Outsourcing Agreements: Price Is Just An Outcome


If this is your first outsourcing agreement, you’re under a lot of pressure to get it right the first time. Whether you work in the Procurement department or you manage the Business unit, you need to convert the complex parameters of your business into specific numbers so that the contract, or at least a Statement of Work (SOW), can be developed.  There are some key parameters that describe how your operations work, that you need to communicate to a vendor in order for the vendor to perform the way you expect. In fact, you need this just so that the two of you are on the same page. The contract process is often hung up when both sides get stuck on this. The vendor is usually happy to help provide parameters for the contract, but you’re going to be VERY reluctant to accept these parameters because you don’t really have any reason to trust the vendor at this point. More likely than not you’re suspicious of any parameters a vendor provides, because you think (sometimes rightly) that the vendor is there to protect their interests and isn’t motivated to give you the absolutely best service at the lowest price. And that’s a big part of this process.

How do we fix this? First of all, you should try the process I’m suggesting during the vendor selection process, rather than after it has been awarded. Why? Because by the time you are at the award stage, when you’re down to just one vendor, the price has already been negotiated. Price was probably a key decision factor for vendor selection. However, did everyone truly understand what they were bidding on? Price is the outcome of the key numbers we’re talking about. If you’ve already selected your vendor and the price, but haven’t agreed on other key parameters (quality of work and production level) you run the risk of buying a service that won’t deliver the product you need. That’s why it’s always better to get this agreed to (and reflected in price) while you are still selecting the vendor. If the vendor is already selected, get these parameters in place as quickly as possible. Here we go!

Remembering that price is the outcome, the two other parameters you need to focus on are Quality and Production levels. If you have two different teams producing the same product, but one team needs to produce the work at 90% quality, and the other at 99%, the team with the higher quality requirements needs to be better (more experienced, faster learners, more mature, more expensive). Down the road, the vendor can organically grow the team and judiciously add new workers, but in order to get your service off the ground the team will need a certain number of experienced workers. Likewise, the higher your expectations for production (should they be 50% utilized… 60%, 80%?), the more experience your team needs. If a good team can run at 60% before errors rise and work backs up, a great team may be able to work at 75% (but may require more expensive workers and managers). Other parameters, such as how long it takes to start work or how the length of the work queue be driven more by the work process, than by people selection. Let’s go onto the next step.

The utilization levels are a question of what you want to set. If you are assuming a 1:1 replacement when work is outsourced, you should assume (as a starting point) that the utilization levels are the same as onshore, whatever that is. You can (and should) build in a continuous improvement clause so that you will benefit from a drive for better work processes. A better way is to leave this parameter open. Tell your vendor that you want the best level of service at the best price, and that they can fill in the blank. Why should you do this? Well, depending on the location and the local talent, it may be more effective for them to have a larger but less experienced team. Alternatively, they might want to keep resources in reserve for peak times. Let them decide how they work best. Then compare the responses from different vendors (who may be offering their services from different locations, with different labor markets). And remember to set a maximum utilization! Some vendors try to make up for an unprofitable contract by getting more work hours out of each worker (if the contract rewards them for doing this). If the vendor says they cannot do this… that’s OK. Just ask them why. The important thing is that it reveals the thinking of the vendor, which will tell you what you need to know about how much or how little the vendor is aligned with you.

All that’s left is the quality parameter. This is where most contract processes grind to a halt. If you’re outsourcing transcription, simple research, document processing, report generation, or any other high volume / real time service… it’s easy to provide a few samples of “prefect work”. Probably a handful of products dominate your production, and because of the volume you know what “perfect” looks like, even if you haven’t fully documented it. If you produce complex industry reports or if you develop  software application, the volume is much lower and the products look less alike. For high volume work produce a few samples of “prefect products” (lets rate this 95%). For low volume work, produce a few samples of “perfect project plans”.  If you don’t have access to perfect products, dummy up a few. Done? Next, take your perfect products and introduce a few errors (on a project plan, things that went wrong). Not fatal, but the kind of work that gets to the client today and is “acceptable” (rate it 75%). Then, add more errors (different types of mistakes than in the last case) that makes the work just barely unacceptable (65%). Clearly indicate each error on the documents and explain the significance of each error (what it is, how important it is… just talk about each). Now, hand this over to your vendor and say, “I would like you to examine each document, review my comments on each error and develop two documents. First, an annotated glossary (a list of each of the Quality Control rules, and any necessary commentary) and a simple quality control guide. This will require some discussions, and you may decide to do some of the work (perhaps develop the glossary). This process will ensure that the vendor understands what you are looking for, and is able to effectively recruit the positions.

Go through this process and you will avoid many of the problems you have heard of in other contracts… not being able to fully utilize outsourced staff (not the right skill match), too many errors (utilization too high for the experience level), or high turnover (the price is wrong, so the vendor cannot afford the right staff). Think about incorporating these steps into your outsourcing process. And that’s my Niccolls worth for today!

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This entry was posted in Best Practices, Common Sense Contracting, Decision Making, Delivering Services, Unique Ideas and tagged , , , , , , , , . Bookmark the permalink.

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