Vested Outsourcing: Five Rules That Transform Outsourcing

By Kate Vitasek

Outsourcing has become a key strategy for many international businesses. But today’s post-pandemic supply chain crisis has many companies finger-pointing and blaming their suppliers for their supply chain woes. While it might be easy to blame your suppliers, research at the University of Tennessee suggests many issues stem not from outsourcing – but rather from how organizations are outsourcing.

The vast majority of outsourcing deals today are structured using a conventional transactional business model with the buyer trying to get the best price/service and the supplier trying to maximize their profits. This buy-sell WIIFMe (what’s-in-it-for-me) mindset pits buyers and suppliers across the table from each other like a tug-of-war; a win for the buyer is a loss for the supplier, and vice-versa.

Take for example the very real issue of inflation. If the buyer has shifted the risk to inflation to the supplier, the supplier loses with a lower margin. And if the buyer has taken the risk on inflation, the company outsourcing suffers from higher costs.

But is there a better way? University of Tennessee researchers believe there is a better way – and call it Vested Outsourcing – or simply Vested for short. The Vested methodology replaces a transactional “buy-sell” relationship with a highly collaborative relational contract using an outcome-based economic model. Business partners create a genuine win-win partnership purpose-build to navigate the dynamic nature of business and drive innovation.

But how do you go beyond simply saying strategic partnership to becoming true win-win strategic partners? By architecting your outsourcing agreement based on the below five simple rules.

1. Outcome-based (not transaction-based) Business Model
2. Focus on the What, not the How
3. Clearly Defined and Measurable Outcomes
4. Pricing Model with Incentives that Optimize the Business
5. Insight vs. Oversight Governance Structure

The Five Rules are supported by ten contractual “Elements” that address and resolve the structural flaws that can emerge in transaction-based agreements: For example:

• A buyer wants “innovation,” – yet the contract with the supplier has an 800-page Statement of Work with exacting details on how the supplier should perform each of the activities in scope
• The buyer wants “outcomes,” – yet the contract spells out dozens of “Service Level Agreement” metrics
• The buyer outsourced to the expert and wanted more “insight,” – yet the buyer left an army of people on staff to provide “oversight” to manage the supplier.
• The buyer wants the supplier to implement “efficiencies,” – yet its transactional pricing scheme inherently incentivizes the supplier to perform more transactions.

The Vested Five Rules for Outsourcing Success

The Five Rules and 10 Elements (noted in Figure 1) work together to form a win-win business model to help outsourcing partners focus on creating and sharing value. Rules 1 through 4 establish the fundamental rules of the contract by establishing the Desired Outcomes, scope, metrics and economics of the partnership. Rule 5 establishes how the parties will govern the relationship.

Combined, the Vested Five Rules help refocus business partnerships from a “what’s-in-it-for- Me (WIIFMe) transactional approach to a highly collaborative “what’s-in-it-for-We” (WIIFWe) Vested business model that promotes (and rewards) the parties when they collaborate. For example, instead of negotiating who will bear the risk of inflation, the parties embrace the fact that inflation is a reality of business and collaborate to identify and invest in operational efficiencies to mitigate the impact of inflation.

Rule 1 Outcome-based vs. Transaction-based Business Model

Traditionally, many outsourcing arrangements are built around a transactional model. Under this conventional method, the service provider is paid for every transaction – whether or not it is needed. The more inefficient the entire process, the more money the service provider can make. Vested, by contrast, operates under an outcome-based model; the service provider aligns its interests to what the company actually wants – success against strategic business goals.

Rule 2 Focus on the What, not the How

Adopting a Vested business model does not change the nature of the work to be performed. At the operational level, there is still a need for material to be stored, orders to be managed and fulfilled, calls to be answered and goods to be delivered. What does change is how the company purchases the outsourced services. Under the Vested model, the buyer specifies “what” they want. It is up to the service provider to figure out “how” to put the supporting pieces together to achieve the company’s goals. This gives the service provider the creative room to challenge the status quo and seek the best solutions to do the job.

Rule 3 Clearly defined and measurable desired outcomes

The third rule of Vested is to clearly define and measure desired outcomes that become the beacon for success. Desired outcomes are jointly developed by the buyer and supplier and represent boundary-spanning business needs, not simply task-oriented service level measures.

EY’s Magnus Kuchler (EY Sweden’s Managing Partner and Nordics Market Leader) explains how organizations make the shift to measuring outcomes under the Vested methodology. “The conventional approach to measuring success is to have dozens – if not hundreds – of detailed service level measures. But true success is almost always defined by more than one process in a networked system. So when you break a process down into small parts, it is easy to fall into measurement minutiae. Real success comes not from ‘did the supplier get the task done’ – but from the end-to-end process succeeding. After all – who cares if your services provider processed an invoice for payment if the invoice sat in an employee’s email inbox for five days waiting for approval? The point is that the end-to-end process failed. What I like about Vested is it eliminates the blame game and uses transparent and collaborative end-to-end root cause analysis where business partners are aligned on a common understanding of success.”

Rule 4 Pricing Model with Incentives that Optimize the Business

The fourth rule centers on structuring a pricing model with incentives that reward the service provider for optimizing the business. A key goal of the pricing model is to incentivize the service provider to drive continuous improvement and to invest in innovation linked to the parties’ desired outcomes. There are two principles for establishing a pricing model. First, the model must balance risk and reward for both parties. The agreement should be structured to ensure the service provider assumes risk only for decisions within their control. For example, a transportation service provider should never be penalized (or rewarded) for the changing costs of fuel. Similarly, a property management service provider should never be penalized for an increase in energy prices. Second, the pricing model needs to link incentives to the desired outcomes. The more effective the service provider is at helping their client achieve desired outcomes, the more incentives (or profits) it can make. A well-structured pricing model creates a true win-win; a win for the supplier is a win for the buyer – and vice versa.

Rule 5 Insight vs. oversight governance structure

The Vested model shifts from a culture of oversight to one of insight. Simply put, the buying organization turns its focus to managing the business with the service provider, not just managing the service provider. Why? If you’ve done a good job of selecting the right partner and aligning their interests by using rules one to four, then the service provider will truly have a vested interest in performing because their success depends on achieving success for the
buying organization.

While many outsourcing deals rely on governance mechanisms, most do so informally. David Frydlinger – Manager Partner for Stockholm-based Cirio Law Firm – shares his experience helping companies create Vested deals. “A key part of creating a Vested agreement is recognizing that you are creating a formal relational contract. This means you must put the relationship front and center and embed formal relationship management constructs into the agreement. We recommend companies create a robust governance schedule written in plain language versus legal-eze. Formally making governance part of the contract obligates the parties to take proper governance seriously. Yet writing in plain language in the form of a contract schedule enables the parties to use the schedule more like a ‘playbook.’ Team members can look at the schedule and clearly see how to govern
their partnership.”

The Vested Business Model

The Five Rules, working in conjunction with the ten contractual Elements, address and resolve the structural flaws that can emerge in transaction-based agreements. For example:

• Suppliers are now rewarded for driving efficiencies and delivering on innovation initiatives
• Outcome-based metrics promote buyers and suppliers to work together to achieve real business success – not just performing tasks
• Relational governance structures and mechanisms foster an environment of collaboration to solve problems, not simply micromanaging performance

From Research to Relevance

Today, over 100 organizations have applied the Vested methodology in outsourcing deals as diverse as facilities management, reverse logistics, third-party logistics, environmental services, fiber optic network management and labor services. UT’s research now includes seven books, 18 white papers, and 18 public case studies that document the success stories of organizations such as Intel (third party logistics), Dell (reverse logistics), Vancouver Coastal Health (environmental services), and Island Health (labor services/union contract with doctors) and BP (real estate and facilities management).

The Vested movement has become a model for best practices in outsourcing globally. UT profiled the lessons from sixteen Europe-based Vested agreements in the white paper – From Research to Relevance (a free download from UT’s research library1). Most recently, BP’s Wendy Cuthbert (Head of Global Workplace Solutions for BP) and Ardell Bunt (Head of Client solutions EMEA for JLL) shared their success in an interview with UK-based EP Business in Hospitality². Cuthbert’s take after making the shift to Vested? “I’d like to think the traditional way of outsourcing has had its day now, and people will start seeing the real benefits of working
alongside in a mutual relationship rather than being one-sided.”

The Bottom Line

The bottom line is the bottom line. Vested outsourcing is helping organizations transform their outsourcing efforts into powerful win-win contracts that yield results – not just for the buying organization, but also for service providers. That is the definition of a true win-win.

The Vested sourcing business model is based on five transformative rules designed to spur collaborative and innovative mindsets. Vested leverages components of an outcome-based business model with the Nobel Prize-winning concepts of behavioral economics and the principles of shared value.

• Behavioral economics is the study of the quantified impact of individual behavior or the decision-makers within an organization. Behavioral economics is evolving more broadly into the concept of relational economics, which proposes that economic value can be expanded through positive relationship (I win-you win) thinking rather than adversarial relationships (I-win-you-lose).
• Shared value principles are designed to generate economic value in a way that builds value for all parties. Entities work together to bring value that benefit all parties–with a conscious effort that the parties gain or share in the rewards. UT researchers call this a “what’s in it for we” mindset.
• Outcome-based approaches, which have roots in the aerospace and defense industries, center on paying a supplier for achieving a defined set of business outcomes rather than paying for a transaction or activity.

These approaches combine to form the Vested business model, which stresses the importance of building highly collaborative, mutually successful relationships with suppliers while emphasizing creating and sharing value for everyone involved. ¹

About the Author

Kate Vitasek is an international authority on the art, science and practice of highly collaborative business relationships. Kate’s award-winning research at the University of Tennessee has led to the Vested® business model for highly collaborative relationships and has been featured on CNN International, Bloomberg, NPR, and Fox Business News. She is the author of seven books and her work has been featured in over 300 articles including Harvard Business Review, Chief Executive Magazine, and Forbes.

References

1. Vested Library, https://www.vestedway.com/vested-library/
2. Why Vested? In Discussion with BP and JLL, Youtube, 2021 https://www.youtube.com/watch?v=ClO9cjK_D7g