There is little doubt about it – outsourcing contracts are complicated. Once a company has selected a supplier and the lawyers have gotten involved, a great deal of effort can be expended on negotiating and drafting a contract that both parties will agree “should just stay in the drawer.” Whilst certain clauses are best left to the lawyers, there are a number of others which need to be understood and actively managed by the operational and governance teams throughout the contract. One example of this is the service level agreement, or SLA.
Anyone who has grappled with some of the service level methodologies that exist will understand just how complicated this area can be. Even advisors can struggle to understand the intricacies of their own tools. The first methodologies evolved in the 1990s to cater to large ITO deals that dominated the outsourcing market at that time and were based on the following basic concepts:
i. Appropriate performance standards should be contractually defined to ensure quality performance levels
ii. They should be easy to measure and report
iii. The client should not pay for poor quality services. There should be some level of fees-at-risk to provide a deterrent for suppliers to fail to meet service levels – known as “service level credits”
iv. If the service is consistently unacceptable, the client is entitled to terminate the contract
v. Performance standards should improve over time
vi. Clients need a mechanism to change the focus of their attention from time to time
As BPO contracts – particularly in HRO and FAO – became more prevalent in the early 2000s, the terms that had been applied to ITO and contact centre contracts were replicated, even for concepts such as benchmarking that make less sense in the BPO services world. As many experienced outsourcers will agree, there was a temptation to try to measure everything under the SLA when first faced with the possibilities.
Most service levels tend to measure one of two things – accuracy or timeliness. Many objective measures of performance require both. For example, it will be important that my suppliers’ invoices are made ready for payment in time for me to pay them and for me to pay them the right amount. As BPO contracts developed initially, the focus was very much on cost reduction. Little attention was paid to improving process hand-offs in-house that might aid the overall process. Suppliers were only prepared to be measured on items over which they had full control and so the number of service levels proliferated – to measure various pieces of a process chain that relied wholly on the supplier and could safely ignore the delays caused by client’s internal approval processes.
Additionally, clients could often not tell how well they performed their own processes prior to the outsourcing engagement. Whilst it might be reasonable to expect a supplier to provide services to a level at least as good as those currently provided, this created an opportunity for suppliers to take a “service level credit holiday,” whilst baselines were established.
The market has matured along with attitudes of both suppliers and clients. Suppliers looked to provide continuous improvement on the elements of a process under their control and at the same time they also started to advise clients on the inefficiencies within the process. Common examples include delays in approvals, automation possibilities and a failure to set consistent, meaningful policies to drive processes and behaviour.
Many clients recognize that suppliers can perform these services better than they can themselves and now require more than just cost reduction from outsourcing. They seek transformation, improvement and standardization and they seek these results across the process chains regardless of nominal ownership. Similarly, suppliers have begun to see that they are best served by delivering real improvements to clients across process flows and that they need to work with their clients to drive improvements in areas that will optimize end-to-end processes. After all, why should a client refuse to implement a suggestion to make rational improvements for its own good in a win-win scenario? When suppliers provide services such as high-end analytics, reengineering, and risk management, they provide impactful business intelligence from which clients can make smart business decisions, including which processes should and shouldn’t be outsourced.
Transaction-based pricing has long been discussed but essentially comes down to productivity of FTE-based pricing (unless employees can be truly shared across clients). Contracts are now moving towards outcome-based pricing rather than merely charging for the number of “bodies” on an FTE basis. This has resulted from recognition by both parties that they can work more collaboratively to drive improvements and to release value to the client’s business as a result. This is appealing to both parties as the efforts made by the supplier can be rewarded under a gain share arrangement from value released to the client that would otherwise have remained locked away. This is a true win-win scenario. For example, suppliers will now commit to service levels for Days Sales Outstanding (DSO) collection metrics, recognizing that they can work with clients to apply techniques to drive down the DSO figure and reduce the working capital requirement for the client.
As the BPO market has been maturing, the more experienced clients are now asking for more than cost arbitrage. They are demanding real business impact over and above the lower costs and the increased productivity. There will always be clients who focus on the lowest cost providers but the real value is driven from the value that is released from inefficiencies in the end-to-end processes. Certain suppliers have recognized this. Clients are beginning to do so.