Achieving real and productive collaboration with your outsourcing partners requires hard work and a framework for designing and implementing long-term outsourcing relationships based on innovation and the achievement of mutual goals.
Extensive research by the University of Tennessee resulted in the development of a new, hybrid outcome-based business model researchers coined as “Vested Outsourcing” or Vested for short. The research led to the book Vested Outsourcing: Five Rules That Will Transform Outsourcing, which outlines the need for a new, modern way to outsource based on trust, collaboration, and working together to achieve mutually beneficial goals. The book shared five key rules, which when applied, increase innovation and improve efficiency. These five rules are:
1. Focus on outcomes, not transactions
2. Focus on the what, not the how
3. Agree on clearly defined and measurable outcomes
4. Optimize pricing model incentives
5. A governance structure should provide insight, not merely oversight
While well received, many were skeptical. One executive praised the book’s “theory,” but quickly suggested it would never work in “practice.”
Like many good researchers, the UT team took this challenge to heart and began to write the second book —The Vested Outsourcing Manual—with the purpose to take the Vested concept to the next level by providing a detailed, practical guide for implementing the Five Rules and crafting a successful outcome-based outsourcing agreement. We teamed with the International Association for Commercial and Contract Management to write a guidebook for how to put the rules into practice.
The Vested Outsourcing Manual shows practitioners how to translate the five rules into a collaborative business-to-business outsourcing with the power to facilitate successful and long-lasting business relationships based on mutually Desired Outcomes.
A Vested contract is first and foremost built using a flexible contractual framework. This is because modern business is not static. Rather, business happens, constantly and unpredictably. A great outsourcing contract embraces the dynamic nature of business versus creating a rigid contractual framework that puts the parties in a box.
The Ten Elements of a Vested Outsourcing Agreement
A key purpose of The Vested Outsourcing Manual is to translate “how” to take the five rules and write them into a formal contract. Researchers mapped 10 contractual “elements” to the rules. The elements work in conjunction with the Five Rules and in essence become the signposts that direct the company and service provider to a successful, long-term relationship.
The Ten Elements are keyed to the Five Rules, as shown below:
The rest of this article provides a high-level summary of each of the 10 contractual elements.
Rule #1: Focus on Outcomes, Not Transactions
Element 1: Business Model Map
This first step is to understand and document an outsourcing business model. The figure below illustrates how the Vested model relates to other sourcing business models along with a sourcing continuum spanning simple transactional deals to investment based models such as an equity partner (e.g. a joint venture).
It is imperative that a company and the service provider align on the most appropriate sourcing business model for their relationship. For example, if the company that is outsourcing wants more of a short term transactional or “utility” type outsourcing deal, this should be clearly communicated to the service provider. And the service provider should not try to “upsell” the organization on capabilities that might drive unwanted costs. Likewise, if the company is seeking an outcome-based business model with the goal to drive transformation or innovation, a Vested model should be the preferred sourcing business model. Once the parties agree on the most appropriate sourcing business model, they can move to Element 2.
Element 2: Shared Vision and Statement of Intent
A Vested agreement is – at its heart – a shift from a transactional contract to a relational contract. As mentioned previously, Vested agreements are typically only used for strategic, longer term relationships. As such, a cooperative and collaborative culture that purposely promotes trust is essential for success. Element 2 is kicked off with the parties creating a shared vision and a formal Statement of Intent that becomes the beacon for the relationship. A key part of the Statement of Intent is to agree on and formally document Guiding Principles that the parties will use not only to help them architect their agreement but which will become an anchor to their contract. The six Guiding Principles that set out the parties’ intent and desired behaviors are reciprocity, autonomy, honesty, loyalty, equity and integrity.
Rule #2: Focus on the What, Not the How
Element 3: Statement of Objectives/Workload Allocation
In a strategic outsourcing deal, the buyer is not simply outsourcing for labor arbitrage. Thus, the buyer should lay the foundation for the parties to do what they do best. Depending on the scope of the relationship, the company outsourcing is likely to transfer some or all of the activities needed to accomplish agreed goals to the service provider. Together, they develop a Statement of Objectives (SOO), which is very different from a standard SOW. Simply put, a SOO describes intended results, not tasks. Based on the SOO, a service provider will draft a performance work statement that defines in more detail the work to be performed and the results expected from that work.
Rule #3: Clearly Defined and Measurable Outcomes
Element 4: Top-Level Desired Outcomes
Element 4 is where the parties work together to define and quantify mutually defined Desired Outcomes. This element is a centerpiece of the whole contract as the Desired Outcomes are really the “end game” of what the company outsourcing is buying. The Desired Outcomes are translated into a limited set of high-level metrics. It is imperative that the parties spend time—jointly and collaboratively—to define exactly success will be measured.
Desired Outcomes are not conventional Service Level Agreements (SLAs), which typically measure a supplier’s “outputs” (e.g. process an invoice in 48 hours, answer a call in 20 seconds). Rather they are strategic business outcomes that serve as the beacon for success. They, therefore, are typically transformational in nature. For example, when Dell shifted to a strategic Vested agreement with its reverse logistics supplier FedEx, the parties agreed on six Desired Outcomes that – if accomplished – would transform the way Dell managed their reverse logistics operations. One of these Desired Outcomes was the reduced cost structure, which FedEx was able to achieve by reducing cost structure by 50% within three years.
Element 5: Performance Management
While agreeing on success measures tied to the Desired Outcomes is essential, it is also imperative the parties agree on how they will actively and jointly manage performance along the journey. Element 4 outlines the mechanisms the parties will use – such as dashboarding and reporting mechanisms. It is important the parties agree on the calculation, source data, frequency and responsibility for how metrics will be collected and reported and used.
As organizations go through the Vested methodology, they often find they have too many metrics; metrics that are real data that is nice to have. For example, in the case of Dell and FedEx, they were tracking over 100 SLAs and operational metrics prior to making the shift to their Vested agreement. As part of the Vested methodology, a key rule was that they would only capture metrics that aligned the a Desired Outcomes. The result? A final scorecard that had 20 “right” metrics instead of over 100 metrics that simply could be tracked. The result was much more focus and accountability to do the right things.
Rule #4: Pricing Model Incentives that Optimize Cost/Service Trade-offs
Element 6: Pricing Model and Incentives
Getting the economics of an outsourcing agreement right is essential for success. A key feature of a Vested agreement is shifting from a “price” to a “pricing model with incentives.” Under the paradigm shift of Vested, the service provider’s profit is directly tied to meeting the mutually agreed Desired Outcomes. Inherent in this model is a reward for service providers to invest in process, service or associated product that will generate returns in excess of agreement requirements. Higher profits are not guaranteed—what business model can claim that? —but getting Element 6 right in the contract provides service providers with the authority and autonomy to make strategic investments in processes and product reliability that can generate a greater return on investment than a conventional cost-plus or fixed-price-per-transaction agreement might yield.
Incentives are a key component of this mix because service providers are taking on risk to generate larger returns on investment. Incentives can be monetary or non-monetary. For example, most Vested agreements have a contractual clause that formally extends the service providers contract term by a year if they achieve a certain level of performance. Most Vested agreements also have some form of “gainshare” type incentive that rewards the supplier for reducing the cost structure.
The secret sauce of developing a pricing model with incentives? It’s all about alignment. The more the buying organization “gets” their Desired Outcomes, the more incentives for the supplier. In essence, the buying organization and the service provider have a vested interest in achieving the mutually defined Desired Outcomes. A “win” for the buying organization is a direct “win” for the service provider, and vice versa. The Vested Outsourcing Manual details 12 step to help organizations create a pricing model with incentives.
Rule #5: Insight versus Oversight Governance Structure
Because Vested contracts result in a new type of “win-win” relationship aimed at achieving mutually defined Desired Outcomes, getting the relationship management structure right is crucial. The four elements associated with Rule 5 provide the tools for the parties to manage and operate the agreement. Combined, these four elements make up the governance structure.
Element 7: Relationship Management
Element 7 provides the anchoring mechanisms for how the parties will manage the relationship. The parties jointly develop the most appropriate relationship management structure that will best help them manage the business – together. A key difference in a Vested agreement and a more traditional outsourcing agreement is the mindset of how to govern a Vested agreement. If you have done a good job on Rules 1-4, you should have aligned the interest of the company outsourcing and the service provider. As such, the focus shifts to managing the business with the service provider, not managing (and definitely not micromanaging!) the service provider.
The contract should clearly spell out the joint policies and mechanisms the parties will use as part of their ongoing working relationship.
Element 8: Transformation Management
As mentioned previously, Vested agreements are designed to be used in strategic relationships that demand collaboration and innovation. Managing transformation, including transitioning from old to new, requires a strong change management capabilities and processes. Element 8 is where the parties jointly agree and document the mechanisms they will use to manage their transformation initiatives. The parties should include all aspects of how they will manage change and transformation, ranging from the tactics of how they should manage contractual changes to how they should strategically manage transformation initiatives. New relationships also include how the parties will transition work to the service provider.
Element 9: Exit Management
Sometimes the best plan simply does not work out or is trumped by unexpected events: Business happens, and companies should have a plan when assumptions change. Element 9 documents how the parties will handle an exit of the relationship if one happens. Think of it as a prenuptial agreement. Good exit management strategy and agreed upon processes provide a template to handle these future unknowns. The goal is to establish a fair plan and to keep the parties whole in the event of a separation when the separation is not a result of poor performance.
Element 10: Special Concerns and External Requirements
The final element recognizes that all agreements are different and that many companies and service providers must understand and adhere to special requirements and regulatory protocols. Thus, it is likely the contract should include additional provisions that address specific market, local, regional, national requirements. These additional provisions may be government regulations or internal company policies that must be adhered to. For instance, in supply chain outsourcing relationships involving information technology and intellectual property, security concerns may necessitate special governance provisions outside of the normal manufacturer-supplier relationship. Or in a healthcare business process outsourcing relationship, US requirements under the Health Insurance Portability and Accountability Act (HIPAA)of 1996 are essential.
Architecting Your Outsourcing Agreement
For some practitioners, completing the Ten Elements will feel like an exercise or a long and complicated homework assignment. In fact, the University of Tennessee’s Creating a Vested Agreement online course provides a step-by-step approach for helping organizations complete a Vested agreement. The “contract” is, in fact, the “homework.”
While creating your contract can seem arduous for some, we prefer to think of it is in terms of architecting a system. By following the Five Rules and the associated contractual elements, organizations learn by doing and transition their thinking from “getting a deal done” to architecting a successful outsourcing relationship. A byproduct of the collaborative Vested approach is the shift from an adversarial “buy-sell” relationship to a truly collaborative win-win partnership underpinned by parties that have truly co-created their future destiny to achieve mutually defined Desired Outcomes.
Creating a Vested agreement enables organizations to move beyond simply paying lip-service about “collaboration” and “partnership” to creating an agreement and a working environment that drives transformative change. And the rules are fully documented in the contract. Simply put, developing a business agreement using Vested’s Five Rules and their Ten Elements is a fundamental business model shift in how a company and its service providers work together.
by Kate Vitasek, Author, educator and architect of the Vested business model | Faculty, Graduate & Executive Education, University of Tennessee
** This blog is a repost from LinkedIn. Read the original post here.