Outsourcing often takes on a "leave-the-driving-to-us" characterization: you turn duties over to a contractual partner, who is charged with taking care of it for a fee, and you don't need to get involved. However, that can lead to serious problems when the interests of the so-called partners are in conflict. Performance-based outsourcing, or PBO, strives to create relationships where goals and benefits are mutual.

Several experts - shippers, analysts and consultants - attending the 14th ARC World Industry Forum, in Orlando, shared their views on PBO with SupplyChainBrain. The participants included: Adrian Gonzalez, director, Logistics Viewpoints, ARC Advisory Group;  Jim O'Brien, independent supply chain consultant; Kate Vitasek, a member of the faculty of the Center for Executive Education at the University of Tennessee; Richard MacLaren, president and general manager of Unipart Logistics; and Brian Fues, general manager - operations, at Penske Logistics. Video interviews with each are available at www.SupplyChainBrain.com.

Q: You say a company might consider performance-based outsourcing if its relationship with a 3PL is stuck in a rut. What does that mean?

Gonzalez:  After a lot of cost and service-level benefits have been achieved in the first few years of a relationship, then what?  Older relationships need new frameworks and ways to structure those relationships to achieve new success.

It's a schizophrenic relationship because in a lot of cases companies outsource because they think the 3PL is the expert. Yet they still want to maintain control over the provider and to dictate how to operate sometimes. That creates some tension there.

Q: Elaborate on that tension.

Gonzalez: A lot of these relationships have been short-term and transactional in nature. That creates constraints in the relationship because many providers are not inclined to invest in technology and people if the relationship is short in time or if it's likely to end soon.

PBO has role to play, but it requires taking a new approach about forming a partnership and creating a shared vision and joint business plan. It's about creating the biggest opportunity possible for both sides. There's a lot of upfront work involved. It needs discipline, but it can be a win for both parties.

Q: If it's a win-win, why isn't this right for everyone?

Gonzalez: It's clearly not the right model for every outsourced relationship, and in fact most don't need PBO. They just want a basic service. But in many cases, where companies have a relationship  now in the 4th or 5th year, the opportunity may exist for it. The trust is already there. Some level of performance has been established. So, the challenge is, how to take it to the next level?

Q: What kind of compatibility, if any, is required of the partners?

O'Brien:  The goals of the parties to an outsourcing relationship are often in conflict. One is to cut costs and the other is to maximize profit. That hurdle has to be cleared from the outset before there can be harmony.

Partnership with a 3PL is like the integration of an acquired company. You're trying to absorb two cultures into one, and the goals are diametrically opposed.

Q: It doesn't sound very promising.

O'Brien: From the trust standpoint - that has to built over time, right? You need to look for a similar culture. I think that's essential. And that's another obstacle. The relationship has to be developed to get that oneness. The interview process is when you need to see if they are similar to you.

Q: Does all this boil down to communication?

O'Brien:  Communication is the foundation of trust and culture. What happens in many companies is great communication, but it's electronic. You have to have an active 3PL presence in the company, and if it's not demonstrating leadership, they won't be accepted.

Also, it's not just communication of day-to-day operations but something more proactive. It has to be at the leadership level. Where we've seen the failures, it's because the 3PL needs to sit at the table of the company purchasing their services.

Q: OK, so the 3PL communicates. What about the other side?

O'Brien: The strategy of the 3PL may be communicated, but the company's is not. You have to get to virtual vertical integration. One of the things that's getting a lot of talk is the move to take over that. To be a great provider, you must provide this integration, be part of that company from the leadership down, within the supply chain or DC or whatever.

Q: The customer has to be willing to engage in that.

O'Brien: PBO will not work unless both sides are willing to bare all, warts and everything. PBO can be successful in those companies that have best-practice- or leader-status in supply chain or technology. It has to be at the top.

Q: In your book, Vested Outsourcing: Five Rules That Will Transform Outsourcing, you say there are several changes that can improve an outsourcing relationship, not least of which is to stop paying for each activity. Tell us more.

Vitasek: One of the two biggest problems in outsourcing is the zero-sum game. In most relationships, we sit across from our partner instead of beside him. If we realize we're each in pursuit of money, we should collaborate more, the company to reduce cost and improve service, the provider to improve its margins. The second is the activity trap. We base outsourcing on transactions rather than results. They get paid every time they do an activity. That creates a perverse incentive not to reduce inefficiency.

Q: Do the five rules you write about address this?

Vitasek: Yes, the first is, you have to have an outcome-based versus transaction-based model. You have to incent the provider to reduce activities.

Second is to focus on the "what" and not the " how." That's the outsourcing paradox. We outsource to the experts, yet we tell them how to do exactly everything.

Three: You have to create a defined and measurable outcome. Define and measure success, because the payment structure is based on it.

Four: A pricing model that uses incentives to solve trade-offs. Many companies approach business as a trade-off: You can reduce your cost but at the expense of service. Real leaders have solved for those trade-offs and have achieved trade-ups.

Five: You need a governance structure that allows insight versus oversight. Stop micromanaging your suppliers. 

Q: You use the term "vested." Is that the same thing as performance-based outsourcing?

Vitasek: It depends. PBO usually gives the connotation that all you have to do is take a contract, slap on some metrics and a bonus and voila. That's not PBO. That's why I like the word vested. Any company not vested in your performance isn't acting in your interest. Enlightened companies are ready for vested outsourcing. You've realized that the same way you've always done outsourcing has given the same results, so, it's time for a change.

Q: You're suggesting a paradigm shift of sorts.

Vitasek: It's "what's in it for we," as I like to call it. When I win at the expense of my service provider, its really is not in my interest.

Q: How widespread is the word on PBO, in your estimation?

MacLaren: The topic has been around for quite some time, but many still don't know about it. PBO is out there, but we need a better understanding of it. Why? A longstanding logistics services relationship is much better for all parties than a short-lived one based on single transactions.

Q: Has the poor economy in any way served as a driver for exploring PBO?

MacLaren: Yes, it has. But the key for most companies is to realize they must transform the kind of relationships they have, away from short-term relationships to long-term ones. That's the kind of journey we've been on with Jaguar and Vodafone.

Q: Tell us about them.

MacLaren:  These are global brands with strong presence. We've had a Jaguar partnership for 25 years, though not in true PBO until the early '90s. We moved from being a U.K. company to being present in most markets with them. Whether management or the boardroom has changed, the relationship has endured. Vodafone came to us off the back of what we did with Jaguar. They were growing hugely in the late '90s and needed a new fulfillment center set up. We built up credibility quickly with them and have built up the relationship since then.

Q: What's the difficult part in PBO alliances?

MacLaren: Culturally we're more aligned to transactions, meaning just paying for something. As we move to outcome-based relationships, we're looking at joint destiny between two companies. It probably takes three to five years to build that needed trust. Once you get past that, and trust is built up, you move forward and go forward. It's a shared-destiny model.

You need to think 10 to 15 years, whereas historically companies think about three years out at most.

Q: We keep talking about the need for a cultural shift. What's your view?

Fues: Performance-based outsourcing is a challenge for some because it requires true partnership rather than an every-man-for-himself approach to business.

Q: You have a longstanding PBO relationship with Whirlpool, right? Fues: It didn't start that way. We had a contract with them for more than a decade, but as time went on, we said how could things get better. We have the proper metrics around the relationship, and the proper people.

Q: What kind of people are you talking about?

Fues: We have field engineers, systems experts and labor management specialists deployed to the field. It's a leap of faith if you do these things, that's there's a pot of gold at the end. But we're achieving a lot of success. Both organizations are committed to it.

Q: How do you know you're successful?

Fues: Many companies don't define success, they just measure what they think is progress. It's better to agree up front what you want to achieve, then you know when you've arrived. You have to have somebody who says we're going to let this activity go and let you do it. You have to be brutally honest with the metrics. With the right ones, it will tell you about yourself, and it won't always be good, but they spur you into correction.

So, it's very much a cultural shift from a supplier relationship to a partner relationship.

View the Complete Videos:
Adrian Gonzalez, ARC Advisory Group
Jim O'Brien, independent supply chain consultant
Kate Vitasek, Center for Executive Education at the University of Tennessee
Richard MacLaren, Unipart Logistics
Brian Fues, Penske Logistics