We generate options for Clients
Outsourcing deal structuring, value creation, contract negotiations, strategy & management
Home Page l FAQ
Is the scope of activities the same during the contract term?
Unless specifically provided in the contract, the scope remains constant. Generally scope reductions may result in price increases (at least at the unit level), depending on the pricing model under consideration.
Can the scope of an outsourcing contract be flexible?
The most often found reason for problem outsourcing arrangements is ill defined scope. Imprecise scope definition attracts Service, Price and Risk problems that soon need revision, repair and renegotiation.
How can the internal scope and cost of services be calculated to ensure that the scope of outsourcing is well defined?
This is one of the most critical part of structuring an outsourcing arrangement. Scope drives Service, Price and Risk. Since scope is defined based on activities, functions and processes, it will not neatly follow the General ledger of most companies but will likely cross department and cost centre lines. A good way to arrive at the internal cost is to conduct a high level Activity Based Cost analysis. The results should be projected for the term of the outsourcing arrangement under consideration (e.g.: 5 years). The advantage of this approach is that it can be easier translated into activities, functions, processes and people that may be affected by the outsourcing arrangement.
We need the vendor to conduct some activities that were not in scope when the agreement was signed. Most of these activities were not known at the time, others became necessary as a result of the fact that we are a regulated industry. Given the in-scope equipment and processes, no other vendor can do the work. Is there a way to avoid the significant overpayments and delays we experience?
This is one of the most asked questions, and a difficult situation. In addition, the situation is well known to vendors and advisors. As your question indicates, if the activities were known when the deal was done, it would have been in the price bid, and subject to market discipline, since other vendors would have bid on it. What we recommend to clients, to cover for this risk, is adding to the deal that: "when the vendor is the only company that can do work necessary for the buyer, then: (a) the vendor cannot refuse to do it; (b) the price is cost plus a prescribed profit margin; and (c) the vendor will make all reasonable efforts to deliver commercial quality in acceptable time." Since the deal is done, we would suggest to note this down for the first renegotiation opportunity, or, if the relationship is good, to try to arrive at a compromise with the vendor.
Our outsourcing deal includes project oriented work. The amount of this work is substantial. If the acceptance test is not conducted by us (the buyer) in 60 days, the work result is DEEMED ACCEPTED . We have several cases where we paid for work, the results have not been properly tested by us, and the results are not acceptable, but since the are DEEMED ACCEPTED , we cannot do much about it. Can anything be done to avoid it?
The concept of DEEMED ACCEPTANCE is a bad (for the buyer) solution to a real vendor problem. The vendor cannot wait forever and spend money on resources, while waiting for the buyer to allocate resources and test the work result. Since this is project work, we suggest that you include in the next project request that: (a) at the end of the 60 days, if the acceptance test is not done, the buyer will make all efforts to complete it; (b) the vendor will reduce the allocated staff for the project to the minimum necessary; and (c) the vendor will be paid according to the reduced staff and resources for the delay caused by the buyer". . This will be a more fit business solution for the business problem, and not ever deem the work result that was not tested, as accepted.
Should the in-house cost (or budget) be disclosed to bidders as part of the RFP?
Practical experience supported by logic says YES . However, most buyers decide or prefer not to disclose in-house cost (or budget). The two most cited objections are that:(a) by disclosing the in-house cost bids will stay close to it rather than bid lower; and (b) the process to determine accurately the in-house cost is time consuming and expensive. We found both objections overcome by the benefits of accurate costs being part of the RFP.
Does the Outsourcing transaction increase the risk to the buyer of outsourced services?
Generally, outsourcing as an action reduces the overall risk inherent in performing the activities in scope. The rationale is that in the self-provision scenario, all risks are retained by the prospective buyer organization. A well balanced outsourcing arrangement ensures that (1) some of the risks are transferred to the vendor, and (2) the risks associated with the vendor performing according to the contract or not are transferred to the vendor.
Different Vendors, or consortia of vendors, represent different risk profiles. Can such risks be taken into account in evaluating the proposals?
To deal with this issue the recommended choice is to base the selection on Risk Adjusted Scores and Pricing. The Risk factors allocation should be done based on specific questions asked in the tendering process. While Outsourcing generally is a reduction of the risk taken by the buyer (by sharing it with the vendor), the past experience and approach of the vendor may introduce new risks.
Is there a straight forward method to conduct a risk adjusted price evaluation of submitted outsourcing bids?
If the objective is to compare the vendors, their submission and approach including the risks that each pose, the answer is yes. There are several methods to view and deal with risk. Most often companies create a list of risks and document the mitigation approach. We found this approach lacking. The risk assessment, factoring and adjustment should be done by the evaluation body. If the evaluation body is expanded to a larger group, such risk assessment can be done by using simple voting technology to collect it, and consensus building techniques (such as Delphi) to conclude. We prefer to quantify the risks and consider them in the price of a submission through the proper risk adjustment methodology. Quantification methods vary widely. Members of this site have access the Risk Adjusted Pricing Framework used by TAU Group.
Is there a way to assess quickly if a price submitted by a Vendor (Proponent) is reasonable, feasible or a "bait and switch"?
With a bit of analysis this can and should be done. The first look should be how far is the price from other bid price submissions. If it does not cluster closely to other submissions, more questions need to be asked or the tendering document (RFP) may have been misunderstood. To arrive at a more analytical approach one would use annual reports for public company vendors or industry numbers for private company vendors. Briefly the calculation is as follows: Start with the total average annual price submitted; Subtract the average net profit from reports (around 10%); Subtract the Sales and General Accounting cost from the reports (SG&A) - generally between 15% and 25%; Subtract 8% of the average annual price submitted for the average risk factors that vendors assign to each opportunity; Add 10% of the average annual price submitted if there is provable evidence that the vendors view this opportunity as a validation deal; Subtract 10% for the initial transition or transformation. If the resulting number is less than 50% of the average fully projected internal cost, the bid price is extremely aggressive and a full analysis should be conducted, preferably together with the Vendor (proponent).
Our deal requires the Vendor to monitor and manage equipment our company owns. These services are subject to the SLA. After recently replacing this equipment in question, the Vendor claims that they can no longer monitor and perform the services at the same levls and prices since that will require additional resources on the Vendor or equipment Supplier side. What is your advice?
The Vendor is obligated to monitor and manage the equipment in the contract as inspected during the Vendor due diligence as conducted and likely documented in the contract. When changes to the equipment are contemplated and executed during the term of the contract, the decision should be made with Vendor input and agreemnt. This ensures service level and price continuity. If Vendor agreemnt was obtained verbally in good faith, this should be documented. If not, this will likely need to be resolved by the two parties (Conflict Resolution). In addition, we suggest a review of the contract language dealing with Change Management and Scope Management.
Most prospective buyers of outsourcing servicies expect savings in the range of 20% compared to the internal costs. What are the sources of these potential savings?
The market has conditioned buyers and sellers to work with this rule of thumb. The 20% is not, in our experience, based on empirical data or analytical research. The savings compared to the internal provision or services always need a very complete and accurate analysis. Generally, the sources of potential savings are: procurement value (or "deal heat"), financial leverage of vendor assets, use of vendor excess capacity, true business model scalability and true economies of scale, labour arbitrage (geography and industry sector), and deep process expertise for the activities in scope
Prior to finalizing our outsourcing contract, the vendor will conduct a due diligence process. What are pro's and con's of such process? What should we do to be ready for the due due diligence process to be conducted by the vendor team?
The vendor due diligence process is important for both sides. Specifically, buyers want to ensure that the agreement is not signed with many "subject to due diligence" statements. The vendor needs to verify that the solution proposed will work for the price proposed. However, practical reality shows that vendors use the due diligence process as a fact finding mission to argue for price increases (more than the bid price). While the buyer should assist the vendor in good faith to have access and conduct the due diligence process, the buyer's team assigned to assist the vendor should be made fully aware of the potential pitfalls of the process. Memebers of this site have access to a sample of the content of such awareness training sessions.
This site mentions the creation and sharing of new value through outsourcing. We (us the buyer and the vendor) have an existing outsourcing deal, where the vendor profits appear inadequate and the measured savings are becoming too thin. What are some of the ways new value can be created and shared?
It is positive to see that the problem is recognized by both buyer and seller. While far from trivial, this is a resolvable problem, in particular since you seem in agreement. We suggest that you look at: Co-marketing; Collaboration in geographies or industry sectors; Sharing some of the savings achieved by the buyer as a direct result of vendor actions; and, Exchange of shares between the two companies. . It is important that any one of the suggested instruments of sharing be well developed, documented and go beyond simple marketing statement of intent. If they have no clear, measurable, documented, and signed economics they will not work.
What are the pro's and con's of outsourcing TRANSACTION PRICING versus conventional pricing?
This answer assumes that by "conventional" pricing the question refers to resources based pricing model. We observe that as Business Process Outsourcing (BPO) is taking hold, transaction based pricing models are preferred more often. If modeled and priced correctly transaction based pricing is preferable since it based on price units controlled by the end user of the buyer. If transactions in scope are not readily found commercially in the market place beyond one seller and one buyer this poses serious market discipline, comparability and benchmarking problems. We also suggest that the following aspects of the pricing model be given extreme attention: Minimum transaction volume guaranteed by the buyer; Tiered transaction pricing; Caps on transaction unit price increases; Early termination fees; Audit and verification rights for the transaction counts underlying data; Firm obligation to maintain up-to-date standards (if transactions are regulated).>>
Our outsourcing vendor requests that we pay in advance for the services provided. We believe this to be unusual. What is the prevalent practice in the market?
The request would be unusual if 100% of the services require little or no capital deployed by the vendor. The prevalent billing practice is to bill in advance for resources that are capital based (similar to paying rent in advance), and in arrears for services based on time and materials (similar to contract and consulting work).
Our outsourcing deal includes incentives for the vendor to reduce the overall cost to us (the buyer). How do we make sure the vendor will do that when reducing our costs means billing less?
The answer to your question is in the difference between SALES (i.e. billing) and PROFITS. The whole vendor incentive plan needs to ensure that the incentive offers more profit to the vendor when the sales are reduced (in particular as a direct result of vendor hard work!). As a buyer, you are at an advantage that your are paying with 10 cents on a dollar. We suggest that when crafting and negotiating this plan you ensure that the negotiator on the vendor side is compensated on the profitability of the deal, rather than the sales in the deal (as it is often the case with sales representatives).
What are advantages and disadvantages of conventional daily (or hourly) rates vs. blended daily rates for project oriented outsourced work?
Conventional daily (or hourly) rates give more control over the choice of resources to the buyer. However with this control the buyer retains the risk of what is the best mix of resources for the project. Conventional rates create a serious contradiction if the buyer wants to buy at fixed prices, or not to exceed pricing, or a prescribed quality. To balance risks, controls and have the onus on the vendor to optimize the project deliverables and cost, we recommend considering blended pricing, fixed or not-to-exceed project price, and a prescribed quality of the work result.
How can it be determined if the SLA in the contract or the RFP is adequate?
Such determination is possible based on experience with market based arrangements with similar scope. A more analytical approach is to review the SLA against the SLA Attributes on this site:
Is there a way to estimate what the total amount at risk (i.e., maximum SLA remedies) should be for the SLA?
Yes. Assuming the SLA framework is not punitive, the amount at risk should impact, even erode the profit, but not put the provider in a net loss position. The average profit of the provider can be estimated based on published annual reports (for public companies), or industry segment.
Our (the buyer) SLA has a few Metrics where there are some dependencies between work done us (the buyer) and work that needs to be done by the vendor. We have endless finger pointing disputes when it comes to applying remedies when such Metrics are not met. How do other buyers deal with this issue?
This is a common issue. The cause are both ill defined scope and circular SLA Metrics . The activities where such close dependencies are present should not be split between the buyer and the seller (i.e.: they should be fully transferred to the seller, or fully retained by the buyer). In addition, to the extent possible, the SLA Metrics should measure results of the vendor work. In all cases where the result is not in the range as a result of the buyer action or inaction, it would be, in our view, unfair to make the vendor pay a remedy. We suggest you take a look at both scope and SLA adjustments, with the first opportunity.
In our (vendor) SLA there are several Metrics that are not met in the case of certain incidents. As a result, we pay multiple escalating remedies for the same incident. Can this be addressed?
This appears to be a poorly constructed SLA Framework, as it checks multiple sequential steps in a process. A well constructed SLA Framework measures results not steps or effort. Most contracts have a process to change the SLA as mutually agreed. We suggest you approach the customer (the buyer) with such a change request.
What is the meaning of the "Outsourcing Paradox"?
Outsourcing is intended to introduce Market Discipline into internally provided (back-office) processes and activities. Yet, many outsourcing arrangements grant exclusive right to perform the services in scope for the duration of the term of the arrangement. This in effect cancels out both the intent and one of the key benefits of outsourcing.
Are there any general parameters or rules to assess the cost of contract or deal governance on the outsourcing buy side?
We consider three major categories as a guide: Location, Complexity, and Buy side profitability. Each case should be analysed in more detail, but we start with the following rebutaable propositions:
Location: Offshore deals between 10% and 12% of TCV ("Total Contract Vaalue"); Local (or Onshore) deals between 3% and 6% of TCV.
In addition, we note the rule established by TAU Group Inc. that: BUY-SIDE OUSOURCING CONTRACT GOVERNANCE IS INVERSE PROPORTIONAL TO SELL-SIDE DEAL PROFiTABILITY. In other words the slimer the Vendor profit margin (or even loss) the more expensive is to manage the vendor to deliver contracted services at the price and service levels prescribed.
Is outsourcing a fad, a management tool, or an economic necessity?
Ronald Coase established in 1937 the theoretical framework as the basis for outsourcing. Coase was awarded the Nobel prize for economics. He states that when the internal cost of processing a transaction exceeds the market price, the transaction will tend to be processed externally. We suggest that outsourcing is an economic necessity and that it affects mostly parts of the business not normally exposed to market discipline forces (IT, HR processes, Supply Chain processes, Accounting processes, e.t.c.).
What activities, functions or processes are most likely to be outsourced by companies?
As a logical consequence of Roland Coase's theorem (1937), the likely candidate will be parts of the company that are not normally exposed to market discipline forces. What is observed in the market place is that the functions more commonly outsourced are: IT, Call Centres, Supply Chain Management, Finance & Accounting, and HR - Processes. The debate continues where do Payroll and Accounts Payable fit. For a visual representation of this follow this link: CLICK TO SEE
The development of the Statement of Work for the contract is very time consuming. Is there a way to do this more efficiently and faster?
The sort answer is yes. If the deal construction is well planned at the time of the tender (RFP development), then the Requirements Section in the RFP should be written such that it becomes the Statement of Work (SOW). The same thing should apply to Services, Service Levels, and Statement of Fees.
Is buying services similar or different from buying goods, and if different, in what way?
Most will agree that there are differences, but the differences appear not well understood, even by procurement departments and professionals. There are in fact more differences than similarities. The differences include: Buying goods is a Balance Sheet transaction, buying services (especially outsourcing services) is a Profit & Loss transaction; the interaction with a vendor of outsourcing services is deeper, more critical and much more frequent; the terms of the agreement with the vendor are not even similar; the relationship with the vendor is completely different. In summary, the knowledge of buying goods (much more available in the market place) does not immediately translate into the needed expertise to buy and manage outsourcing services. The transition requires learning and new experiences.
A vendor made a calculation mistake at the contract negotiation table. The error is material and to our advantage. What is the best way to deal with this?
Assuming the outsourcing deal will last an average of 5 years or more, this error will become obvious and create perceived (and perhaps real) harm. We believe negotiations should build trust, even in an adversarial environment. We prefer and welcome opportunities to convey this to the other side and start the relationship on a solid foundation. We suggest that by pointing the error out to the vendor and engaging in a problem resolution mode, the vendor will most likely reciprocate with a concession when needed.
Vendor site visits seem to be a recommended part of a vendor evaluation process in procurement (RFP). Is there a way to be more precise when considering the vendor site visit results in the final vendor evaluation?
To achieve a more precise and comparable result of any site visits, site visits should be turned into site inspections. This entails having: prescribed forms, questionnaires, process and buyer team training. Instead of a site tour the process will ask the same questions, look for evidence that the answers are verifiable, and score the site visit (inspection) accordingly. This implies that the vendor site visit (inspection) will be allocated points in the overall evaluation score card. The same answer would apply to vendor references.
We have prepared an economic model of our outsourcing deal. Part of the model are payments to be made to the vendor in cases of termination for convenience or buyer's (our) breach. Should we provide in the model, in such termination cases, payments to the vendor of all or a part of the profit expected for the remaining duration of the deal?
For the purpose of answering this question we will assume this is a straight buy-sell outsourcing deal (i.e.: no shared economic interest). In both cases of Termination for convenience (of the buyer) and the breach by the buyer, there is a fairness argument that the vendor should receive all or a portion of the expected profits realized if the deal would go to full term. At the same time, the deal should be fair to both sides and economically balanced. By balanced we mean that there should not be situations where the vendor makes more money doing no work than doing the work; which will be case here (for early terminations). To be fair, if you decide to include in the economic model compensating the vendor for loss of expected profits, you should ensure that you (the buyer) get compensated for the same relative portion of your (the buyer's) savings in the case of breach by the vendor, termination for cause (service levels) or abandonment (by the vendor). Thus, the economic model is balanced for both sides.
The end of an outsourcing deal has many scenarios. Is there a comprehensive check-list to ensure that all scenarios are properly analysed in the deal economic model and documented in the deal?
The scope of services of each outsourcing deal determines specifically what will be required in the Termination provisions of the deal. In addition, the market does establish what vendors are geared to offer and the general expectations of most buyers. A full analysis requires that all cases be identified and rights and obligations checked for completeness. Site members have access to the TAU Group Termination Analysis Framework which we constantly update to reflect the market and reflect the specific scope of every deal and the most critical aspects of service provision.
Both Vendors and Beneficiaries (buyers) use the term "Partnership" describing the relationship. Is this appropriate?
In most cases the use of "partnership" to describe the relationship is NOT appropriate, but a widely preferred marketing language twist. If the deal under consideration is a straight buy-sell deal, the concept of Partnership simply does NOT apply. Vendors tend to use this to position the deal management, governance, and escalation as a relationship of equals. If the deal under consideration includes specific shared economic interest, at least for some of the deal, the term Partnership is appropriate.
Checking vendor references is a recommended part of a vendor evaluation process in procurement (RFP). Is there a way to quantify reference check results in the final vendor evaluation?
To quantify and compare the results of reference checks, they need to be driven by the buyer (less free form, more prescribed). This requires having prescribed: interview questionnaires, process and buyer team training. This implies that the results of the reference checks will be allocated points in the overall evaluation score card. The same answer should apply to vendor site visits.

©TAU GROUP INC. 1989 - 2010 All rights reserved.