Navigating the uncertain new world of outcome-based outsourcing

Published March 14, 2016

Category: Process-Specific

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Written by: Robert Kenney

Robert Kenney

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The days of paying supply chain outsourcers by number of FTEs are on their way out. In that purely cost-based model, the OEM’s interests – keeping hours low to contain costs – are inherently pitted against their managed service provider’s – putting more FTEs on a project to maximise revenue. Instead, OEMs are now exploring outcome-based models, where sellers become partners who share the risks and rewards of achieving their goals. But while many businesses are rightly excited about this evolution, it’s both early and fraught with challenges and uncertainties, not the least of which surround the changing dynamics between OEM project owners and procurement, and between OEMs and vendors.

Aligning business interests and procurement requirements

Business project owners love the shared risk/reward concept. What could be better than having vendor compensation directly tied to your specified success metrics? However, procurement teams are struggling with how to operationalise this in a world where RFP responses have always been evaluated on an apples-to-apples basis.

While outcome-based models appeal to many business owners within large companies, what ends up being negotiated over the commercial table after the sales discussion, often results in a more traditional cost-based model: it’s simply easier for both parties to feel comfortable with what they are getting.

So, how can you navigate around these obstacles and create a successful outcome-based model?

Liaise early and extensively

Traditionally, most RFPs are generated because business teams need to reduce costs. An RFP process discussion may, or may not, take place between business stakeholders and procurement. If it does, since the RFP goal is pretty straightforward, the conversation is also. Resulting RFPs generally follow a template and, all things being relatively equal, vendors who come in at the lowest cost win the business.

Because outcome-based models are complex and nuanced, there needs to be much earlier, and more profound, engagement between business and procurement departments regarding how to structure each competitive bid process. First, make sure the project is a strategic priority across all OEM stakeholders. Then, have business owners explain what their challenges are and what, specifically, they want to achieve, why they’re bidding this out in the first place. Procurement also needs to understand how vendors might interact with the business to deliver those outcomes.

For instance, if you’re a technology hardware company who wants to provide an enhanced service experience to customers, your outcomes may include obtaining a mean-time-to-repair of three days, or an average hold time for customer calls of less than two minutes. Your vendor would get paid a prescribed amount according to whether they accomplish those goals within certain time periods. The number of FTEs or hours they put into the project are irrelevant.

Engage potential bidders before creating RFPs 

Internal teams aren’t the only ones who need to engage earlier. It’s important to bring potential vendors into the conversation as well, before you create the RFP.

Because outcome-based models are new to all parties, the way that OEMs imagine vendors would structure a deal may not actually be feasible or attractive to those vendors. Therefore, if you bid out an RFP with no prior vendor input, you may not get the right type of responses.

Two or three years from now, when outcome-based contracts are the norm, bringing vendors in so early may not be required. But today, because they’re so revolutionary, the more upfront thinking and collaboration you do, the more likely you’ll produce a RFP that will result in substantive responses.

Note, also, that vendors need to understand whether they can take on an outcome-based model. It can’t be a sales tactic to acquire a new customer – it must be a total company decision, and the risk / reward profile may not be acceptable to everyone. Thus, the very nature of an outcome-based RFP may limit the number and type of respondents. This is important to know upfront, as well.

Establish a baseline

In order for vendors to respond to an outcome-based RFP, they must understand the type of effort that will be required to meet your goals. The outcomes you’re looking to drive have to be based on facts. This necessitates defining the starting point. Therefore, the biggest consideration in creating an outcome-based RFP is the maturity of your KPIs. How well vetted are they?

If they’re not well-vetted, it’s important to do a baseline assessment that includes describing the processes you’re currently using to achieve existing results. If this baseline doesn’t exist, or even if it does, structure an assessment into the RFP. The vendors will likely want to validate it anyway as part of their engagement.

Go gradual

Going cold turkey, from purely cost-based to outcome-based RFPs, isn’t feasible for many companies at this point. Instead, take a graduated approach. We often recommend kicking off engagements with a traditional pricing model, such as time and materials/headcount, for a six-months-or-so period, and then adding, or replacing that with, outcome-based pricing. During the kick-off period, the vendor would use data analytics to identify current KPIs so they can then make recommendations for process improvements over the vetted baseline as well as to identify if the current measured KPIs are actually the right KPIs to measure.

What kind of RFP responses might you receive? The outcome-based portion of a response to an RFP for improved asset recovery, for instance, may include a $XX/month baseline and note that, if the vendor improves recovery from the OEM’s stated rate of 80% in 60 days to 85% in 40 days, the vendor will be compensated $XX+. A response to an RFP focused on logistics cost reductions may specify compensation equal to XX% of the savings driven by the vendor on a quarterly basis.

If you haven’t dug into outcome-based models yet, it’s time to start. The tide is already shifting. Whether you’re in high-tech, medical equipment, broadband, mobile or any other market that depends on outsourcers, the way services will be procured, priced and sold will soon be completely different. The better prepared your business and procurement teams are to bring these new type of RFPs to the table, the faster you can ramp to success.

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