What Companies Need to Understand about Outcome-Based Approaches in Outsourcing

Among the various changes that will impact outsourcing over the next five years, Don Schulman, General Manager of Finance and Administration at IBM, says the first will be a focus on outcomes-based pricing models. “Focusing on clients’ end-to-end processes, the discussion moves to outcomes pretty fast when considering the advantage of an outsourcer doing a client’s work. Over the next five years, this will become a critical differentiator in the way clients and providers work together,” he predicts.

Les Mara, who leads Enterprises Services BPO in EMEA for HP, agrees. “In the next few years, I think that outcome-based approaches will accentuate polarization in the market between niche providers and mainstream providers.” He predicts polarization because he believes that buyers can only undertake these sorts of arrangements with larger, more mature, asset-rich providers.

Mohammed Haque, Vice President and Head of Enterprise Solutions Service practice at Genpact, says that 90-95 percent of outsourcing arrangements today are still based on time and materials or a fixed fee with only five percent tied to outcome-based pricing. But he predicts that, within the next five years, 40-50 percent of the contracts will be outcome based.

Though some companies achieved truly outstanding results from outcome-based approaches, to date they are few and far between. The problems with this sort of outsourcing arrangement lie in the following aspects:

• It requires that the buyer have a deep level of trust in the provider — not only its capabilities but also its continual demonstration of partnering.
• Measurable outcomes require a level of visibility that one or both parties may not be willing to provide.
• It may not be possible to measure a provider’s exact impact on an outcome.
• The service provider must assume a great deal of risk since it does not have influence over all aspects that impact its ability to achieve the outcome. And the amount of risk increases significantly when the outcome is higher up on the value chain.

Historically, companies found it difficult to achieve success in these kinds of outsourcing arrangements. What will enable the predicted shift to nearly half of the deals being outcome based in the next five years?

Enablers and catalysts for the change to outcome-based outsourcing

The industry experts we interviewed discussed three catalysts that will enable buyers and service providers to widely adopt an outcome-based approach over the next few years.

1. Outsourcing is now evolving beyond savings through labor arbitrage and focusing on new and different ways to create value, including synergies between functions as key drivers of value. Scott Mingee, Senior Vice President, Business Development for ACS’s commercial healthcare, finance and insurance lines of business, explains a key enabler of changing from unit-cost or transactional-cost approaches to outcome-based approaches. “The approach is changing especially in areas where the buyer has a significant fixed cost. This is forcing them to get more creative because so much of their current spend isn’t in people, so there’s not as much savings available through labor arbitrage. The value in an outcome-based approach depends on transformation through new innovations that a provider needs to bring to a specific function.”Rahul Singh, Head of BFS & INS BPO at Tata Consultancy Services (TCS), concurs and adds that customers will no longer want to pay huge fees for “consulting” and “improving” processes; instead, the providers will find it imperative to transform the processes to drive better output and outcome.
2. Providers are now investing and innovating around invigorating their capabilities in and around new value creation.Mingee says leading providers are now building the capability for a value-creation approach and that more buyers will adopt it as the basis of their arrangement over the next three to six years. Part of this involves building platforms and simplifying processes. But it also requires that providers gain deeper knowledge of a customer’s industry. Haque at Genpact believes the industry knowledge and domain knowledge will play an important role in achieving business outcomes.Haque also says the capability for delivering more value outcomes necessitates “providers not being tied to a linear group. It will call for a change in the mix of the consulting and technical teams. Providers will have to change their complete game in order to help their customers change the outcomes,” Haque states.Mara agrees. “In outcome-based approaches, the outsourcer doesn’t just provide services; it also takes responsibility for achieving a different business outcome on a different level of balance-sheet performance.” He cites an example of migrating all of a buyer’s finance and accounting functions within the engagement’s pricing based largely on the provider’s performance in improving the buyer’s working capital position.Mara says that, although this is an extreme example of an outcome approach by today’s level of risk adoption, he believes “buyers and providers should definitely be encouraged to focus on outcome objectives. I don’t believe buyers should just hand over a process in the sense of ‘do this for us’ anymore. Outsourcing can deliver higher value, and outsourced processes need to achieve outcomes that align with the business agenda of the client.”However, he adds that outsourcing arrangements focusing on outcome objectives can only be successful when both parties are collaborative and take a partnering approach.
3. The partnering approach to outsourcing relationships will deepen.“Outcome-based sourcing creates a greater level of dependency on the service provider,” warns Mara. Haque explains it is “extremely important that the buyer understand the level of risk the provider must take to help the customer achieve the desired business outcome. This will only work if it is a complete partnership type of relationship and if there is strong governance and relationship management. And senior leaders on both sides must work together.”V.K. Raman, Head of Domain BPO Services at TCS, says that over the next two to three years the delivery of transactional services will become a hygiene factor and providers will increasingly contribute to the customer’s business strategy. Outcome-based sourcing will involve a longer contract life. And it will definitely involve a deeper level of collaboration as well as the buyer’s willingness for the provider to take on a trusted advisor role.

Advice for establishing an outcome-based model

There are some fundamental things that are different in structuring an outcome-based approach to outsourcing.

1. Transparency and trust. Mingee at ACS says the parties must first get to a deeper level of trust, which will also increase the level of transparency, collaboration, and information-sharing than currently exist in most outsourcing arrangements in today’s environment.”By transparency, I’m talking about sharing with your partner all of your information, not just some basic volumes and general costs. It’s both companies talking about their business, where their problems lie, the opportunities, and developing a shared vision of a new outcome.”Historically, companies that achieved outstanding success with outcome-based approaches undertook those initiatives only after they achieved a certain level of mutual trust. However, because of the three enablers described above, and because of the impact of the mid-sized market being more willing to immediately adopt outcome-based approaches as a means of quickly gaining competitive advantage, the outsourcing industry will likely see more companies establishing outcome-based sourcing initiatives sooner in the time frame of a relationship.
2. Data requirements. Haque advises buyers must understand that a switch to outcome-based pricing “cannot happen overnight. For many, it is a journey that can take at least 18-24 months to implement.” The buyer must have complete data, and the provider must do an assessment of the buyer’s landscape.
3. Measuring outcomes. Mara warns that companies in an outcome-based arrangement must critically review service level agreements (SLAs) to ensure they align with the desired strategic business outcome. “Most companies today are accustomed to SLAs that measure activity and workflow steps, and those outputs are not necessarily aligned to business outcomes.”
4. 4. Risk-reward models. For the greatest and riskiest outcomes, buyers and providers may need to employ a shared risk-reward model. Besides demonstrating a willingness to “put skin in the game,” this strategy incents the right behavior on both sides (including enforcing a commitment to change) that can influence the desired outcome.

Impact on third-party advisory services

In contrast to the current trend of buyers infrequently using third-party outsourcing consultants to help structure cost-based approaches in outsourcing, many buyers turn to expert third-party advisors for help with outcome-based sourcing arrangements.

However, Mingee at ACS believes outsourcing consultancies will change as adoption of this type of outsourcing increases. “Third-party advisors’ experience has largely been in unit-based sourcing,” he explains. “I think they will need to evolve into areas of specialty, with outcome-based sourcing as a specialty, or perhaps outcome-based approaches within towers or industries as specialties. I am not sure exactly how it will evolve, but I believe this specialization and verticalization will become more and more important relative to the use of third-party advisors.”

Examples of structuring outcome-based services

ACS recently developed an outcome-based offering in healthcare communications. Here’s an overview of how the provider can originate this kind of an offering and how buyers will benefit by adopting such an approach.

• Buyers’ business situation: (1) Demand on healthcare payers to communicate more effectively with their members and with healthcare providers (such as hospitals and physicians). (2) Healthcare reform and legislation will create more competition for consumers, which will drive the creation of products and an added emphasis on creating consumer “stickiness” for health plans. (3) The continued cost escalation of healthcare in the U.S. economy is forcing health plans to look for new and different ways to create value, including ways to monetize their existing infrastructure and operational assets.
• The impact of the provider’s capabilities and industry knowledge. Because of ACS’s expertise in the healthcare vertical, it recognized the following situations. (1) It could help health plans extract new value out of the health plans’ printing and communications infrastructure. (2) It could also create value by reducing the insurance companies’ biggest communications cost factor: postage. (3) It could create additional new value by integrating/converging the insurance companies’ various customer service communication channels for explanations of benefits and remittance advice.
• Risk-reward model. The offering uses a shared risk-reward model to align and incent both parties’ behaviors in achieving the outcome. “A large part of our revenue only comes if we successfully extract new value by reducing their postage spend,” reports Mingee. He says postage for a large national health plan may represent $70 million of a $100 million budget in overall print and mail operations. In the past, insurance companies moved to electronic communications but there was no incentive to control or shut down paper communications, so they ended up paying for both. The risk-reward model enables achieving the desired outcome.
• The provider’s investments. ACS has invested in infrastructure enabling an ecosystem approach to communications, which would aggregate the communications of multiple health plans and multiple healthcare providers, thus creating new value by further significant cost reduction. Mingee says the provider’s infrastructure investments plus its vertical expertise will cause the healthcare communications market to “work together in new and different ways to streamline processes and create new value by taking costs out of the system.”

BancTec also provides an outcome-based approach to document-centric processes. Paul Diegelman, BancTec’s Practice Manager of Finance and Accounting Optimization, describes its “Inbound Services” offering as a “process-enriched structure for handling, processing, and decisioning all incoming business documents in a manner that achieves balanced outcomes of compliance, risk management, and client service in a long-term, jointly supportable business case.”

BancTec’s approach leverages the synergies between document management and downstream business processes such as F&A, HR, healthcare membership management, loan servicing, and others. “The mailroom isn’t just a place where mail is delivered — it’s the point of origin for many key business processes that affect a client’s working capital, customer relations, and profitability,” Diegelman says.

This more comprehensive end-to-end approach, which is platform based rather than based on geographically dispersed labor, creates outcomes of reduced costs, reduced process friction, faster time to resolution, and reduced risk through improved compliance with policies and procedures.

The BancTec exec says, “The market has already begun to realize that these sorts of opportunities exist, and adoption of this centralized, outcome-based approach for document management and the resulting downstream business processes will accelerate within the next few years, especially among the Fortune 1000.”

The vision

Mara at HP comments that companies have found various sources of value through outsourcing over the past few years; but, with outcome-based approaches, outsourcing comes almost full circle to its original vision and value proposition.

Mingee points out that providers demonstrate their commitment by making substantial investments in not only service delivery solutions, but industry knowledge and have acquired demonstrable experience in the field. Providers are not just building platforms or enabling infrastructure. Their knowledge and experience leverages the IT and delivery investments to make outcome-based sourcing successful.

There is a saying that “life isn’t about finding yourself, it’s about creating yourself.” Companies that leverage an outcome-based approach to outsourcing over the next few years will have a new competitive advantage from creating their own value in outsourcing.

Lessons from the Outsourcing Journal:

• Although some companies achieved outstanding results with outcome-based outsourcing, this approach historically saw low adoption because of its challenges regarding the required level of trust and visibility, measurement of outcome, and the service provider’s ability to impact influences on the outcome.
• The next five years will see a greater adoption of outcome-based approaches to outsourcing because of these catalysts and enablers:
  • The necessity to create new value beyond labor arbitrage and ensure the value aligns with the buyer’s strategic business goals
  • Providers’ investments in developing vertical solutions, platforms, and other enabling infrastructure, thus increasing their ability to impact outcomes
  • Deeper level of partnering in relationships, which will impact trust and collaboration and facilitate the provider’s ability to influence outcomes
• For the greatest and riskiest outcomes, buyers and providers may need to employ a shared risk-reward model. This incents the right behavior on both sides (including enforcing a commitment to change) that can influence the desired outcome.