This article was first published in the June 2012 International edition of Accounting and Business magazine
The relationship between an outsourced service provider and a client is like a marriage, whether the service provider is a third party or a captive entity. At the start, both parties are flushed with happiness and hopeful their expectations will not just be met, but exceeded.
Unfortunately, as the relationship matures, satisfaction levels can drop. In outsourcing relationships, with both parties having typically committed to it lasting between five and seven years, this happens when there is misalignment between services agreed in the contract, services expected by the client, and the services actually delivered. This misalignment is sometimes exacerbated by the role of the ‘marriage arranger’ – represented in outsourcing by the specialist teams from both service provider and client who negotiate contract terms. The negotiators are not necessarily those who will be providing and receiving the outsourced service, thus increasing the risk of misalignment between client expectations and the service agreed in the contract.
For example, some services covered by the contract may be neither expected nor delivered, and are thus irrelevant. Other services may be agreed and expected, but not delivered. Service providers can also waste resources delivering services that are neither expected by the client nor agreed in the contract.
There is a sweet spot where the services expected by the client are both agreed in the contract and delivered by the service provider. The bigger the sweet spot, the better. However, over a long-term relationship, careful management is required to avoid any creeping waste in service provision or growing misalignment between client expectations and service delivery.
Based on KPMG firms’ experience, value leakage in outsourced service relationships is most likely to stem from three core areas: operational, performance and portfolio management challenges.
Operational challenges arise, for example, due to the duplication of services provided by both service provider and client. To avoid this, attention needs to be given to redesigning and re-skilling the retained finance function, so that individuals are equipped for their new roles managing the service contract. Performance challenges can arise when problems are not managed or the service provider’s performance is not at expected levels. This could, for example, result from the high degree of personnel churn currently experienced by many service providers.
Turning to performance management challenges, value leakage can occur when service providers identify opportunities for improvements, but the client is unresponsive or fails to make adjustments. Improvement opportunities are likely to be identified once the service handover is completed and process standardisation achieved. Having analysed the client’s data, the service provider may gain new information that could be applied to improve the service – but client action will often be required.
Existing contracts can be reviewed to identify where client organisations could be driving increased value from their outsourcing relationships.
Reviews conducted by KPMG over the last 12 months, using our value assurance framework, reveal some typical areas of conflict between client and service provider. There are, for example, often issues around performance, with the credibility of performance metrics often challenged.
This may be exacerbated by insufficient pre-contract baselining. Clients moving from a decentralised service delivery model to an outsourced model are unlikely to have the right baseline information available. This makes it difficult to set realistic baseline service levels for the provider, or to hold the provider accountable.
Lack of trust
Problems arise with processes too, with efficiencies sometimes lost through clients’ failure to focus on end-to-end process optimisation. This can result from a lack of trust in the provider and an unwillingness to hand over certain processes.
KPMG’s reviews have also found problems in realising the full potential of outsourcing contracts. Some firms complain they are not receiving the levels of innovation outlined in their contracts; but service providers are dependent on client cooperation to help implement innovative ideas.
Other challenges arise in terms of a client’s ability to implement change globally. First-level savings can be achieved through labour arbitrage, but achieving additional benefits requires more significant change. Unless these changes are made, service providers contracted to deliver cost savings will take the hit and suffer falling profit margins, with declining service levels certain to follow. Both parties must, therefore, agree in advance how they will work together to deliver additional savings beyond any easy, early wins.
Finally, problems with perception often occur. Many CFOs often comment that, from what they have heard, their organisation has a poor relationship with its service provider. On investigation, however, KPMG firms often find few significant issues; the CFO is simply picking up ‘noise’ within the system. Day-to-day minor issues do arise, just as they did before the outsourced service contract was put in place. The noise they create is amplified, however, because now an external party can be blamed.
Experience suggests that the higher up the organisation you go, the more ‘noise in the system’ occurs. Such negative perceptions are dangerous and need to be managed. If key stakeholders have poor opinions of the outsourcing relationship, it will ultimately fail and achieving the expected value will prove impossible.