Outsourcing can provide many benefits to businesses – including more flexibility, improved service and reduced costs – but it almost never provides these benefits at the levels that are expected. The most successful outsourcing programs typically reach only 95 percent of the service levels and cost savings that were expected – and were contracted for. Less successful programs may miss their targets by 30 percent or more.
The difference between the value and services that are contracted for in an outsourcing agreement, and those that are actually delivered, is known as value leakage. A company’s size and where it is headquartered geographically aren’t major factors it its risk for value leakage. We have seen firsthand that some midsized, Latin American companies are global leaders in managing outsourcing relationships and maximizing the business benefits from their outsourcing activity. The keys to success are to understand contract terms and industry best practices – and how to enforce them. This article will show you how to recognize value leakage and how to prevent it.
To prevent value leakage from occurring over time, companies must carefully manage their service providers, which often requires processes and approaches that companies do not already have in place.
Understanding Value Leakage
Some value leakage occurs in all outsourcing engagements, and most are still successful even if all contract terms are not met. TPI’s research and experience covering thousands of outsourcing engagements indicates that outsourcing transactions typically provide between 70 percent and 95 percent of the expected value. While those levels are common, they don’t have to be acceptable. If we go to the grocery store, we do not expect the clerk to accept 70 to 95 percent payment for what is in our basket. When we receive a paycheck, we expect it to be for 100 percent of our salary. What is the difference between these examples and outsourcing transactions? When we work and shop, the terms and conditions are usually well understood by both parties, and easy to enforce. Outsourcing engagements are highly complex, so they usually lack this simple clarity, especially for companies with limited experience.
There are many forms of value leakage, both direct and indirect. Direct causes may include billing for services that were not performed, or failing to apply a volume discount. Not submitting a monthly report is an example of indirect value leakage. The omission may not cause a problem or a direct expense, but is an instance where the client does not receive what it contracted for.
It is important to remember that outsourcing provides value beyond labor cost savings. To realize the full value from outsourcing, companies need to make sure they are receiving all the benefits they contracted for, including technology and security upgrades, service levels, risk management and increased operational flexibility. Over time, seemingly small things like failing to provide reports or documenting small changes in procedures can lead to confusion over rights and responsibilities that can escalate into disputes. Such disputes, and the time and expense required to resolve them, can be avoided simply by following the established service terms.
Minimizing Value Leakage
Why are some companies much better at governing outsourcing relationships than others? Experience is a very important factor, but it isn’t a requirement for success. One of our clients in Chile has excelled at governance starting with its first outsourcing contract and is one of the best companies in the entire world at maximizing the value of its outsourced services. Another company in the region with a similar business model, which is a much larger corporation with more outsourcing activity throughout its global operations, continually struggles with value leakage despite its experience. The major difference between the two companies is how they govern their relationships.
Our experience working directly with clients clearly shows the companies who have the least value leakage are the companies who do the best job of monitoring and managing their service agreements. The risk of value leakage in an outsourcing contract relates directly to the company’s ability to govern the contract.
As our Chilean client proved, first-time outsourcers will not necessarily have high value leakage. Inexperience can be overcome by serious management focus, adequate budget, strong staff and implementing industry best practices. To prevent value leakage from occurring over time, companies must carefully manage their service providers, which often requires processes and approaches that companies do not already have in place. Value leakage occurs throughout the life of the outsourcing engagement, and typically increases in the later years of the contract. Companies who are accustomed to having long-term relationships with their customers and suppliers may not realize they need to manage outsourcing service providers more actively and aggressively than the other firms they’ve done business with for years.
Attention to detail is essential. If contract terms are not managed consistently, small things like late or incomplete deliverables, service exceptions and gradual loss of content in routine contract adjustments become the norm. The longer they are allowed to continue, the more they degrade the quality of the relationship. Once performance levels and responsibilities become unclear, it is very difficult to return them to contracted levels without dispute or a time-consuming renegotiation of the relationship. In these cases, value leaks because client company managers and executives lose productivity by investigating and resolving issues that could have been prevented by proactive governance.
Some of the most important steps organizations can take to minimize value leakage include:
- Understand contract terms, service levels and how they are measured
- Institutionalize the knowledge in the organization; do not rely on a few key professionals to understand the outsourcing relationship
- Build both executive- and operations-level relationships with the service provider and align expectations at each level
- Put processes in place to ensure both the service provider and your own staff are meeting their commitments
- Continually monitor performance and communicate the findings
While the points above provide specifics, the key to success can be summarized in two words: good governance.
It doesn’t take a large company, or an experienced one, to govern outsourcing relationships well. Even though outsourcing has not been widely adopted in Latin America, there are no geographic, business or cultural barriers that will prevent companies here from being extremely successful in their outsourcing efforts. The key is to implement good governance practices, which we will cover in our next article.
Lynn McNeal,TPI Partner, leads the global firm’s sourcing advisory team for the Latin American region. His deep, broad sourcing experience and expertise across a wide variety of industries spans sourcing strategy, sourcing process and negotiation and renegotiations, transition management, divestitures, acquisition integration, operational assessments and service delivery models.
Gerardo Fernández, senior advisor with TPI, offers Latin American clients extensive experience with and for industry leading organizations. Gerardo’s expertise includes information technology (IT), governance processes and business transformation. His knowledge spans strategic planning, financial analysis and performance reporting, project management, product management, account management, financial reporting and marketing. For more information on maximizing the value of sourcing for your company, contact firstname.lastname@example.org, or email@example.com.