Vested Outsourcing: From Transaction to Transformation

Kate Vitasek
Posted: 07/09/2012

Face it. "Business happens." If your outsourcing strategy is not flexible and nuanced enough to deal with that basic fact then it’s long past time for a change in the way your outsource contracts are negotiated and managed.

A common mistake outsourcing companies make is that they cling to traditional transaction-based contracting models and create detailed statements of work (SOWs) and then strictly define the work to be done. This handcuffs service providers’ flexibility and their ability to innovate.

A more flexible agreement framework is needed in today’s economic and business environment. This was validated in 2009 when Oliver E. Williamson received a Nobel Prize for his scholarly contribution to economics. One of his key teachings is that contracts should be highly adjustable or adaptable, rather than prescriptively outlining detailed transactions, rigid terms and conditions, SOWs and working relations.[1]

If you have followed our work at the University of Tennessee, you know we promote a Vested Outsourcing philosophy that relies on Five Rules to help achieve mutual goals and economic alignment between companies and their service providers. If you missed it, please follow the links above.

But how do you embed these rules into an actual outsourcing contract? It’s a question we often hear, and why University of Tennessee researchers teamed with the International Association for Contract and Commercial Management to demystify how it works in our second book- The Vested Outsourcing Manual.[ii] The Manual is a step-by-step guide for developing collaborative business-to-business agreements and working rules that will facilitate successful and long-lasting business relationships based on mutually Desired Outcomes.

In the Manual, we outline 10 Elements that should be part of a Vested agreement. It shares how to translate the rules into a physical contract, guiding practitioners away from the typical transaction-based mind-set while providing a clear path to flexible, collaborative and win-win contracting success. Below is a summary of the 10 Elements.

The Ten Elements of a Vested Outsourcing Agreement

The 10 Elements are keyed to implementing Vested Outsourcing’s "Five Rules," as shown in this table:

10 Elements of a Vested Agreement

Rule 1: Outcome-Based vs. Transaction-Based Business Model

Element 1

Business Model Map

Element 2

Shared Vision Statement and Statement of Intent

Rule 2: Focus on the WHAT, not the HOW

Element 3

Statement of Objectives/Workload Allocation

Rule 3: Clearly Defined and Measurable Desired Outcomes

Element 4

Clearly Defined and Measurable Desired Outcomes

Element 5

Performance Management

Rule 4: Pricing Model Incentives are Optimized for Cost/Service Tradeoffs

Element 6

Pricing Model and Incentives

Rule 5: Insight vs. Oversight Governance Structure

Element 7

Relationship Management

Element 8

Transformation Management

Element 9

Exit Management

Element 10

Special Concerns and External Requirements

The elements are highlighted below.

Rule #1: Focus on Outcomes, Not Transactions

Element 1: Business Model Map

This first step is to understand and document an outsourcing business model in order to see how well the parties are aligned to each other’s goals. Jointly mapping a model will pinpoint the transactions of value between the parties, leading logically to collaboration, loyalty and mutual satisfaction, market share and sustainable profit. This element also establishes a culture in which the company and the service provider maximize profits by working together more efficiently, no matter who is doing the activity.

Element 2: Shared Vision and Statement of Intent

With the business model understood and mapped, the parties then work together on a joint vision and Statement of Intent that will guide them for the duration of the Vested relationship. A cooperative and collaborative mindset opens a conversation between the parties: They share what is needed, admit to gaps in capability, and focus on the benefits that the other party can bring to fix gaps in capability.

Rule #2: Focus on the What, Not the How

Element 3: Statement of Objectives/Workload Allocation

This element lays the foundation for the parties in the Vested partnership to do what they do best. Depending on the scope of the partnership, the company transfers some or all of the activities needed to accomplish contract goals to the service provider. Together they develop a Statement of Objectives (SOO), which is very different from a standard SOW. 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

To have an effective, successful Vested Outsourcing relationship, the parties must work together to define and quantify Desired Outcomes. This element is a centerpiece of the whole enterprise because without mutually defined Desired Outcomes in place, a Vested agreement cannot go forward. Outcomes are expressed in terms of a limited set of high-level metrics. Once they are agreed upon and defined, the service provider proposes a solution that will deliver the required level of performance at a predetermined price.

Element 5: Performance Management

Once Desired Outcomes, Statements of Intent and SOOs are in place and the agreement is implemented, the parties then measure performance to determine if the Desired Outcomes are achieved. These include high-level performance management measures that are easily understood by business stakeholders and all parties involved in the process.

Rule #4: Pricing Model Incentives that Optimize Cost/Service Trade-offs

Element 6: Pricing Model and Incentives

The parties must have a properly structured pricing model that incorporates incentives for the best cost and service trade-off. The approach of many procurement professionals to outsourcing is perennially stuck on one thing: getting the lowest possible service and labor pricing. The strategic bet—and paradigm shift—of the Vested model is that the service provider’s profitability is directly tied to meeting mutually agreed 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. This element provides service providers with the authority and autonomy to make strategic investments in processes and product reliability that can generate more value and a greater return on investment than a conventional cost-plus or fixed-price-per-transaction agreement might yield.

Incentives are a key part of this, because service providers are taking on risk to generate larger returns on investment. An incentives package delivers the most commercially efficient method of maintaining equitable margins for all parties for the duration of the relationship. Pricing models using Margin Matching are recommended for a Vested agreement. The margin matching method is used to adjust pricing points by establishing trigger points that reset prices when that point is met. For example, the inflation rate might be a trigger point for resetting inventory carrying cost charges.

Rule #5: Insight versus Oversight Governance Structure

Element 7: Relationship Management

A relationship management structure creates joint policies that emphasize the importance of building collaborative working relationships, attitudes and behaviors. The four elements associated with Rule 5 provide the tools for parties to manage and operate the Vested agreement. The parties monitor the agreement within the framework of a flexible governance structure that provides comprehensive insights into what is happening.

Element 8: Transformation Management

This is a new relationship model—people and company ecosystems are changing and doing things differently. They likely are not operating in familiar comfort zones. Managing this transformation, including transitioning from old to new—along with change management once the new agreement is up and running—is often difficult and complex to implement. It is imperative to preserve as much continuity as possible among personnel and teams as the transition progresses into day-to-day implementation and operation. The focus is one creating a culture that rewards innovation, agility and continuous improvement.

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. An exit management strategy can provide a template to handle 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

Governance frameworks are not one-size-fits-all, especially in more technical or complex relationships. 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, the governance framework may require additional provisions that address specific market, local, regional and national requirements. For instance, in supplier and supply chain relationships involving information technology and intellectual property, security concerns may necessitate special governance provisions outside the normal manufacturer-supplier relationship. Supply chain finance and transportation management are other areas that often require special handling under the governance framework.

Conclusion

Developing a business or outsourcing agreement using Vested Outsourcing’s Five Rules and the 10 Elements is much more than delivering a higher level of service on a given activity, a blur of metrics or simply counting transactions or filling seats more cheaply.

The Vested model enables the parties to build a solid, cooperative foundation for sharing and creating value.

The 10 Elements enable progressive companies to change their mind-set and challenge old-school approaches by establishing a dynamic, modern business-to-business contract. Companies move beyond simply paying lip-service about "collaboration" and "partnership" to creating a win-win agreement and an atmosphere that drives transformative change.

[1] Oliver E. Williamson, "Outsourcing: Transaction Cost Economics and Supply Chain Management," Journal of Supply Chain Management 44, no. 2 (2008): 5–16.

[ii] Kate Vitasek, Jacqui Crawford, Jeanette Nyden, and Katherine Kawamoto, The Vested Outsourcing Manual (New York: Palgrave Macmillan, 2011).

Kate Vitasek
Posted: 07/09/2012

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