Outsourcing: Solution or Setback?

By Jim Tompkins, President, Tompkins Associates

Competition, globalization, technology, pace and the capital markets have all had a major impact on business today. From the CEO to the warehouse operator, downsizing has resulted in fewer people in the organization, but even more work to accomplish.

As organizations look for an alternative route through today's competitive white water, many companies are turning to specialty providers to outsource their non-core functions. Audit, landscaping, payroll, food services, janitorial, etc. are functions that are typically outsourced. Although not as typical, it is reasonable to think that outsourcing strategic non-core functions such as logistics operations, information technology, marketing or manufacturing operations could result in significant savings. Today, as companies strive to do more with less and still compete, many are considering outsourcing a viable solution.

Unfortunately, outsourcing of strategic non-core functions is often one of the most challenging types of outsourcing, frequently resulting in failure. As a result, many companies view this type of outsourcing as an organizational setback waiting to happen.

The reason for these outsourcing failures is organizations' lack of a core competency in the process of outsourcing. The objective of this white paper is to help organizations recognize this challenge and begin to gain a core competency in outsourcing.

Getting Started

All businesses consist of three types of functions: Core Functions, Tactical Non-Core Functions and Strategic Non-Core Functions.

Core Functions are an organization's core competency—the unique business functions that makes the organization successful, the critical activities that allow it to thrive. For example, a research organization may also do some manufacturing and distribution but their core function is research because that is the primary service the company provides.

But companies cannot exist by only performing core functions. Other functions are necessary too—payroll, audit, janitorial and food service are tactical non-core functions that are absolutely necessary, but should not, by definition, have an impact on the bottom line. Certainly you can argue that if your food service providers poison your staff, your landscape providers destroy vital electrical cables/connections, your payroll providers embezzle your funds, your auditors allow others to misreport your income or the janitorial staff throws away important papers, these things will certainly impact your bottom line. Yes, these functions are important, but for them to impact your bottom line they really, really need to be done poorly.

To the contrary, logistics or manufacturing operations, information technology and marketing are excellent examples of strategic non-core functions that, if done well, can have a major impact on your bottom line. The reason for these impacts on your bottom line is both the much greater costs of these functions vs. the tactical non-core functions as well as the implications to the success of the business if these functions are not done well as compared to the tactical non-core.

For example, imagine that a company outsources both food service and logistics functions. If you were not satisfied with the quality of the food service company's performance, you would bring in another company to provide this service. But if the outsourced logistics arrangement is not working, not only have you made a major investment in transition costs, you have also likely exposed your customers to poor service. As a result, you risk losing customers, and in the transition to a new provider, your existing customers could incur serious interruptions in service. Poor performance in either outsourcing scenario is not good, but poor performance in your strategic non-core functions will have a major impact on your bottom line and may very well take years for your operation to recover from the impact.

For many companies, outsourcing tactical non-core functions is the norm. These service providers offer straightforward, end-to-end packaged services that require little customization. You walk the property with the landscape service provider; they send you a two-page proposal, a monthly fee and a one-page contract. You sign the contract, the provider performs the landscaping and invoicing as per the contract, and you pay the provider. Very simple, very straight forward and your landscaping looks great.

For a moment, consider the companies who, in an effort to provide even greater focus on their core functions, take the same simple approach to outsource their strategic non-core functions. Believe it or not, I have seen multi-million dollar logistics outsourcing efforts where the process was little more than the approach I presented for the landscape outsource. This is where the outsource solution becomes an organizational setback.

Taking the Plunge into Outsourcing

To take the plunge into outsourcing strategic non-core functions without a robust outsourcing process will not only prevent an organization from achieving the benefits, but will likely also result in a major setback for the organization. When considering a potential outsourcing effort for these functions, it is important to take a strategic approach. A solid, up-front effort is required to first, identify the functions to be outsourced, so that the right processes are considered that have the best returns and second, to identify the goals that the outsourcing should achieve. Consideration must also be given to the risks, potential benefits and market availability of the service providers. Once a good decision about what to outsource has been made, a robust process must be followed to ensure achieving the benefits of outsourcing. The process we have defined consists of seven steps:

Defining requirements and the request for proposal (RFP)
Evaluating bids and selecting outsource partners
Creating outsource relationships
Forging the legal relationship
Getting started: Putting the relationship in motion
Establishing the outsource relationship
Managing the relationship

Step One: Defining Requirements and the RFP

The first step in the outsourcing process is to define specifically what is to be outsourced and to develop an RFP defining the functions to be outsourced. Keys to success for this step include:

Clearly define the scope and boundaries of what is to be outsourced. Establish the goals to be achieved by outsourcing. Outsourcing is typically driven by efforts to achieve one or more of the following: Cost reduction, increased customer satisfaction, greater focus on core functions, increased competitiveness, release of capital, reduced future investment and to reduce risk. A common mistake made by many companies is outsourcing to avoid an existing problem or to bypass poor performance in some other area. Be sure that your objectives for outsourcing are to accomplish positive goals and not to avoid negative circumstances.
Develop a detailed, realistic timeline for the outsource process. Identify key milestones such as:
1. RFP released to vendors
2. RFP response deadline
3. Site visits
4. Short list
5. Due diligence
6. Selection of outsource partner
7. Term sheet signing
8. Contract signing
9. Implementation start date
10. Implementation completion date
Involve senior management early, often and at key decision points. It is important that everyone close to the project, but particularly senior management, understands the scope, goals and timeline of the process. Setting realistic expectations and obtaining leadership support are very important steps. Do not assume that today's level of performance is what is required for the service provider. The goals must fit the organization's needs over the life of the relationship.
Establish a benchmark of doing the functions to be outsourced yourself. Understand the cost drivers of self-performing and service levels that will serve as a baseline for the outsourced activity.
The RFP should provide a clear set of requirements and path forward, and must communicate a desire for innovation and creativity. Do not use the RFP to tell potential providers how to do their job. Instead, use it to demonstrate exactly what needs to be done and what expectations the outsourcing should fulfill. The full range of requirements should be set forth to include seasonality: slow season, normal season and busy season.
When building your bidder's list, you should perform extensive research to be certain that all viable candidates are asked to bid. Consider outsource providers as well as industry players. After qualified candidates are identified, each candidate should sign a Non-Disclosure Agreement or a Confidentiality Agreement prior to receiving the RFP.
Share the outsourcing process and timeline with each qualified provider. Be sure all candidates are given the same information and opportunity to present their best bid.
After sending the RFP to each candidate and receiving assurances of their desire to submit a proposal, perform a financial and business due diligence check on each potential candidate. Prepare appropriate background questions and concerns about each candidate.

Step Two: Evaluating Bids and Selecting Outsource Partners

Once the responses to the RFP are received, there must be a methodical bid evaluation and provider selection process. Keys to success for conducting this process include:

It is important to control communications with all potential providers in the process of evaluating bids. Communications can be best handled through a single point of contact that will manage all communication with the potential providers. All providers should be given the same information, and all questions and answers should be handled through the contact.
Having the right people involved in the evaluation process is key. The team that will evaluate the bids should represent a variety of different "touch points" with the outsourced function. This cross-functional team should have a good understanding of the function being outsourced and should ultimately be involved with the outsource provider in some capacity.
Evaluation criteria should be published as a portion of the RFP. The evaluation team must agree on the definitions of the criteria and how each is weighted. There may be one weighting of criteria for short list selection and another for final selection. For example, short list evaluation criteria may be:
1. 50% Solution
2. 25% Credibility and reliability
3. 25% Flexibility
Whereas the criteria for final selection may be:

10% Quality of solution
15% Comfort with ability to deliver/implement the solution
10% Continuous improvement culture
10% Value added services
15% Cost
10% Reputation/related experience
10% Terms and conditions
10% Open communications/culture
10% Financial stability

The evaluation process should not be rushed. Enough time should be allowed to ensure the process is fair, detailed and robust.
The evaluation process is a business decision, not one driven by low cost or personal preference. The process must be methodical and neither relationships nor executive preferences should be overly emphasized. The evaluation criteria must be rigorously applied in a fair and equitable manner, and evaluations must be made based on the facts presented in the written bid. Do not allow a slick sales team or presentation to bias the bid evaluation.
Bids are often complex. Be sure all bids address the full scope of the functions to be outsourced and that the evaluation is of "apples vs. apples." Get into the details of the pricing and do the arithmetic on the pricing proposal for benchmark levels. Do not assume anything about the bids—dig into the details and really understand each potential provider's assumptions and approach.
When evaluating the bids, it is a good idea to call at least three customers of each potential provider and obtain insights into the provider's performance. Ask a standard set of questions and be certain to obtain provider feedback on everything that gives you concern. If appropriate, visit customers and get a first-hand view of the provider's performance.
Have a clear understanding with the potential providers and the evaluation team regarding how you will be handing short-list determination, second visits and additional information requests. Be sure the short-list process is followed and the evaluation team and process are maintained throughout the process.
Do not release any details of the bidding process until after a binding term sheet or contract is signed. Especially for larger outsourced contracts, it is appropriate to go to detailed, binding term sheet discussions with more than one potential provider. Until a binding relationship is established, always retain more than one option.

Step Three: Creating Outsource Relationships

It is very important that everyone associated with an outsourcing relationship understand that outsourcing is not just about buying services. Outsourcing is a business relationship that must be developed and evolved. Keys to success in creating an outsource relationship include:

Outsourcing is giving up internal control of a business function and trusting others to handle this function for you. Many have an intellectual understanding of this fact, but emotionally have a hard time accepting it. Rather than just a business tool, outsourcing is a new way to think about business and requires a different thought process. Therefore, the relationship between a supplier and a customer is not the same as the relationship between a company and a provider. It is very important that everyone associated with outsourcing get these differences clearly defined in his or her own mind.
Communication protocols must be established early on in an outsourced relationship. All relevant parties must have at least an initial face-to-face meeting and then be encouraged to communicate frequently to establish rapport. Information about the outsource relationship must be broadly, consistently and openly presented to a cross-section of people within both the company and the provider.
Multiple touch points between the company and the provider must be established as early as possible and should go beyond the provider's sales organization and involve the people who are actually going to do the work. People from both the company and the provider must be current on the RFP, the solution and the negotiation on the term sheet and contract.
Equally, the roles and responsibilities for both the company and the provider must be established as early as possible so that a clear understanding by all parties exists about who is doing which tasks. All boundaries for responsibilities must be explored to be sure all parties have the same understanding.
The chemistry between the company and the provider must be allowed to evolve so that open, honest communications can result. It is important that both companies' cultures are understood so that the relationship can evolve. As a result of frequent, ongoing communication, trust will grow as expectations are met. Open discussions about trust are to be encouraged.
An important relationship hurdle is the pricing structure that is put in place between the company and the provider. At the highest level the pricing options are:
1. Fixed cost
2. Transactional cost
3. Cost plus
4. Management fee (Each option has advantages and disadvantages. It is important that both the company and the provider have a clear understanding of how the pricing model will be applied. Surprises here can destroy relationships.)
A second major area where surprises can destroy relationships is lack of agreement on what is meant by "service levels." It is critical that time is spent early on to define and determine performance measures for each service level.
An important relationship factor revolves around the transition of employees from the company to the provider. Factors such as compensation, benefits, severance and government regulations must be clearly understood and communicated to all. Individuals to be transitioned must understand the positive aspects of moving from the periphery of the company to a core group within the provider. Each individual to be transitioned needs to have his or her own personal fears and concerns addressed.
To truly make the relationship between partner and provider a win/win, both parties in the relationship must benefit when things go well. Thus, early in the relationship some form of a gainsharing or goalsharing process needs to be put in place so that the win/win relationship is not just a thought process, but also a reality.

Step Four: Forming the Legal Relationship

Interestingly, the better the two parties do at forming the legal relationship the less likely it is needed. But the poorer the two parties do on the legal relationship the more it is needed. If the legal relationship is done well, the success of the relationship will be measured by the accomplishment of the goals established for the outsourcing. If the legal relationship is done poorly, the protection the legal relationship provides each of the parties will be the criteria used to determine how poorly the relationship was done. The legal relationship should:

Follow a set path. The legal relationship can follow a variety of paths. Options include:
1. Binding Term Sheet to Contract
2. Letter of Intent or Non-Binding Term Sheet to Contract
3. Letter of Intent to Binding Term Sheet to Contract
4. Contract (Independent of which approach is used, the key players from the company and the provider and the legal representation from each should be involved from the outset. The company should take the lead in developing the legal documentation at each step of the process. Documents should provide for flexibility for the relationship, as we all know the relationship and the requirements will evolve.)
Clearly define the details and schedule for transition steps. Key questions that need to be answered include:
1. What assets, operations, employees, testing and go-live transition steps need to take place and who has responsibility and accountability for these to happen?
2. What will take place if these do not happen as planned?
3. How will you know if these transition steps occurred or not?
Define each service level and the criteria to measure each. Penalties and rewards must be set forth for not meeting or exceeding these service levels.
Set forth the issues on confidentiality and ownership of intellectual property and data. Specifics relating to confidentiality, intellectual property and data must be understood by all associated with the outsource relationship.
Specify the frequency and content of all reporting and documentation of the relationship.
Define the pricing model, the invoice terms and the payment terms. There must be a clear understanding how these issues will change and evolve over the life of the relationship.
Set forth the relationship governance for resolving disputes should they occur.
Present the ultimate dispute resolution mechanism as a three-arbitrator panel for binding arbitration. The legal relationship should define the termination guidelines, procedures and costs.
Establish the rights to audit the relationship and the responsibilities thereto.
Define the rights of approval or censure with respect to provider facilities, staff, procedures, etc.

Step Five: Getting Started or Putting the Outsource Relationship in Motion

Start-up is not easy. The go-live of an outsource relationship requires that thousands of things to go well. Irrespective of all the planning, hard work and testing, no go-live will ever be flawless. Keys to success that will simplify go live include:

Implement the transition plan as set forth in the contract. Methodically go through the contract and be sure each requirement is being met. Methodically go through the transition plan and be sure each step has been addressed. Work the plan. Do not let time pressures or "surprises" throw you into a panic mode.
Do not allow yourself to say, "That is not how we have always done that." Recall you have outsourced this function and your job is no longer "how" to do something, but rather the meeting of requirements and service levels.
Deal with the FUD factor: Fear-Uncertainty-Doubt. People are afraid of the unknown, and it is human nature to resist change. So flood the people with information. Explain to them the negative push from the prior approach as well as the positive pull to the future approach. Ensure this applies to all levels within your organization.
Manage expectations. You will not go-live at full production speed or efficiency. The learning curve requires time to get things right. Be patient and pace the start-up expectations to realistic levels.
Be certain not to continue the mistakes of the past. Outreaches that were not effective, inventory that is dead, past mistakes and damaged materials need not be outsourced. Prevent past mistakes from lingering.
Go to the site before go-live and be familiar with the operation. Be familiar with the people. Be onsite at go-live. Communicate and encourage people. Personally lead the celebration for the success of go-live.
Assure accuracy of data and information at go-live. Be sure the people have the information needed to do their jobs.
Oversee and check the process for the creation of the first reports, service levels and invoices. Perform a "handshake" on the first edition of each of these documents. Be sure there are no surprises and both the company and the provider feel good about what is happening.
Be aware that there will be problems at go-live. Identify the root causes behind these problems and solve them. Fully address all early problems and be sure both the company and the provider understand the problem and the resolution.
Be aware that there will be people who complain and do not like the "new" way of doing things. Address all concerns and overly communicate with all involved with the complaints. Be sure all complaint cycles end with positive feedback and communications.

Step Six: Establishing the Outsource Relationship

Getting past start-up is important, but it is a long way from ultimate success. Investing the time and resources to making the outsource relationship work is what is needed to help the relationship evolve. Some keys to successfully establishing and evolving the outsource relationship include:

Outsource relationships are between both organizations and people. Yes, there is a contract between the company and the provider. But more important is the relationship between the people from the company and the people from the provider. Failure to adequately invest in the people side of the relationship will hurt the relationship.
Establishing a regular, ongoing process for business planning, evolution and communications is critical to keep the relationship evolving. Decisions must be made with respect to the level of and frequency of formal and informal communications and meetings.
Guidelines must be established and implemented for how to handle continuous improvement. An ongoing process of continuous improvement is required for all outsource relationships to flourish. Creativity and innovation must be encouraged on both sides of the relationship.
A rewards structure of gain sharing or goal sharing must be implemented so that both sides are motivated to participate in improving the performance of the outsource relationship.
Regular, ongoing executive interactions are critical. Depending upon the magnitude of the relationship this may require a regular CEO-to-CEO, face-to-face interaction. These interactions should have both structured status reporting activities and unstructured, informal communications about the evolution of the relationship.
Effort must be invested in going back to the RFP and the contract and asking what surprises or changes have taken place. Problem areas should be identified. Any areas where reality is different from expectation should be reviewed. The outcome of these discussions will be identified opportunities for improvement.
Effort needs to be invested to review how well you are performing against the initial goals that were established for outsourcing. This needs to be much more than a cost vs. budget analysis but a full, robust analysis of the success of outsourcing.
A formal "lessons learned" round table meeting must take place both by the company alone on the topic of outsourcing, as well as between the company and the provider on the specific outsource relationship.
An objective going into the relationship was a win/win relationship. The company and the provider must sit down and review how this has evolved. The fact is if both parties are not happy with the relationship, neither party will be happy with the relationship.
At the end of the contract term there are basically three options:
1. Bring functions back in-house
2. Extend the contract
3. Take the contract out to bid

A good outsource relationship will share thinking on these options and there will be no surprises.

Step Seven: Managing the Outsource Relationship

Like all of business the outsource relationship is alive and dynamic. Keys to success that can help the relationship to be fresh and relevant include:

Leadership focus, diligence and follow-through on continuous improvement initiatives are important. Staff from both the company and the provider get busy with their day-to-day routines and forget to continue to push the boundaries of continuous improvement. With leadership continuing to make this a focus, the relationship will continue to prosper.
On a regular basis, leadership should refer back to the contract and see how it is going. Are you following the contract? If not, is this good or bad? Are you following the timelines and responsibilities included in the contract? Is there room for improvement?
The business that was outsourced goes through business cycles. How is the relationship and performance holding up under the changing business climate? What changes need to be made to align the outsource relationship with the evolving requirements?
Keep in mind how the relationship is functioning and how you could improve performance. How should service levels, budgets and incentive plans be upgraded to assure the relationship is fresh? It is important that goals for the future of the relationship be established and both the company and the provider accept these goals. Making the future better will not happen unless leadership sets the pace here.
Performance levels must be reviewed and kept current. Joint efforts need to be invested to see how improvements in performance levels can be achieved.
The customers or users of the provider's services should be brought into the process of improving the outsource relationship. A customer/user round table should be conducted to identify specific opportunities for improvement.
In all outsource relationships there will be an evolution of the relationship. People leave organizations, requirements change, and businesses change, and the relationship must adapt and continue to evolve. A key to being sure the changes do not upset the outsource relationship is open communications. Both the company and the provider should be challenged to define opportunities to improve communications.
Leadership must demonstrate their ongoing commitment to the outsource relationship with their active involvement with the relationship through the investment of their time in the relationship. Ongoing relationship development meetings should be held to advance the relationship to the next level.
There should be no surprises in the relationship. Ongoing strategic discussions from both the company and the provider must take place to be certain the relationship stays current and focused on the correct priorities.

Developing a Core Competency in Outsourcing

Outsourcing can be a critical business solution when pursued in accordance to the guidelines presented here. Without a core competency in outsourcing, outsourcing can become a setback for many organizations. Outsourcing done well can have tremendous payback; outsourcing done poorly can bring a business to its knees. If you are in doubt about pursuing an outsourcing initiative, leverage the expertise of proven outsource process consultants. With the proper planning great benefits can follow.

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