Potential Benefits of Outsourcing
Lessons Learned
Lessons
Learned:
****
This section starts with the assumption that the organisation wishes to outsource with a vendor. Regardless of the reason, rational/political/financial survival, the outsourcing organisation must negotiate a sound contact to ensure their expectations are realised.
The first step to a successful outsourcing arrangement is to realise that outsourcing vendors are not partners because profit motives are not shared. Claiming that vendors are partners is like claiming Compaq is a partner just because you purchased a laptop from them. Account managers at outsourcing vendors are rewarded for maximising profits, primarily from charging clients additional fees for services that extend beyond the contract. When a clients costs increase, so do the vendor’s profits.
The danger in viewing the outsourcing vendor as a partner is that the organisation may sign a very loose agreement. After the agreement goes not effect, the vendor may not provide the level of service the customer expects. Instead, the vendor may refer to the written contract as the only source of its liability. Organisations may subsequently be charged excess fees for services that they assumed were in the contract. FirmA was charged a significant amount of fees the first month into the contract. These charges were for services they assumed were covered in the agreement. The vendor responded that services not documented in the contract are above the baseline and subject to excess fees. This doesn’t imply that the vendor was unethical; more likely, the vendor representatives who made the verbal promises are off on another sale. The remaining account manager, has no recourse but to follow the contract stipulations. After all, her first responsibility is to her [new] organisation. Organisations in this situation have little recourse since the vendor possesses a significant amount of power in the relationship.
Once potential outsourcing organisations realise that vendors are running businesses and are themselves motivated to maximize profits, they can protect themselves by signing an airtight contract. The contract is the only mechanism that establishes a balance of power in the outsourcing relationship. Contracts reduce the threat of opportunism. When service levels, cost structures, and penalties for non-performance are in the contract, the vendor is legally obligated to deliver on such. The motive is to establish a balance of power that benefits both parties. Since the initial position favours the vendor, the organisation needs to leverage their position. The points which follow will help FirmA, or any organisation, level the playing field.
Vendors will likely present their standard contract to the prospective organisation. This contract should be immediately discarded. The key to successful outsourcing arrangements is building a organisation-specific contract. The vendor’s standard contract typically obligates the vendor to perform the same level of service that the organisation’s internal department provides during the baseline period. These contracts neither set performance standards nor include penalty clauses if the vendor fails to meet requirements. The payment schedules in these standard contracts may also favour the vendor. This was one area that FirmA was able to shift the balance of power during the initial negotiations, and include in their agreement. The standard contract that the vendor had placed in front of FirmA required them to pay the bill on the first of the month, prior to service delivery. The CFO who reviewed the contract, explains the impact of the proposed payment schedule:
“[the outsourcing vendor] wanted it day one net 15. We got it to in arrears net 45. There was a difference in a five-year contract, there was a difference of several hundred thousand dollars. So that’s why they play those games.”
So the first lesson in contract negotiations is to discard the vendor’s standard contract. Create an organisation-specific contract, but make sure that the contract is complete before consummating the deal.
Since both parties are often anxious for a relationship to begin, the temptation to close negotiations quickly is strong. The outsourcing vendor, in particular, may try to convince the organisation to sign the contract before items are clearly specified. They assure their clients, “we’ll take care of the details later.” But since the vendor is not legally bound to alter the contract, they may never agree to supplement the original.
FirmA signed an incomplete outsourcing contract in early 1994. The vendor promised to define services, service level measures and service level reports within the first six months. As of May 1996, these items remain incomplete, primarily because of the dispute over the baseline package of services. FirmA managers argue that certain services were understood to be covered in the contract. The vendor argues that if they were not already in the contract, then those services are subject to excess fees. This major problem could have been avoided if FirmA postponed the start-up date in order to complete the contract.
During negotiations, the vendor uses a host of their technical and legal experts to represent their interests. These experts thoroughly understand the way to measure human resource services and how to protect their interests. In order to counterbalance the vendor’s power, organisations should hire experts to represent their interests. Several of the people interviewed admit that outsourcing experts may be expensive, but they believe will help prevent excessive charges.
Two types of outsourcing experts are recommended, a technical expert and a legal expert. A technical expert is helpful when measuring baseline services. This expert may often be a former HR professional or a ex-outsourcing vendor employee. They not only create technical measures of the organisation’s human resources processes and systems, they are able to convert these measures to the technical characteristics of the outsourcing vendor. Organisations may feel wary about using their in-house staff to assist in baseline measures since many of these people may be affected by the outsourcing contract.
A legal expert familiar with outsourcing contracts is also recommended. These experts, who should work in conjunction with the organisation’s internal legal department, ensure the organisation’s wishes are documented in the contract. Together, the legal expert and internal lawyer pose a strong legal team. Organisation’s will typically wish to hire a legal expert at the final stages of negotiation. A technical expert, however, is typically needed much sooner, particularly during the measurement of baseline services.
During contract negotiations, the organisation’s current human resource services are documented during the baseline period. The baseline period becomes the yardstick that determines what services the vendor is obligated to provide to the organisation. The outsourcing vendor will charge a fixed fee for delivering this package of services, but will charge an excess fee for services above and beyond the baseline. Therefore, the organisation must measure every service during the baseline period to ensure that these services will be included under the fixed fee umbrella.
FirmA suffered serious service problems and excess charges because they failed to measure all services during the baseline period. Some interviewees assumed that their request for proposal documented their service needs, but RFP’s are only high level descriptions of service requirements. Baseline measures must be very detailed. The length of the baseline period is an important consideration. Since service volumes typically fluctuate, a baseline period of six months is appropriate. Vendors often suggest averaging monthly measures, but this results in the organisation exceeding baseline services 50% of the time. A more equitable solution is to create a volume variance for each service level. The organisation will not be charged an excess fee as long as volumes remain within the agreed upon ranges. Since outsourcing decisions often cause a lowering of morale, management may fear that employees might ignore or sabotage the measurement effort. Several of the individuals suggested that employees and users maintain service logs during the baseline period.
Some questioned during interviews why service level measures needed to be developed since the baseline period allegedly covered this issue. The answer is clear: the organisation or vendor may wish to add, combine, improve, or delete measures. Thus, the baseline measures merely provide a yardstick for what the vendor’s obligations will be during the contract. For every service that the vendor is expected to provide, a service level measure should express the level of service required. During this phase of the contract negotiations, interviewees warn that vendors will try to manipulate measures in their favour. At FirmA, the vendor attempted to dilute measures in two ways. First, they tried to dodge accounting for 100% of services. Second, the vendor tried to manipulate the laws of probability in their favour.
Measures typically require vendors to deliver a certain amount of work in a certain period of time. For example, vendors may agree to process 90% of all requests within 7 days. The organisation, may never know what happens to the remaining 10%. This 10% may be serviced very late or never at all. Despite the fact that 10% of the work may never be accounted for, vendors technically meet their service level requirements. The best way to avoid services falling through the cracks is to specify 100% service accountability. The organisation should require that exceptions be fully documented and reported.
Vendors may also dilute measures by exploiting some simple laws of probability. At FirmA, the vendor finally agreed to deliver 95% of a particular service within the agreed upon time frame. FirmA agreed to the measure, as long as the service was delivered correctly. The vendor countered with a proposal to implement two measures. The first measure specified that 95% of the service is completed on the target date. The second measure specified that 95% of the service will be accurate. By proposing two measures, the vendor attempted to dilute the service level since the probability of the service being delivered on time and accurate is only slightly more that 90%.
During negotiations, organisations may spend a significant amount of time developing measures, then fail to require the vendor to report on these measures. Vendors may tell their clients that their standard reports address their measures, but this claim may be untrue. For example, FirmA complained that the vendor’s standard reports only indicate the volume of service performed. For instance, the vendor’s open requisition report indicated “45 new positions placed in que during the month.” This report does not specify how many positions were actually submitted or the average turn around time for the requests. According to the contract, the vendor was meeting service levels. Users, however, complain that some new position submissions took over 90 days to fill. Service level reports should document the agreed upon service levels, the service performance for the current time period, exception reporting for missed measures, and trend analysis for performance from previous reporting periods.
Organisations realise that HR (staffing and recruiting in particular) is often a volatile business. There are bound to be occasional events that prevent the vendor from meeting a service level measure. In some instances the organisation may even be at fault. Thus, in addition to the service level reports, the organisation and vendor must agree upon problem escalation procedures. Typically, the vendor will request that fault be determined for each missed measure. This protects the vendor’s interests, since they are contractually bound to meet measures, they should not be punished for their clients errors. Perhaps a bipartisan committee will determine the blame for missed measures. Granted, this task is an annoyance to most; as professionals we want to fix problems not fix blame. However, the reality is that dollars may be exchanged as a result of a missed measure.
Services may be divided into critical versus non-critical categories to prevent micro-management. For non-critical measures, such as recruiter training hours, perhaps the vendor may miss this measure twice a year. For critical services, such as on-line availability of candidate data, the organisation may require immediate reporting, problem resolution within a specified time period, and perhaps even a cash penalty. In cases of severe service problems, the organisation may insist on cash compensation. The organisation may also wish to escalate penalty amounts with frequency of their occurrence.
Organisations should also include a clause for severe volume fluctuations caused by acquisitions, mergers or sale of business units. In cases of the sale of a business unit, the organisation may specify a major reduction in the fixed fee expense. The vendor, however, may insist for several months notice to allow ample time to redirect resources. The organisation may also want the vendor to promptly accommodate mergers or acquisitions. The vendor may insist, again, on advanced notice. In addition, the vendor may insist on charging the organisation a transition fee for the volume adjustment.
Most lawyers will insist that a termination clause be included in the contract. This clause protests both parties, since the desire to terminate by one, will severely affect the other. Either party may need to terminate because of bankruptcy or sale of the organisation. The organisation may wish to terminate because of a failure to provide services. Most contracts require either party to notify the other within a specified time period. The organisation, however, will typically require more time to find an alternative to meet their HR needs. Negotiating with another vendor may require six months; rebuilding an internal department may require another six months. In addition, the organisation needs the vendor’s assistance to transfer processes and systems to another site. Vendor assistance should be specified as a requirement for termination, regardless who initiated such.
The lessons learned so far have concentrated on protecting the interest of the organisation. The term organisation, however, excludes many of the organisation’s employees. In particular, the HR employees will be dramatically affected by the outsourcing decision. Organisation’s have a social responsibility to treat these people fairly; that includes informing them of the decision as soon as practical and helping them secure positions elsewhere. In typical outsourcing arrangements, the vendor will hire the majority of the organisation’s employees for a one-year period.
****
Introduction and Overview | Potential Benefits of Outsourcing | Unintended Consequences | Lessons Learned | Summary
Home | Outsourcing - IT focus | Outsourcing - HR focus
Updated on January 17, 2003
© Copyright 2003 Allan Low. All rights reserved. Reproduction of this Web Site, in whole or in part, in any form or medium without express written permission from the author is prohibited.