Executive Briefings

Performance-Based Outsourcing: What's in it for "We"?

I am writing this piece from Knoxville, Tennessee where I've been attending a 2 ½ day course on Performance Based Outsourcing at the University of Tennessee. The class wraps up tomorrow, so I have a bit more learning to do, but here are some of my key takeaways so far:

1. Performance Based Outsourcing (PBO) is grounded in game theory, a branch of applied mathematics that (according to Wikipedia) "attempts to mathematically capture behavior in strategic situations, in which an individual's success in making choices depends on the choices of others." Said differently, game theory has shown mathematically that when parties cooperate, they both win, but if they don't cooperate (i.e., if they approach a situation as a zero-sum game), then they end up with less or both lose. Eight game theorists have won Nobel prizes in economics, including John Nash, who was the subject of the movie "A Beautiful Mind." In short, PBO is not some "pie-in-the-sky" concept conjured up by academics and analysts; it's actually grounded in science and mathematics.

2. I like the way Kate Vitasek, one of the instructors, summarized PBO: it's about what's in it for "we" instead of what's in it for "me".

3. Many people equate PBO with gain-sharing contracts, but they are not the same. As Mike Ledyard, another of the instructors put it: a well structured gain-sharing agreement gets you close to PBO, but most gain-sharing agreements are not well structured-i.e. they are too narrowly focused, both in terms of scope and timeframe.

4. If anything, PBO should be equated with "lean" principles because finding and eliminating waste, which benefits both parties, is a key element of PBO.

5. Implementing PBO is much easier in an existing 3PL-customer relationship because a certain level of trust and business alignment already exists. You can do PBO in a new relationship or in a competitive bid, but it's significantly more difficult.

6. Instead of issuing a Statement of Work (SOW), companies should issue a Statement of Objectives (SOO). Karl Manrodt, who also taught in the course, differentiated the two this way: a SOW expresses the tasks to be done by the 3PL, and may specify how the tasks are to be done. In contrast, a SOO expresses the outcomes the customer expects, without specifying how they should be achieved. A SOO gives the service provider more flexibility and freedom for creativity.

7. Implementing PBO "the right way" takes a lot of work and discipline, and it requires 3PLs and customers to make a clean break from the way they've always done things. It's a mind shift that will be difficult (if not impossible) for many 3PLs and customers.

My list of insights goes on, but I'll save them for another day. Let me end on this note: if you're a logistics service provider or a customer that is frustrated with the status quo, and you're saying to yourself, "There has got to be a better way," then I highly recommend that you take this course. And I'll also repeat what I said back in February, this time with more conviction: 2009 will be the year that performance-based outsourcing starts to gain traction in the logistics industry.
ARC Advisory Group

I am writing this piece from Knoxville, Tennessee where I've been attending a 2 ½ day course on Performance Based Outsourcing at the University of Tennessee. The class wraps up tomorrow, so I have a bit more learning to do, but here are some of my key takeaways so far:

1. Performance Based Outsourcing (PBO) is grounded in game theory, a branch of applied mathematics that (according to Wikipedia) "attempts to mathematically capture behavior in strategic situations, in which an individual's success in making choices depends on the choices of others." Said differently, game theory has shown mathematically that when parties cooperate, they both win, but if they don't cooperate (i.e., if they approach a situation as a zero-sum game), then they end up with less or both lose. Eight game theorists have won Nobel prizes in economics, including John Nash, who was the subject of the movie "A Beautiful Mind." In short, PBO is not some "pie-in-the-sky" concept conjured up by academics and analysts; it's actually grounded in science and mathematics.

2. I like the way Kate Vitasek, one of the instructors, summarized PBO: it's about what's in it for "we" instead of what's in it for "me".

3. Many people equate PBO with gain-sharing contracts, but they are not the same. As Mike Ledyard, another of the instructors put it: a well structured gain-sharing agreement gets you close to PBO, but most gain-sharing agreements are not well structured-i.e. they are too narrowly focused, both in terms of scope and timeframe.

4. If anything, PBO should be equated with "lean" principles because finding and eliminating waste, which benefits both parties, is a key element of PBO.

5. Implementing PBO is much easier in an existing 3PL-customer relationship because a certain level of trust and business alignment already exists. You can do PBO in a new relationship or in a competitive bid, but it's significantly more difficult.

6. Instead of issuing a Statement of Work (SOW), companies should issue a Statement of Objectives (SOO). Karl Manrodt, who also taught in the course, differentiated the two this way: a SOW expresses the tasks to be done by the 3PL, and may specify how the tasks are to be done. In contrast, a SOO expresses the outcomes the customer expects, without specifying how they should be achieved. A SOO gives the service provider more flexibility and freedom for creativity.

7. Implementing PBO "the right way" takes a lot of work and discipline, and it requires 3PLs and customers to make a clean break from the way they've always done things. It's a mind shift that will be difficult (if not impossible) for many 3PLs and customers.

My list of insights goes on, but I'll save them for another day. Let me end on this note: if you're a logistics service provider or a customer that is frustrated with the status quo, and you're saying to yourself, "There has got to be a better way," then I highly recommend that you take this course. And I'll also repeat what I said back in February, this time with more conviction: 2009 will be the year that performance-based outsourcing starts to gain traction in the logistics industry.
ARC Advisory Group