May 23, 2016
Outsourcing represents a fundamental component of an organization’s cost management strategy. But in the delivery of complex outsourced services, there is often a disconnect between the prices negotiated during the procurement phase and the actual costs of what is delivered over the term of the contract.
A $200 Billion Problem
The International Association of Outsourcing Professionals has confirmed that the annual contract value (ACV) of outsourcing relationships in global industry eclipsed $1 trillion in 2014. Value leakage from outsourced services is estimated to be 20% of ACV, or $200 billion worldwide. This includes complex dynamic services for IT, logistics, facilities, BPO and other business functions. Sources of leakage include invoicing errors, unrealized discounts and earnbacks along with unrealized performance gains from contracted service-level agreements (SLAs).
The chart below illustrates the value leakage problem, which is the difference between the expected value captured during the procurement stage and the delivered or actual value realized over the term of an agreement.
The Supplier Governance Maturity Gap
A just-released industry report from The Shelby Group and SirionLabs documents how executives across industry sectors responsible for managing outsourced services believe their supplier governance capabilities have not kept pace with the growth in spending. The next chart, excerpted from our report, Overcoming the Value Gap in Outsourcing Engagements, 2016 Report on Outsourcing Governance Maturity, reveals the stark gaps that exist for five key supplier management capabilities: Contract Management, Performance Management, Financial Management, Risk Management and Relationship Management. The data is based on a cross-industry survey of executives from procurement and sourcing, vendor management, consulting and business/executive management.
Current State of the Industry
Our research reveals the following challenges that exist today in managing outsourced services delivery:
- The vast majority of attention paid to outsourcing arrangements is “pre-signature.” From business case development to scope determination to supplier selection and finally contract negotiation, the majority of corporate attention (and resources) is paid to this aspect of the outsourcing relationship.
- Most outsourcing contracts are negotiated without an operational perspective. Once “ink is on the paper,” the contract becomes the responsibility of the people charged with management of the outsourcing arrangement. In most cases, the operational team was not involved in defining the contract obligations for the outsourcer. This leads to many discussions about “what was meant by…”, and that leads to further value leakage from what was contemplated.
- The governance infrastructure for most firms is Excel. This may be the most damning aspect of “post-signature contract governance.” There is no equipping framework and automation infrastructure to assist in the management of these contracts — contracts that can run upwards of 7 years, 3000 pages and hundreds of millions of dollars.
Key Concepts and Insights for Overcoming the Value Gap
The following are some of the key concepts and insights shared in the report by The Shelby Group and SirionLabs:
Brute-force attempts at achieving cost savings from suppliers backfire because many sellers have a decided advantage in maintaining desired margins.
To address the value leakage problem, executives from procurement, sourcing, supplier management, project management and shared services teams must move beyond an enforcement mindset to enable opportunities for value creation that yield benefits for all stakeholders involved in the value chain.
Supplier relationship management and performance management, within which the greatest capability gaps exist, need to be viewed from a partnership perspective.
Buyers and sellers need access to a common source of truth in near real time with regard to accountability for performance and value creation.
In order to overcome the value gap in outsourced services delivery, companies must implement a comprehensive approach to supplier management that:
- Enables integration of all key supplier management disciplines (contracts, performance, finance, relationship and risk) on a single platform
- Provides configurable workflows for all key processes within each discipline and automates high-volume activities like performance and invoice validation
- Delivers advanced analytics and predictive insights in client-supplier relationships by normalizing the heterogeneous data with the help of smart taxonomies
Such a system will allow organizations to redirect their focus to supply chain value and risk and relationship management while reaping productivity gains, improving performance visibility and forecasting expected outcomes.
In summary, we believe that clients need to look beyond cost control and SLA monitoring to focus on initiatives that drive greater strategic value and competitive advantage from outsourcing partnerships.
Download a copy of the report: Overcoming the Value Gap in Outsourcing Engagements, 2016 Report on Outsourcing Governance Maturity.
The Shelby Group