Vested Outsourcing: Five Rules That Will Transform Outsourcing

14 May 2010 Kate Vitasek

A collaborative business model can bring transformational value to both the firm outsourcing and its service provider. Kate Vitasek, founder and lead researcher in the concept of vested outsourcing, explains all.

In 1994 I was given the challenge to develop a worldwide outsourcing strategy for Microsoft's marketing programmes. At the time, Microsoft was a $4bn company working to realise Bill Gates' vision of putting a computer on every person's desk. In order for Microsoft to achieve this objective, it needed to reach as many people as possible through as many venues as possible, so marketing was a big deal at Microsoft.

The programmes were great for sales, but operationally speaking they were a nightmare because each one had different customers in different parts of the world, with different operational requirements and materials. To help solve these problems, Microsoft turned to dozens of outsource providers worldwide.

My primary goal was to get the absolute best service levels from our service providers at the absolute best price.

Three years later I left Microsoft to join Stream International, which at the time was one of Microsoft's largest outsource partners. It was a $1bn-plus outsource service provider, managing some of Microsoft's most complex outsourcing problems, including much of its corporate licencing fulfillment worldwide.

"Everyone was working to achieve what was in their own best interest rather than work together for a much broader definition of success."

At Stream International, the goal was always the same: sell as much as you can with the highest profit margin possible, which would maximise revenue and preserve profit margins. In almost all cases, the company charged its clients a price for each 'activity' performed, which was customary for the industry. For example, there was a cost per minute to answer calls and provide technical support to the clients' customers; there was a cost per 'touch' to manufacture the customer's product; there was a price per pallet to store the customer's product. In short, the more activities performed, the more money Stream International got paid. And since the sales reps were on a commission plan, the more revenue they booked, the more they made. If the customer pressed for lower prices in one area, it was the sales rep's job to shift the pricing around to keep Stream International's profit margin 'whole'. As such, the sales reps gave it their all to maximise revenue and profitability for the firm because when the company won, they personally won.

The operational and business management teams within Stream International had profit and loss (P&L) responsibility for accounts. The goal was simple: meet customer service levels and meet P&L targets. Business managers had to live with the clients for daily interactions, so for the most part, they would give their customers their all to make the customers happy; as a result, the company was a customer service-oriented firm. Customers would repeatedly ask business managers to bring proactive ideas to make the business better. After all, the customers had outsourced to the experts!

One of two interesting dynamics would occur.

The first dynamic had to do with the type of ideas that were generated. For example, if the business manager found ways to bring efficiency to the client, management often frowned because it would reduce revenue. When a smaller number of activities are performed, revenue is lower, or when the cost to perform services decreases, revenue decreases. Being efficient was just bad business. Over time, a culture developed where business managers would focus their improvement ideas on areas that would generate more revenue for Stream International. These revenue-generating ideas were termed 'value added activities'. A good business manager was very clever at identifying ways to perform an activity that would solve a client's problem. Once again, business managers gave it their all. Stream International solved the problem, and in return it was rewarded with billable activity. More activity meant more revenue.

The second dynamic also evolved over time. When a business manager developed an idea that would have a positive impact for clients, clients often discounted the idea or chose not to approve the improvement initiative. Clients often said: "That is not the way we did the work before. Please do the work we have outlined in our standard operating procedures." In essence, the clients had outsourced to the experts, but they were not open-minded to change the way the work was done. Another common reason clients gave for not wanting to approve improvement initiatives was because they would have to get another group involved that controlled that part of the process.

Whack-a-Mole approach doesn't work

"Companies such as Microsoft and Accenture were pioneering how to approach outsourcing in their transformational OneFinance deal."

If everyone was giving it their all, what was the problem? The problem, as I saw it, was that while each party was giving it their all individually, the overall solution was far from optimised. Decisions were made in a vacuum to optimise the individual firm’s goals rather than looking at the total picture. I came to call my observation the 'mole' theory because the effects were similar to the Whack-a-Mole game children play. When a child whacks the mole in the game, the mole is never really eliminated but is chased somewhere else. Everyone was working to achieve what was in their own best interest rather than work together for a much broader definition of success.

Vested is better

By nature, the company that is outsourcing and the service provider have the same goal: to make profit. However, they approach this goal from opposite viewpoints. Cost to the company that is outsourcing is revenue to the service provider. My premise is that they should create a business model where both the company that outsources and the service provider are able to maximise their profits. Doing this means creating a culture where both parties work together to make the end-to-end process efficient regardless of what party is performing activities. This means creating an approach where service providers are rewarded for reducing their revenue.

To be successful, companies would have to change the lens through which they look at problems. In short, my plan would pay the outsource provider to meet service levels while making the overall operations of what is being outsourced as efficient as possible. The more efficient the process, the more profit the outsource provider. Under my vision, companies and people would not be rewarded for giving their all to solve their immediate problem and improve their individual position. All for one, one for all.

"For many, vested outsourcing will seem like heresy to tried and true procurement methods."

In 2003 I joined the University of Tennessee to spearhead a multi-million research project funded by the United States Air Force to study some of the world's best outsourcing arrangements. My work validated my premise – companies that worked together, creating an agreement with economics that created a vested interest in each other's success could bring transformational efficiencies to how work would get done. Companies such as Microsoft and Accenture were pioneering how to approach outsourcing in their transformational OneFinance deal, which won the Shared Services and Outsource Network award for Best Mature Outsource Services Delivery.

Our findings were codified in the book Vested Outsourcing: Five Rules that will Transform Outsourcing, which teaches companies the fundamentals for structuring their outsourcing relationships as well as providing an implementation process steeped in research.

It is crucial that today's CEOs push their organisations to apply innovative thinking that can help drive transformational results. Vested outsourcing helps companies move beyond professing partnership and the elusive win-win; it teaches companies how to contract and govern a successful partnership. Following the vested outsourcing rules develops a collaborative business model so powerful that it drives efforts to solve for an optimised, complete solution, bringing transformational value to both the company outsourcing and their service provider.

Making the investment

For many, vested sutsourcing will seem like heresy to tried and true procurement methods, while for others it will seem like a fresh approach to help companies achieve better success with outsourcing. Microsoft and Intel – both known for their innovative cultures – are early advocates for vested outsourcing, and the former has successfully used the approach for outsourcing facilities management and accounting. Leading service providers UPS are also fans. The firm's Brad Mitchell, president of Distribution and Logistics, has proclaimed that "companies will take a vested interest in vested outsourcing", projecting it will be one of the top five trends.

The University of Tennessee’s findings are clear: companies that invest in applying vested outsourcing’s 'five rules' can drive transformational improvements for both the outsourcing company and the service provider.