Digital, Commerce & Creative 101: Outsourcing: creating a win/win partnership and driving the right behaviour

Logically, an agreement is where both parties get benefit and value. But in outsourcing the complaint most often heard from both customers and suppliers is that there is no win/win. So, what does win/win really mean in an outsourcing environment?

In our view it broadly means 'fairness' and in this short article we look at four areas of where fairness can bring the desired win/win result.

Pricing

Let us start with pricing. Outsourcing had a reputation in its early days for aggressive pricing negotiations. In truth neither customers nor suppliers really understood the challenges of pricing long term relationships. These long term agreements often had pricing models that over the years became unrealistic particularly when applied to services which can change in scope and delivery methods over the period. The result was a build-up of resentment which inevitably led to poor performance.

So, the first win/win during negotiations must be to ensure that the supplier will make a commercial return from the outset and will continue to do so over the life of the contract. This is both parties’ responsibility and the customer needs proactively to test the pricing assumptions of the supplier.

In particular, we recommend that both customers and suppliers think carefully about two areas. The first is financial engineering. This typically involves pricing being artificially low in the early years and thus artificially higher in the later years. Therefore, at any one time there is an imbalance in the work-risk-reward ratio. The second is rigidity of pricing particularly in those sectors, such as financial services, where regulatory changes are frequent, and where experience has shown that it is impossible for suppliers accurately to predict future changes over the long term.

As an aside, it also means that where a contract has gone wrong and the supplier is not making enough return, it is likely that the customer will have to recognise that renegotiation of pricing is the only way to maintain the services and improve the relationship.

Culture Fit

Many customers make a point in their tenders of trying to ascertain a culture fit. The problem however is that cultures can change, both at a corporate and individual level. One cannot contract for potential changes in culture but the contract can help. We are sometimes asked why outsourcing agreements are so long and take so much time to put together.

Experience shows that in long term relationships it is important that a high degree of certainty as to what the parties really agreed is required and that quicker deals with an emphasis on negotiators using phrases such as "we will have a sensible conversation" rarely have the desired outcome. That is not to say that a more imaginative approach cannot be taken in contracting. For example, in recent years so called ‘output based’ services are proving popular which allow the supplier to have some more flexibility in how it delivers the services.

Contract Bias

Outsourcing contracts often have a bias in favour of the customer. A frequent complaint from suppliers is that customers sometimes insist on very one sided terms. A key point for customers is to recognise that unreasonable terms, and therefore risks, are likely to be reflected in the pricing somewhere.

A good starting point, for both sides, is to ask whether you would accept such terms if the position was reversed.

It certainly helps a win/win in negotiations if the legal advisers are experienced in outsourcing and regularly advise both suppliers and customers.

A recent development is the concept of standard terms for use in outsourcing. Although in its early stages, the Global Sourcing Association (GSA), the UK industry association and professional body for strategic sourcing, has started to develop industry recognised standard terms. See here.

Outsource Management and Governance

To ensure continuity and mutual understanding particularly in the critical early stages of an outsourcing agreement experienced customers and suppliers often ensure that someone who was involved in the negotiations continues to be involved in the outsourced operations. This should be at least until the successful completion of transition and, if transforming the services is also undertaken, until the successful completion of transformation. Similar involvement is also desirable in the case of open book pricing agreements, for example in a cost plus a percentage management arrangement.

A robust governance regime is essential. Aside from the contractual mechanics ensuring that issues can be raised and discussed, both sides need to remember to employ experienced and empowered relationship managers. Also, each side needs to be able to escalate within their own organisation any issues and make decisions quickly. Traditionally, suppliers are better in this regard as customers, having outsourced a major function, tend to regard issues as those for the supplier to sort out. Indeed, over the years, customers have had to accept that a key requirement of outsourcing and the avoidance of issues building up is to have a specialist outsourcing function dedicated to overseeing and collaborating positively with its major outsource suppliers.

Conclusions

It would be nice to think that these comments are so obvious that they should not need making. Unfortunately, however, we continue to see these sorts of problems each coming from a different aspect of outsourcing. But if you believe in fairness in contracts and their operation, then a good analogy is health and safety - everyone – on both side – commercial, legal and relationship management has a responsibility to work towards it.