11 Reasons Outsourcing Relationships Fail | The Vendor Underprices the Contract

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 and 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 fourth installment of the series, I will address the problem of vendor underpricing of ITSM contracts.

Vendor Underpricing

Does vendor underpricing really happen?  And is it a problem?  The answer to both questions is an emphatic Yes!  Having been in this industry for more than 30 years, I have seen the good, the bad, and the ugly when it comes to managed service contracts for ITSM, and I can tell you with certainty that more than half of all vendor proposals are underpriced.  This is a serious problem for both vendors and buyers alike and is largely responsible for the high levels of buyer dissatisfaction in the industry

You know the drill. An RFP is written and distributed to as many as 20 managed service providers.  Most, if not all of them will submit a proposal.  You (the buyer) spend hundreds of hours reading, clarifying, evaluating, and ranking the proposals.  Then you down-select to the best 5-7 proposals and invite those vendors to deliver an in-person pitch.  After “vendor day”, and another down-selection, 3-5 proposals make the final cut.  It’s an exhausting process, for vendor and buyer alike.  It’s time consuming, inefficient, and rarely produces the intended result.

It is a well-established fact that there is massive overcapacity in the market for ITSM outsourcing.  By some estimates, the industry capacity is more than 2X the demand for outsourced services.  The result is cutthroat competition to win new business.  A vendor can compete on quality, price, both, or neither.  Many MSPs, in their zeal to win new business, will compete on price because it’s the most obvious differentiator.  Furthermore, because price is so easy to compare between competing proposals it tends to carry more weight in the evaluation process than quality and service levels.  The unfortunate result is that the lowest priced proposals in a typical RFP cattle call end up winning the business almost 50% of the time.  And proposals that are in the bottom price quartile (meaning low price) when compared to competing proposals, end up winning the business a stunning 75% of the time!

Why is this bad? Well, you’ve undoubtedly heard the old adage that “You get what you pay for.”  This turns out to be remarkably true in the market for ITSM outsourcing, where there is more than a rough correlation between price and quality.  As quality goes up, the price goes up, and vice versa.  And because quality and service levels are much harder to gage and intercompare than price, the lure of low price is too strong for many buyers to resist.

This is where underpricing comes in. How do I define underpricing? If a vendor has no chance of fulfilling their contractual requirements because a proposal is priced too low, that proposal is underpriced.  ITSM is a labor-intensive business.  More than two thirds of all ITSM costs are personnel related.  This includes agents, technicians, supervisors, team leads, QA/QC, workforce schedulers and trainers.  So, if a proposal or contract is underpriced it’s almost always because the vendor is not proposing enough staff, has hired or is planning to hire low-cost staff (meaning unqualified staff), or both.  Imagine a field services function that requires 90 techs to be properly staffed, but the service provider hires only 70 techs.  Or imagine the service provider hiring the requisite 90 techs, but they are all unqualified for the job.  In both cases the service provider is highly likely to miss their performance and service level targets, resulting in customer dissatisfaction and a potential breach of contract.

A Proposed Solution

As a buyer, how do you tell the difference between underpriced proposals and realistically priced proposals?  More importantly, how do you differentiate between high value a low/no value proposals? The answer is benchmarking.  By benchmarking a group of vendor proposals against a peer group of similar outsourcing contracts, it is possible to not only avoid the trap of vendor underpricing, but to identify which proposals offer the greatest value.

The term value is somewhat subjective, but at MetricNet we have defined an objective value metric that enables buyers to quantify the value of any outsourcing proposal.  The value metric provides three crucial pieces of data for outsourcing customers:

• The minimum viable price
• Overall Proposal Value on a scale of 0% to 100%
• An overall ranking of vendor proposals

The table below summarizes these metrics for a group of 12 proposals that were recently submitted to one of the largest airlines in the world.

Let me explain how this chart works.  The annual pricing and price per ticket come directly from the vendor proposals, perhaps with some minor calculations.  From benchmarking data we know that any proposal with a price tag of less than $34.50 per ticket is not viable.  In other words, at that price it would be impossible for the vendor to meet the terms of the contract.  Those vendors have been highlighted in red, meaning STAY AWAY!  It is worth noting that of the 12 vendors who submitted proposals for this RFP, seven of them were disqualified for underpricing their proposals.

A balanced score is then calculated for each proposal using a well-established algorithm developed by MetricNet, and now widely used in the industry to rank the overall effectiveness of a support organization.  You can learn more about the balanced score here.

The Proposal Value is then calculated by dividing the balanced score by the Price per Ticket and multiplying that ratio by 40.  You will note that a higher balanced score tends to produce a higher value score, while a higher price per ticket produces a lower value score.  Which is as it should be.  Value increases as the balanced score increases, but it decreases as the price increases.

Finally, we can rank the vendor proposals based on their value scores.  Vendor #9 had the highest proposal value, at 74.1%.  It is worth noting that the proposal with the highest balanced score (vendor #10) did not have the highest value score.  Likewise, the vendor with the lowest acceptable price (vendor #6) also did not have the highest value score.  So, the highest value represents the best tradeoff between price and performance, while also surpassing the minimum viable price threshold.

Some Final Thoughts

Most vendor selections are based on more than just the Proposal Value Score.  Other factors such as the vendor’s reputation and references in the industry, a vendor’s location, technology footprint, their understanding of AI and machine learning, and of course their value proposition will factor into any final vendor decision. But the point of this whitepaper is to help you avoid one of the most common failure modes in outsourcing: vendor underpricing.  Benchmarks will help you identify the minimum viable price for a given proposal or RFP.  The remaining proposals, those that that are viably priced, can be ranked based on their price and balanced score to produce an overall proposal ranking.