Kate Vitasek is an internationally recognized innovator in the practice of supply chain management and outsourcing and is the author of the influential book Vested Outsourcing: Five Rules that will Transform Outsourcing.
She is the founder, faculty and lead researcher in the concept of Vested Outsourcing, which was developed in conjunction with the University of Tennessee.
World Trade Magazine recently described the Vested Outsourcing concept as one of the most influential concepts of global commerce. Kate has also won recognition from the Supply Chain Council for her research.
Kate took time to explore her Vested Outsourcing concept to WorkPlace Now.
What is Vested Outsourcing?
Traditional outsourcing deals are often transaction-based – the more work that’s done, the more that the buyer has to pay. The more floors washed, or calls answered the more money the service supplier makes – the dollars are firmly tied to activities. However, the economics of traditional deals are not aligned to the best interests of either the buyer or supplier. With Vested Outsourcing, the economics are in the results, not the activity itself. Vested Outsourcing is a longer term approach that incentivizes a supplier for helping the buyer to achieve a specific strategic result. By focusing on results instead of activities the buyer and supplier become aligned and both parties have a vested interest in each other’s success. This works as the service provider is not paid to simply show up and do the work; they are rewarded when they achieve that outcome. This motivates a supplier to invest and innovate to achieve the outcome.
Does it mean that outsource suppliers make more money?
No, Vested Outsourcing doesn’t guarantee that service providers will make more profits. Rather it gives the outsourcing provider the autonomy to invest in their processes to achieve the agreed outcome. This means that they are empowered to generate a higher return on their investment compared to a conventional transaction or fixed price approach. However, they can only achieve this higher return if they provide the desired outcome for the buyer, which means that both parties win. A typical rule of thumb is service providers make a low (often 50% of market) margin on performing the work, and a very high one (often three times that of the market) when they achieve the buyer's desired outcomes. The supplier’s higher margins come directly from incentive payments based on the value they have created for the buyer.
What are the "five rules" to create a mutually beneficial outsourcing agreement?
- The first is that you need to move out of the activity trap, where you pay for every activity or transaction whether you need it or not.
If you pay for the transaction then there’s an inherent incentive for the service provider to perform that activity, rather than look for a better way to do something. In a traditional outsourcing relationship, the provider would be paid based on units received, pallets stored, units packed etc., but in a Vested Outsourcing agreement they could be paid based on meeting the performance level for orders filled.
- The second rule is to focus on the “what”, not the “how”. If you write down everything that you want a supplier to do in a statement of work and tell the supplier how to do it, then you’re not going to get innovation. Buyers need to tell suppliers the outcome that they are looking for and let the supplier come up with finding a better way of doing things.
- The third rule is to have clearly defined and measurable outcomes, you need to know where you’re going if you’re going to get there. Both parties need to be explicit in defining the outcome with the service provider paid for the value that its solution delivers, rather than activity performed.
- Rule four is pricing model with incentives. A complex outsourcing relationship should have a pricing model because the inputs vary. The model must balance risk and reward for both parties and should be structured to ensure that the provider assumes risk only for decisions within its control. The pricing model also needs to incentivize and reward the supplier for meeting outcomes.
- Rule five is insight versus oversight governance structure, which is how you manage the business with the supplier. Instead of managing a scorecard to the service level agreement, you want to measure the supplier against your desired outcomes. You need to develop a culture of insight, which is being observant and perceptive, rather than looking at the minutiae. We see most Vested Outsourcing deals have a “less is more” philosophy – focusing on a limited number of KPIs (key performance indicators) rather than using detailed SLAs (service level agreements).
What are the top-three things to avoid?
The first is to avoid the outsourcing paradox, which is when companies outsource to an expert provider and then tell them what to do. If you have hired a service provider as an expert, then don’t micromanage them. Another one is the activity trap, which ties the supplier’s revenue to activities, because the service provider will have an inherent perverse incentive to perform more activities, or put more people on the account. The last one is the power of not doing. I often see this when a company has a “green scorecard”, but is not achieving their business outcomes. I refer to this as a “watermelon scorecard” because it is green on the surface, but red below the surface. If you have a watermelon scorecard, maybe it is time to challenge your existing approach for outsourcing and perhaps shift to a vested approach.
What advice would you give to a company looking for an outsource partner?
The most important thing is fit, so I would tell them to buy on compatibility, not price. All too often people in an RFP process look at capabilities and price. If you pick a supplier that has the right capability and right price, but is the wrong fit, then you’re going to be divorced at some point. It’s much better to pick on fit and then structure the deal on the outcomes that you want. Bottom line, you need someone who will fit your culture. If you want innovation and the service provider doesn’t have a track record for investing in innovation, then you’re not going to be a good fit. The reverse is also true. If the service provider is highly innovative and you’re not, then you’re going to frustrate them because your employees will likely be what I call “junkyard dogs” – folks that hunker down and don’t want to change any process even if they will drive efficiencies. We have created a survey tool, called the Compatibility and Trust Assessment, which measures a buyer and supplier’s compatibility across five core attributes of “fit”.