The record speaks for itself: Successful outsourcing of information technology or other business processes is hard work. The process of selecting a service provider with which to build a long-term relationship is intense and critical to far-reaching aspects of corporate performance. Yet, there’s often a tendency to try to short-cut the process by taking a more sterile approach through benchmarking measures of cost and quality as a means of relationship-building. This is often attempted as part of a source-selection process and part of a price-renegotiation technique in mid-course.
Benchmarking has a role, but the role is far less significant in a critical outsourcing relationship than one might use to make a decision on true commodity services. We will review the nature of a successful outsourcing relationship with emphasis on the appropriate use of benchmarking in that context.
Copyright 2003 TPI, Inc. All Rights Reserved Page 1 of 5 Benchmarking: A study in which components of a company s contracted services, such as price, service levels and terms & conditions are compared to those of peer companies. Successful Outsourcing: Benchmarking or Relationship Building A Position Paper from TPI Executive Summary The record speaks for itself: Successful outsourcing of information technology or other business processes is hard work. The process of selecting a service provider with which to build a long-term relationship is intense and critical to far-reaching aspects of corporate performance. Yet, there s often a tendency to try to short-cut the process by taking a more sterile approach through benchmarking measures of cost and quality as a means of relationship-building. This is often attempted as part of a source-selection process and part of a price-renegotiation technique in mid-course. Benchmarking has a role, but the role is far less significant in a critical outsourcing relationship than one might use to make a decision on true commodity services. We will review the nature of a successful outsourcing relationship with emphasis on the appropriate use of benchmarking in that context. Introduction The fundamental premise of the underlying business model of outsourcing is one that has been tried and tested during decades of industrial development. Simply stated, the benefits of scale yield efficiencies in operation, cost-effectiveness through leverage, and expertise by virtue of focus. The abundance of readily available examples of successful outsourcing relationships yields several key lessons from firms that have gained experience through practice. The range of critical success factors is wide, yet there is a common tendency on the part of some market observers and consultancies to confuse one of the more critical features of successful outsourcing. Contrary to the opinion of some commentators, relationships are the nucleus of successful outsourcing. While many would like to consider the acquisition of outsourced services as being commodity in nature, analogous to pulling up to any fuel station and being able to choose from three distinct grades of service, facts remind us that successful outsourcing is a relationship business. Relationships require time and energy to build between complementary parties in order to stand the test of time. Relationships are relatively difficult things to measure precisely. One usually knows, intuitively, whether a relationship exists with another party and the nature of that relationship. However, there are few indices or metrics to gauge the fuel grade of a relationship personal or professional. When the outsourcing of important business services such as information technology, human resources operations, finance and accounting functions, call center services, or even procurement is viewed through the lens of commodity services, the likelihood of a successful long-term relationship is severely diminished. Attendant to the term commodity is the perception of standard industry service definitions and the ability to perform meaningful cost and quality comparisons on a like for like basis. Today s suite of outsourced information technology and business processing services are simply not able to be benchmarked against industry alternatives with sufficiently high fidelity. Furthermore, doing so undermines the beneficial effect of a strong buyer-provider relationship. Untitled Document Copyright 2003 TPI, Inc. All Rights Reserved Page 2 of 5 Defining an Outsourcing Relationship In order to fully realize the benefits of an outsourcing relationship, a continuum of events must exist. " The foundation for the transaction is a clear understanding of the client s environment (operational, financial, technological, political and cultural) and any major changes that are likely to occur. Those environmental characteristics are rarely identical to those of industry peers or geographic neighbors. " The understanding between corporate buyer and industry service provider is the product of a relationship-building experience. The relationship forms through a Socratic process that ensures alignment across a range of important dimensions. In contrast, rushing to a union introduces risks to the long-term relationship by virtue of the process steps that are deferred until after a contract is signed. " The understanding of the relationship is then combined with the strategic and tactical direction of the companies in undertaking an outsourcing. These business interests are memorialized in the contract, along with the other elements that provide the client with protection, both legally and financially. " Rarely are long-term outsourcing contract decisions made purely, or even largely, on the sterile factors of pricing and contract terms alone. If executed with the benefit of industry learning, an enterprise will select a service provider that offers the best promise for a successful long-term relationship, supported by a strong contract and market terms. " Finally, a strong and watchful management, one that is intimate with the content, intent and spirit of the relationship, needs to be put into place to oversee the contract, build and nurture the provider relationship and oversee and authorize any additional work or other changes that may be required over time. The relationship is defined by such terms as commitment, integrity, reliability and innovation. Less important are the subordinate factors such as performance to individual service measures and pricing of individual services. Everything is considered in the context of the relationship. Does Relationship Equate to Blind Trust? No relationship is successful if the parties are blind to the environmental factors influencing each other. Yet, the desire to find a convenient and directly relevant measure of service cost and quality in an outsourced relationship is a fleeting goal. There are several reasons for benchmarking being in direct conflict with building and maintaining a successful outsourcing relationship, including: " Benchmarking is based on a concept of "similar" in order to compare normalized data. No matter how hard one tries, the variance in service definition and quality measures attendant to today s technology-enabled outsourced services simply means that like-for-like comparisons are relatively rare. By this definition, today s ITO and BPO services generally fail to qualify as true commodities; " Getting agreement with a service provider as to the philosophy of benchmarking is quite difficult. True, there are common contract terms and clauses covering benchmarking provisions, but these are intended to provide a basis for a discussion regarding the relationship, rather than provide for an automatic pricing change. Using mark-to-market comparisons as a basis for discussion can be used effectively in the context of a long-term relationship. Using benchmarks for an automatic pricing change makes it relatively difficult to prevent it working in "both" directions; " There is enormous difficulty in agreeing on even base data for benchmarking. Most outsourcing contracts comprise a portfolio of interrelated services. The relationship entails a base service charge for a base volume of services and individual prices for variances (up or down) from the baseline service volumes. Decomposing the base service charge to the point that fixed cost is directly attributable to a portfolio of services is exceedingly difficult. It s an attempt to reconstruct history as it existed prior to the signing of the contract. Untitled Document Copyright 2003 TPI, Inc. All Rights Reserved Page 3 of 5 " The granularity of benchmarking is too broad. Very rarely will a benchmark provide a corporation with sufficient relevance of a sample set. Until such time as the industry elects to contract for discrete services of true commodity nature, the focus will need to remain on relationship-oriented measures of satisfaction. The use of periodic market assessments to re-establish price and quality commitments simply ignores the needs of the enterprise and the basis from which it has evolved. Falling into the Benchmarking Trap is a Fatal Flaw Benchmarking as a means of prompting dialogue on a broader agenda of service costs and quality is a widely used technique. Benchmarking as a mainstream tool for selecting a service provider initially, or for periodically adjusting price and quality commitments, is fundamentally flawed. In the provider selection process, the fundamental approach proven effective in the industry is the development of a base case financial model and corresponding measures of resource volumes and service metrics. These artifacts of the insourced environment provide a basis of reference for considering sourcing. In mid-term, a benchmark is often used to answer questions regarding market trends and to facilitate dialogue with the service provider on cost and quality improvement plans. If, instead, one engaged in a benchmarking approach to attempt to compare internal costs and quality against the broader market, several issues would arise to prevent a true comparison: " Benchmarking is based on total cost. It does not differentiate retained costs/activities versus pass-through or service provider-assumed. It merely provides a lowest common denominator viewpoint that may not be fairly extensible to a broader scope. " It is exceedingly difficult to correlate the provider s invoices for sourced services with the corporate budget that is generally a key point for comparison throughout the life of the contract. " Using benchmarking often does not provide sufficient specificity for service providers to develop their best bids. Benchmarking metrics lack the contextual relevance that will ultimately be revealed in terms of client satisfaction with the sourced services. As such, a service provider that proposes costs and quality commitments solely on the basis of a benchmarking comparison is shooting in the dark. " Benchmarks are not sufficiently specific and are often based on data that is up to two years old. The source of the data is often dubious, and the relevance to the client s geography, industry, and business situation is usually obscured. Benchmarking is only effective when it brings the management of both parties to the table to review any anomalies and to jointly understand the cause for the gaps. Recommendations for the appropriate use of benchmarking include the following: 1. Contractually obligate the service provider to come to the table, not to automatically lower the price necessarily but to review market trends. 2. If the benchmark is performed well, it should be able to show the differences and the potential cause of the difference, i.e. technology breakthrough, software innovation, or a change in business process. Ask, What happened? 3. The gap should be of a material nature and considered within the context of the entire relationship. 4. Make sure all non-technical aspects of the deal are considered. Was there financial engineering? Who owns the assets? These factors are often overlooked by critics who are looking at the terms of a deal in isolation. 5. Consider the gap in light of the overall success of the contract. Consider the flexibility the service provider has demonstrated to date. Consider the value adds the relationship has brought to the client. Can the providers used within the benchmark sample set provide the same? Untitled Document Copyright 2003 TPI, Inc. All Rights Reserved Page 4 of 5 There are Benchmarking Best Practices Available for Outsourcing Contracts The outsourcing contracts that stand the test of time, avoiding litigation, early termination, or eventual insourcing, generally include benchmarking clauses, as benchmarking is one of many tools available to the corporate enterprise to keep the attention of the service provider. From time to time during the term of an outsourcing contract the client may measure the quality and cost-effectiveness of the contracted services through service level reports, user surveys, and independent third-party benchmarking services. Independent benchmarking generally follows a procedure similar to this: a. Pool: The parties agree on a pool of suitably qualified and experienced benchmarkers. The initial pool will be specified initially and may be varied from time to time by agreement. b. Selection: The client may choose any benchmarker from the pool to conduct a benchmark. c. Initiation: The client may initiate a benchmark of all or any part of the services at any time during the term by giving a notice to the service provider specifying the benchmarker and the services to be benchmarked. d. Assistance: The service provider will give the benchmarker access to any premises, equipment, personnel or documents, as well as any assistance, required by the benchmarker to conduct the benchmark. e. Comparison: The benchmarker will compare the quality and cost of the services against the quality and cost of well-managed service providers performing similar services to ensure that the client is obtaining pricing and levels of service that are competitive with market rates, prices and service levels, given the nature, volume and type of services provided by the service provider. f. In making this comparison, the benchmarker will consider the following factors and adjust the prices to the extent appropriate: i) Whether service provider transition charges are paid by the client as incurred or amortized over the term of the agreement; ii) The extent to which service provider pricing includes the purchase of customer s existing assets; iii) The extent to which service provider pricing includes the cost of acquiring future assets; iv) The extent to which the contract calls for the service provider to provide and comply with unique client requirements; and v) Whether Service Taxes are included in such pricing or stated separately in service provider invoices. g. Report: The client ensures that the service provider receives a copy of the benchmarker's report. h. Discussion: The report is used in formal and informal relationship-management reviews. Provisions to ensure that any extreme variations are addressed are generally prescribed in the contract. Untitled Document Copyright 2003 TPI, Inc. All Rights Reserved Page 5 of 5 Conclusions Benchmarking has a role in successful outsourcing contracts. Its role is that of a tool in the portfolio of relationship aids. If clients, however, over-use benchmarking in the source-selection process and/or in the course of an active relationship, they risk prompting service providers to behave in the manner suggested by the act of benchmarking: the provider will perform to the lowest acceptable level of quality and adopt a reactive posture in all matters. Relationships demand more thoughtful and comprehensive approaches that consider their unique circumstances and that will promote long-term objectives. Sourcing, done right, works.