Sometimes the financial analysis of outsourcing activities is stretched too far, forgetting that any outsourcing supplier in the end needs to deliver services: a case of over-negotiation.
Any failure in delivering the agreed level of service will impact directly on the public perception of your own company, maybe affecting your business.
“Beauty contests” between outsourcing suppliers, where customers ask them to underbid each other are dangerous if the customer lacks the required in-house knowledge of the activities they are trying to outsource.
Usually, the outsourcing supplier that “bites the bullet” either is planning to gain in the long term, or quite simply lacks the knowledge to understand the real costs of the outsourcing contract.
If your outsourcing supplier lacks the resources required to understand the evolution of your business and proactively support your business, probably either you or your supplier will use third party resources to fill a temporary (?) void- usually with unpredictable impact on quality.
A contract is the typical “framing device”- but is having a contract enough?
Financial penalties are not going to recover any business lost due to the failure of an outsourcing supplier that is unable to deliver the service agreed.
Contract definition is usually quite complex, but if the “technical” annexes are properly detailed, this is usually a good sign that one of the following three events is happening:
- “the good”
- both you and your supplier understand the requirements, and the contract allows to deliver the services you need now, while covering also the management of possible evolutions; yes, this is a “win-win”
- “the ugly”
- your supplier understands the contract better than you do; probably, you will end up paying more than you expected- also to obtain the services that you assumed to be included
- “the bad”
- you understand the contract, while the supplier does not; if you are lucky, the net result is that your supplier will deliver services at below the market price; if you are not so lucky, this will have an impact on the long-term viability of the contract and probably a negative impact on the relationship with other outsourcing suppliers, as well as maybe affecting your business.
If a contract is no protection, another device that is becoming more and more widespread is, of course, an insurance policy. But what do you get from insurance?
An insurance policy is built around an assessment of the risk to determine the premium to pay the insurer, so that if any of the negative events covered happen, the insurer pays the agreed amount.
With this (limited) definition, it is quite clear our approach: if a set of penalties embedded in a contract is no safeguard, while should insurance be any different?
The issue is not one of reality, but of perception: unless an insurance company invests in some companies that are able to actually “supply” the services the insurer covers, the business risk is not reduced.
As usual, insurance providers spread across the system the financial risk linked to the policy using re-insurance.
Therefore, while obviously contracts and insurance policies could reduce the financial burden due to the failure of the outsourcing supplier to deliver the service agreed to, we suggest focusing your negotiation on the actual definition of the SLAs.
Reason? If you halt your business due to a continued failure from your outsourcing supplier, no matter how much you are paid by the insurance company- your business is gone.