Don't Outsource the Relationship

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IIE Solutions Author(s): Tompkins, James A

It's not someone else's job when your company's bottom line is at risk.

There is a lot of hype and emotion surrounding the topic of outsourcing. Everyday, I see an article or column strongly in favor of outsourcing and almost as often an article or column strongly against outsourcing. The fact is that outsourcing has been a major success for some organizations and a major failure for others. The technical, business, and operations knowledge of the industrial engineer can minimize the hype and emotion of outsourcing and assure its successful application.

Why outsource?

No one has extra time. In fact, many organizations are unable to focus on what is really important because all the key people are simply too busy. Their organization's decision processes are gridlocked, which has a negative impact on performance. Herein lies the primary reason to outsource: to allow key people to focus on what is really important and not on what is urgent. Organizations should focus their attention on their core competencies and evaluate non-core processes for outsourcing potential.

The process to develop a successful outsourcing relationship methodically follows:

* Conduct a baseline and market research study.

* Perform the solicitation process.

* Select the service provider.

* Create the outsourcing relationship.

* Establish the contract.

* Start up the relationship.

* Establish an ongoing relationship.

* Manage the relationship.

Baseline and market research

A baselining and market research initiative has five basic components.

Establish a baseline analysis team. This team is responsible for collecting the data, analyzing it, and preparing baseline summary documents for the potential outsource functions.

Define data requirements and analysis methods. This definition process starts with the development of a list of the data required to document each current function or process fully. Then the team must identify the appropriate method for collecting data, performing the analysis, and reporting the results. The goal of these steps is to understand the current functions, determine current requirements, develop high-level selection criteria, and get steering team agreement.

Develop a baseline model. The baseline model is used to validate existing functional processes. It involves collecting data about the processes, mapping the business processes, developing issues lists, developing cost and service level baselines, comparing internal baselines against industry best practices for validation, and preparing a summary document for each process considered a candidate for outsourcing.

Perform market evaluation of service providers. This is accomplished by identifying potential providers, preparing requests for information for high-level due diligence of available providers, and evaluating the RFI responses to identify potential service providers based on selection criteria.

Develop specific outsourcing recommendations. In this step, the team determines the feasibility of outsourcing specific functions or processes based on the work it has done, identifies those functions or processes that meet company financial return objectives, prioritizes the list of potential outsource providers, obtains consensus on the prioritized list, and prepares for the next steps in the outsourcing process.

Solicitation

Once your outsourcing team has identified its outsourcing targets, it is time to solicit providers for the process or processes being outsourced. This is one of the most critical components of the outsourcing process, and it must be done properly. To prepare a request for proposal that will allow you to select the best provider, take the following actions:

* Clearly set forth the goals to be achieved through outsourcing, keeping in mind that your primary goal will be to return leadership and management focus to the levels necessary for peak performance. Do not assume that todays level of performance is what is required for the service provider.

* Develop a detailed, realistic timeline for the outsource process. Identify key dates such as RFP release, RFP response, site visits, short list, due diligence, selection, term sheet signing, contract signing, beginning implementation, and completing implementation.

* Involve senior management early, often, and at key decision points. Be certain senior managers understand the scope, goals, and timeline. Set realistic expectations. Obtain leadership support.

* Be certain that a wide range of candidates are pre-qualified before sending the RFP. Consider outsource providers as well as industry players. Perform extensive research to be certain all viable candidates are asked to bid by creating an RFI that dearly defines your needs and evaluating the responses to those needs.

* Clearly define the scope of what is to be outsourced and then clearly establish the boundaries of what is to be outsourced.

* Establish a benchmark based on doing the functions to be outsourced. Understand the cost drivers of self-performing and service levels that will serve as a baseline for the outsourced activity.

* Be certain the RFP provides a clear set of requirements, a clear path forward, and a dear desire for innovation and creativity. Use the RFP to tell people what needs to be done. Do not use the RFP to tell potential providers how to do their jobs.

* 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.

Service provider selection

Evaluating proposals and choosing your final candidate is a time- consuming process. Keep in mind that success is all in the details. You must stay focused and consider all angles when you evaluate proposals. Here are some tips for a successful evaluation:

* Deciding who will do the evaluation is as important as how to do it. The team that will do the evaluation should come from a variety of touch points with the outsourced function.

* The evaluation process is a business decision, not a low cost or personal preference. The process must be methodical. Relationships and executive preferences should not be overly emphasized. The evaluation criteria must be rigorously applied in a fair and equitable manner.

* The evaluation process should not be rushed. Often, time pressures are present, but these pressures should not result in the team's allowing the process to be anything other than fair, detailed, and robust.

* Have a clear understanding of how your team will handle 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 through the short list and ultimate selection process.

* Be sure to evaluate proposals and not sales presentations. The written bid is what should be evaluated. In a similar way, you must evaluate the potential provider's company as a whole and not its sales team.

* Bids are often complex. Be sure all bids address the full scope of the functions to be outsourced. Be sure the evaluation is apples- to-apples and oranges-to-oranges.

* Until a binding relationship is established, you should always retain more than one provider. Therefore, do not tell any potential provider they are the winner until a binding term sheet or contract is signed. For larger outsourced contracts, it is appropriate to hold detailed, binding term sheet discussions with more than one potential provider.

The outsourcing relationship

Outsourcing is giving up internal control of a business function and trusting others to handle it for you. Therefore, the relationship between you and your outsourcing provider cannot be taken lightly. Although you may have built a great relationship during the selection process, this is not the outsourcing relationship that will take you through your initiative. Creating the outsourcing relationship involves the following four actions:

Getting the relationship started. A failed relationship can lead to complicated and costly legal battles. Therefore, as soon as is practicable, you should create a new team - the implementation team - comprising members of both companies to begin creating your relationship. This includes setting initial expectations, identifying resources in advance, determining where you are now and your destination, defining the relationship desired, and planning for resistance.

Selecting a fee structure. Fee structures should be as flexible as the relationships that create them. At the highest level, the pricing options are fixed-cost, transactional fee, cost-plus, activity-based, management fee, and combined structures. Each option has advantages and disadvantages. It is important that you and your provider explore each option before you decide which you will apply to your initiative.

Validation. During validation, a client and a provider work together as a team to understand what the other is selling and what it needs. Both must be prepared to change assumptions or make adjustments to their expectations.

Setting realistic timeline expectations. Before you and your provider g\et involved in the legal issues necessary for cementing your relationship, you need to develop a realistic and detailed timeline. This creates common thinking about the process and the next steps.

The contract

Involve experienced outsource counsel early. Your legal team needs time to understand the drivers behind your decision to outsource and what your goals are for the outsourcing initiative. It is best to involve the legal team before or during the RFI step to improve your selection process. Your counsel will then be familiar with all the players and can contribute to the selection process. This also better prepares the legal team when it is time to negotiate.

Your legal team's outsourcing negotiation strategies should include understanding your company's negotiating position as well as its objectives in the outsourcing initiative. To accomplish this, make sure your counsel has the answers to the following questions:

* What is driving the decision to outsource - commercial, financial, or technological concerns?

* What departments are affected and what are the consequences to each?

* How can the objectives be used in negotiations with the provider?

You and your legal team should also decide whether to wait until you have selected one Final provider (sole source) before you start the negotiations or to begin the negotiation process with two Finalists (negotiating in parallel).

It is best to lead the negotiations with a binding term sheet, which allows you to settle on the terms of the deal without bogging down the parties involved in legalese. The negotiated term sheet embodies the deal and will be the basis of the agreement. Properly constructed, it makes preparation, negotiation, and execution of the definitive agreement a simple process and allows you to continue to evaluate and improve the service provider's proposed charges, technical solutions, and legal terms.

At minimum, the term sheet must integrate commercial, legal, technical, and financial issues; balance risk and reward; balance certainty and flexibility; provide price predictability; and plan for exit.

Service levels and performance measures are the contract terms that will trigger a great deal of discussion between your company, the legal team, and the provider. The service level part of the agreement must identify each service level clearly and objectively. Performance measures are usually included with service levels. These are performance indicators that are aligned with your strategic direction, are appropriate to the project, and provide readily understood signals of when the provider is succeeding and when improvement is needed.

A common practice is to include a provision for benchmarks against which you and your provider periodically compare services and prices with industry best practices. This requires looking outside your organization for best-in-class performance comparisons and comparing your business with companies within and outside your industry. Many consulting groups and research organizations have developed formal benchmarking data and offer it as a product for this purpose.

Startup

The period of transition from selection through implementation is underestimated, taken for granted, and not given enough effort. Work hard to prevent this from happening. Both parties must understand and accept that they are dealing with new people and a new culture and be prepared to make adjustments.

During this time, you and your outsourcing provider must also be aware of and avoid the outsourcing relationship pitfalls of unrealistic goals, false perceptions, and lowered expectations. The negative results of these pitfalls are nonperformance, cost increases, and failure to achieve continuous improvement. To prevent these difficulties, you should define and manage expectations, develop metrics, conduct roundtables with senior management, and review your transition plan often.

During the transition period from selection to startup, teams should be built to foster communication and knowledge transition. These teams should consist of members from your company and the provider's company. You and the provider must ensure that any teams you create within your organizations mirror one another, and you should decide whether each of you will have a project manager or if one project manager from the providers company will suffice.

Establishing rules of engagement will facilitate the relationship. Consider the following questions: How often will we meet, who will be involved in startup and transition, how will each party treat the other, what is strictly forbidden, and what hierarchy will be used for problem escalation? Answering these questions will help establish the rules of engagement as well as the roles and responsibilities of both companies.

Develop a solid communications plan that focuses on the quality of information shared. The first step is to set clear communication expectations up front. Decide early on who is going to communicate what to whom and when. Then, as you would with any other part of the project rollout, document those communications requirements in the form of a plan and then publish that plan.

An ongoing relationship

Outsourcing relationships are between organizations and people; therefore, several types of relationships can form during and after implementation. The two most common are vendor/client and partnership. Ideally, you want your post-implementation relationship to move beyond vendot/client and toward partnership.

As you begin building a lasting relationship with your provider, an important thing to remember is that there is no off-the-shelf approach. Establishing a relationship that is geared toward long- term success is as much an art as it is a science. The trick is communicating properly so that any disagreements become an impetus for moving the relationship and initiative forward. Therefore, you must adopt an acceptance mindset and agree to communicate fully with your outsourcing provider so that your companies can build the lasting relationship necessary for outsourcing success, which includes the following agenda:

* Establishing a regular, ongoing process for business planning, evolution, and communications

* Implementing a rewards structure of gain sharing or goal sharing

* Ensuring that there are regular, ongoing executive interactions

* Reviewing the RFP and the contract after implementation and identifying surprises, changes, and problem areas

* Measuring performance against the initial goals established for outsourcing

* Conducting formal lessons-learned roundtable meetings

* Encouraging creativity and innovation on both sides of the relationship

* Building a lasting outsourcing relationship by emphasizing continuous improvement

To create the right kind of outsourcing partnership, all organizational units within each company should be 100 percent directed toward the success of the outsourcing initiative. There can be no adversity between the outsourcer and provider. Instead, you and your provider must function as a cohesive, collective whole. The goal is to eliminate the we-vs.-they problem that can undermine an outsourcing relationship. After the continuous improvement process is in place, your relationship with your provider has a greater chance of growing, improving, and remaining strong. However, you can improve these chances even more by learning to recognize the signs that your relationship may be in trouble.

The behaviors that can lead to a failed initiative are poor executive communication, the elimination of daily relationships between managers of both parties, failing to maintain metrics and monitor the relationship, not accepting responsibility, and using metrics as a whip instead of a tool.

As soon as either party realizes that any of the above behaviors are occurring or may occur, get together as a team and address them. None of these problems are insurmountable. Return to first principles and ask tough questions. Disregard what was done in the past and address the present and future. You may even want to hold more frequent roundtable discussions to work things out.

Managing the relationship

Managing an outsourcing relationship for the long-term may be compared to taking care of a marriage so that you can get to your silver anniversary celebration. This is not easy. There are numerous challenges to overcome.

The keys to meeting these challenges and ensuring success in your outsourcing relationship are leadership, continual communication, implementing change, and preparing for the future. Leadership for all companies involved must demonstrate its ongoing commitment to the outsourcing relationship by staying actively involved and investing time to keep it going. Leaders should maintain focus on the relationship and understand that business will change over the life of the outsourcing agreement.

Successful management of an outsourcing relationship is the result of continual communications between all parties. The relationship managers and outsourcing team should conduct regular meetings to review and update service levels, budgets, and incentive plans. Company executives from both organizations need to hold semi- annual relationship meetings. You should also hold annual customer focus meetings to get an understanding of where your customers' business is going and to identify changes that need to be made to meet their needs. After the customer focus meeting, you and your provider must hold a planning meeting to determine how best to react to customer requests and discuss process changes and implementation plans.

In a long-term relationship, change is inevitable. You and your provider must be prepared to make adjustments to the process. If you have fostered continual communications, it will not be difficult to develop a process with your provider to implement changes. The first step is to have a documented plan. The second step is to take your plan and put it into action while monitoring performance, cost, and attitude. The third step is for both parties to document what went right and what went wrong during the process change so chat you can better plan for the future.

All contracts have life spans, so openly discuss the end of the contract term to let your provider know what you expect. Part of preparing for the future includes considering the possibility that the contract will not be renewed once it has expired. Make sure that you have a solid, documented plan for managing the exit and transfer costs. And don't forget to share the signs of a successful initiative - the rewards for excellent outsourcing relationship management - and celebrate in a fun environment.

The risks of not pursuing outsourcing and focusing on your organization's core competencies are great. Unfortunately, the risks of pursuing outsourcing without a robust process are also great. The industrial engineer is uniquely qualified to assume organizational leadership for outsourcing and follow the methodical process presented in this article. It is time for the IEs to step up to this challenge.

This article is based on the book Logistics and Manufacturing Outsourcing: Harness Your Core Competencies by James A. Tompkins, Steven W. Simonson, Bruce W. Tompkins, and Brian E. Upchiirch, published by Tompkins Press in 2005.

OUTSOURCING BENEFITS

Direct benefits

* Reduction in manufacturing and distribution costs through the consolidation of operations and reduction of inventory carrying and transportation costs

* Reduction in management and hourly head count

* Improved accuracy through better inventory visibility and production tracking

* Flexibility and wider range of service

* Access to global networks and superior technology (world-class WMSs, TMSs, MESs, OMSs) results in the collaboration that consolidates loads and allows smaller organizations to share space, IT support, and operations

* Improved service through shorter order cycle time, visibility of available inventory, and accountability

* Improved quality that is the result of less damage, less scrap, and improved response time to inquiries

* Reduction in capital investment and cash infusion because facilities are no longer on the balance sheet and assets can be sold

Indirect benefits

* Creating a catalyst for change by highlighting how outsourced operations are managed

* Initiating or fueling change by allowing a company to offer new services because outsourcing has improved performance

* Stimulating analysis because of the requirement to document business processes and their costs

* Converting sluggish functional areas into dynamic, successful ones

* Developing resources and contacts brought to the table by the service provider

RFID INTEGRAL TO SUPPLY CHAINS

Most U.S. supply chain executives consider radio frequency identification and electronic product code technologies important to their supply chain management operations, according to a recent EPCglobal survey.

More than 85 percent of the 400 responding supply chain executives indicated that the technology is extremely important, very important, or somewhat important. Nearly 65 percent of respondents said having a single global standard and securing as much access as possible to royalty-free standards are extremely important or very important.

James A. Tompkins, Ph.D., is president and founder of Tompkins Assodates, a supply chain consulting and integration firm. Tompkins has authored and contributed to 25 books and more than 500 articles. Tompkins has consulted with more than half of the Fortune 500 companies including Newell-Rubbermaid, Rite-Aid, Sara Lee Knit Products, and the Gap. He has been an IIE member for 30 years, is an IIE fellow, and served as a president on the Board of Trustees.

Copyright Institute of Industrial Engineers Nov 2005
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