – that is, undertaking the benchmarking exercise in order to obtain an “apples to apples” comparison of pricing. Factors that are included as part of the normalization exercise include:

• The state of the customer’s environment – how modern it is may well have an impact of what techniques a vendor may utilize in order to deliver services, how efficient the vendor may therefore be, and accordingly, what the vendor’s pricing is in turn.
• Where the services are being delivered from – the use of different geographical locations require the vendor to remunerate is resources at different levels in order to remain competitive in those marketplaces from a salary perspective. This in turn has an impact on the vendor’s cost base, which is realized as contributing factor the hourly rate charged for those resources.
• The quality of services the customer desires to obtain – the quality of services is inextricably linked to each of the scope of services and the pricing for services. Together, these three elements are locked as a triumvirate. So, for example, if you wish to increase scope, but maintain quality, then typically there will be a corresponding increase in pricing; and if you wish to maintain scope, but increase quality, then again there will typically be a corresponding increase in pricing.
• The scope of services the customer has bargained for – the pricing for certain services where they alone constitute the scope of services for a certain outsourcing may be radically different than the price for those services where they form part of a much broader scope of services in an outsourcing. The difference between these two models is that the vendor may be able to achieve an acceptable level of profitability by cross-subsidizing the price between two or more services under a broader mandate. The healthy margin of profitability it may achieve with respect to one line of service is then used to offset another line that is less (or not) profitable. The broader outsourcing thus permits the vendor greater pricing flexibility than could be realized with respect to the single line of service alone.

There are many more like examples, and all of this is the province of the benchmarker to normalize so that its report results in an “apples to apples” comparison of pricing. Most vendors hate benchmarking; a few have corporate policies in place that preclude their entering into deals that require benchmarking. It’s not difficult to see why vendors have this reaction – a benchmarking clause is used exclusively to lower the vendor’s pricing under a deal, and never to permit it to increase pricing. So it’s all downside for the vendor, or at best, the maintenance of status quo. 

Beyond Benchmarking 

The difficulties inherent in the normalization process are what lead me to conclude that benchmarking is not a substitute for a competitive RFP process. But does that mean this concept should never form part of an agreement? If a customer is entering into a long-term outsourcing agreement (5 years in length or more), then I believe some concept of benchmarking is important to include as part of the agreement. The problem the customer faces with respect to the pricing for a long-term outsourcing is to account for the impact of time and associated changes on the marketplace (new technology, new methodologies, new tools, resources, etc.), which, in the absence of a benchmarking clause, would be external to the deal.

However, I also believe that a long-term outsourcing agreement must include other concepts that are also intended to support a customer’s ability to account for time’s impact, such as “continuous improvement” clauses, and SLA review / improvement clauses that entitle customers to set new SLAs and modify existing SLAs within an agreed framework. And, most importantly, a long-term outsourcing should include an annual strategic planning concept in which the customer can describe its intended strategic direction for the forthcoming future, and the vendor can find ways to contribute to the success of that future, including through the utilization of new technology, new methodologies, new tools, resources, etc.

In this way, to my mind, governance takes an increasingly important role with respect to the maintenance of “on market” pricing as part of a long-term outsourcing, as the parties conceptually move closer to an arrangement resembling a strategic alliance. The art in this context is to identify metrics for success that align each party’s interest. This is a point I will cover in my next article in which I seek to bust the myth that what’s good for a vendor must be bad for a customer and vice versa.

There is an old adage that goes: “a good arrangement between parties is one where the contract can be put away at the end of the negotiation and never looked at again.” And who can complain with the apparent wisdom of this adage? It implies that the parties are so sufficiently well aligned and cooperative that a written contract is merely a formality, and that any circumstances can be accommodated through rational and cooperative behavior. I’ve never met a businessperson who did not subscribe to this adage. And I myself never questioned its apparent wisdom until the past 24 months or so. I now believe that, while there may be transactions where this adage may continue to hold true, it makes little sense in outsourcing arrangements. Let me explain why.

The complexity of an outsourcing arrangement is in many senses unique. That is not to say that other corporate commercial arrangements an enterprise may enter into are not complex. However, an outsourcing transaction is unique in its impact on the enterprise’s internal processes. The way things were done prior to an outsourcing are often manifestly different than the way things are done subsequently. It is a truism to say that changing process is difficult to do. Accordingly, a “stay back” team conventionally helps an enterprise manage its way through these changes. These teams are often comprised of individuals who have deep project management expertise, and are in turn supported by IT and finance groups. Even if the stay back team starts out by managing the relationship in strict conformity to the agreement, over the term of the arrangement (which may span many years), the contract is typically referred to less and less. Instead, decisions on how to handle issues, which inevitably arise in the context of an outsourcing, are dealt with in real time by each party’s business personnel, often with little regard for the processes set up in the agreement. This fluidity to the parties’ relationship can lead to some significant issues.

First, the regimes set out in the outsourcing agreement, which are designed to provide protections for the customer, are not followed. By way of a recent example, a customer and its outsourcing vendor determined that a change was required as part of an outsourcing. The vendor proposed initiating the change as a new service outside the documented change control process, on the basis that it would be “faster”. The customer agreed; speed was desirable to it. Subsequently, there was a disagreement over amounts payable as part of the institution of the change. In the circumstances, the customer’s agreement to permit the change to be made outside the documented change process deprived it of: (i) agreed contractual provisions detailing the allocation of responsibility for costs in the context of changes; and (ii) dispute resolution mechanisms, culminating in mandatory baseball arbitration provisions (which in turn had been drawn up in reference to agreed principles). To the extent that the original negotiation resulted in processes and an allocation of risk that the customer had fought hard to win, moving off the negotiated agreement had the inadvertent effect of depriving the customer of those benefits.

Second, at a more ordinary-course level, the agreement can and should act much like a map through a dark forest. Inasmuch as an outsourcing may last many years, it is not unreasonable to imagine that the parties may well forget who is responsible for doing what, particularly where those responsibilities may change what had been ordinary course behavior for one of the parties. For instance, in one outsourcing, as year-end arose, the customer found it had a certain amount of money left over in its budget. Rather than fail to spend the whole of the budgeted money, the customer decided to acquire certain hardware to replace older equipment forming part of the infrastructure of the business it had earlier outsourced. The problem was that that hardware refresh obligation was the vendor’s, not the customer’s. The vendor had also acquired equipment for the same purpose. To further complicate matters, the customer had chosen equipment different than what the agreement had contemplated in certain material respects. This had the effect of creating unintentional additional costs for the vendor to maintain the equipment, and the vendor needed to be reimbursed for the equipment it had acquired but was unable to utilize elsewhere. So what started as an innocent step taken by the customer to save money resulted in a material cost increase as part of its outsourcing. This problem could easily have been avoided if the customer had but referred to the agreement.

Finally, the propensity for the parties to move “off piste” in terms of their contractual relationship creates a further problem. Relative to any particular issue or change, as parties compound decision upon decision, and act upon act, and in doing so, ever increasingly draw themselves away from the contract terms themselves, the problem that arises becomes one of contractual interpretation. If in these circumstances (which may involve activities between the parties unfolding over months or even years), one party raises its hand and indicates there’s been a breach by the other, and begins to desire to seek recourse, it can be exceedingly difficult to interpret the circumstances against the contractual provisions with any clarity or precision. In situations like this, real ambiguity can emerge as to whether there is recourse, and if so, to what extent. Can the existing contractual provisions be applied? Or, have the parties varied the agreement by their conduct, and if so, what are the present terms? Or, have the parties undertaken activities not contemplated by the original agreement and which are therefore not subject to its terms at all; and if so, what terms are relevant to the arrangements between the parties?

Increasingly, I have come to believe that it is an essential part of outsourcing governance “best practices” to include a lawyer or clerk whose responsibility it is to analyze all proposed changes from the perspective of the contract. Now, this approach assumes that there are provisions in the contract that are helpful to the customer and are accordingly worth adhering to. Assuming that’s the case, our experience in the past few years has been that even if this were someone’s full time job, the costs saved by having that person around to ensure adherence to the contract terms would typically far outweigh the costs associated with paying that person’s salary.

So, the next time you hear someone say, in the context of an outsourcing arrangement, that “a good arrangement between parties is one where the contract can be put away at the end of the negotiation and never looked at again” you may find you have a different perspective.

In the previous post, I looked at a Gartner Group survey, which found that one of the biggest issues resulting in contracts being prematurely renegotiated was that they lacked the flexibility to handle unforeseen changes. This is the second in a series of posts examining some of the ways in which outsourcing agreements can be structured to accommodate change over the life of the contract. In my last article, I looked at contractual mechanisms designed to accommodate unanticipated M&A activity. In this article, I look at mechanisms designed to address the financial responsibility for future changes. 

(i) Allocating Financial Responsibility in Advance

Over the course of an outsourcing agreement, required changes may affect the delivery of services under the outsourcing contract or either party’s related costs. Since these changes can result in additional or decreased costs, the time spent on deciding which party should bear those costs or benefit from a cost reduction can delay the timely implementation of required changes. It is in the best interests of both parties to avoid this problem, which can be accomplished by addressing the allocation of financial responsibility for such changes upfront, at the time the contract is entered into. The typical stumbling block in resolving this point is that the parties do not know the exact nature of these changes in advance. However, a way forward can be found if they anticipate and account for financial responsibility according to certain categories of potential changes.

(ii) Determining Financial Responsibility According to Categories

Broadly speaking, there are two categories that should be considered: (a) changes that will be implemented by the vendor for no charge; and (b) changes that will be implemented by the vendor for a charge. The agreement should cover both kinds. 

While every transaction is different, there are many examples of changes that typically fall within the first category. For instance, changes that must be made in order for a vendor to comply with applicable law may be borne by the vendor without charge to the customer, and accordingly would fall within the first category. The parties may identify other examples applicable to this category. For the reasons referred to above, it is a best practice for the agreement to include the allocation of financial responsibility for this category. 

The second category can, in turn, be divided into two subcategories: (a) changes that affect the particular customer as well as other customers of the vendor; and (b) changes that affect only that customer. 

In the first subcategory, if there are changes that are required by some but not all of the vendor’s customers and that do not fit within the category of changes that the vendor is required to implement without charge to the customer, one way of allocating financial responsibility would be for the customer to be responsible for the charge, but on a pro rata basis. The logical point being addressed in this instance is that the vendor will be required to make the change for each customer affected, but should not charge each one individually the full cost of implementing the change. Instead, it is divided equally between all such customers. The existence of this subcategory, and its relevance to any particular outsourcing, assumes that the vendor’s infrastructure used to deliver the services to the customer is being shared and used for other customers.

Finally, the second subcategory functions as a basket that catches every other kind of change. These are changes required by the customer that do not fall into either of the two preceding categories, and the financial responsibility for which should be fully borne by the customer.

By accounting for changes in this way ahead of time, a long-term outsourcing agreement can accommodate changes through embedded contractual terms that are designed to provide flexibility and financial predictability, even if the particular changes themselves can’t be foreseen. 

One of the most complicated things to address as part of a long term outsourcing is the implications of change. Gartner Group recognized this when it released the results of a survey in which it found:

• 55% of enterprises have renegotiated their outsourcing agreement terms within the lifetime of the contract;
• 15% of such renegotiations occurred within the first 12 months;
• only 23% of enterprises did not expect to enter into renegotiations; and
• nearly 8 in 10 outsourcings will go through renegotiations at some stage.

According to Gartner’s survey, one of the biggest issues leading to contract renegotiation was a lack of flexibility in the outsourcing contract sufficient to accommodate unforeseen changes (fully 50% of survey respondents identified this as the cause of their renegotiation).

To my mind, these survey results are a clarion call for the importance of taking care to anticipate the impact of changes on an outsourcing — the longer the outsourcing transaction term, the greater the necessity for such forethought. This is the first in a series of posts that will look at some of the types of events that can occur during the life of an outsourcing agreement and the mechanisms that can be built into an agreement to handle these changes in manner predictable to both customer and vendor.

1. Unanticipated Impact on M & A Activity

It is obvious that an enterprise’s entering into of an outsourcing agreement does not result in a stoppage of that enterprise’s other mergers and acquisitions activities. However, outsourcing agreements often fail to address the nexus between M&A activity and the outsourcing itself. If an enterprise has entered into an outsourcing, what happens if it wants to sell an affiliate where that affiliate is also a beneficiary of the same outsourcing? Has the outsourcing made the affiliate unsalable in the sense that the running of its business is dependent on the outsourcing for some important business function? What happens if the enterprise acquires a new affiliate which the parent enterprise desires to have extended the benefit of the outsourcing? These are questions best raised at the start of the outsourcing (when a customer’s bargaining power is greatest), rather than in the middle of an M&A deal when these issues tend to rise to the surface.

(i) Acquisitions

If an enterprise acquires a new affiliate, and as part of the integration of that affiliate with the enterprise’s corporate environment, desires to extend the benefit of its existing outsourcing to that affiliate, there are some contractual mechanisms which will help facilitate that outcome.

The “Affiliate Clause”. The first is an affiliate clause which states that at the customer’s request, the vendor will provide services to the affiliates of the customer, as though these parties were the customer itself. The effect of a clause such as this is to negate the need for a re-negotiation of the outsourcing deal documentation. Instead, the services are provided through the parent enterprise to the affiliate, with the parent becoming responsible for the affiliate. More specifically, managing this M&A circumstance through an affiliate clause means there is no direct contractual relationship (known as ‘privity of contract’) between the affiliate and the vendor, which in turn means that neither can enforce the contract terms against the other. Accordingly, the clause must provide on the one hand that the parent enterprise will enforce the contract on behalf of the affiliate, and on the other, that the parent enterprise will be responsible for the affiliate’s breaches. In this way, the contractual relationship stays directly between the parent enterprise and the vendor, but accommodates the addition of the affiliate. With the introduction of a new affiliate in the mix, volumes under the outsourcing may well increase along with the associated fees under the deal — these changes would typically be addressed as part of the change control process (the controls on which are important and will be explored another post). 

Participation Agreement. Another way to handle this circumstance would be through the introduction of a participation agreement. Unlike an “affiliate clause”, a participation agreement is entered into directly between each of the vendor, the parent enterprise and the affiliate and functions, by incorporating the outsourcing agreement’s terms and conditions by reference, so as to extend those terms directly to the affiliate. The difference between the affiliate clause and the participation agreement is the lack of a direct contractual relationship between vendor and affiliate (or lack of privity of contract) in the foregoing example and its maintenance in the latter. The effect of this difference means that in the latter example, a vendor may could make a claim for damages directly against the affiliate under the participation agreement and vice versa. In this way, the allocation of risk between the parent company and its affiliates viz-a-viz the vendor is handled differently in the two models. Different customers may prefer one approach over the other. Another difference is the requirement for administration on the part of the customer and vendor — the affiliate clause requires no subsequent contract documentation to be entered into, although both approaches likely result in the necessity for change order documentation to be settled. There is one more important thing to consider in the case of the participation agreement and that is how do cross-defaults work? The participation should specifically address circumstances in which the parent enterprise terminates its agreement with the vendor — is the effect of such a termination likewise a termination of the participation agreement? The opposite should be considered as well — if an affiliate terminates the participation agreement, should that result in a termination of the parent company’s outsourcing agreement? Different customer and circumstances will dictate different answers to these questions, but it is important to address this point.

(ii) Divestitures

The approach with divestitures should be managed in a similar fashion. The parent enterprise’s outsourcing agreement should include a divestiture clause. Such a clause would state that if an affiliate is sold to a third party and thereby ceases to be an affiliate of the parent enterprise, then such affiliate could continue to obtain the benefit of the outsourcing by entering into an agreement for such services directly with the vendor. This approach would create a directly contractual relationship between the former affiliate and vendor, with the result that breaches under the new outsourcing agreement and associated liability would flow directly between the vendor and the former affiliate. The rationale for this approach (as opposed to an approach that was strictly the opposite of the affiliate clause) is that the parent company no longer has control over its former affiliate, and accordingly, would no longer desire to be deemed to be responsible for its breaches or to act to on its behalf with respect to its claims against the vendor. What is critical on this approach is to settle the terms and conditions of the agreement to be entered into by the vendor and the former affiliate. It’s not enough to simply say, as is often done, that the parties will enter into an outsourcing agreement. Leaving it at that results in an unenforceable ‘agreement to agree’. Instead, definitive terms and conditions (including pricing) must be set. One approach is to state that it would be on the vendor’s standard terms and conditions (including pricing), and annex a copy to the main agreement. Another approach would be to duplicate the terms and conditions of the parent company’s agreement. Whatever is ultimately negotiated, bringing certainty as to the term, scope of services, service levels and pricing for such services is desireable in that it aids in the M&A divestiture activity by creating operational and pricing certainty which can be factored into the M&A deal. 

More generally, with respect to be both acquisitions and divestitures, by accounting for M&A activity ahead of time in a long-term outsourcing agreement, the acquisition or sale of an affiliate can play out through the outsourcing agreement in a predicable manner, thereby limiting financial and contractual uncertainty. 

In a recent conversation over outsourcing at a conference, I was struck by the importance of governance to the ultimate success of an outsourcing. The individual I was speaking with (let’s call them the ‘customer’ for purposes of this article) described their situation as one in which their enterprise was late in the term of a BPO outsourcing involving the transfer of a certain business function to a service provider. As they drew nearer the end of the term and began to consider a renewal, this customer undertook a more detailed analysis of the health of the transaction with its service provider. And that’s when several questions arose.

Same Mess For Less, I Guess?

As the customer explains it, the original goal of the deal was to save money. To that end, the financial terms were structured such that the customer was to pay the service provider an amount less than the amount it cost itself to perform the same function for the same level of service – in other words, the “same mess for less”, in business parlance.

However, the customer’s operations were spread among divisions that operated with a certain amount of autonomy. At the same time, the customer’s stay-back team – the personnel who helped originally structure and negotiate the transaction – became dispersed to other areas within the enterprise relatively quickly after the closure of the transaction. As change orders began to be exchanged between customer and service provider, there were fewer and fewer people left to evaluate not just whether the technical change would be beneficial to the customer, but whether the cost for the technical change remained consistent with the customer’s original business goal. Inevitably, through multiple change orders, the service provider began to increase the scope of services being performed. It also steadily increased its charges to the customer over the term for those services. By the time of the customer’s reanalysis for renewal purposes, what the vendor was doing for the customer was significantly different than what it was originally retained to do, as were the fees being paid.

The business goal of “same mess for less” had effectively been subverted. The insidious element of this problem was that it arose not from a single change order, where frankly the customer’s corporate finance group might well have identified the problem arising. Instead, the business goal became unwound through the cumulative effect of multiple change orders over several years – a much more subtle process. 

So how do you protect yourself against this kind of problem? I believe the answer lies in effective governance.

Clear Objectives

First, it is essential to have clearly articulated business objectives. Indeed, these objectives should first be formulated and articulated in the procurement process as part of an RFP, and then subsequently refined through the transaction negotiation process. By the time of closure of the deal’s negotiation, they should be well understood by both parties.

Best practices provide for the business objectives to be (i) communicated in writing to the vendor; (ii) measured, monitored and reported upon periodically; (iii) objective in nature (as opposed to being subjective). In the example at hand, the business objectives also need to be communicated through the customer’s own enterprise, across disparate departments and divisions. It falls to the customer though, and in particular the stay-back team (more about which, below), to be vigilant in determining whether change orders (whether proposed by the service provider or the customer itself) are consistent with the customer’s business objectives.

Stay-Back Team – the Customer’s Institutional Knowledge Base

A stay-back team is also a critical element of success. Think of this team as the customer’s institutional knowledge base for the outsourcing. The stay-back team represents a group of individuals retained by an outsourcing customer whose purpose is to take over the management of the business relationship with the new service provider. Best practices dictate that the stay-back team be comprised of individuals who were responsible for the original negotiation of the outsourcing transaction. In this way, they should be intimately familiar with the customer’s business objectives for entering into the outsourcing. At the same time, it is desirable that they represent different subject matter expertise within the customer’s enterprise (e.g. tax, corporate finance, technology, etc). This gives the team multiple perspectives from which to evaluate the success of the relationship and changes in the relationship that may arise from time to time (whether through change orders or otherwise under the contract). It goes without saying that the institutional knowledge of the stay-back team cannot be allowed to dissolve over the course of the outsourcing’s term. Certainly, individuals come and go from enterprises, and it is possible that the stay-back team members themselves may vary over the term. However, if members of the stay-back team are to be replaced, it is essential that their replacements be transitioned into their role in such a way as to preserve the institutional knowledge base pertaining to the outsourcing. 

Communication, Command & Control

With the goals articulated and the stay-back team monitoring their success or failure, a final important element for success comes with communication. The service provider should be required to report on its achievement of the company’s objectives, and key objectives, in turn, should be the focus of periodic joint meetings with the service provider to assess whether the transaction is on track or not.

This is often done with specific service attributes or functions through the establishment of service level agreements, but there is no reason why the broader business level objectives of the customer cannot be measured, monitored and reported upon as well, provided they are themselves objective. Best practices in this area prescribe a monthly dashboard report from the service provider, attached to the monthly invoice, in which all key service levels and business objectives are identified, along with a description of whether or not they have been met. The assessment of this dashboard report should again fall within the purview of the stay-back team.

Assuming that key objectives are being missed, it is also important to consider a command and control element to the relationship with the vendor. Specifically, a well-structured relationship between the parties should provide for rights on the part of the customer to dictate (the command component) that the service provider initiate remedial actions (the control component). Notice that I am not saying that the customer should prescribe to the service provider how to correct the problem (although, if the answer to the customer is obvious in that respect, that information should be conveyed) but rather to communicate that the problem exists and have the service provider identify the means and timeframe to correct it. This regime should be include contract performance provisions which specify: (i) the circumstances in which the customer is entitled to seek adjustment to the service provider’s charges, and the formula for determining the extent of such adjustments; and (ii) the service levels which the service provider is responsible for meeting, and the remedies for the service provider’s failure to do so.

The combination of clearly articulated transaction goals, their ongoing assessment by a knowledgeable stay-back team, and the periodic communication of their achievement to the service provider (along with associated remedies for failure to meet those goals) are all key attributes to the more general concept of effective governance. In the end, a governance model that remains focused on outcomes strategically important to the customer remains a key ingredient to a successful outsourcing.