Innovation and Flexibility: Requirements for Outsourcing Success

We hear it all the time. A client says, “My outsourcing provider keeps using the same old tools and doing things the same old way,” or “My business needs have changed, but my outsourcing provider wants to hold me to the letter of the contract.” In a Forrester Research study highlighted in CIO Magazine, (CIO Magazine, “More Outsourcing Innovation Consternation,” September 17, 2007), innovation and flexibility were cited as the two biggest areas of dissatisfaction among outsourcing clients.

“Frustration is a function of expectations,” one of my favorite adages, really applies to this point. Toward that end, let’s peel back the layers of the proverbial outsourcing “onion” and discuss why outsourcing clients are often unhappy with provider performance due to inflexibility in contract management or lower than expected levels of innovation.


“Innovation” is defined by Merriam-Webster’s Online Dictionary as “the introduction of something new” or “a new idea, method or device.” Clients of outsourcing services often wonder why providers aren’t continually introducing the latest and greatest people, processes and tools to continuously improve “steady state” services.

Well, it’s all about the money. Recent studies have shown that providers of outsourcing services average only 5-6 percent net income for providing information technology outsourcing services. That 5-6 percent is derived largely from a provider’s ability to accurately collect client data, construct a baseline model of tools and resources that will meet the client’s contractual requirements, successfully transition to the required service delivery model and provide said services on an ongoing basis.

So, clients of outsourcing services need to ask themselves: what incentive does a provider have to continually change a successful, working delivery model when they’re only making a 5-6 percent return on investment on the existing contract, given the change itself will likely add cost, and the provider stands little chance of improving that return in exchange for undertaking all the associated risk of change?

Clients and providers must realize that in order for both organizations to be successful, the goals and agendas of both organizations must be aligned and realized over the course of the agreement. A well-written outsourcing contract includes incentives for both parties to introduce changes that will increase efficiency. Risk/reward or gain sharing clauses and similar provisions are excellent mechanisms for encouraging innovation, as they provide an incentive to both organizations for taking on risk. Be aware ahead of time that client financial organizations are historically not in favor of these types of incentives due to the complexity they add to the budgeting process, but the potential savings of such programs far outweigh the challenges of additional budgeting work.


Let’s face facts – all businesses change. The outsourcing contract is at its best completely accurate for about as long as it takes the ink to dry on the signature page. This is not due to a lack of effort or good faith in constructing the initial contract. The client’s business is dynamic and business changes most always mean that the services delivered by the provider need to change, too.

Meanwhile, as previously discussed, the provider has attempted to build a financial model that provides an adequate return on their initial investment, and has little incentive to implement changes that may adversely impact that model.

Negotiated correctly, however, it’s precisely that “reasoning” that allows the client some leeway in promoting flexibility. No provider will want to implement a change that might adversely impact their current operation and financial return, but for changes that will NOT adversely impact the provider, clients should assert that there shouldn’t be a corresponding cost increase – in other words, “turn about is fair play,” right?

Throughout my career, I’ve had the good fortune of dealing with providers that – contrary to many “traditional” approaches – seek to price the initial contract accurately, make a fair return on investment over the course of the contract, and then simply tell the client, “If you want to make a change, and it doesn’t increase my cost, then it doesn’t increase your price.” They’re satisfied with their initial ROI projections, and aren’t looking to increase it incrementally with each implemented change order.

For that reason, we’ve proposed a new metric in several engagements. Very simply, this measurement evaluates flexibility and innovation by tracking change orders from two perspectives: 1) the total number of change orders submitted vs. the total number of change orders billed, and 2) the cost of all change orders vs. the amount billed. We have actually seen this measurement used as the deciding criteria between two down-selected providers in a large global outsourcing opportunity. One provider had charged several hundred thousand dollars in change fees over the course of a contract, and their primary competitor had instead charged tens of thousands over the same period with relatively the same baseline. Guess which provider won the new contract?


Innovation and flexibility are cited as two of the biggest areas of dissatisfaction in outsourcing agreements, but that doesn’t have to be the case. Client’s can’t expect providers to pay for continuous innovation while at the same time beating them up about price any more than providers can hold steadfast to a contract or operating model that no longer meets their clients’ business requirements. Clients and providers must not only keep their own objectives in mind, but also those of their partners, and make every effort to formulate a win/win partnership both at the outset and, just as importantly, over the course of the relationship.


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