In our Vested Outsourcing work, a major focus is governance. A poor governance structure can drive a good outsourcing relationship into the ground. Research by the Corporate Executive Board shows that poor governance can erode up to 90% of the business value anticipated for an outsourcing agreement. The Outsourcing Center reports that governance plays a role in 62% of outsourcing relationship failures.
But what does a good governance structure look like?
A governance structure has to do three key things for a company and its service provider: Clarify expectations, align goals, and adapt to business changes.
As legal scholar Ian Macneil has said, the reason most outsourcing contracts don’t define good governance structures (or, often, any governance structure at all) is because the traditional contract template is designed for simple transactions, not collaboration, over short time frames, not years.
The biggest single flaw in the traditional contract template is that it assumes a static environment. That’s fine for a one-time transaction. Get beyond that and you’re in a dynamic environment.
The second biggest flaw is that governance implies collaboration. The traditional contract template is designed to manage risk and enforce terms and conditions.
Macneil tells us that a contract should be an instrument for cooperation, providing a flexible framework with clearly defined objectives, measurable desired outcomes, a baseline, and a process for managing change.
In their white paper “Upacking Outsourcing Governance: How to Build a Sound Governance Structure to Drive Insight Versus Oversight,” authors Kate Vitasek, Gerald Stevens and Katharine Kawamoto provide this working definition of a governance structure: A framework and joint process that encourages ethical, proactive changes for the mutual benefit of all the parties.
How do you build it? Well, assuming you and your outsourcing partner are coming into this process with a collaborative, “what’s in it for we” mindset and a high level of trust, here’s how I’ve distilled Vitasek et al’s recommendations:
· Establish mutual and shared accountability, and consider the end-to-end process outcomes of the combined entity. It takes both the company and the service provider to produce the outcomes. Think of the two as a single entity.
· Create a “reverse bow tie” management structure with a clearly defined escalation process.
· Drive a disciplined business review process focused on two things: understanding what is happening and why, and developing transformation and continuous improvement initiatives.
· Define, in detail, an exit strategy reflecting the reality that for any number of reasons (such as acquisition) the parties may need to end the relationship.
It’s not easy, and good governance requires an investment of time and money. At its simplest, good governance involves stepping back from the day-to-day firefighting to take a long view, looking broadly at the end-to-end process and looking forward to anticipate the future. Many companies that have established effective governance structures dedicate at least one person in each company full time to managing the governance process.
That might sound expensive, but go back to my first paragraph. Poor governance kills most of the value of an outsourced relationship. Good governance starts with a good structure, but it needs time and attention to pay off.
I’d like to expand a little on the first three of the four bullet points above.
The concept of mutual and shared accountability reflects the reality that the success of an outsourced service relationship absolutely depends on both parties working together. If you just throw the tasks over the wall at the service provider and expect them to do everything, and blame them when things go wrong, you’ve started the death spiral. I’ve met dynamic duos of managers, one from the company and one from the service provider, whose bonuses are tied to the same metric. Together they succeed.
That degree of collaboration and commitment starts with the reverse bow tie management structure. Instead of funneling all decisions through a SPOC at each company, assign two people, one from each company, to be responsible for a subset of the overall activities. Vitasek calls this the “two in a box” structure. The success of each “two” depends on working together to achieve a defined business outcome. The escalation path should be also “two in a box,” all the way up to the two CEOs.
That might seem anathema to traditional procurement organizations that use market power to dominate their service providers. But Vitasek, with co-authors Mike Ledyard and Karl Mandrodt, documents the importance of this shared accountability – all the way to the top – in the extensive research on successful outsourcing relationships embodied in their book “Vested Outsourcing: Five Rules That Will Transform Outsourcing.”
As I wrote in a previous post, this is not about playing nice. It’s about playing smart, learning from the failed relationships and the successful relationships.
The business review process should have four components: service delivery management, transformation management, agreement compliance and relationship health. Ideally, these tasks should be divided among four individuals, because the disciplines and activities in each are quite different.
Service delivery management is about managing the day-to-day business, understanding what is happening and why. The “why” provides the fuel for continuous improvement initiatives. This process must also provide a forum for addressing problems, including grievances raised by either side.
The transformation management process should be focused on the end-to-end process of the combined enterprise. It should develop, evaluate and choose initiatives based on fact and data, with a long-term view. And it’s incredibly important. As Nobel Prize winner Robert Solow has shown, 87% of all economic growth comes from process transformation – not new products, just process.
Put your smartest people in charge of the transformation management process, because that’s where you will find the most upside.
The agreement compliance process needs to be disciplined. It’s too easy to make a decision and go without documenting and, at times, amending the contract. It’s an essential element of protecting the overall enterprise from disruption caused by personnel changes that can bring changes in attitudes and approaches.
Relationship health reflects the fact that business relationships are built on interpersonal relationships. Vitasek et al describe a process illustrated by Whirlpool that looks at five elements of the relationship to assess its overall health:
1. Communication. Is it open, honest, adequate and timely?
2. Responsiveness. Do the parties do what they say they will do? Do they demonstrate joint efforts and joint problem solving?
3. Problem-Solving: Do the parties work together to eliminate barriers to change and align key processes?
4. Service Provider Profit: Is the service provider getting rewarded for above-and-beyond performance, and getting compensated for investing in transformation initiatives?
5. Working Relationship: How do the parties evaluate themselves and each other, up and down the management levels? What do internal or downstream customers have to say? What do external customers have to say?
I don’t know about you, but item 4, Service Provider Profit, made me say “Whoa!” An outsourcing company concerned about their service provider’s profit? It makes sense, though. The outsourcing company’s success depends on the service provider’s success, and the service provider’s success depends on its ability to generate profit growth. And if the biggest upside from the relationship comes from process transformation, what better way to keep the two parties’ interests aligned? Provide the biggest rewards to the service provider in the form of profit gains in return for successful transformation initiatives.
A structured and staffed governance process provides the framework for that success. More at the Vested Outsourcing website.
