Relationship between Clients and Venders in Outsourcing

Abstract

This paper will examine complexities in the relationship between the client and the outsource vendor and the effect these relationships may have on benefits and risks to both parties. It will also analyse how different categories of contractual agreements relate to the intensity of the relationship and hence to the risk of success or failure. Methods of keeping a balanced relationship structure in place to manage change control, and the need for conflict resolution should the relationship become strained or break down altogether, will also be discussed.

Introduction

As economic and political outlooks change across the world many businesses have given consideration to utilising a cheaper source of expertise and labour from outside the confines of their existing organisation. EU member states are now largely free to trade their services without political interference and barriers, offering many opportunities to increase economic competitiveness. The outsourcing vendor may even exist thousands of miles from the country in which the client operates. Advances in telecommunication technology over the last decade have resulted in easily identifiable work ideally suited to outsourcing in particular: IT services and Call Centres. Despite the growth in outsourcing contracts, computer world (2007) found that at least 50% of outsourcing contracts were terminated early.[10][12]. An investigation of the appropriate literature indicates that trust, commitment, communication quality, cultural similarity and balanced interdependence all have an effect on the quality of the outsourcing relationship [2].Each of the factors listed hasbeen found to be significant and directly related to the ‘Relationship Quality'.[1]

Relationship Quality

What factors contribute to a ‘Quality Relationship'?

A paper referred to as Step by Step Guide suggests that there are three main factors: it should be the right strategic decision; the match needs to suit both parties and the relationship needs to be well-managed [3][21].
The two parties can form a successful early relationship if their initial exploratory discussions are frank and honest about factors crucial to a sourcing relationship.

Lee et al suggested that a fit between the client firm's IT capability and the vendor's competence will significantly contribute to a successful relationship [17].

Short and long term goals together with expectations need to be discussed at an early stage. It is suggested that the best practiceis to document these preliminary discussions in a way which suits both parties which can later act as a point of reference.[3]

At the start of the contract the client needs to be able to evaluate the vendor performance.
Criteria for measurement must be in place right at the beginning. This can be used as a benchmark to assist in quality control as the agreement progresses with time. It should not be forgotten that client activities may change over time (for instance the company may introduce new products or services) generating a need for the original benchmark to be re-evaluated.

In a situation which necessitates change,the relationship must be flexible on both sides. Flexibility is best achieved in situations where both parties understand their respective businesses and have a realistic expectation of what the vendor can provide.Offering incentives [3][14](such as sharing cost saving), to the provider may enhance satisfaction, furthermorethe reverse may be applied in the form of penalties if the service falls below a certain standard. If these standards are to be applied, they must be applied consistently at all times.Penalties should be sufficiently substantial to prevent complacency and sloppy work [14].

Governance needs to be clear and have sufficient detail to avoid ambiguities, relating to what is to be supplied, to what standard and with what financial, legal or other consequences if the standard is not achieved or maintained.

The Governance Model can be interpreted in the following way [3][20]:
• Identify the types of issues and changes which may arise during the relationship;
• Design a governance model that describes each role required for governance;
• Define the rights of the buyer and provider
• List the accountabilities of the buyer and provider
• Principles to guide decisions and actions
• Set procedures for handling issues and changes
• Create a process for escalation if initial steps are unsuccessful
• Vet the model with other representatives of the parties
• Revise the governance model, as necessary, based on feedback

This Model may have a few variations [18][20].
A study concentrating on the Psychological Contract Perspective relates to the contract as a governance instrument for outsourcing relationship management and risk mitigation [13].
Designing and documenting governance before signing of the contract will strengthen trust and ease issue resolution.[3]

Good Communication

It has been identified that both structured and non-structured communication on a regular basis is essential to keep good relations intact. Many outsourcing failures are put down to inadequate communication between clients and outsource vendor. Efficiency and effective communication should be one of the key skills required in the outsourcing management team. There are however many ways to communicate in the modern age. Some managers believe that face-to-face offers better results than telephone or email. Face-to-face communication may not always be possible because the outsourcing company will not necessarily be in the same country or even on the same continent. In his book, NariKannan examined the effectiveness of ‘Multiple Mechanisms' of outsourcing communications[19].

He raised a very interesting and important issue: ‘the person doing the communicating should verify if the listener got it right.'Hence the language barrier may be a cause of misinterpretation of an action and cause friction at a later stage. Companies will often have a dedicated outsource manager whose directive would be to ensure a daily consistently reliable service and to negotiate with the provider when the buyer and provider slip out of alignment due to a change in business needs and goals. The use of IT resources provides good flexibility to a changing business environment [15][16]. The manager must have a sound understanding of; human resource, financial, and IT implications in order to negotiating a feasible solution with the provider.

It is not uncommon that a relationship between Vendor and client becomes strained. There can be many reasons for this to happen. The Outsourcing relationship should be continuously under review to detect a deteriation before it manifests itself too deeply [3].

Reviewing the Relationship

The Journal of Work Process Improvement [3] recommends:
Periodically conduct joint buyer and provider relationship previews. Reviews should cover:
• Quality of the relationship, including communications and issue resolution;
• How the relationship might be improved to better achieve goals;
• Solicitation of examples of particularly good issue resolution or communication episodes;
• Identification of unresolved issues or misunderstandings. Share audit results with members of management. Repeat positive approaches identified, and remedy noted problems.
The issue, may however, not be solved by any of the actions listed above. In that case it is recommended that team replacements on either side be attempted. It could possibly be a personality conflict which is causing the friction. It is not unusual for people to fall out due to reason not associated with the terms and conditions on the contract.

Terminating a Relationship

Should the relationship take an irreversible turn for the worst then an ‘Exit Plan' will need to be implemented. This should be in place early in the relationship with all the; legal, human resources, transfer of responsibility and change management structures ready to be activated to ensure losses and disruption to the business is minimised. The planned exit strategy may not just be as a result of a breakdown in the relationship. There can be other factors involved. For example India is by far the most popular offshore outsourcing destination for reasons of cheaper labour, English speaking and level of Education, but as outsourcing to this destination matures then so does the economy on which it is based. This raises living standards and with it pay expectations also increase. The current wage inflation in India (2006) was 15% [4] Countries such as China and Brazil are already competing for a slice of this lucrative market. The savings for many UK based companies can be up to 60% by utilising offshore outsourcing. This may get eroded if pay rises force the vendor to renegotiate the contract. The exit clause in the contract could eventually be utilised to switch over to new and more financially competitive vendor.

It would be interesting to investigate typical case studies of actual outsourcing breakdowns and understand what went wrong.

In an article called ‘Outsourcing Change' [5] it was suggested that the outsource manager might be in a position which he or she did not expect or want to be in, after the company decided to go down the route of outsourcing. A usual by-product of outsource implementation is a reduction in onshore labour. The reduction in the labour force can sometimes be considerable. Existing managers may lose their jobs altogether as there will be no staff to manage or be forced into roles which are very different in nature to their previous position. Potentially this could have a detrimental effect on the relationship between the two parties due to poor moral of the manager or lack of experience in this new role. Another point raised in the article [5] is the perception of quality. The onshore manager may be dissatisfied with the action of the offshore team who do not understand the concern. This could be a cultural matter and performing the task requested is what matters and the quality to which the task is done is irrelevant.

The Risks of Outsourcing

A paper called "40 Risks to Establishing an Outsourcing Relationship" [6] identifies ten risks for each category; Strategy (#1), Selection (#2), Implementation (#3) and Management (#4). Some of the items mentioned have already been covered in this paper, but it's worth mentioning a selection of interesting points raised. With regards to Strategy, ‘Outsourcing undesirable functions versus the ones that provide greatest competitive advantage'([6]#1.1).

A company might decide that product advertising should be outsourced in order to be relieved of the task of printing and distributing leaflets. The advertising side of the business may form a distraction when the company wishes to concentrate on producing an end product to sell. Outsourcing advertising and promotion may even make the company product less competitive due to an increase in cost. Pepsi Cola (operating in Hong Kong) only outsourced non-core tasks. They discovered early on that outsourcing their IT controlled product line, even in mainland China was more expensive than hiring their own in-house development staff [10]"Outsourcing in the international market without international operations experience" ([6]#1.4) this could lead to tensions at an early stage in the relationship if both parties have different cultural values. In Middle East cultures it is considered impolite to talk business in a direct way in the initial meeting. There needs to be a gentle lead-in of greetings and ‘small talk'. This is just one example of the need for employing internationally experienced staff
"Lack of risk analysis and risk assessment planning" ([6]#1.10) This is indeed complex and probably impossible to cater for all risks. The last decade has been troubled with natural and manmade disasters. Tsunami's striking Indonesia, Thailand and Japan. Earthquakes in Japan and New Zealand. Floods in Pakistan. Wars and unrest in countries which for many years have been considered stable. Considerable thought must go into the ‘Expect the Unexpected' scenario [20]. No matter how intense and stable the relationship is between the parties in the worst case any of the above could cause a dramatic and sudden end to the outsourcing project. Perhaps it is better for companies to spread the risk and not rely on just one outsource contract. If two contracts are in force simultaneously then if one is suddenly lost the other can take up some or all of the slack.

The second list refers to "Outsourcing Selection Risks". Most of the statements in this list are fairly logical and obvious. The last statement however is interesting ‘Making the selection process a personal rather than a commercial decision' ([6]#2.10) This is probably a good enough reason why the final decision on the selection of the vendor should not be down to just one person.

"Outsourcing Implementation Risks" mentions "Not establishing an outsource relationship that has sufficient flexibility to deal with business fluctuations" ([6]#3.1) as previously discussed this could be a major concern if not treated with great care. The choice of vendor is so important. Negotiating a good financial deal with the vendor may end up a disaster if there is no mechanism in the agreement to cope with new products that need to be added.

Last in the category is ‘Management Risks' Most of the points have been mentioned before, but ([6]#4.8) ‘Expecting too much from a provider in the early months after go-live' It's likely the provider will need time to adapt to the new situation and protocols. Continuous monitoring and feedback involving many regular management-vendor meetingswill be needed to ensure the quality of the service provided is raised to its optimum level and maintained at that level.

Statistical analysis of why failure occurs is available from a company called the "Outsourcing Centre" [7]. In a survey conducted in 2004 based on information from a sample of 305 buyers and providers in N. America, Europe and Asia one third of which were buyer and two thirds providers listed nine criteria on which the survey would contain. These were:
• Buyer's unclear expectations up front
• Poor governance
• Poor Communication
• Provider's Poor Performance
• Buyer's multi-supplier environment
• Interests become misaligned over a period of time
• Not mutually beneficial
• Poor cultural fit
• Other (do not fit into any of the above category)

Finding #1 revealed that by far the greatest cause of failure was the ‘Buyers unclear expectations up front' at 23%. Next at 15% came ‘Interests become misaligned over time'.
Other factors such as: poor governance, poor communication, provider's poor performance and not mutually beneficial all registered in a narrow band between 8% and 13%. ‘Failure due to poor cultural fit' was low at 5%.
Causes that did not fit into the common categories were: ‘Interests that were poorly aligned to begin with', ‘small but continuous changes in the scope' and ‘Buyers that are not committed to the full change management effort necessary for success.
Finding #4 in this survey matched the same criteria to ‘Most Frequent cause of Relationship Failures'
The results revealed that all criteria occupied a narrow band between 9% and 16%. This suggests that there was no single cause that was dominant in terms of the relationship failure although ‘Buyers unclear expectations up front' did top the table at 16%. This result showed a strong correlation with the Failures of Outsourcing survey. Interestingly, ‘Poor Cultural Fit' also came out with 16% in the relationship failure survey but did not have much influence on the overall Outsource Failure (5%).
An Article in Network World [8] the first global outsourcing survey to be undertaken by KPMG concluded that 60% of respondents claiming problems with their outsourcing provider are mostly staff-related. The survey also revealed that sourcing arrangements are not managed correctly with 79 percent of survey respondents unaware of the cost of selecting a sourcing provider. It went on to state. Head of KPMG's IT advisory, EgidioZarellaafter examining the results he commented "Sourcing is completely a people's business; only 13% blamed technology when the contract went bad." He also commented on the purchaser's reluctance to employ a full time Outsource Relationship Manager, instead relying too much on consultants to give advice on the agreement. Due to the fact that outsourcing is relatively new there are not many managers around with vendor management skills. Results of the study found that IT departments are shrinking as IT professionals move to more specialist roles such as Vendor Management.

Failure Recovery

The ‘Outsource Centre' [9] published an article relating to the how to recover from an outsourcing failure. First it is necessary to find out what caused the failure in the first place. The buyers commonly quoted three areas which resulted in the failure:
1. The buyer lost trust in the provider because what the provider initially told the buyer was not true.
2. The buyer was not happy with the level of staffing on the provider side and that the provider was cutting corners for economic gain.
3. There was little or no flexibility. Over a period of time, the provider became unwilling to work with the client's changing needs.

Reason 1 is not difficult to understand. When you look at the situation from the provider's point of view they might be inclined to glamorise their capabilities in order to gain the upper hand when competing for contracts, in the same way an individual may overstate their capabilities on a CV in order to gain better prospects for being invited to an interview.

Reason 2 may refer to complaints from the buyer's clients that they are kept on hold for long periods by a call centre. This tends to be less common these days compared to a decade ago. Many relationship managers have learnt from previous experience that a numerical objective is far easier to quantify than a single ambiguous statement in a contract. For example; in the worst case situation, how long should a customer be kept on hold when being directed through a call centre?

Reason 3 this is likely to be due to the lack of initial planning on both sides. Change is bound to happen eventually and the appointment of a ‘Change Manager' will ensure that both parties are prepared when the need to be flexible comes along.

After experiencing a failed relationship there has been a tendency to ‘treat the symptoms' rather than eliminate the cause, but it's not always easy to identify the cause and a culture of blaming the other party may be the end result.

The study suggests the employment of an independent third party to examining what went wrong in the failed relationship. It also suggests that the buyer should be honest and inform the new provider about the failed relationship with the previous provider. Another idea that was mentioned was to make use of a third party to periodically perform a ‘Relationship Health Check' between the buyer and the provider [21]. Typical criteria relating to an ‘Outsourcing Health Check' is covered by Nigel Swycher of Olswang[20].

Conclusion

The relationship between the client and the outsource vendor is truly one of great complexity. This research found that there are many guidelines for successful outsourcing available and if these were followed then there may be a reduced risk of vendor-client failure. Success or failure will ultimately depend on the management skills of the personnel employed on both sides. Managers with experience in outsource dealings will have gained a great deal of knowledge and hence will be better placed to avoid the pitfalls which could lead to failure of the relationship resulting in termination of the client-vendor agreement.This point was substantiated in a Computerworld study [11] which reported that many companies were filling the experience void with additional coaching.