BFM2013_2_10_Costing outsourcing

Most outsourcing contracts describe the cost of the service delivered by the supplier, but there is a limited assessment of the costs still left inside the customer organization.

Moreover, often contracts that compare outsourcing vs. internal costs do not analyse the history of the development of costs, but just the costs to be replaced.

Studying the history of the internal costs and their relationship with organizational structure and strategy could actually give a fair view not only of the “instantaneous” costs, but also of the speed, acceleration, and level of absorption across time.

If you build this “history”, represented by a simple chart, and then compare it with the models (usually, financial plans) offered by different suppliers, you can also focus the negotiation on specific differences to be inserted in the contract- and maybe also assess the compatibility between their corporate culture and your own (outsourcing is a marriage, not a date).

This inclusion is quite important, because when outsourcing the contract to an external company, the costing model they offer is representative of their eCI (embedded Corporate Identity), and any discrepancies that are not managed usually result in additional costs- on either side (who bears them is then a matter of negotiating power).

We are coming again to the same point: you need to understand where you are before you can outsource.

Properly managed outsourcing relationships could add value to your company, as the supplier could add a new perspective on ways and means to deliver services- and improve delivery.

Whenever outsourcing, you should insert clauses to retain inside your company the knowledge required to develop your own business.

If Knowledge Management is introduced after outsourcing then probably the most effective way is to involve your outsourcing suppliers in the process, so that they can help you in identifying the knowledge boundaries.

The clear definition of where the outsourced activities are linked to the knowledge distribution inside your own company allows moving from a quantitative approach to outsourcing to a qualitative one, but built on reality, not expectations.

Quantitative analysis is able to assess the outsourced activities vs. previously agreed measures of compliance with already known activities, but gives limited indications on the evolution.

Deriving from the quantitative measures new KPI (Key Performance Indicators) that can be used to monitor the evolution of the outsourced activities is a useful exercise.

Anyway, such KPI exercise requires full co-operation from both parties: you can “slip” that requirement into the outsourcing contract, but without the full and willing compliance and understanding of the outsourcing supplier, you will be better off by focusing on just the quantitative measures.

A more detailed description of this decision support approach will be contained in the next issue of BFM, focused on Business Continuity Governance .

Sometimes, this structured quantitative and qualitative approach is not feasible, e.g. for lack of resources.

A typical example is when a first outsourcing company obtains an outsourcing contract that is actually a facilities management activity.

This being the case, probably your own current outsourcing/facilities management supplier will be unwilling to sustain the additional costs required to “map” the current status, understanding that you are scouting for a new supplier.

Manage your communication properly to ensure a smooth transition, e.g. by allowing the current supplier to provide a proposal for the new service, but based only on information about existing services that they released and shared with you (and therefore potentially with other prospective suppliers).

Whenever involved with customers that have de facto lost control of their own knowledge, we suggest to identify knowledge boundaries, as described in Issue01 of BFM , and then start developing a roadmap to “get back in control” (which, sometimes, could imply a whole programme of activities, not necessarily all visible to the outsourcing company, and involving also some crisis management).

Eventually, either the external supplier will accept the new structured approach, or their degree of freedom will be so limited that their own unwillingness to cooperate will become the main reason to replace them with another supplier that is able to co-manage a proactive outsourcing.

Every business relationship could turn sour, and also strategic outsourcing does not protect you from a failing supplier or a change of business strategy that makes the existing arrangements untenable.

For critical activities, we always suggest customers to keep at least an internal “knowledge presidium” (a subject matter expert) to keep abreast of the knowledge transferred to external suppliers.

Ideally, as discussed in the next issue of BFM on Business Continuity Governance , each business should define the minimal level of service required to pass through a time of crisis or to fill the void left by a failing supplier.

Some companies include in their own contracts redundant facilities, to ensure disaster recovery, as well as “on demand” contracts to cope with short-term business needs that cannot be managed by either internal resources or the existing suppliers.

Beware of using “on demand” external suppliers that are called only when there is a crisis: the risk is that they will optimize their own resources allocation- and have just “sandbagging” staff available, while waiting for the real experts to be released elsewhere.

In the end, all the processes suggested can be simplified by properly managing the outsourcing selection process.

BFM2013_2_11_Outsourcing contracts

Assuming that your company really wants to outsource an activity to an external/internal supplier, you should first identify if this is a one-off event or could be the first step of a series of outsourcing contracts, with the same or a variety of suppliers.

If you insert outsourcing as an option inside any new business development or project activity, then outsourcing becomes another tool to build your own strategy, but you need to adopt a structured approach to simplify the assessment of both internal and external proposals.

The first step should be obtaining proposals from companies that are actually able to deliver the activities you require with a cost structure that is acceptable, now and for the length of the outsourcing relationship.

Also, you should carry out some market research to identify outsourcing suppliers that are able to understand your business.

Do not ask for detailed proposals immediately: the cost of assessing proposal coming from companies blatantly unable to deliver the service could be staggering.

From the first (internal and external) prospective outsourcing suppliers, a short-list of companies that could be invited to the next round should be derived, using a vendor evaluation process to quantify the compliance with your expectations.

The short-listed prospective suppliers should then be invited to supply the detailed proposal.

Currently there is a trend toward absorbing part of the costs for all the short-listed suppliers, as anyway the customer will receive a better understanding of its own activities.

Do not limit the assessment only to the documentation provided: short-listing is useful also to reduce the prospective suppliers to a limited number, so that you can visit their premises, check with some customers, and interview them to understand if their eCI (embedded Corporate Identity) is compatible with your eCI.

Also, we strongly suggest that you identify and define the profiles of the resources to be provided by the supplier, notably the person who will manage the relationship (as described in previous sections), to avoid suppliers that deliver their best people only in the pre-sales phase.

The actual definition of the contract is a somewhat more complex activity, and resources are available on the market to help structure the details.

Beside the structure and content of the contract, the other issue to consider is its duration.

A proper definition involves also a financial plan linked to the phasing-in plan, so that the supplier can structure the proposal according to the cash flows.

The effective duration of the first contract, and the plan for the contract extension, should be tailored for the specific business requirement; e.g. a 1-year ERP outsourcing contract is probably a loss-maker, while a 5-year contract could justify the investment required to understand the current status.

Try to link the contract duration to the investment plan: outsourcing a part of your infrastructure that requires a 20-year investment plan on a 3-year non-renewable basis is not exactly going to generate real interest in outsourcing suppliers that know how to manage their business…

Finally, did you think about the consequences of what you included within the contract?

While a legal writ spanning hundreds of pages would be formally water-tight, it would require months just to be understood, and probably the actual resources involved on both sides to manage the contract would not understand all the details- and use informal agreements.

BFM2013_2_12_Managing outsourcing

By outsourcing activities you do not remove the need to manage their results and their integration with other activities that have not been outsourced, or that have been outsourced to other (internal or external) suppliers.

Outsourcing contracts should contain also the management structure to be used not only to authorize any changes, but also to manage the day-by-day activities; while the execution can be outsourced, the responsibility cannot be transferred.

In our experience, meetings with a fixed schedule, e.g. weekly or monthly, should be used only at the beginning of the contract, as after some time meetings would become just a social event.

Instead, a proper process should be defined to report any problem and monitor the SLAs (Service Level Agreements), with a limited number of scheduled meetings linked to specific budgeting activities.

A properly managed strategic outsourcing contract should be considered like yet another element to be considered (another cost centre) within the normal budgeting process.

Besides managing the current outsourcing contract, you should use the budgeting process and the results from monitoring activities to negotiate the evolution of services- outsourced and in-house.

If the selection process has been properly carried out, your supplier should be able to deliver not only quantitative information, but also a qualitative assessment that you will be able to compare with your own internal qualitative assessments.

Any discrepancies could be analysed to identify either new needs, or a need to improve the services, or even just (re)training needs.

The business environment, technologies, regulations etc. will probably add another set of changes, that should be properly managed to maintain the agreed level of service, and only if your supplier understands your business you will be able to delegate most of the change activities.

As discussed at the beginning, knowing the reasons of the outsourcing is mandatory to ensure a proper understanding of the priorities.

Defining the strategic outsourcing properly will also reduce the risk that the management costs of the relationship with your supplier could exceed any savings obtained by outsourcing your services.

If the suppliers understand the process, probably they will be able to give you feed-back not only on the activities, but also on ways to improve them.

A properly managed outsourcing contract will turn your supplier into an internal consultant that will deliver to your organization feed-back derived from the delivery of services across your industry.


Outsourcing costs, and generates results only with long term agreements; if you do not invest, do not expect the outsourcing suppliers to do it for you.

The first step toward a successful strategic outsourcing is understanding: your business, your needs, your suppliers’ capabilities.

Before outsourcing, verify that you understand the “knowledge boundaries” of the outsourced activities and that you are able to convey this information to your suppliers.

Measuring the performance should not be limited only to quantitative assessments, but also to the actual fulfilment of business needs.

A continuous reassessment should be carried out also of the qualitative parameters used to monitor the evolution of both your services and the overall relationship with your suppliers.

If your suppliers understands your business and their integration in your business cycle, then they can become proactive long-term partners, supporting your continuous service improvement activities.