Buy Now. Pay Later.

In this article for leading publication Outsource, founding partner Andy Palfrey reflects on the pitfalls of financial engineering in outsourcing deals and offers a few thoughts on how to avoid getting caught in the outsourcing 'credit crunch'.

"Most days I read an article, have a conversation or attend a meeting where outsourcing finds itself the victim of a good old fashioned beating. Like a scene from a Hollywood blockbuster, outsourcing ends up with a bloody nose and black eye, dished out by its disgruntled consumers for a wide range of reasons.

One area that is currently receiving considerable attention is that of Financial Engineering (FE), whereby an outsourcing deal is structured to deliver considerable commercial upsides soon after signature. The benefits can be significant, with FE typically enabling the early year ‘savings’, which are usually the keystone of the business case. Sadly, the latter years of such deals are often not so rewarding…

Many deals struck are starting to look less impressive than they did when the ink was wet (which was, of course, bang in the middle of the recession). Up-front savings are long forgotten and the transition and transformation programme is complete. Unfortunately, the service provider charges (which include ‘repayment’ of the upfront savings) are often considerably above market run rate, which is further compounded by changes to business requirements not being properly addressed. Dissatisfaction is expressed – but the service provider (which is still recovering its up-front investment required to deliver the client’s required end-state and only now beginning to make its profit) has little opportunity to be particularly flexible or to reduce its charges. This ‘inflexibility’ is perceived as profiteering and “not in the spirit of partnership”. The rot sets in and in more extreme cases, the irrecoverable breakdown of the relationship ensues.

So why do these ‘buy now, pay later’ fiascos occur? What is the root cause? Greedy service providers? Unexpected and rapid changes in business environments? Poor deal management? New technology? Deforestation of the Amazon?

The answer, as always, is much simpler. In my humble opinion, and underpinned by twenty or so years of follicle-destroying experience, it’s nothing more complex than a lack of vision and properly communicated, well-understood objectives…

A lack of vision can have a catastrophic impact on the long-term viability of an outsourcing transaction and the level of business value that it generates. Sadly, the importance of clear vision – with supporting strategy and well-communicated and -understood objectives – is often overshadowed by a ‘show me the money’ rhetoric that supports a rapid step change (i.e. reduction) in cost. Being comparatively simple to engineer, the focus of the transaction becomes a financial one, rather than one of how the service will meet the business requirements over the term.

Sadly, when outsourcing deals are structured in this way (by focussing on the immediate savings –typically “the same mess for less”), there are few silver linings or miracle cures available. Snake Oil may work – and will of course be peddled by many – but I personally wouldn’t rely on it. Rather, I’d focus efforts on not making the mistakes in the first place… Some simple advice:

  • Define your vision, strategy and objectives. Spend more time than you think necessary on considering what the wider business needs are – not just the requirements of the business unit that is running the outsourcing programme (e.g. IT, HR, F&A, etc.). Consult and engage the business stakeholders early and ensure there is suitable representation on the programme governance board. All too often the ‘business’ (i.e. those who are the main consumers of the service) are poorly (sometimes never…) represented. Also, make sure that the deal does not conflict with other initiatives: deals struck in comparative isolation that then fail to support wider business goals are all too common.
  • Collaborate – don’t confront. Once the business vision is clear, documented and fully supported, engaging the market with clarity, confidence and conviction becomes much easier. Underpinning this should be a genuine desire to collaborate and be receptive to service provider ideas. How would you want your service provider to behave? Would you want them to be prescriptive and confrontational? Exactly… Sadly, all too many deals are constructed using blunt, antiquated approaches and screaming “I’m the customer and spending millions – I must be right – so just do what I say…” The service provider should know considerably more about its services than you do. You should know a lot more about your business than the service provider. Focus your resources accordingly – tell them what your business needs are and let the service provider focus on developing the best solution.
  • Simplify processes. Outsourcing deals are typically managed via a myriad of complex processes, reports, dashboards, metrics, KPIs, OLAs, SLAs and the like – often with very little understanding of the mechanics that underpin them. My advice here: focus on keeping things simple. A deal with fewer components that are better engineered (and hence better understood, more robust and manageable) is invaluable.
  • Build a great team from the outset. The deal should be managed by a team that has the correct, and best available, skills and experience. Ideally this team should have been involved in the creation of the deal from the beginning. All too often businesses cobble together an ill-considered organisation at the last minute that is wholly incapable of managing the deal to best effect. More worryingly, not having the team intimately involved in the development of the deal places the body of knowledge – and hence the locus of control – with the service provider – an undesirable imbalance.

These things might sound simple – and to be truthful, they are. Whilst less headline-grabbing than the multi-million savings, headcount reduction or shiny new technology and services associated with major outsourcing deals, suitable focus on these four areas is likely to realise much more business value over the term of the deal.

Buy now, benefit later…"