Jennifer the Junkyard Dog

A recent client inadvertently turned a competent manager into a classic Vested Outsourcing Junkyard Dog.  This unintended consequence of a decision to outsource facilities management services turned the set of cubicles set aside to support Jennifer (not her real name) into a hellhole of high turnover, low morale and performance well short of potential.

Jennifer led the RFP to outsource most of the functions she had managed for years.  She was highly experienced and well regarded. The contract structure was largely dictated by her company’s legal department and the framework provided by a consultant.  But it was her job to write the Scope of Work and define the Service Level Agreements.

It was that last part – writing the SOW and defining the SLAs – that wound up hurting her company more than anything.  As the in-house expert, she knew what needed to be done, how it needed to be done, and how to assess performance.  In her eagerness to get it right, she wound up with an 800-page contract with 82 sets of SLAs covering every last detail down to how often to cut the grass.  Many of the SLAs were ambiguous and subjective, but she knew what to look for.

In fairness to Jennifer, the company that won the RFP accepted that monster SOW and its 82 sets of SLAs.  It’s hard to judge that decision.  In any negotiation there are too many factors for an outside observer to assess.  But the approved contract launched Jennifer and the service provider team assigned to support her into a downward spiral.

No matter what the service provider did, it was never good enough for Jennifer.  I don’t think Jennifer deliberately took the position that the service provider could NEVER do it right.  In fact, she told me she would love to see the service provider perform well.  But let’s examine the pressures she was under and the incentives she might feel, even if not consciously.

Bottom line, if the service provider performed well, it would make her look bad.  She was the expert.  She’d managed those functions internally.  If the service provider wound up doing BETTER than she had, what would her bosses think?  And the combination of excessively detailed SOW and somewhat ambiguous SLAs left her room to always find fault.

Unable to ever get it “right,” the service provider team’s morale steadily deteriorated.  By the time I met them, nearly two years into the contract, their leaders were frustrated and miserable, performance was less than they would have liked, they were experiencing high turnover, and there seemed to be no way out.

What they needed to do was rewrite the SOW and apply Vested Outsourcing's Rule 2: focus on WHAT should be done, at the highest level possible, and not HOW; make sure SLAs were few, clearly defined, objective and measurable; and establish a jointly managed governance structure that could address any needed changes and drive process improvements.

And if we could rewind, I would have suggested transferring Jennifer to the service provider.  Then she would have had every incentive to lead her team to beat her own historical performance.

Do you have a Junkyard Dog in your world?  Please share your story.

Edward's Great Expectations

Edward fumed.  “Why can’t these guys be more innovative?  I told them when we outsourced to them, I needed them to be innovative.  But it’s just same old same old.”  Edward (not his real name) was a procurement manager for a large consumer products company.  He was visibly frustrated but hopeful that applying Vested Outsourcing practices would help.

“Tell me how your agreement is structured,” I said.

“It’s simple. We had three homegrown facilities, legacies of acquisitions.  They consolidated everything into one of their facilities.  They receive all our inbound products and components, inventory them, then fulfill orders, picking, packing and kitting.”

Edward wasn’t through venting.  “At every quarterly business review, they go through the scorecard, and everything looks great, and then I ask them about innovative practices, and they talk about some arcane improvement in materials handling systems, or something like that, but it’s nothing to write home about. And these are the people who came to me and said ‘We can revolutionize your operations, drive huge efficiencies.’  But it just looks exactly like what we were doing, only centralized.”

“Are they performing well?”

“Absolutely.  They’re very good, always hitting their metrics.”

“But you’re not getting something you want.”

“Exactly.”

“Edward,” I said, “I bet the problem lies in your contract.  I bet the reason you’re not getting innovation is that it’s not in the contract.”

“Yes it is!  Here, I’ll show you.”  And there it was, a single sentence buried dozens of pages into his MSA:  Supplier shall innovate.

“Edward, what’s your pricing model?”

“We pay them to receive.  We pay them to inventory, by the pallet.  We pay them to pick, pack and ship by the touch.”

“Do you pay them for innovation?”

Edward became flustered.  “What do you mean, do we pay them?  Of course we pay them.  The whole purpose of the contract was to get innovation!”

“Edward, I hear your frustration.  I’m going to tell you something you may not want to hear. The reason you’re not getting innovation is that you didn’t buy innovation.  You bought activities, and thereby set up a pricing structure that actually inhibits innovation.  We call it the Activity Trap.  Your supplier has no financial incentive to innovate.  In fact, it’s just the opposite.  If they innovate, it will only hurt them.”

“How will it hurt them?  It’ll hurt them if I don’t renew the contract!”

“Any innovation will mean reducing touches, or reducing inventories, or reducing some activity they’re getting paid for.  Which means they lose revenue.  When you’re asking them to innovate, you’re asking them to give up revenue.  Why would they do that?  Just like you, they’re in the business to make money.  You have great expectations, Edward, but until you revise your pricing structure based on the Vested Outsourcing principles we’ve been talking about, to make innovation financially rewarding to them, you’re going to get the same old same old.”

With that, Edward launched a contract amendment process that eventually got him what he really wanted:  continuous transformation of his distribution system.

What are your expectations?  And where are the gaps in your outsourcing agreement that cause you frustration?

Freaks in the Supply Chain

In our Vested Outsourcing work, we talk a lot about managing incentives.  We often refer to the book “Freakonomics” by Steven Levitt and Stephen Dubner.  In their work, they delight in putting the spotlight of incentive analysis onto urban myths, business lore and conventional wisdom.

Most supply chain professionals have by now had some exposure to the wonders of data analysis:  Set up your processes so you can capture the data that you can mine for insights that lead to process improvement.

We urge our clients to go beyond data analysis to explore the incentives that … drive the behaviors that generate the data that you can mine for insights that lead to process change.  We believe that becoming a “freak” about incentives will actually lead to process transformation, not just process improvement.

Consider a typical 3PL’s pick, pack and ship operation.  Most such contracts are priced by the activity.  Each pick, pack, or ship gets charged at a set price.  Enter a business owner who wants transformational change.  She asks for it at a QBR.  She sends out an email.  She brings it up in a one-on-one with her counterpart at her service provider.

She’ll promptly get transformational change, right?

What the Freaks teach us is that people and organizations respond to three types of incentives:  Economic, social and moral.  “Economic incentives” mean money.  Do this, make money.  Do that, make more money.  “Social incentives” mean peer pressure, appearances, keeping up with the Joneses.  Do this, look good to your friends.  Do that, look good to your community.  “Moral incentives” are defined by what the individual believes is right, or by the values an organization espouses.

What incentives does our 3PL have to generate transformational change?   Moral incentives?  Yep, right there in the corporate values statement:  Be an agent for transformational change for our clients.  So in that QBR, the 3PL’s managers are enthusiastic and promptly start tossing around ideas.

Social incentives?  Producing transformational change has some cachet in the 3PL world.  You can win awards for it!  So the 3PL’s executives say “You betcha” and start tossing around ideas.

And the economic incentives?  Well, let’s see.  It turns out that with an activity-based pricing model, our 3PL would actually be penalized for innovation. 

How can that be?

Because pretty much any transformational change involves taking picks, packs and ships out of the process.  If our 3PL gets paid for every pick, pack and ship, taking any of them out means giving up revenue.

Why would they want to do that?

Of course they wouldn’t.  In the world of Vested Outsourcing, if you want transformational change, an activity-based pricing structure becomes a perverse incentive because it penalizes the behavior you really, really want.  We call it the Activity Trap.

Our frustrated business owner might say, “You should do it because it’s the right thing to do.”  To our 3PL’s executives, a more important “right thing to do” is grow profits.  She might say, “You could win an award.”  To the 3PL, it might be more important to look good to their investors.

In either case, giving away revenue might not be such a good place to start.

How might our business owner and her 3PL change their pricing model to help them generate transformational change AND grow profits for both?  I look forward to your suggestions.

Dave's Desired Outcomes

A young marketing manager, newly arrived in Seattle and fresh from seven years of “basic training” at Frito-Lay, got a referral to Dave, the CEO of a fast-growing coffee company.  When our marketing manager got Dave on the phone, they chatted amiably for a couple of minutes, then Dave got down to business.

“How do you think you might be able to help me?”

The question stopped our young marketing manager in his tracks.  “I can help you with marketing strategy.  New product development.  And sales promotions.”

“I’ve got those areas pretty well covered,” Dave said.  And thus ended any potential business relationship.

Where did our young marketing manager go wrong?  He offered activities, not results.  Working on strategy, product development or promotions, those are activities.  Dave wanted results.

That young marketing manager was me.  I think about that experience whenever I get into a discussion about the first Rule of Vested Outsourcing:  "The business model must be outcome-based, not transaction- or activity-based."

If I had a “do-over” with Dave – don’t we all wish we could have a few “do-overs”? – I’d like to say something like this:

“Dave, I can drive your top line with innovative promotions, packaging and channel development strategies.  I can also drive your bottom line by applying the analytical rigor and business case development skills I learned at Frito-Lay.”

I’m pretty confident that focusing on what were probably his most important desired outcomes – growing revenue and profit margins – would have taken the conversation deeper into the realm of “how” and at least gotten me a face-to-face interview.  And once I’d satisfied Dave that I had the skills and experience that would make it likely I would succeed, we might have talked about how he might pay for me…

…bringing us into the realm of Rule 4 of Vested Outsourcing:  "Pricing model incentives are optimized for cost/service tradeoffs."  I doubt Dave would have signed up for a straight salary.  We probably would have worked out a lower-than-market base plus a bonus tied to specific revenue and profit margin goals.

A focus on desired outcomes rather than activities (Rule 1) coupled with an incentive structure that motivated my best efforts to achieve those desired outcomes (Rule 4) would have made for a mutually beneficial, rewarding and – I would bet – fun working relationship with Dave and his company.

Considering this example, how can you sharpen your definition of the desired outcomes you or your client wants from your outsourcing relationship?  And how would you design the pricing model to best deliver those outcomes?  I’d love to hear your story.

From Win-Win to Win-Win-Win

In the midst of working out a win-win outsourcing deal, the two parties striking the deal can inadvertently set themselves up for problems if they forget one key person:  the end user.

Whether the end-user is internal or external, it’s the end-user’s satisfaction that will make or break the deal.  I’d go so far as to say the end-user’s satisfaction (or lack of it) will make or break the outsourcing company’s bottom line.  Making sure that end-user is satisfied means that any agreement has to provide benefits to all three parties.  So if you’re not going for win-win-win, you will lose-lose-lose.

And if the company’s ability to satisfy end-users doesn’t improve over time (and relative to competition), the suffering will grow exponentially.

Many outsourcing agreements fail.  I see a variety of reasons for this, usually boiling down to rushing the deal, sucking the life out of the vendor or outsourcing for the wrong reasons:

·      Rushing through planning and transition kills performance.

·      An all-too-frequent pattern of beating up vendors on price blocks investments in transformational process change and service improvements.

·      Outsourcing for any reason other than getting better at what you do as a combined entity will undermine the project’s effectiveness (think balance sheet moves).

Without continuous improvement in performance for the end-user, the company enters a downward spiral toward its eventual death.

Focusing on the end-user breaks that pattern.  An agreement built around measurable benefits to the end-user creates a framework for working together.  When the company and the service provider work together, they become vested in each others’ success.  Neither can accomplish alone what the combined entity can produce.  Cost never stops being a factor, but cost decisions get made in the context of external performance measures – based on the preferences of end-users – and mindful of the many alternatives end-users have to buy similar products or services from others (think market share). 

So if you’re having problems with your outsourcing agreements, bring the end-user back to the table.  Make sure the agreement rewards all three parties and “vests” the company and the supplier in each others’ success.  Collaboration will assure maximum benefits to all involved.

A true win-win is a three-way win:  one for the company outsourcing, one for the supplier, and one for the customer.  After all – isn’t the customer why everyone is in business?  Let me know what you think.