Your CFO walks into your office 18 months after you signed your first outsourcing contract and asks, “What happened to the savings you promised?”
To prepare for this question, hopefully you have created and properly staffed a Vendor Management Office (VMO) function that manages the contract, relationship, performance, and financial aspects of the agreement. But to be able to explain any discrepancies (or even better, avoid them) ask the following questions:
1. How have addressable costs changed since the inception of the contract?
When the original base case and business case financials were constructed, costs should have been divided into two key groups – addressable (those that can be affected through outsourcing and un-addressable (those that cannot. Addressable costs are directly tied to people, processes, and technology in labor (e.g., employee salary, benefits, bonus, taxes and contractors) and non-labor (e.g., travel, office supplies, software tools, and technology.) Un-addressable costs are those that remain in the company or department regardless of who performs the work (e.g., network transport, facilities overhead, and selected software and technology expenses).
2. Has the inflation clause in the contract become effective?
For modeling purposes, a business case is most often constructed as ‘inflation neutral.’ In most contracts that we’ve seen, providers want an inflation clause included in the contract. Post contract signing, you should have revised the business case to include the impact inflation has had, both from what would have been your costs and the provider’s price. If anticipated inflation on your costs exceeds what the provider recovers via a COLA clause, your business case improves. If the inverse is the case, your business case will degrade over time.
3. Has the Foreign Exchange (FX) Rate clause kicked in?
If you have an offshore component to your delivery, the provider will typically ask for a contract clause that changes your payment terms based on currency rate fluctuations. Unfavorable currency shifts can degrade your initial business case. While such shifts are out of your control, it’s good practice to put a cap on the effects of such shifts.
4. Are your costs growing because your business is?
If your business needs more project work, servers, storage or applications because it is growing, that is not necessarily bad. However, a well constructed contract will still yield lower cost of growth than what would have been the case had you stayed insourced.
5. Have any unplanned corporate overhead allocations been assessed to your department?
From time to time there is a rebalancing of existing corporate overhead costs (e.g., HR, Administration, facilities) across departments. This may have happened after you locked in your business case. If the allocation increased for your department, this is an unplanned cost that impacts your savings line. From a corporate view, there is no impact. Properly reflected, this will not adversely impact your business case as it is an un-addressable cost.
6. Are you spending enough on vendor management?
To increase the apparent return on outsourcing, some organizations deliberately fail to provide enough staff to manage the outsourcer. This can boost returns in the short run, but eventually you will need to staff to the appropriate level to manage the outsourcing arrangement and to ensure you deliver on your commitments to the business.
7. Did you follow your plan for reductions in force?
Did you end up keeping higher-end high cost people and releasing lower cost resources? Did you keep an extra few people for good measure? While this is easy to do on an emotional level and can provide the feeling of insurance, it will chew into the savings built into your business case.
8. Were your actual transition costs greater than estimated?
If the transition took longer than planned, it will can raise costs for the customer (in the form of payroll, severance, retention bonuses, advisory fees, etc.) or for the provider, in the form of labor, tools, travel, etc.
9. Did the provider under bid the work?
Some providers think they can ask for more money once they are in place and you’ve lost the staff that previously performed the work. But unless the provider can materially prove that work volumes have changed, they are obligated to deliver per the contract. To prevent this, we seek assurance from the provider at the highest levels that they are not promising more than they can deliver and will make a reasonable margin on the work. If a provider still underbid, executives on the client side must hold the provider’s feet to the fire.
10. Was the outsourcer hit with pent-up demand?
During an outsourcing transition, it’s a good idea to “freeze” some work so the internal team can focus on the transfer of knowledge to the provider. This can create pent-up demand from the business that is eager to take advantage of the outsourcer’s lower costs. If not controlled, this can drive costs beyond those planned in the business case. Managing demands and prioritizing work is just as important in an outsourced arrangement as when you did the work in-house.
11. Are you inspecting and reconciling the provider’s invoices against work volumes and what was contracted for in the agreement?
We find a surprising number of provider invoices that lack the detail required to reconcile the work performed against the Charges Schedule in the contract. This results in errors in the invoices. A good VMO will catch these anomalies and ensure you are getting what you are paying for.
12. Did the provider hire more of your people than anticipated and/or established an on/off shore mix that is more tilted to onshore than anticipated?
If the provider has rebadged more than expected (or hired displaced people as contractors), you may benefit from their institutional knowledge. But the added costs can damage the business case. Similarly, using more onshore staff than planned can improve results, but also raise your costs. An effective VMO will alert you to these issues and allow you to decide whether the added service is worth the extra costs.
One of the toughest jobs in outsourcing is tracking the impact changes may have on your business case. While you can’t control all these changes, knowing what they are — and how to best manage them — will help your bottom line and help you stay in the good graces of your CFO.
This article originally appeared on Global Delivery Report