Vested Outsourcing

[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.