TIMBER LANE ADVISORS P: (877) 355-1483 Discussion Topictimberlaneadvisors.com/files/133105845.pdf · and replicating home-grown systems and internal capabilities is just too great

© TIMBER LANE ADVISORS, LLC ALL RIGHTS RESERVED 1 [email protected]

Discuss ion TopicEssentials of ...

Negotiating Outsourcing Agreements

The SituationOutsourcing Is Unfamiliar to Many

The outsourcing of core and non-core business activities has become increasingly common since the late 1990’s. After a somewhat rocky start, outsourcing has grown rapidly and steadily since that time and is now a relatively familiar concept for most Fortune 200 companies. Industries such as consumer-finance, travel and hospitality, and customer support have been its leading adopters and, as a result, have become reasonably skilled in recognizing where outsourcing can work (and where it doesn’t). Unsurprisingly, these pioneers have also developed reasonably good skills for implementing and managing outsourcing when they do choose to pursue it.

Others businesses, further down the Fortune 1000 index, have been slower to adopt outsourcing and are less familiar with its concepts and business practices. Conservative management, relatively sheltered industry segments, fear of the unknown, and concern about the affect outsourcing would have on customers, internal staff, quality, and reputation all create valid reasons for hesitation.

However, many of the factors that drove Fortune 200 firms to outsourcing affect smaller and mid-sized firms as well. Internally-developed, legacy IT transactions systems are reaching “end of life” and require replacement. Internal operational capabilities and physical infrastructure are becoming dated and require re-investment. New market channels and products are being

introduced, creating more competition for scarce internal resources and talent. High local labor costs and the expense of sub-scale internal operations are creating cost pressure in core market segments. As a result, many smaller-to-mid-sized companies are under stress and seriously approaching outsourcing, reluctantly, for the first time.

These companies (correctly) recognize outsourcing as providing both new capabilities -- and substantial risks. Yet for many organizations, the question of “whether” to outsource cannot be indefinitely avoided --- the investment and operating cost associated with updating and replicating home-grown systems and internal capabilities is just too great (and risky in its own right) to continue solely with in-house solutions, resources, and operations. Therefore, for many firms, the question is not whether to engage in outsourcing, but instead, a question when and where to use it and how to conduct the outsourcing process.

Problem #1Deciding Where (and How) to Begin

For many companies, the question of when, where, (and how) to outsource can seem overwhelming. Outsourcing could apply to a wide range of internal activities (see table attached to the end of the this article). Therefore, internal debates often rage within the organization:

Where should outsourcing start?

KEY POINTS1.0OUTSOURCING IS UNFAMILIAR TO MANY MID-SIZED FIRMS

2.0PERFORMING OUTSOURCING CORRECTLY IS A CHALLENGE

3.0COMMON SENSE GUIDELINES CAN HELP

1.Plan for a Front-Loaded, Multi-Stage, Methodical Process

2. Run “Just About Everything” In Parallel

3. Get Appropriate Negotiating Support

4. Focus on Getting Agreement to the Full Set of Deal Terms Early

5. Make the Deal Part of the Down-Select Process

6. Keep More Than One Supplier Through the Post Proposal Planning Phase

7.Start Work (if you must) But Don’t Commit Until You “Have a (Complete) Deal”

TIMBER LANE ADVISORS VOL. IX P: (877) 355-1483

mailto:[email protected]



• In a problem area needing immediate improvement?

• In a relatively “safe” backwater operation, to test out the concept?

• In the area with the biggest potential for economic improvement?

• (And if so, how would you accurately measure that potential?)

When should outsourcing begin? • During a once-in-a-generation

technology refresh cycle?

• As part of a cost reduction or “transformation” program?

• During a change of executive leadership or business strategy?

• After a merger or as part of acquisition integration?

• During a “stable” period to “get ahead of the curve” in anticipation of pending industry change?

How should the outsourcing process be run?• What are the process steps and how

long will they take?

• Which industry players should be included and why?

• What’s the best way to:- Develop the outsourcing design

and business case?- Manage the project? - Drive to a supplier selection

decision?- Implement the transition?- Manage the new entity in

operation?

All-too-often, when faced with such systemic uncertainty, companies do one of two things -- they:

• “Freeze” and do nothing -- “kicking the can down the road” for a later date, foregoing both the benefits and risk of outsourcing,

• “Plunge In” at the first opportunity (and vendor) they find convenient, thinking that, since they have to start sooner or later, they might as well start now.

Occasionally, companies try to systematically compile a complete list of outsourcing options, evaluate the risk and promise of each option using some kind of criteria, and set up a roll-out sequence and resource base to support the outsourcing process -- but this is the exception, not the rule. Furthermore, even if companies take a systematic approach, they still run into (and often get overwhelmed by) a myriad of unexpected difficulties, internal capability and resource gaps, and process uncertainties that muddle the result or retard their progress.

Unfortunately, until companies have gone through the outsourcing cycle, they just “don’t know what they don’t know”.

Problem #2Being Led Astray by the “Industry”

One way, of course, to help solve Problem #1 is with outside assistance. Companies can hire outsourcing practitioners from other companies further down the outsourcing learning curve. Alternatively, they can hire outsider advisors: strategy consultants, technology consultants, benchmarking specialists, operations experts, and deal consultants all offer “experience for hire”. Law firms specialize in outsourcing and off-shore transactions. However, there is always a risk that the resources you engage (new hires, consultants, lawyers) may only bring “part of the picture” (i.e. they know a lot about part A of the outsourcing process, but are less skilled or unskilled in parts B and C). Plus, it can seem rather overwhelming (not to mention expensive).

Therefore, many companies considering outsourcing turn to the outsourcing industry itself for guidance. Outsourcing vendors (whether they be software-as-a-service providers, off-shore administrators, or integrated consulting-outsourcing firms, etc.) bend over backwards to make the outsourced operations and the transition seem simple, straightforward, and routine.

And why not? These companies are in the business of getting clients to convert to their business model. If they are outsourcers “worth their salt”, then they should know something about making the transition and running a successful operation in production. In the long term, they can’t afford to have a set of deeply disgruntled clients pulling away from their services or requiring endless cycles of error correction and support (let alone creating law suits and bad word-of-mouth). Consistent and profound customer failure is bad for their business.

However, it is one thing to realize that it’s in the interest of the outsourcing provider to do a good job -- and it’s an another thing entirely to rely on this “invisible hand” to make your particular transition right, painless, or desirable. Companies who “buy into” this “we are all in this together” mantra and rely on it to get the right design, a decent deal, and adequate performance are usually cruelly mistaken.

If you are not convinced, consider the following: the vendors have a vested interest in having your purchase their services. So, of course, they will mention the benefits of the new model and talk about the ways in which they will simplify the transition. They will highlight their “turn-key” packaged solutions that will make migration a breeze. They will promise to re-engineer your existing, old-fashioned and hopelessly silo-ed operations “on their nickel” so that you end up with a stream-lined, industry competitive technology solution with industry leading labor rates. They will show you their “top tier” architects, project leaders, and other resources (suggesting -- but not promising) that these “experienced hands” will guide you at every step of the way. From their point of view, all you -- the buyer -- needs to do is demonstrate your “commitment” to the “partnership” (by signing the comprehensive production and implementation agreement now), because once you are committed (and pay), they’ll be able to open the flood gates and





overwhelm you with experience, detail, and care.

Some of you readers may guess where this is going. But for those still not convinced, consider for a moment whether it is possible that some of those desirable “capabilities” may still be planned, but un-built, vapor-ware (or robust exaggerations). Perhaps some of those senior, attractive resources may not actually be engaged on your project. Perhaps all that follow-on “detail” work will reveal substantial, previously unidentified performance gaps in the proposed solution or customization requirements needed for your business that will take more time and resources (and customer cost) than anticipated.

These unpleasant “discoveries” don’t necessarily imply bad faith on the part of the outsourcer, it’s just that certain things were emphasized (and others unspoken) during the initial conversations. It is even possible that the outsourcing sales team you dealt with is unwilling to admit or recognize the fact that they are over-simplifying and over-selling their solution -- as Upton Sinclair wrote:

It is difficult to get a man to understand something when his job depends on not understanding it.

Therefore, seen from this perspective, it’s generally a bad bet to rely too much on your potential supplier for the guidance and understanding you will need in the outsourcing process.

The Problem #3Facing Multiple Challenges at Once

Aside from the problems of expertise -- and where to go for it -- there are very real challenges companies have to master as they pursue outsourcing, even if they have access to the the right skill sets and talent. For example, companies contemplating outsourcing need to ensure:

• That the “design” of the outsourcing solution “fits their

needs”. In other words, that the solution they are buying:

- Has the “right amount” of the “right technology” in the “right places”,

- Has access to the “right type” of operational capability and personnel,

- Maintains the “right mix” between in-house and outside resources and activities,

• That the “transition” to the outsourcing state is successful,

• That the design “in operation” works as intended, which depends a great deal on having:

- The “right” detailed requirement definition,

- The “right” measures and metrics of performance,

- The “right” incentives and governance structure for the managers involved,

• That the design is “flexible” enough over time to accommodate the tactical and strategic changes the business will need over multiple years of continued operation.

These challenges (design, transition, operational performance, on-going flexibility) tend to “bite” a company at different times in the outsourcing process. For example, a company may not be sure it has the right (or wrong) implementation plan until it is well into the actual transition. Similarly, a firm may not be certain whether the design is right (or flexible enough) until it is trying (and failing) to use the outsourced solution in operation.

However, just because these mistakes “become apparent” one at a time doesn’t mean that the challenges should be “managed” in the same way. Instead, experience shows that all of these challenges need to be worked at the very beginning of the outsourcing process.

Design:For example, getting the right

outsourcing “design” depends a great

deal on the up-front process of vendor identification, qualification, and selection. Yet, many companies in the market for outsourcing services pick their supplier first (perhaps based on industry reputation or business connections) and develop the specific solution later.

This “pick first and design later” approach is, in essence, backwards. The whole point of the selection process is to identify and pick the supplier who best understands and responds to what the customer company wants and needs. Knowing which supplier is “best” depends on the specific “design” the supplier offers and “capabilities” and “commitments” that back that design up. Therefore, picking the supplier without fully understanding the design that would be offered (i.e. the “we’ll work it out together later” approach) puts the “cart before the horse”.

Transition:Similarly, serious mistakes are often

made during the implementation planning phase that follows the initial design conversation. The transition plan for outsourcing is often quite complex, and the resource investment required from the parties involved to build and execute that plan is often a very large part of the overall purchase expense. (Often transition is more expensive than the service or license cost itself). And of course, the implementation plan is critical to the overall project’s success in its own right (a great design is of no use to anyone if it is not installed).

Yet, customers inexperienced with outsourcing routinely make their up-front supplier selection decision well before the migration activities, customization requirements, and resource loads for their project are truly established. Furthermore, once implementation is underway, it is often too difficult, too time consuming, too expensive, (and too politically damaging) to reverse course and back-out of an outsourcing project that “just isn’t what you expected it to be”. As a result, companies become





burdened with costs and difficulties that could have been relatively easily avoided if more effort and care was expended early in the outsourcing process.

Operational Performance:Third, whether the outsourced

design “works in operation” after implementation depends a great deal on the quality of the internal-generated, detailed “requirements” that describe to how the solution will work once it “goes live”.

This specification and due diligence activity is different from the high level “what should the system or operation have” question typically asked in up-front sourcing activities. For example, a solution may be scale-able, flexible, configurable, and low cost --- and still not be able to meet the specific, detailed performance specifications a company takes for granted today in its own internal operations. (It’s the difference between strategy and tactics: the outsourced solution a company picks must meet its overall (i.e. strategic) requirements: cost structure, scale-ability, etc. -- and it must also meet the low level, transactional expectations embedded in “how works actually gets done”).

With companies inexperienced with outsourcing, this detailed level of specification often occurs late in the outsourcing process (somewhere after implementation planning or even later as part of a last-minute “clean-up” to the contracting process).

Sadly, this timing is far too late. In fact, detailed performance specification should be occurring during in the supplier selection process because, if the customer company doesn’t know or can’t express what it truly wants and needs (at both a strategic and tactical level), it becomes virtually impossible for the outsourcer to give (and for the company to select) the “right” design solution. Many otherwise well-designed and implemented outsourcing efforts “fall apart” in operation because critical business requirements are missed and

performance assumptions are left untested until “things go live”.

Changing the detailed performance specifications later in the process (i.e. after supplier selection and contracting) can be an expensive, lengthy process. On the positive side, once a business transitions to outsourcing (and fails in operation), it become relatively clear, relatively fast what is missing and why. On the other hand, possessing this “20-20 hindsight” knowledge may not be of much use if core business operations are affected and the chosen outsourcing supplier is physically or technically unable to provide what is needed -- or able to do so but only at substantially increased cost.

On-Going Flexibility:Finally, whether the outsourced

design works in years two, three, and beyond after transition depends, to a great extent, on the promises and commitments made during the initial deal and contracting process. If business and legal understandings and commitments are not on paper -- and if that paper is not committed to early in the process when leverage is available -- then the business flexibility on which that the customer company is counting will likely not be there when it is needed (not at least when either party’s core interests are at stake).

For example, questions regarding how:

• Volume, mix, and capacity levels will change,

• Industry service and productivity levels will evolve,

• Currency markets, input pricing, and inflation will behave,

can’t be known with certainty at the beginning of an outsourcing relationship. However, whether stated or not, each party in the outsourcing negotiation holds implicit assumptions about how these real world variables will affect the relationship and transaction economics.

Companies experienced with outsourcing deal with these issues directly,

at the start of the outsourcing process. Inexperienced companies, like punters in Vegas, all too often just “take their chances”. So, once again ... the conversations that occur at the start of the outsourcing process are critical.

The Problem #4Believing in the Fallacy of Partnership

Getting so many different challenges right at the same time, just as a outsourcing process is getting started, creates enormous senior management, program management, resource, time, and skill challenges on the company pursuing the outsourcing. This challenge to “get everything done, all up-front” is further burdened by the fallacy of “partnership”.

The fallacy of partnership is created in part by the outsourcing supplier itself. Outsourcing suppliers sell themselves to the mid-level and senior team as “strategic partners” willing to “do whatever it takes” to “make things right” in return for 1) an early selection decision, 2) a long term contract, 3) limits on competition (or favored access to other areas of the business), 4) unique access to the customer’s operations, customers, and knowledge base, and 5) real limitations on the customers ability to “switch” to alternate solutions at a later date (e.g. via high contractual buy-out clauses or high operational transition costs).

This promise of “partnership” is usually eagerly embraced by the customer.

Partnership and Middle Management:For mid level managers,

“partnership” saves the managers from having to laboriously think about, document, and potentially re-imagine their current work practice and desired outcomes. Why try to untangle the existing mess of undocumented work activity, out-of-date metrics, and various end-customer exceptions when your “partner” is offering to do so -- and in fact re-engineer it for you -- during





implementation? Since the upfront workload of outsourcing seems truly overwhelming, why not take advantage of this unique opportunity to solve a long standing problem and reduce work load at the same time? Besides, if the internal organization was particular good at sorting out, documenting and redesigning its work practices it might not be considering outsourcing to begin with. Faced with a choice between certain pain and potential outsourcing supplier-driven “salvation”, many middle managers choose salvation, with hope and (unwarranted) expectation.

Partnership and Senior Management:Partnership is seductive for the

senior team as well. Senior leaders often think that outsourcing depends on the strength and fit of the “senior relationship”. As senior executives interact with the outsourcer’s senior team (through frequent meetings, rounds of golf, or shared “C” level camaraderie), senior leaders start to imagine that close relationship bonds with the outsourcer will really make a difference in operation. That point of view is not entirely wrong -- but it leads senior executives to (mistakenly) put too much confidence in their “partner’s” willingness “to make things right” as long as customer executives “reach out to them” when needed.

This “presumption of senior partnership” typically lasts until the first big operational or financial “blowup”in the relationship. The actual, lower-level spirit of partnership actually starts to erode quite early in the implementation process as the supplier misses deadlines, back-tracks on what the customer presumed to be promises, etc. -- but the “senior relationship” typically hangs on until the competing economic and operational interests of the two different entities decisively collide: perhaps over the first (unexpected) price increase, or a period of sustained service shortfalls, or an unforeseen operational crisis.

This senior “schism” often comes as a shock and a precipitates crises of trust in the customer-outsourcer relationship. Seen in this light, a conflict becomes more than just the exploitation of a contractual ambiguity or a legitimate claim stemming from another party’s corporate self-interest. Instead, it is a personal affront -- a betrayal -- leading to intense “buyer’s remorse” and internal and external recrimination. Therefore, in these situations, it is not surprising that many’s companies’ initial outsourcing relationship end spectacularly badly (e.g. with early terminations, substantial legal and termination fees, refusals to conduct further business together, etc.), much like a messy divorce, full of “bad blood” and lasting antipathies.

In the end, “partnership” is a nice goal, but it is incomplete foundation for a successful outsourcing relationship.

The Problem #5Believing in the Fallacy of Control

The myth of “partnership” is not the only false assumption haunting the outsourcing process. While virtually all good-sized companies are used to managing vendors and using outside parties to design and implement “special projects”, few first time outsourcing customers truly understand what it means to turn over operational control of an important, integrated part of their business to an outside third party.

Typically -- and tragically -- these companies assume that managing their outsourced provider will be like managing other more traditional suppliers -- or worse, they assume that managing their outsourcer will be like “managing themselves”.

Why does this disconnect occur? Why do companies systematically underestimate the complexity of managing an external third party? One reason for this underestimation is the fallacy of “control”.

In managing internal operations, companies typically operate with a “presumption of control”.

A few companies exhibit this control directly: they operate in a relatively military manner, with strict hierarchies and clear lines of command. When the boss says jump, the organization moves, or else unfortunate personnel consequences follow.

More often, the internal lines of command and control are vague, confused even. On a daily basis, it doesn’t seem that any one internal leader has much control over the interactions within or across departments. In these organizations, management operates in a sort of “feudal” world of limited control, independent fiefdoms, and behind-the-scenes bickering, resistance, and positioning. All claim “fealty” to the throne of the CEO, but in truth, power is not as absolute or automatic as some outsiders might presume.

However, even in these “lightly controlled” cultures, command and control exists when it needs to -- for example, during periods of crisis. During “normal” times, alignment across organizations can be weak; job definition and HR restrictions limit how staff can be deployed; and corporate “inertia” reigns. However, during a serious crisis, things change, and change rapidly: resources are moved across job and organizational boundaries, communication across functional heads increases, and “command and control” exerts itself until the situation stabilizes. Afterwards, perhaps after some personnel changes and a reorganization, a new status quo re-exerts itself.

This truism -- that when it really matters, the organization can summon its resources, change its practices, and make unprecedented economic commitments --does not apply to outsourcing arrangements. Why? Primarily because the outsourcing provider is a different, separate economic entity with its own business to run and management to satisfy. That is not to say that the





outsourcer won’t care if its customer has a serious problem -- they will and they will often exert significant energy on their customer’s behalf to help make things right. That is just good business and a sound long term marketing strategy.

However, there are very clear limits to how far and how fast the outsourcer will go. Will they bankrupt themselves on your behalf ? Unlikely. Will they pull resources away from other accounts to stabilize your situation? Not necessarily. Will they insist on being paid additional to do so? Most likely, particularly if they can demonstrate that it is not solely “their” fault that the crisis happened in the first place. Which leads to the question, “Do you really want to be arguing over whose fault it is and how much the outsourcer should be paying to address the problem, while the fire is raging?”

Of course not. But the arms-length outsourcing relationship will experience turbulence and friction because of the customer company’s loss of control. The customer company doesn’t control the outsourcing supplier’s resources. It can’t unilaterally change the supplier’s work practice and compel activity regardless of financial implication. It can’t disregard the economic and other objectives of its outsourcer and its management team.

Although, traditional, internal methods of control won’t work (e.g. performance appraisals, staff appointments, budgeting decisions, etc.) -- other, non-traditional techniques can help: clear contract documents, thorough supplier monitoring and oversight, personal relationships and economic leverage, etc. However, this “switch” to a different set of control mechanisms often only becomes clear with hindsight. Understanding the the traditional “rules of the game” have changed is often the first brutal “lesson learned” from the outsourcing experience.

The Problem #6Accommodating Outside Interests

As if all of this were not enough, there is a substantial amount of “good-

intentioned” regulation and outside perspective that must be incorporated into many outsourcing arrangements that makes operational success and effective control even more difficult.

For example, outsourcing is often subject to strict regulatory guidelines for managing, monitoring, and reporting on the performance of third party outsourcing suppliers. Regulations associated with federal laws (such as reporting and privacy provisions in Sarbanes-Oxley, HIPPA, Gramm-Leach-Bliley, the Foreign Corrupt Practices Act, etc.), state and federal regulatory agencies (e.g. insurance commissioners, bank regulators, States Attorneys General, etc.) and industry-standard best practices (e.g. independent auditor guidelines, industry security protocols, etc.) introduce contractual, performance, monitoring, and reporting requirements that must be accounted for in the outsourcing relationship.

And since outsourced operations are not part of an internal operation, customer companies need to build additional structures and invest in specialized resources to implement, track, improve, and ensure supplier compliance with these external requirements. Often, customer companies would have to do some of the same activities even if they had kept the operations internal -- but with outsourcing, they can’t get away easily by making it “yet another line management responsibility”.

As a result, in outsourcing, customer companies need to make “explicit” the assumptions, policies, and practices that they might otherwise handle implicitly elsewhere in their organization. Specifying what exactly those obligations might be takes expertise (see: find an experienced attorney) and getting commitment (from the outsourcer) takes lengthy and difficult negotiation at the start of the outsourcing relationship -- because neither the outsourcer or the customer want to be left “holding the bag” for certain high risk “guarantees” or

compulsory “yet-to-be-defined” obligations created by regulators at a later date. Working out who will own up to what, when, and for how much is virtually always a struggle in outsourcing -- and one worth fighting at the beginning of the process.

The Problem #7Realizing that a Complex World = Complex Contract

Not only is it practically more difficult to manage an outsourced third party supplier, it requires a lot more contractual and organizational “mechanism” to make the arrangement work than most first-time companies expect.

Why all this contract and administrative complexity? Partly because, as stated earlier, none of the customer companies’ traditional, internal command and control mechanisms apply to the outsourced provider. Customer companies have to create new mechanisms, specific to that relationship, from scratch.

For example, formal contractual reporting, governance, and conflict resolution processes become important. Staff turnover -- and staff selection and screening, training, and solicitation ground rules matter. Operational decision-making processes such as volume forecasting, capacity planning, and work scheduling need to become explicit because they are no longer controlled by the same financial organization.

Second, the contracts get complex because outcomes and service levels now must be explicit and detailed. In internal operations, if management doesn’t like the definition of work, or the metrics, or the goals of the operation -- they can change them. In outsourcing, it requires a negotiation -- and potentially more cost. Some of the same costs might have to have been absorbed by an internal organization as well, but with an outsourcer that cost is explicit -- and out-of-pocket, and therefore more shocking.





Third, unfamiliar concepts like “service level credits” (money back from the outsourcer when standards are not met) -- unheard of in internal operations -- take on new importance. “Dry” legal concepts like indemnity and liability and intellectual property protection suddenly take on much higher importance when external failure on one of these points can prompt massive internal losses or unwanted regulator intervention.

Fourth -- growth, decay, and termination concerns all must be explicitly covered in the contract before the outsourcing relationship even begins. Questions like:

• How does organic growth -- or growth by acquisition (or decline through divestiture) affect pricing and service?

• Can the customer company migrate the purchased services to an acquired entity without additional up-front cost? Can a divested operation continue to use the systems and processes for period of time after divestment?

• How does the acquisition of the customer company or the outsourcer affect the transaction?

• Does either entity have a say in the acquisition or divestiture process? What if a company’s major competitor acquires the outsourcing provider?

• What about intellectual property ownership? Is the technology the customer is about to use “free and clear” of claims from other organizations? Would the outsourcer stand behind that claim monetarily?

• How about the material the customer is providing to the outsourcer (e.g. work practices, information, data, systems, etc.) -- who will own them? Will they be protected? What if changes are made to them by the supplier during the relationship?

• What if customer has some “secret sauce” proprietary insight or

business practice -- how can the customer give the outsourcer access to it and still exclusively benefit from it if that information has to be embedded in outsourcer’s technology or operation?

• How does the customer end the relationship? -- (because at some point in the future it will have to end). What kind of transition assistance, leave-behind materials, and advance notification would the customer (or supplier) require? Will the outsourcer be required to support the customer during this time -- for how long and to what extent?

• What if the customer wants to terminate for cause -- on what grounds can they get out? What about the supplier?

• What if the customer wants to get out “for convenience”? Can they? At what cost? What about the supplier?

All of these questions are fundamental to the health and well-being of the outsourcing arrangement -- and all need to be explicitly discussed at the very beginning of the outsourcing process. The end result is a complex, long, and inter-related contract requiring substantial discussion, documentation, and attention to detail.

Yet business leaders at “new to outsourcing” entities routinely underestimate how important these “non price” deal terms are to the ultimate success of the outsourcing endeavor. For many first timers, the outsourcing contract’s length and depth appear to be “overkill”, or “boilerplate”, or “stuff ” that can be left to “the attorneys” at the end of the selection or transition process. Instead, “letter agreements” or “letters of intent” (or proffered supplier “paper”) seem like a much more expedient way to go the process. These “simplifying assumptions” are typically quite wrong and lead directly to outsourcing failure later in the outsourcing relationship.

The Problem #8Realizing that a Complex Contract = Complex Negotiation

Because the outsourcing contract itself is so complex -- and because negotiating that agreement is so inter-mixed with the selection decision, the design process, the implementation planning process, etc. -- a special deal negotiation process is required. This process requires:

• A clear understanding, up-front in the process, of the key deal terms (commercial, administrative, and legal) that will come “into contention” during the negotiations and beyond,

• A small, talented, and senior team to handle the high level negotiations as part of a larger solution design, supplier selection, and implementation project,

• Direct links into the economic modeling and selection process, so that “hidden” acquisition and operating costs can be discovered early (e.g. hidden future year licensing costs) ...

• ... And so that the selection decision can be made based on the attractiveness of the suppliers’ deal terms, along with traditional factors such as price, technological attractiveness, implementation confidence, and timing.

Slightly later in the selection process -- after progress has been made on the high level issues -- the high level deal teams needs to be married to lower level “content” negotiating team (subordinated to and running in parallel with the senior deal team). This “content” deal negotiating team works closely with the customer IT and operations teams doing planning and due diligence. This content team focuses on:

• Defining -- and building out -- the detailed “statements of work” and “service level agreements” that





would comprehensively and exhaustively define:

- What is to be done by the supplier (in terms of outcomes and key control points),

- Metrics and key performance indicators,

- Reporting requirements,- Key personnel requirements,

• Defining and documenting the detailed pricing schedules, covering:

- Initial (and out-year and event driven) pricing and life cycle costs,

- Productivity, currency, volume, input factor, and mix change assumptions,

- Optional (but pre-negotiated) charges for additional services ,

• Defining and documenting supporting contractual schedules covering details such as:

- Security provisions and protocols,

- Governance processes,- Employee transition, screening,

and training matters,- Relevant customer company

policies and procedures,- Disaster recovery plans and

procedures, - Dispute resolution.

Recognizing that outsourcing

negotiation is a whole new experience worthy of its own special process is, itself, often an expensive, post-outsourcing “lesson learned”.

The Problem #9Believing in the Myth of the Executive

Underestimating the complexity of the outsourcing “deal” often leads senior executives in customer companies to believe (wrongly) that outsourcing deals are (ultimately) “made at the top” of the organization. For these executives, outsourcing is like other “strategic” deals (such as mergers, acquisitions, large customer deals, strategic joint ventures), and, as a result, outsourcing will need the

senior most relevant executive to “push the deal over the finish line”. Key terms (usually perceived primarily in terms of pricing) will have to be settled in the final two minutes of the game, by the “big cheese”.

The outsourcing provider works hard to encourage this line of thinking. Suppliers crave access to to a customer’s key decision-makers. They want to be reaching “agreements in principle” with a company’s leadership. Working with the senior team ensures that the process will get done relatively quickly (which typically is high on the agendas of both suppliers and customers). Working at the top also ensures that complicating detail (from the legal and procurement departments, from working-level due diligence teams, from un-consulted internal stakeholders) will be avoided, and it effectively blocks the senior executive “into a negotiating corner” (i.e. it becomes extremely difficult for the “senior-most” executive to plausibly claim that he / she has limited negotiating authority, or to appear confused or indecisive, or to reconsider a previously conceded point).

Besides, involving non-senior executive deal players (specialist negotiators, attorneys, the procurement leaders) seems too unwieldy for most senior executives leading the outsourcing selection-negotiation process. It’s an understandable mistake: outsourcing projects are often “confidential” and more people “in the know”, the more potential “leak paths” a project has to manage. Besides, and it can be more difficult to align multiple players on a common negotiating approach than on just relying on oneself.

What such executives often fail to appreciate is that “leaks” are probably less likely to come from a professional deal team than from working level personnel in other functional areas or in the senior management team itself, that experience and expertise really do matter (especially when going up against a supplier deal team that does scores of

these types of engagements every year), and that other (potentially more objective) perspectives and measured amounts of “push back” might just be essential to developing an effective negotiating understanding and approach.

Realizing that the best negotiating team may not be the senior executive -- or even slightly less senior executives more directly tied to the program -- is often a hard lesson for even experienced customer companies to come by.

The Problem #10Getting “Incinerated” on the “Burning Platform”

Consultants and internal change agents often wax lyrically about “creating a burning platform” in order to create the “urge” to change in a slow moving, inertial organization. Setting high targets, short time lines, and a “high stakes” environment can “bring out the best” in an organization and encourage it to “think and do the impossible”. As many experienced outsourcing customers will tell you, “urgency” and “focus” and “change management” all help make an outsourcing project a success.

The key is to not overdo it. Outsourcing is big; it is complex; it requires multiple, simultaneous streams of work; it takes time (often measured in months, not weeks). Intentionally rushing the process to create “urgency” will more likely create “gaps” and “mistakes” a company will repent at leisure later during implementation or live operations.

What’s worse is that many first time customer companies create their own “inferno” without even realizing it. They wait until the fourth quarter to start a process they need live on January 1st. They spend months on internal debates discussing whether to outsource, and they don’t use that time to run a parallel process and talk with potential supplier candidates (which would allow them to refine their data and make progress in the event that they decide, after all, to go forward with the project). Furthermore,





they lose credibility and leverage with their potential suppliers by seamlessly passing on all the “day-to-day” decision-making “trauma” their internal organization is going through (e.g. the “the project is on ... no, it’s on hold ... no it’s dead ... no, it’s back on,” conversation common to many organizations).

When real customer or internal deadlines force an organization to speed up the process, or cut corners, or resort to interim expedients -- that’s one thing (and usually not a good one). Choosing to do it that way is a prescription for disaster.

The Problem #11Marrying Your “One and Only”

A final temptation for companies considering outsourcing is “target lock” on one potential solution or supplier. The customer company, worried about the length of time required to understand, spec out, and negotiate a deal, hopes that by “concentrating on a ‘lead’ candidate”, the process will move forward more quickly and with a fewer disruptions to its current, on-going internal operations.

Of course, “single-threaded” due diligence, implementation planning, and contract negotiation almost always result in the customer company “marrying” its “lead candidate”. What could have (and should have) been a competition becomes a coronation. Negotiations go on (and on and on) because the details still need to be worked out (and because the mid level customer team resources are reluctant to accept the unfavorable contract and performance guarantees being offered at that stage by the “anointed” outsourcer). By “single-threading” (i.e. single sourcing) negotiating leverage is gone; the deal is already essentially “done” (on the supplier’s terms), and the internal implementation and contract teams are merely trying to make the best out of a bad situation.

What seemed like a good idea at the start of the process: focusing scarce

internal resources on the most likely preferred candidate -- becomes a “trap” -- i.e. too much time and investment spent on one alternative to realistically change course after a few intense weeks of interaction.

Could this situation have been avoided? Certainly -- by keeping the selection and negotiating environment competitive for as long as possible.

But for how long? Long. Longer than you might

think possible. Through the up-front sourcing exercise. Through term sheet negotiation. Through detailed due diligence and implementation planning. In an ideal state, a customer company would have two fully negotiated contracts, implementation plans, and economic proposals from two equally qualified suppliers to choose from on the final “make a decision” date.

Is this ideal realistic? Yes -- it is perfectly realistic and it

has been done many times by companies well-versed in running outsourcing processes.

Is it expensive in terms of internal resources? Not necessarily. Much of the

activity of the negotiation team can be leveraged from one supplier to another: determining and communicating the key deal terms, specifying (in detail) the service and service expectations (and other schedules) required, reiterating the customer company’s expectations, etc. During negotiation there is a lot of reusable content and activity. The actual face-to-face conversation and process for “getting to ‘yes’” would be different for each supplier, but that is actually a small portion of the overall negotiating effort.

A similar amount of “commonality” is true for the business, technology, and implementation teams as well. Understanding and communicating the conditions of the internal environment (e.g. data maps, system linkages, internal requirements, customization

requirements, etc.) is largely supplier “indifferent” and has to occur regardless of how many suppliers are involved. Plus “going through the exercise” of mapping “how” each supplier solution would work in the customer company’s environment raises new insights and questions that can be applied to actually improve the due diligence and planning process (e.g. “if supplier A solution does this, what about supplier B?”).

Furthermore, working with “more than one” does not necessarily imply that the customer team works “equivalently” with each supplier. Perhaps there is a dominant, preferred supplier or solution. If so, then the customer company can send 60% (or even 80%) of its scarce time and energy with the “most preferred” supplier without entirely abandoning the alternatives.

As a result, “multi-threading” across multiple suppliers is not as complex or expensive as it may seem.

Is it worth the effort? Yes, the benefits of competitive

negotiation and discovery are substantial. In my experience, nothing makes the entire negotiating and planning process faster (and better) than competition between more than one viable alternative. Suppliers feel the pressure to dedicate their best resources and planning efforts to the project. Suppliers also feel the pressure to negotiate on otherwise “off-limits” terms and pricing. Buyers become more knowledgable and educated about their own business, the business of its potential suppliers, and the industry as a whole.

In fact, when it comes to outsourcing, “conventional wisdom” gets turned on its head. If a customer company wants a good deal, fast, don’t focus on a preferred supplier. Instead, compete it openly and for as long as possible into the decision-planning process.





Key Take-AwaysNegotiating for Success

So, what does it take to successfully negotiate outsourcing arrangements?

1.Plan for a Front-Loaded, Multi-Stage, Methodical Process

The ultimate success of an outsourcing effort depends on clarifying expectations, understanding a range of competing offers, and negotiating understandings at the very beginning of the outsourcing process. Expect a heavy work load at the “front end” -- in fact, the more that is done early, the better the overall outcome. Also expect a relatively lengthy series of follow-on phases leading through exhaustive due-diligence, negotiations, and planning. Give yourself enough resources, runway, and endurance to succeed.

2. Run “Just About Everything” In Parallel

Given that so much has to be done at once and throughout the process, be prepared to run multiple work streams simultaneously: a selection process, a program management process, a senior deal negotiation process, a subordinate detailed contract negotiation process, implementation planning process, etc.

3. Get Appropriate Negotiating Support

Don’t rely solely on internal resources. Get qualified, independent advisors -- they will save you money in the end. Shield your senior team (as much as possible) from direct supplier negotiation involvement.

4. Focus on Getting Agreement to the Full Set of Key Deal Terms Early

The outsourcing “deal” is more than price. It includes hidden contractual costs and explicit performance guarantees. It includes legal terms like intellectual property protection, liability, and indemnity. It includes terms affecting business flexibility such as term and termination and transition rights.

Waiting until the end to discuss these topics is too late. Negotiate the full set of key deal terms early.

5. Make the Deal Part of the Down-Select Process

Realize that the selection decision for an outsourcing provider is a complex decision. It involves understanding and trading-off a variety of very important factors: a technology / capability choice, a commercial (pricing and terms and conditions choice), a implementation (confidence and timing) choice, etc. Make sure that you have answers to the full set of key deal terms before finalizing a selection (or even a preference).

6. Keep More Than One Supplier Through the Post Proposal Planning Phase

Competition among outsourcing suppliers is the very best way to get a good deal, fast. Single sourcing and single-threaded negotiations are a false hope -- they actually lead to longer and more difficult negotiations than strictly necessary. Keep more than one supplier engaged for as long as possible -- even to the very end. It is more “affordable” than you realize.

7. Start Work (if you must) But Don’t Commit Until You “Have a (Complete) Deal

Many times, the timing pressures of a project (or the length of the planning and implementation process) require “work” to start with one (or more) companies prior to the conclusion of contract negotiations or the detailed design process. In such situations, proceed -- but don’t “throw in the towel” and agree to the supplier demands or otherwise cut-short the negotiation process. Simply “authorize” (limited) activity (e.g. the fielding of a supplier integration team) for a limited time period using an interim contracting mechanism. Such an agreement can allow work to proceed while you continue to negotiate the major issues. If you are forced to pursue this path, make sure you

continue to aggressively work the “main issues” and be prepared to “walk-away” (and perhaps pay out of pocket for) the work that was done during the “exercise”. Better to run the risk of added planning cost (which typically can be avoided or refunded if your successfully reach a final deal), than take on the “hidden costs” inherent in a poorly constructed or negotiated long term contract.

How to Get StartedAssisted “Blocking and Tackling”

The solutions I have noted may sound like “common sense”, and, in fact, they are. They are what I call “blocking and tackling” - but as you may recognize, such common sense practices can be exceedingly rare in nature. So, outside support may be warranted. I call it “assisted blocking and tackling”.

Timber Lane Advisors offers a range of services that can be sequenced or combined in any number of ways to help you overcome the internal obstacles to Strategic Sourcing success:

• Strategic Planning Seminar: work closely with your procurement and business leaders to facilitate a session to develop a more coherent understanding of the issues and plan of attack.

• Strategy Development: conduct in-depth interviews, industry research, and analyses to develop well-grounded alternative approaches to current in-house thinking.

• On-Going Sounding Board / Challenger Service: interact regularly with key leaders to find blind spots, ask tough probing questions, and make adjustments for successful implementation.

• Implementation Activities: conduct change or improvement actions; run sourcing, supplier due diligence, or contract negotiations; or help you build and develop an organization’s capabilities.





• Executive Coaching: work with your key leaders and their teams to develop their capabilities.

In you are interested in our services or would like a follow-up conversation, contact me at your convenience,

Martin J. SalvaTimber Lane Advisors1-877-355-1483






BUSINESS AREAS AMENDABLE TO OUTSOURCING

• Core (and ancillary) IT transaction systems,

• IT architecture planning, infrastructure management, and hardware and user support,

• Software development, maintenance, and testing,

• Advertising, trade show, and media management,

• Direct marketing production and distribution,

• Marketing material production and distribution,

• Sales and customer management software and skills training,

• Call center and other customer forms of contact management,

• Order processing and fulfillment,

• Production, mailing, and management of statements, proxies, reports, and customer billings,

• Specialized operations (e.g. credit risk analysis, underwriting, actuarial services, fraud detection,

claims management, security screening, collections & recoveries),

• Back-office support (e.g. accounting, invoice management, project management, business

analysis, HR benefits and payroll and retirement administration, staff recruiting and training,

food service, contingent labor acquisition and management, and lease and facilities

management).




Information Technology Deals

• Outsourcing core software-as-a-service applications (banking, credit card, e-commerce, HR administration, payroll, retirement services, benefits, business functional software, claims administration)

• Outsourcing of data center, disaster recovery, and infrastructure support teams

• Outsourcing of in-house and industry standard software application, development, and maintenance (AD&M) activity

• Negotiation of telecom services and pricing (voice, data, cell)

• Acquisition of standard and customized software packages (licensing, maintenance, implementation)

• Acquisition of hardware (storage, main frames, servers, desktops) and associated re-seller implementation agreements

Operations and Back-Office Outsourcing

• Call center operations (inbound, outbound, collections, recoveries)

• Printing (direct mail, statements & billings, financial reporting, marketing)

• Back office operations (claims, transaction processing, imaging, records, mail)

• Legal (firm selection, litigation management, transaction services)

• Outside labor resources (consulting, staff augmentation, temporary staffing)

• Corporate expense (in-house aviation, travel, fleet management, security, facilities and leasing management, food service)

Internal Operations Improvement / Large Scale Change Programs

• Large scale (e.g. 20%) internal cost reduction programs addressing inherent and structural costs, systemic / process drivers, and tactical execution and staffing

• Lean manufacturing, Kaizen, and other forms of quality control, process engineering, and continuous improvement

• Sales & Operations Planning facilitation

• System design and roll-out planning and implementation

• Sales force and service operations design, roll-out, training

• Product and process design (reuse, modularity, options packaging)

Procurement and Supply Chain Management

• Make / Buy and Supply Base Strategy

• Strategic sourcing

• Requirements definition / requirements enhancement

• Deal negotiation and contracting

• Supplier management and compliance monitoring

• On-going cost reduction discipline (3-5% annual cost reductions year over year)

• Procure-to-Pay system selection, roll-out, and management

MARTIN J. SALVA

Martin J. Salva is the Managing Director of Timber Lane Advisors, LLC. With over twenty years relevant strategy, procurement, and operations management experience, Martin is a former management consultant and Chief Procurement Officer. Martin’s current practice specializes in procurement strategy, outsourcing, and change management.

WORK EXPERIENCEVP and Chief Procurement Officer CUNA Mutual Insurance

VP Contracting and SourcingCapital One

Principal with Booz & Co.

Procurement, the Ford Motor Co.

EDUCATION

MBA and Masters in Operations from J.L. Kellogg School of Business and McCormick School of Engineering at Northwestern University

Undergraduate engineering degree from Harvard College

Two Years U.S. Military Academy, West Point

Portfolio of Experience

TIMBER LANE ADVISORS P: (877) 355-1483



Documents

TIMBER LANE ADVISORS P: (877) 355-1483 Discussion Topictimberlaneadvisors.com/files/133105845.pdf · and replicating home-grown systems and internal capabilities is just too great