Executive Briefings

Lessons for Successful Outsourcing Based on Nobel-Winning Economist's Work

Drawing on the work of Oliver Williamson, who was awarded a Nobel in 2009 for his work in economics, several practitioners and academicians associated with the University of Tennessee, Georgia Southern University, Cranfield School of Management, and the International Association of Contract and Commercial Management have released a white paper called Unpacking Oliver: Ten Lessons to Improve Collaborative Outsourcing.

The paper attempts to summarize Williamson's work to enable supply chain management professionals to draft better outsourcing agreements. Ten key lessons are summarized as: 

1. Outsourcing is a continuum, not a destination.
Deciding to in-source or outsource is rarely a simple "yes or no" decision. Most often the decision encompasses a tradeoff between safeguards and price. In other words, it is a hybrid of what tasks or responsibilities each party will complete. Choosing who does what can be determined by using the other lessons noted below. The goal is to reduce costs, and improve service while maintaining or increasing profit margins for all partners.

2. Develop contracts that create 'mutuality of advantage.'
Williamson shows that the contract itself can have negative impacts on business if an organization does not think through how to structure the contract properly. In short - don't just say win-win - contract for win-win by committing to a 'What's in it for We' approach.

3. Understand the transaction attributes and their impact on risk and price. Companies should look to identify all costs, including transaction costs associated with asset specificity, uncertainty, frequency and work to develop solutions that can mitigate these risks and the costs associated with them. It is important to understand the true "Cost to Serve." Don't ignore the risks - but identify them and determine the best way to manage them. Failure to manage the risks will lead to one-sided agreements by pushing risks on to the service provider or the customer. Doing so will simply cause the service provider to raise costs or the customer to want to reduce the price without trying to manage the real issues. Risks and costs need to be addressed from a "holistic" supply chain perspective. Remembering the sum of the local costs does not equal the global cost.

4. The greater the bilateral dependencies, the greater the need for preserving continuity. Companies that are "promiscuous" frequently bid and transition work to new suppliers that are likely to experience higher overall costs than if they had developed a fair and equitable contract that preserves continuity and eliminated switching costs.

5. Use a contract as a framework - not a legal weapon.
Creating a detailed contract and associated statement of work puts the outsource provider and customer into a "box." This limits innovation and encourages finger-pointing when there is inevitable scope creep and changes. Instead of trying to "guess" about the future, it is better to indicate an outline of the work to be done, and provide recourse for ultimate appeal. For work yet to be determined, focus on the process and tools to be used, not on the work to be done.

6. Develop safeguards to prevent defection.
It is important to recognize that business relationships may need to change due to changes in the market and for this reason contracts need a well thought out exit management plan. Due to the changing market place, a perfect supplier (or customer) today might not be a perfect match in the future. For this reason, practitioners should clearly identify the costs associated with terminating a contract. Create safeguards in the contract that are fair and equitable in terms of keeping either party "whole" in the event that a contract needs to be terminated prematurely.

7. Predicted alignments can minimize transaction costs.
Predicted alignments or what is sometimes thought of as "shared visions" can and does reduce transaction costs. When at all possible, create a shared vision that will guide how both the company and the service provider will work. Companies should create mutually beneficial outsourcing agreements whereby the service provider is rewarded financially for achieving the desired outcomes for the company that is outsourcing. Develop pricing models that reward and incentivize service providers for achieving the desired outcomes.

8. Your style of contracting matters; be credible.
Organizations that use their "muscle" to gain an advantage over suppliers may have a short term win, but they will lose in the long term. Companies will ultimately face higher market costs and transaction costs from switching or transitioning suppliers, or at a minimum from suppliers being forced to use conventional negotiations to put in myopic and costly contractual provisions and behaviors that simply drive up hidden costs.

9. Build trust; leave money on the table.
Leaving money on the table may sound foolish, but when striking a strong business relationship it can signal a constructive intent to work cooperatively that will build an environment that is credible from start to finish. As the old proverb states "Give and it will come back to you, generosity gives rise to generosity."

10. Keep it simple.
Organizations should strive to keep relationships and contracts pragmatic, plausible and correct. Those are excellent lessons in life and for a good business relationship and supporting contract.

Source: Vested Outsourcing

Drawing on the work of Oliver Williamson, who was awarded a Nobel in 2009 for his work in economics, several practitioners and academicians associated with the University of Tennessee, Georgia Southern University, Cranfield School of Management, and the International Association of Contract and Commercial Management have released a white paper called Unpacking Oliver: Ten Lessons to Improve Collaborative Outsourcing.

The paper attempts to summarize Williamson's work to enable supply chain management professionals to draft better outsourcing agreements. Ten key lessons are summarized as: 

1. Outsourcing is a continuum, not a destination.
Deciding to in-source or outsource is rarely a simple "yes or no" decision. Most often the decision encompasses a tradeoff between safeguards and price. In other words, it is a hybrid of what tasks or responsibilities each party will complete. Choosing who does what can be determined by using the other lessons noted below. The goal is to reduce costs, and improve service while maintaining or increasing profit margins for all partners.

2. Develop contracts that create 'mutuality of advantage.'
Williamson shows that the contract itself can have negative impacts on business if an organization does not think through how to structure the contract properly. In short - don't just say win-win - contract for win-win by committing to a 'What's in it for We' approach.

3. Understand the transaction attributes and their impact on risk and price. Companies should look to identify all costs, including transaction costs associated with asset specificity, uncertainty, frequency and work to develop solutions that can mitigate these risks and the costs associated with them. It is important to understand the true "Cost to Serve." Don't ignore the risks - but identify them and determine the best way to manage them. Failure to manage the risks will lead to one-sided agreements by pushing risks on to the service provider or the customer. Doing so will simply cause the service provider to raise costs or the customer to want to reduce the price without trying to manage the real issues. Risks and costs need to be addressed from a "holistic" supply chain perspective. Remembering the sum of the local costs does not equal the global cost.

4. The greater the bilateral dependencies, the greater the need for preserving continuity. Companies that are "promiscuous" frequently bid and transition work to new suppliers that are likely to experience higher overall costs than if they had developed a fair and equitable contract that preserves continuity and eliminated switching costs.

5. Use a contract as a framework - not a legal weapon.
Creating a detailed contract and associated statement of work puts the outsource provider and customer into a "box." This limits innovation and encourages finger-pointing when there is inevitable scope creep and changes. Instead of trying to "guess" about the future, it is better to indicate an outline of the work to be done, and provide recourse for ultimate appeal. For work yet to be determined, focus on the process and tools to be used, not on the work to be done.

6. Develop safeguards to prevent defection.
It is important to recognize that business relationships may need to change due to changes in the market and for this reason contracts need a well thought out exit management plan. Due to the changing market place, a perfect supplier (or customer) today might not be a perfect match in the future. For this reason, practitioners should clearly identify the costs associated with terminating a contract. Create safeguards in the contract that are fair and equitable in terms of keeping either party "whole" in the event that a contract needs to be terminated prematurely.

7. Predicted alignments can minimize transaction costs.
Predicted alignments or what is sometimes thought of as "shared visions" can and does reduce transaction costs. When at all possible, create a shared vision that will guide how both the company and the service provider will work. Companies should create mutually beneficial outsourcing agreements whereby the service provider is rewarded financially for achieving the desired outcomes for the company that is outsourcing. Develop pricing models that reward and incentivize service providers for achieving the desired outcomes.

8. Your style of contracting matters; be credible.
Organizations that use their "muscle" to gain an advantage over suppliers may have a short term win, but they will lose in the long term. Companies will ultimately face higher market costs and transaction costs from switching or transitioning suppliers, or at a minimum from suppliers being forced to use conventional negotiations to put in myopic and costly contractual provisions and behaviors that simply drive up hidden costs.

9. Build trust; leave money on the table.
Leaving money on the table may sound foolish, but when striking a strong business relationship it can signal a constructive intent to work cooperatively that will build an environment that is credible from start to finish. As the old proverb states "Give and it will come back to you, generosity gives rise to generosity."

10. Keep it simple.
Organizations should strive to keep relationships and contracts pragmatic, plausible and correct. Those are excellent lessons in life and for a good business relationship and supporting contract.

Source: Vested Outsourcing