Too often outsourcing negotiations lead to engineered pricing – pushing upfront cost to the out years – allowing buyers to construct a “winning business case” and supplier pursuit teams to “close a deal.” Both parties swallow hard, knowing the cost bubble has been deferred, not eliminated. The honeymoon is underway but eventually governance teams from both sides turnover and sometime around Years 2 or 3 the buyer feels stuck with an out-of-market cost structure that has the business screaming for change. Time to restructure or benchmark and potentially there goes the relationship.

This scenario is played out repeatedly in the marketplace. Anxious service providers in pursuit of new logos place big bets on their ability to reduce delivery cost and sell new services. Both of these objectives are difficult to achieve in the short-term, placing the provider account executive team under stress from corporate while desperately trying to develop a customer relationship and meet extreme expectations from end users. This classic Outsourcing 1.0 conundrum is a symptom of the mindset that many in our industry have accepted as normal: take what you can get now and defer the pain for the next guy. The buyer wants to transfer risk and book short-term savings. The provider wants a new logo talking point for the street and a backlog of recurring revenues. Both sides tick the box and hope for the best.

The cumulative effect of these engineered relationships has taken its toll on a number of service providers. Although there are several other factors contributing to the fundamental shift occurring today in the sourcing of complex services – including the unprecedented accelerating pace of change in technology and the resulting establishment of new ways to achieve a different level of outcomes  – the legacy me-focused mindset combined with engineered pricing has created a survival need for change for many. None of the traditional Tier 1 service providers have gone unscathed and, like all of their competitors, are facing a new world that demands an exploration of alternative service and business models to remain competitive.

The margin compression effect of financial engineering on the front end followed by contract renegotiations in the mid-term creates an unsustainable business model for the providers and leaves the buyer wanting more. The service levels are green but the account is red – margins less than anticipated and low customer satisfaction. Service providers, under continued pressure from the financial markets, have shifted focus from revenue growth to margin expansion. Although the revenue opportunity associated with a “takeover and transform” approach is still tempting, more providers are seeking high-margin transformation project engagements followed by recurring, standardized “as a Service” relationships that provide more predictable outcomes. This new model places greater emphasis on business outcomes and agility over just the traditional process and cost efficiencies of the “same mess for less” mentality.

That all sounds good but there is still a very large elephant in the room – the cost bubble. How does a buyer engage a service provider to start a transformational journey without incurring a significant financial bogey? To put it bluntly, it may not be possible. However, for most, it is achievable. Depending on the size of “your mess” and the stretch required to achieve your desired state, it may very well require funding beyond your current operating and capital budget. If so, there are a number of steps you should take to address the business need, including:

  • Build the case – like any business decision, a case for change must be established and communicated, so a cost-benefit analysis with a risk assessment should be developed and socialized to secure funding.
  • Establish perspective – clarify the differences between the current economic conditions and related needs and those that prevailed at the time of previous contract engagements or that served as the basis for the current budget.
  • Be transparent – if forced to engineer the charges with the service provider, be as transparent as possible with respect to the amount that is financed and avoid burying it in the service charges.

The lack of transparency, beginning with the economics of the relationship but extending out to other motives and challenges, is a significant inhibitor to establishing a service relationship where both parties are pulling in the same direction and creating value not otherwise achievable.

Although some situations will unavoidably require investment, many others can be managed within budget if the parties are willing to reset the relationship framework. The reset begins with a revised mindset, moving beyond a buyer-provider relationship to one of partnering, where the parties work together to co-create the strategy and execution of mutually beneficial outcomes. Risk is shared. Trust is essential. This form of hyper-collaborative partnering is not for everyone and not appropriate for every situation. However, if the service has a strategic impact on the business and speed and agility are differentiators, the legacy buyer-provider managed services model is not sufficient.

So how does partnering versus buying change the economics and avoid the cost bubble trap that has plagued so many relationships? We’ll dive deeper into each of these in the future, but the following elements of partnering create the environment necessary to avoid the cost bubble trap:

  • Compatibility and Trust: When two organizations decide to work together within a complex service relationship, the relationship must be seen as the substance of the deal that transcends the solution and the terms and conditions. As such, finding a partner that values mutuality and transparency is paramount. Codify the win-win sales talk with a contractual commitment to a set of values and behaviors. With this as a foundation, the risk of creating a ticking time bomb to scratch a short-term itch is significantly reduced.
  • Business Model: Create clear objectives and align the incentives. The market has become expert at solving the wrong problems, pushing transformation projects that are not meaningful or relevant to the business. The business needs to be involved in establishing the objectives of the program. The business model should then encourage both parties to pull in the same direction by allocating the bulk of the margin to the achievement of desired outcomes. These outcomes can include budget objectives such as self-funding transformational change via tactical initiatives to reduce ongoing operating costs. With this partnership mindset, cost transparency not only provides a measure necessary to ensure the achievement of the joint objectives but also engenders empathy, further bonding the joint ownership of the program. Additionally, taking a holistic, systems view of the change initiative and capturing hard cost savings beyond the immediate scope of work as well as conservatively quantifying the business value generated can change the nature of the conversation with the stakeholders.
  • Joint Stewardship: In the complex world of ITO and BPO service relationships, the governance mindset can make or break the success of the relationship. Organizations, not just deal teams, must be committed to the success of the partnership. Business happens, and over the course of the relationship variables will change, including financial inputs and objectives. Managing a shared risk and reward business model requires a mix of art and science and a lot of trust. Avoiding financial pitfalls such as financial engineering or cross-subsidization requires not only a contractual framework that allows the parties to deal with the unexpected but also a shared culture of looking out for each other knowing it is in the best interest of the program in the long run.

Albert Einstein is often quoted as having said, “The significant problems we face cannot be solved at the same level of thinking we were at when we created them.” I believe the lack of financial transparency in a business relationship between two organizations is another wall that needs to be torn down in order to discover more value. The closed book mentality that we’ve grown up with has helped foster the atmosphere of self interest and that each side needs to take care of themselves and not worry about the success or failure of each other. The market is telling us it’s time to change our level of thinking.