11 Reasons Outsourcing Relationships Fail – Client and Vendor View the Contract as a Zero-Sum Game

In the first article in this series, I outlined the 11 most common failure modes for IT outsourcing relationships.  These are summarized below for your reference:

• The vendor over-promises, and fails to deliver on their commitments
• The client fails to exercise proper governance over the vendor contract
• The vendor underprices the contract and fails to earn a profit
• The contract fails to align vendor with client goals and objectives
• Vendor reports contain raw data, but rarely include proper diagnosis
• The client does not understand the metrics included in vendor reports
• Both client and vendor view the contract as a zero-sum game
• Vendors spin data and reports to cast themselves in the most favorable light
• Continuous improvement is ill defined or not included in the contract
• Vendors experience extremely high turnover on a client project
• Vendors and/or the client do not adequately train personnel

In this eight installment of the series, I will address the problem of clients and vendors viewing the outsourcing contract as a zero-sum game.

Avoiding the Zero-Sum Trap

A zero-sum game is when your gain is another party’s loss, and vice versa.  Some business transactions truly are zero-sum.  The stock market, for example, is often cited as zero sum.  When you buy or sell a stock, your win is the counterparty’s loss, and your loss is the counterparty’s win.

But when it comes to IT outsourcing, zero-sum is a very common but cynical viewpoint. Under the zero-sum mentality, there is no “win-win” scenario.  There are only winners and losers, and both sides want to win.  The inevitable result is that contracts forged under a zero-sum mindset are ill conceived, and vendor/client conflict is all but guaranteed.  But there is another way.  I have seen win-win contracts with my own eyes. They do exist!

Let’s start by defining what a win-win contract is.  From the vendor’s perspective a winning scenario looks like this:

• They are treated fairly
• They are compensated fairly
• They earn a reasonable profit on the contract
• There is the possibility of contract expansion and/or renewal if they perform well
• The client is happy with the vendor’s performance

And from the client’s perspective a winning scenario looks like this:

• The vendor is meeting their contractual obligations
• The management team at the client is satisfied with the vendor’s performance
• The end-users are satisfied with the vendor’s performance
• The client is paying a fair price for the vendor’s services
• The vendor is acting in good faith with the client
• The vendor is open to change and continuous improvement

There are, of course, many other attributes we could add to this list.  But at the very least, these are the building blocks of a win-win business relationship.  Unfortunately, fewer than 5% of all managed service contracts fall into the win-win category.

So, how do we ensure that both sides end up with a win in their business relationship?  Start by defining in as much detail as possible your own goals and objectives.  Then ask yourself if the vendor can reasonably meet your objectives.  Most of these objectives can be quantified.  Examples of quantifiable performance objectives include performance targets for such metrics as Customer Satisfaction, First Contact Resolution Rate, and Mean Time to Resolve.  Other goals are more subjective, but can nevertheless be quantified. For example, if one objective is to shift left, you can define the percentage of tickets that you expect to be resolved at each level in the support organization, and then specify how those percentages evolve over the life of the contract.  Likewise, if the contract specifies that the vendor will mature the ITIL discipline of problem management, you can quantify their success in this endeavor by measuring the reduction in ticket volume per user per month.

This begs the question of whether the vendor can even achieve the goals and objectives you envision for your contract.  Too often, performance targets specified in contracts and RFPs are arbitrary, and based on nothing more than a best guess. This is a recipe for frustration, as the result can be performance targets that are too easy for the vendor to achieve, or performance targets that are impossible for the vendor to achieve.  There is, however, a time-tested solution.

Benchmarking is an indispensable aid in the sourcing toolbox.  By benchmarking other service providers, one can determine the performance levels that are possible and achievable rather than simply fanciful.  As an example, the performance quartiles shown below have been excerpted from a desktop support benchmark performed by MetricNet in conjunction with a contract re-compete.

How do we interpret this data?  Well, it’s quite simple.  Anything that falls outside the range of the first quartile (top quartile) is either unrealistic or unacceptable.  A performance target that falls within the second, third, or fourth quartile is not aggressive enough and will be too easy for a vendor to achieve.  It’s unacceptable.  By contrast, a performance target that falls outside of the top quartile on the high side (i.e., better than top quartile performance) is unrealistic, and the vendor will fail to meet that target.  Our recommendation, therefore, is to establish performance targets that get you into the top quartile.  In other words, the break point between the first and second quartile is where you specify your performance targets.  This is the prototypical sweet spot where the vendor is delivering their best all-in performance, and the customer is receiving the best possible value for their outsourcing dollar.

For this particular benchmark, the top quartile performance can be summarized as follows:

• Price per Ticket = $79.64
• Customer Satisfaction = 94.7%
• Technician Utilization = 63.0%
• First Contact Resolution Rate = 87.0%
• Technician Job Satisfaction = 91.3%
• Mean Time to Resolve = 3.8 hours

For this particular outsourcing contract, these are the price and performance targets that are both realistic and achievable.

The Challenge of Industry Overcapacity

Those who are familiar with IT outsourcing know that there is massive overcapacity in the industry. Some analysts have estimated that the capacity for outsourcers to deliver IT services is at least double the demand for such services.  Moreover, overcapacity in any industry has the effect of driving prices down.  In an industry where buyers are prone to picking the low-cost bid on an RFP, this is a big mistake.  Because more often than not the price on the lowest cost bid falls outside of the top quartile; meaning that it’s lower priced than the best benchmarking data in the top quartile.

When a vendor proposal is underpriced (i.e., better than the top quartile benchmark price), neither party wins.  In fact, both parties will lose because the vendor will have an unprofitable contract, and the buyer will be disappointed because the vendor will fall short of delivering the performance specified in the contract.  That’s a classic lose/lose. This is why picking the low-cost bid is almost always a mistake.  You are far better off with a contract that is higher priced (but still in the top quartile), because if the other performance targets are specified properly (also top quartile) you should have every expectation that the vendor can meet their performance objectives.  That’s a classic win/win!

Some Final Thoughts on Zero-Sum Contracts

Zero-Sum contracts are the norm in IT outsourcing.  However, these contracts almost inevitably lead to disappointment on the part of the vendor, the client, or both.  A far better strategy when sourcing IT services is to think win-win: how does the vendor win and how does the client win? The best approach to resolving this dilemma is to benchmark other, similar outsourcing contracts to determine what levels of price and performance are possible.  MetricNet recommends establishing price and performance targets that are top quartile for the industry.

Not only does benchmarking lead to the best all-in value for both vendor and client, but it also prevents the reckless tendency for clients to pick the low-cost proposal in an RFP competition.  Some low-cost proposals are legitimate, i.e., the vendor can achieve the performance targets specified in the RFP.  But most are not. Benchmarking not only provides guidelines for the performance targets you specify in an RFP or contract, but gives you insight into the lowest price possible while still allowing the vendor to achieve the performance targets specified.