value insights

Outsourcing Performance Management Strategies- Valutrics

As organizations outsource larger and more complex processes, performance management has become increasingly challenging. Performance management is more complex in business services than in manufacturing. Whereas many manufacturing processes can be standardized and modularized, it is more difficult to standardize service processes, thus increasing the difficulties of developing effective performance measures for use in outsourcing arrangements. Services lack the tangible attributes of physical products, and include many attributes that are difficult to specify in measurable terms, which often leads to incomplete specifications of both requirements and service levels.  This makes it difficult to make meaningful comparisons across organizations, and understand the causes of variances in process performance. organizations struggle to identify what should be measured and how to normalize data across different organizational contexts.  Even when organizations know what to measure, they fail to achieve accuracy, as performance data are not defined or collected consistently. Moreover, the approach to data collection for performance management in many organizations is driven by the requirements of financial cost reporting, rather than understanding the factors affecting performance. Effective performance management is acknowledged in the literature as a critical influence on successful services outsourcing. There is a consensus on the need to link outsourcing and performance management with the business strategy of the organization.  In fact, performance management and business strategy are closely linked, as performance measures and management are critical elements in translating an organization’s strategy into reality.  Performance management is a way of making the mission of an organization tangible and establishing objectives and performance measures that can be understood. The motives of organizations in outsourcing decision-making are often dominated by performance concerns. The use of the core/non-core logic by practitioners in outsourcing decisions is driven by performance considerations. organizations should perform internally ‘core’ processes where they have a superior performance position that is difficult to replicate, whereas they should outsource ‘non-core’ processes where vendors have superior performance positions. As well as impacting business strategy, performance management has implications for both the decision to outsource and implementing and managing the outsourcing arrangement.

Performance management and outsourcing evaluation
In making the decision to outsource a process, organizations often focus on processes with which they are experiencing performance problems. This creates significant difficulties when organizations outsource such  processes.
organizations assume that external vendors can provide processes at a higher performance level than internal functions. Often, vendors cannot meet  client performance expectations because of problems that were present in the process when it was performed in-house. Failure to understand the causes of poor performance may also lead an organization to outsource processes, often labelled as ‘problem processes’, that are critical to competitive advantage. Prior to outsourcing, organizations should have an understanding of the key measures that indicate performance in a process relative to vendors or competitors. Analyzing the causes of poor process performance in areas of cost and service quality expands the range of sourcing options available – ranging from outsourcing to internal process improvement.

A major source of difficulty for organizations when measuring outsourcing performance is that they have never effectively measured the performance of the process when it was performed internally. This means that the organization is developing performance measures for the first time when the process is outsourced. These performance measures are often ineffective and create difficulties in the outsourcing arrangement. For example, a major difficulty with poor performance management in the outsourcing process is that organizations have no way of knowing whether the external vendor has performed the process better or worse than the internal department previously. Indeed, some have argued that organizations should create metrics to measure the quality of processes for a while, and improve performance internally before outsourcing.10 Ineffective performance measures also mean that performance milestones established in the initial phases of the outsourcing arrangement are unrealistic, and lead to relationship difficulties as the client becomes disappointed with the performance of the vendor.

Integrating performance management
the stages involved in integrating performance management into the outsourcing process include:
Stage 1: Cost analysis
Cost analysis involves assessing the cost position of the client in relation to both vendors and competitors in a process. The major cost drivers associated with a process should be identified. For example, cost drivers associated with customer service processes include labor rates, location of facilities, number of customers served, sales per customer and service levels offered. Cost drivers differ across organizational processes. For capital-intensive processes the major cost drivers are likely to be the cost of equipment, whilst for highly labor-intensive processes, the major driver of costs is labor rates. At a general level, there are a number of drivers of costs that impact upon the cost position of an organization relative to those of vendors and competitors:
•  Factor costs. One of the most prominent influences in cost analysis of the outsourcing decision is that of factor costs. Factor costs refer to the inputs that are used to perform organizational processes and include labor, capital, land and raw materials. Vendors may have a significant cost advantage in a number of areas as a result of having lower factor costs. Perhaps the most common influence on factor costs is that of labor rates. Many organizations can realize significant cost reductions by outsourcing to vendors that have much lower labor costs, often due to their location.
•  Economies of scale. These can be achieved through internal development or outsourcing to vendors. Economies of scale in certain processes can be realized internally through the achievement of high relative market share in the client’s respective product markets. Alternatively, vendors are often in a position to realize scale economies, as they are supplying the same services to a number of clients and achieving the benefits of specialization.
•  Experience. Often as a result of specialization, costs can be reduced through experience built up over time that competitors can find extremely difficult to replicate.
•  Complexity. The range of products and services offered by an organization influences costs. Also, enhancing value for customers through adding unique product or service features is likely to increase costs. Complexity can dilute the impact of reduced costs associated with other cost drivers such as scale economies. Introducing a constant stream of new and innovative services can make it extremely difficult to realize scale economies.

Stage 2: Benchmarking
As well as considering costs, an important element of capability analysis in outsourcing evaluation involves assessing the relative performance along a number of dimensions including quality, flexibility and service.
Analysis along these additional dimensions is important given the experiences of organizations that have embarked upon outsourcing primarily on the basis of costs. Initial analysis may reveal that a vendor possesses a lower cost position, while at the same time being weaker in areas such as quality and service. organizations must have an understanding of non financial performance measures that indicate performance in a process relative to vendors or competitors.

Benchmarking is a valuable approach for assessing an organization’s performance relative to potential vendors and competitors.
It is important to understand and prioritize the processes under scrutiny in order to integrate benchmarking into the outsourcing process. It is not feasible to undertake an extensive benchmarking exercise for every potential outsourcing candidate. In fact, the evaluation of outsourcing for an organization is likely to focus on one or a limited number of processes as a starting point rather than on every organizational process. The prior experience of the organization in the area of benchmarking is a key consideration. Where it is the organization’s first experience with benchmarking it may be beneficial to undertake a brief and highly focused exercise that is likely to deliver a high impact. This section outlines a number of the critical aspects involved in undertaking a comprehensive benchmarking exercise for outsourcing purposes.

Select benchmarking approach
This involves deciding who should undertake the benchmarking exercise. An organization can use internal staff alone or involve external consultants to assist with the benchmarking exercise. A team should be formed to carry out the benchmarking of the processes under scrutiny. This team should be composed of personnel involved in outsourcing evaluation, such as senior management, as well as representatives from the process under scrutiny.

Analyze the process
From an outsourcing perspective, it is important to analyze the  process under scrutiny to understand the process, complexities, problems and process interdependencies. Process analysis assists with providing a benchmark against which improvement can be measured. The level of analysis will depend significantly on the impact of the process on  competitive advantage. In the case of a process deemed to be of critical importance, it is necessary to conduct extensive analysis to determine the strategic options in terms of either internal improvement or using an external vendor. This more extensive analysis will involve  carrying out a number of tasks including: identifying the people and their roles in the process; determining the role of vendors in the process; and mapping and documenting the process by interviewing relevant people

Identify potential partners
Once processes have been analyzed and understood, suitable benchmark partners should be found. Based on the mapped processes and the metrics developed, the development of a partner profile can assist in identifying companies carrying out similar processes. In the context of outsourcing, the most competent vendor of the process is a valuable benchmarking partner. Information from vendors can be much more readily obtained than from competitors, which are likely to have a natural reluctance to share commercially sensitive information. In relation to competitors, benchmarking can act as an imperative for strategic action. For example, where an organization establishes the performance benchmark for its competitors, this can serve as a reliable indicator of competitive advantage. In relation to the use of partners in other industries, access may be more readily achievable than to direct competitors. With full access obtained it may then be possible to determine whether there is the potential to improve performance rather than considering the outsourcing option. Alternatively, the exercise may reveal too significant a disparity in performance, which may lead an organization to outsource the process to a more competent vendor.

Collect and analyze data
Effective benchmarking involves ensuring that the right information is collected and then analyzed. The first phase involves designing a questionnaire based on the partner profile. The benchmarking questionnaire should be a clear, formal agreement and understanding about what data and information are to be collected and shared. Rules need to be agreed with the partners in relation to the level of access to, and use of, confidential information. As well as a questionnaire, internal reports, site visits and interviews can be carried out with key staff within the partner organization. The success of the benchmarking exercise will depend upon the organization understanding the results and consequences.

Stage 3: Sourcing option selection
Employing cost analysis and benchmarking provides an organization with a number of potential sourcing options :
•  Outsource. In this case, the analysis will have revealed that vendors are more capable in performing the process than the client organization. This option is most appropriate when the process is not critical to competitive advantage and/or the opportunism associated with outsourcing is manageable.
•  Continue to perform the process internally. In this case, the analysis will have revealed that the client organization has superior performance relative to potential vendors. This option is most appropriate when the process is critical to competitive advantage and/or the opportunism associated with outsourcing is unmanageable.
•  Invest to perform the process internally. In this case, the analysis will have revealed that the client organization is less competent at performing the process than vendors or competitors. This option is most appropriate when the process is critical to competitive advantage and the client can replicate and advance upon the performance of vendors.
Once an organization has decided to outsource a process, it should have an evaluation and control process to ensure that the outsourcing arrangement is accomplishing its performance objectives. Essentially, this involves comparing actual performance with desired results and providing feedback, so that management in both the client and vendor can evaluate the results and take corrective action. Performance measures provide the following functions in an outsourcing arrangement:
•  Control. Performance measures allow the client to evaluate and control the performance of processes for which vendors are responsible.
•  Communication. Performance measures are essential for communicating performance to management in the client and vendor for purposes of control. Well-designed and communicated performance measures provide management in the client with a sound understanding of what the vendor has to deliver, without having to understand fully the intricacies of the processes. Poorly developed and communicated performance measures can lead to frustration and create difficulties in the relationship between the client and vendor.
•  Improvement. Performance measures identify the disparity between actual and anticipated performance. Identifying and understanding any performance disparities can serve as a basis for developing an improvement strategy. In many instances, the onus will be on the vendor to make the improvements. However, in some instances the client may have to make adjustments to their internal operations to allow for performance improvements.

Stage 4: Performance management and outsourcing implementation

Establish outsourcing objectives
Many companies embark upon outsourcing without establishing clear objectives for what they intend to achieve. The absence of clear objectives can create difficulties in managing the outsourcing process in a number of areas including selecting the most appropriate outsourcing relationship, drawing up the contract and managing performance in the outsourcing relationship. Typical outsourcing objectives include reducing costs, enhancing service quality and obtaining higher levels of service in the provision of the process. The objectives established will reflect the underlying motives for the organization considering outsourcing as an appropriate strategy. For example, in many cases, organizations outsource with the objective of obtaining higher quality service at a lower cost from external vendors. In this case, the key objectives will provide valuable direction for managing the outsourcing process. This will involve the organization ensuring that it is selecting the most capable vendor in terms of cost and quality. Moreover, the client must ensure that the chosen vendor maintains and improves its performance throughout the life of the outsourcing relationship.

Establish performance measures and standards
There are a number of steps in establishing performance measures and standards. The client should firstly decide on which aspects of the outsourced process should be measured. Priority is often given to the most important aspects of the process, and those that account for the highest proportion of cost, or the greatest number of problems.
Performance measures should then be developed. They should be verifiable, which means they are based on an agreed set of data and a well understood and documented process for converting this data into the measure. Performance measures should be expressed in meaningful terms and, therefore, be fully understood by the vendor. The performance measures should capture the characteristics or outcome of the outsourced process in a numerical or nominal format.
Finally, performance standards should be established as a reference point for acceptable performance. Standards can be based on past performance measure values used when the process was performed internally, or externally published benchmarks. Each standard will normally include a tolerance range, which will define acceptable performance deviations from the vendor. These performance measures and standards will be incorporated into the service level agreement (SLA).

Stage 5: Vendor performance evaluation
Many difficulties associated with outsourcing arise from the failure of vendors to deliver and meet the requirements and performance expectations of the client. In order to reduce these risks and pre-empt vendor failure, the client must have a formal mechanism to determine whether the vendor is meeting the performance levels set and whether the objectives in its approach to relationship management are being achieved. Evaluation of vendor performance involves determining whether the vendor is meeting the required performance standards set out in the SLA. Having an effective mechanism for evaluating vendor performance can also serve as a basis for comparing performance levels with those of other potential vendors in the supply market.
The approach to assessing performance will depend upon the nature of the relationship and the complexity of requirements. For example, in cost-focused outsourcing arrangement for standard call center services, the client is likely to focus on measuring the performance of the vendor quantitatively against a number of criteria including average speed of answering calls, first-time call resolution, total calls handled and call abandonment rate. The focus is on inspecting the outcomes of the process rather than attempting to diagnose the causes of poor performance. The responsibility for performance rests solely with the vendor with little or no assistance provided from the client to resolve problems.
Where the client’s needs are highly complex and specific, the approach to performance evaluation will differ considerably. The increased dependency between the client and vendor necessitates a relational contracting outsourcing relationship, where the evaluation of performance is a joint endeavor, with both the client and vendor attempting to identify and deal with the causes of poor performance in any areas. As both the client and vendor are responsible for the success of the relationship, the focus should be on performance improvement. This focus on improvement not only center s on cost reduction but also can encompass any performance area such as service, flexibility and responsiveness. There is also an onus on the client to effect performance improvements. The client may attempt to achieve improvements in its own internal operations that can assist the vendor in meeting the required performance levels. Therefore, both the client and vendor must be aware of the other’s performance expectations. The development of relational contracting outsourcing  relationships will involve the client and vendor working jointly over the long term to improve performance levels and meet each other’s expectations.
involved in the process and analyzing organizational documents and  reports.

Stage 6: Take appropriate action
The approach to performance management will have to change as the outsourcing arrangement evolves. Performance measures established at the outset of the outsourcing arrangement may lose their relevance and ability to distinguish between strong and weak performance. This is particularly important when the requirements of the client have changed during the relationship. Such changes can make initial performance measures redundant and necessitate the development of new performance measures. In addition, as the vendor becomes more familiar with client requirements and delivers improved performance, the frequency of measuring performance may have to change. As the relationship between the client and vendor develops, the approach to performance management extends beyond straightforward reporting to creating mechanisms for identifying improvement opportunities and anticipating future problems.

Effective performance management during the outsourcing relationship requires appropriate skills in both the client and vendor, not only to understand performance but also to drive performance improvements. Often, the client does not commit sufficient resource to addressing performance problems, primarily as a result of viewing problems as the responsibility of the vendor. An over-emphasis on measuring performance by the client in the outsourcing arrangement can damage the relationship, as the vendor views it as a mechanism for extracting more favorable terms in future contract negotiations. However, effective performance management in the outsourcing relationship has a number of benefits. Determining effective performance measures prior to and during the relationship can serve as a benchmark for improvement. A strong emphasis on performance  management is necessary for creating a culture of continuous improvement in the outsourcing relationship. Of course, the client has to align the outsourcing relationship with its desired performance objectives from outsourcing. Where the client is seeking continuous improvement, the outsourcing relationship should be on a collaborative basis, dominated by a joint approach to addressing performance problems and driving improvements.