Contracts

1
Contracts
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Overview

• There are four sections to consider in an
  Outsourcing contract
• Scope of services
• Performance standards (service-level agreements)
• Pricing schedules
• Terms and conditions

3
Scope of services

• negotiated using the RFP
• What services will the provider perform?
• Are there particular processes that are critical
  to the provider's performance?
• What activities and decision rights will be
  retained by the organization?
• What about the deliverables?
• differences to be addressed, negotiated, and
  accepted

4
Performance Standards

• the contract should specify a standard for each
  significant activity that is being performed
• the performance of activity should be measured
  against standard
• provider should regularly report its measures and
  be subject to audit
• Remedies if the provider fails to deliver on its
  promised performance

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Performance contd

• consistent failure, the option of early
  termination
• if the failure is inconsistent but still
  damaging? realistically termination is only an
  option of last resort
• For this reason, many agreements contain
  liquidated damages, which should be negotiated.

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Performance contd

• provider may try to negotiate performance
  incentives to receive a bonus for exceeding
  certain performance standards
• real test is whether the provider really adds any
  value (lower costs, increased revenue, greater
  customer satisfaction)
• some suggest no bonuses be paid during any period
  in which there are service-level failures

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Pricing Schedules

• Price is negotiable. Cut the best deal
• Set the framework for
• Volume changes
• Scope of service changes
• Institutional changes
• Environmental changes (closing locations)
• Structural changes
• Handling changes in key pricing terms such as
• Cost of living adjustments
• Foreign currency translation
• Obtain services from third parties

8
Pricing

• Pricing algorithm should be simple
• agree to a unit based or similar algorithm that
  automatically adjusts for volume changes
• The provider will look for opportunities to
  increase scope and fees

9
Terms and Conditions

• Factors of production
• Get specific about who and what are going or
  staying. Make specific lists about what is going
  to the provider
• People
• Facilities
• Equipment
• Software
• Third party contracts
• People may involve severance packages.
• Relocation cost who will pay? Cost of
  transferring leases etc?

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Terms and Conditions

• Management and Control
• Address decision rights over flowing areas
• Factors of production (resources to be deployed)
• Processes (how work will be performed)
• Management (how operating decisions will be made
  and by whom)
• Strategy (how long-term direction will be set and
  by whom)

11
Terms and Conditions

• As the scope-setting and negotiating are being
  performed, think about the decisions that will be
  required.
• Now is the time to negotiate who makes those
  decisions - the organization or the provider.
• Generally the provider will control the factors
  of production, processes, and most of management
  decisions.
• The organization will have oversight over these
  decisions and will control or share control over
  the remaining management and strategic decisions.
  But what does oversight mean?

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Terms and Conditions

• The organization, for example, may want to have
  final approval over
• The provider's account manager and key direct
  reports
• Any voluntary movement of personnel to other
  contracts
• Any significant changes in technology (that might
  too tightly lock the organization to the
  provider, for example)
• Any changes in the outputs (for example, report
  formats and frequency)
• Any changes in the processes (that could harm
  related organization processes, for example)

13
Terms and Conditions

• Billing and Payment Terms
• Will there be any discount for early payments?
• Will the payments be monthly?
• What will the penalty be for late payment?
• In What currency will payments for foreign
  services be made?
• Will the organization be allowed to withhold
  payment for unsatisfactory service?
• If there are disputes, can the organization
  withhold payments?

14
Terms and Conditions

• Termination Provisions
• Outsourcing agreements typically provide for
  termination
• At contract expiration
• For cause
• For convenience
• Upon change in control
• Termination for cause based on breach of terms.
  Should be viewed as last resort.

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Project Management

• Risk assessment
• Risks to project, managing, transition, provider
• Senior management acceptance and support
• Opposing forces
• Employee announcements
• Tell employees before word leaks out
• Choosing project leader
• Choosing project team

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Setting Objectives

• Organizational objectives
• Problems to be solved?
• Other options?
• Outsourcing targets
• Why were they chosen?
• Activities of targets level of performance
• Outsourcing Initial plan objectives
• Set obj for resource, management, project issues
• Criteria to evaluate outsourcing success
• Measure criteria timing, on budget, meet
  objectives

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Existing and projected Costs

• Measure existing costs
• Necessary to know where we are, and whether
  outsourcing makes financial sense
• Cost by element salaries, benefits etc
• Activity-based costing
• Identify all activities
• Group activities
• Determine activity drivers consumption of
  resources
• Use above to trace costs of activities
• Produce list of costs of each activity activity
  cost pool

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Performance standards

• Measuring current performance levels
• Productivity, quality, timeliness, outputs,
  finance
• Desired level of performance
• Risk analysis
• May be avoided, retained, reduced, transferred
• Risks if make no changes, outsource, successful
  or not
• Setting priorities selling to 3rd party, joint
  venture, unit as an independent venture
• Contribution value
• Check each unit low performing-high cost

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Selecting Service providers

• Identify providers
• Check others in industry who outsourced
• Industry association directories
• Web pages
• Provider qualifications
• Ability to deliver, experience, performance, etc
• Evaluation criteria
• Assign weights, make judgments
• Decision time

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Negotiations

• Principled negotiating
• Separate people from the problem
• Focus on interests, not positions
• Generate various possibilities before choosing
• Insist on result based on objective standard
• Preparing for negotiations
• Team prepared to negotiate, strategy planned
• Provider sales process completed, ground rules
  set
• Negotiation levels
• High-level issues, term sheet, detailed issues -
  contract
• Face-to-face negotiations
• Be yourself, fair play, could take weeks
• Principles of fairness
• Deserve needed service, provider deserves fair
  price, you deserve fair market value for assets,
  plan to correct mistakes in contract, both must
  see win-win

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From Outsourcing to Business Processing
Outsourcing

• Functional process outsourcing
• Business processes end at customer many internal
  processes to support company staff (acct, IT,
  etc)
• BPO is a Process centric approach better than
  dept outsource
• New skills/software become available
• All the work of internal process is outsourced
• Breaking down Barriers
• For BPO to work, silos need to operate as one
• Need shared services to consolidate activities
• Transaction, technology, E-sourcing
• Transaction-intensive processes at center of BPO
• Location of IT and staff can be separate
• Confluence of Internet, software apps,
  process-centric thinking
• Speed, scalability, accessibility

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Outsourcing to BPO

• Scaling and integrating supply chains
• From 1000s to 100s suppliers
• Better pricing save 5-15
• BPO often includes supply chain consolidation
• Hospital - 4 sites food purchase 4 million
• Morrison (mgmt spec) 600 clients, food purchase
  350 million

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Offshore Dimension

• Parts of operations sent off-shore
• Global markets global sourcing
• PG found rates, competition, work ethic produced
  cost advantage
• Centralized purchasing advantage 1 yr saved 28
  mill
• Offshoring value model
• Opportunity to change net cost and capabilities
• 4 sourcing strategies strategic, commodity,
  value, beachhead
• Strategic, positive net cost and net capabilities
• Commodity, only positive net costs
• Value absorb higher costs to gain capabilities
• Beachhead only interest in establishing
  presence

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Offshore Dimension

• Finding value
• Each activity has different opportunity map
• India top for IT
• Putting jobs in perspective
• Great attention to offshoring
• Short term gain or improving business
  performance?
• Companies allocating offshore savings to
  retraining etc for affected employees
• Manufacturing jobs left US, replaced by services
  industries
• RD spending increased
• Doom and gloom not supported by facts

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Developing Global Strategy

• Effective outsourcing is integrated into overall
  business strategy
• Move from reactive tool to weaving outsourcing
  into fabric of decision making and operations
• 3 ways
• Top down
• Bottom up
• Integration

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Top Down

• Instead of outsourcing as an outcome, strategic
  outsourcing drives decisions in 7 steps
• Segment the market
• Project changes in segments over plan period
• Assess each segment size and growth
• Decide which segments to pursue/dominate
• Source Map required competitive advantages, and
  each will be created internal or outsourced
• Forecast business outcomes (revenue, costs,
  profit)
• Invest capital, operating funds, people

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Bottom-Up

• Zero-based approach to select activities not a
  competitive advantage
• If starting from scratch today, would we build
  the capability inside?
• Are we so good at it that others would hire us to
  do it for them?
• Is this an area from which our future leaders
  will come?
• Top down examines contribution to competitive
  advantage, bottom-up separates activities done
  from habit, not need

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Integration

• Additional competitive advantage through
  integration of internal and provider staff
• Implement specific management programs to capture
  and leverage power of integration to add benefit

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Optimizing Outsourcing Opportunities

• Riding wave
• 2004 6 trillion on outsourcing
• Go where most outsourcing activity, and robust
  providers
• Manufacturers outsource 70 product content
• 75 outsource basic facility services cleaning
  food
• Mature providers
• Seeing opportunities in process terms
• Redefine in end-to-end terms, evaluate total
  opportunity
• Gives firm understanding of delivering value to
  customer
• Prioritizing the best
• After areas have been scoped, need to prioritize
• Develop score sheet to evaluate, rank
  opportunities 3 factors
• Size of opportunity, assessment of suppliers,
  assess benefits
• Gauging, overcoming risk 4 classes
• Strategic, Operational, Result, Transactional
• Outsourcing Customer interface

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Building the Business Case

• Capturing current cost
• Diagram process across org. verify relationship,
  cost at each stage
• Full costs important in outsourcing
• Must make projections of costs and volumes
• Planning costs, Transition costs, Oversight costs
• Forecasting benefits
• Comparison of as-is option against outsourcing
• Cost saving NOT major reason speed, flexibility,
  quality, skills, capital savings, innovation
  important parts of value equation