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Five Rules to Strategic Outsourcing

Five Rules to Strategic Outsourcing

by Kate Vitasek, Faculty, Graduate and Executive Education Author, University of Tennessee

Reverse Logistics Magazine, Edition 98

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All too often companies that outsource experience what University of Tennessee researchers call the Watermelon scorecard: SLAs (service level agreements) are green on the surface, but often neither the buying company nor the service provider are happy with the outsourcing relationship.

In 2003, the University of Tennessee (UT) began research into some of the world’s most successful strategic outsourcing partnerships—including those at P&G, McDonald’s and Microsoft—to see if they could crack the code into why a few outsourcing relationships were racking up supplier of year awards and industry accolades. What enabled these “winning” relationships to deliver success and win more than the usual outsourcing relationships?

What emerged from the research and field work was the Vested Outsourcing (or Vested) business model and methodology. The researchers learned powerful lessons, including how following five simple ‘rules’ and 10 contractual ‘elements’ could to spur collaboration and innovation in an outsourcing relationship. Today the Vested business model is catching on – thanks to companies like Dell/FedEx Supply Chain (FSC) and Intel/DHL who have successfully used the Vested model to drive transformational success in their reverse logistics operations.

This article is a primer on the Vested model and shares the highlights from Dell and Intel case studies – both are which are public case studies.

The Five Rules of Vested
The Vested model is centered on Five Rules (Figure 1 below) that - when followed - enable a buyer and service provider to create a true win-win contract. Rather than sit on opposites sides of the negotiating table, the parties jointly follow a structured step-by-step methodology to architect a win-win contract where the service provider’s success is directly tied to their ability to drive success for their client. Ergo, the parties are vested in each other’s success because a ‘win’ for the buyer is a ‘win’ for the service provider.

The Vested Five Rules work in conjunction with 10 contractual Elements to create a strategic outsourcing agreement that takes the parties away from the traditional buy-sell, “what’s in it for me” (WIIFMe) sourcing philosophy to a highly collaborative “what’s in it for we” (WIIFWe) mindset in which the parties’ interests are tightly aligned.

A key part of the Vested methodology is the buyer and service provider collaboratively work together to craft their physical contract around each of the Elements, as outlined in the table (Figure 2)

Vested for Success: Dell/FedEx Supply Chain (FSC)
Dell had worked with the reverse logistics provider Genco since 2005 (Genco was acquired by FedEx in 2015 and rebranded as FedEx Supply Chain in 2017). Dell was one of the first companies to pilot the Vested methodology.

The relationship was strategic. But the actual contract was highly transactional in nature with 19 transactional billable line items. If FSC performed a task, Dell got charged. FSC assumed the risk of meeting a set “price per transaction” while maintaining service levels. The agreement worked reasonably well for a time, but Dell’s leaders continued to face cost pressures, insisting on an “every dollar, every year” procurement principle — despite FSC assuming much of the risk under the contract terms. FSC warned further price pressure would harm service levels. And the short term nature of the contract coupled with a termination for convenience meant FSC’s finance executives were far from excited about investing in any improvements or innovations for Dell.

By 2011, the honeymoon was over and the relationship was in danger of falling apart.

A Dell executive heard about UT’s research on Vested and sent two team members to UT’s Executive Education course to learn more. The question was, could they turn the theory into practice to drive innovation?

The answer was yes. In 2012 Dell and FedEx succeeded re-structuring their outsourcing agreement to embody Vested’s “what’s in it for we” mindset and Five Rules. Here is how.

Rule 1: Outcome-Base vs. Transaction-Based Business Model. Dell and FSC started by creating a joint shared vision and six Desired Outcomes to refocus the relationship. This helped the parties avoid the “activity trap” in which FSC was paid for performing a task or activity — regardless of whether it is needed.

Rule 2: Focus on the “What,” not the “How. Dell learned how to let go and trust FSC’s expertise when they replaced their detailed SOW with a jointly created and significantly shorter taxonomy and workload allocation that clearly showed how the parties would work together to achieve their shared vision and Desired Outcomes.

Rule 3: Clearly Defined and Measurable Desired Outcomes. In a Vested agreement, metrics are aligned to Desired Outcomes. For Dell and FSC, this meant reducing the number of metrics from over 100 to 20 clearly-defined metrics using a Requirements Roadmap tool. Importantly all of the metrics they used aligned to the six Desired Outcomes.

Rule 4: Pricing-model with Incentives that Optimize the Business. The economics of the relationship also needed to change. Gone was the “price per box” and in its place was a transparent pricing model that incentivized FSC to make strategic investments in processes that would help reach the Desired Outcomes. The more effective FSC was at achieving the Desired Outcomes, the more incentives (or profits) they earned. A win-win economic model with a “grow-the-pie – share-the-pie” logic.

Rule 5: Insight vs. Oversight Governance Structure. As part of the Vested methodology, the Dell/FSC Core Team set up a Vested governance structure that ultimately helped the parties navigate their relationship well past contract signature. From executive levels to frontline working levels, everyone is aligned. The responsibility of managers for specific areas is clearly outlined to keep the companies’ program and account managers informed.

The results were nothing short of transformational (Figure 3).

Rob McIntosh now the Senior Vice President, Dell Global Fulfillment, Logistics and Trade, referred to transformation to a Vested model as a “fairy tale” in a Supply Chain Brain video.

But true to the Vested model - FSC also was a winner. A key part of the contract were incentives to drive transformational results, including bonus checks and automatic contract extensions.

Six years later, the parties decided to “refresh” and update their agreement to address “lessons learned” and address changing a business environment.

This was key because the move to refresh was a recognition that Vested is not a “one and done” contracting process, but rather a methodology to seek continual alignment under a flexible governance framework. John Coleman, FSC general manager of operations for Dell’s reverse logistics business, said, “The refresh process was a necessary exercise: It allowed us to revisit our Desired Outcomes. But more importantly, it allowed us to reflect on areas where we had grown apart and helped us rework key governance mechanisms such as onboarding, executive churning and buy-in.”

Dell and FSC learned an important lesson on how to sustain a Vested agreement, especially because people come and go and the nature of the business is dynamic and changes over time.

Vested for Success: Intel/DHL Supply Chain Services
A natural consequence of building the future is changing priorities and letting go of the past. In 2012, Intel exited from its desktop motherboard business to focus on artificial intelligence, cloud computing, and other emerging and transformative technologies. Intel informed DHLSC and sought to renegotiate the pricing based on the new demand projections. This was not good news for DHLSC, since Intel procurement spend is DHLSC’s income. The decline in demand posed a severe challenge to the sustainability of DHLSC’s business model and the viability of its operations managed out of The Netherlands.

John Hayes and Ruud de Groot were the Intel and DHLSC leaders for the reverse logistics being managed out of DHLSC’s Beringe operations in The Netherlands. Both Intel and DHLSC had experience with a Vested pilot project in Costa Rica that had transformative results in the forward logistics space. Could making the switch to a Vested business model be the answer to their reverse logistics situation?

The parties started by reviewing their existing relationship and business in an objective manner to understand if the Vested Five Rules might apply to their situation.

For Intel, Vested appealed to Intel’s desire for transformational results. The formalized and systematic manner of Vested also aligned well to Intel’s culture of promoting process rigor. For DHLSC, Vested represented the opportunity to demonstrate an innovative approach for managing the entire supply chain. DHLSC also welcomed how the methodology enabled them to be an equal partner in leadership and participation, ultimately enhancing success for Intel.

The choice was made. Rather than negotiate, the parties would apply the Vested methodology to restructure their reverse logistics contract. They immediately set out to adopt the Vested principles of trust, transparency, collaboration, and fairness, which ultimately led to a true win-win agreement for both companies.

The companies found the non-adversarial nature of Vested refreshing, helping them move away from the “zero-sum” game usually employed in conventional buyer-supplier relationships. They moved away from “us vs. them” and risk avoidance thinking.

The Vested methodology not only helped the companies mitigate the impact of volume reductions on cost, but led to much, much more as it also enabled the parties to achieve improvements across the board on virtually all aspects of the business. (see Figure 4).

Both Hayes and de Groot believe the shift to Vested saved what likely would have been a failed business relationship due to reduced volumes and changing business circumstances caused by Intel’s exit of the desktop motherboard business. As John Hayes, a Supply Chain Architect for Intel’s Global reverse logistics group, explained, “The old contract promoted an us vs. them culture that could have led to perverse incentives and opportunism. With Vested, our interests are truly aligned through mutually defined Desired Outcomes and economics that reward DHLSC for achieving the Desired Outcomes. Vested helped us move from trying to shift risk to one where we win together. A win for DHLSC is a win for Intel.”

Still not convinced? Download the complete case study from the University of Tennessee’s website.
Kate Vitasek is an international authority for her award-winning research and Vested® business model for highly collaborative relationships. Vitasek, a Faculty member at the University of Tennessee, has been lauded by World Trade Magazine as one of the “Fabulous 50+1” most influential people impacting global commerce.

Her pioneering work has led to 6 books, including: Vested Outsourcing: Five Rules That Will Transform Outsourcing, Vested: How P&G, McDonald’s and Microsoft Are Redefining Winning in Business Relationships and Getting to We: Negotiating Agreements for Highly Collaborative Relationships. Vitasek’s work also won the Supply Chain Council’s Academic Advancement award for it’s impact in advancing business.

Vitasek is internationally recognized for her practical and research-based advice for driving transformation and innovation through highly collaborative and strategic partnerships. She has appeared on CNN International, Bloomberg, NPR, and on Fox Business News. Her work has been featured in over 300 articles in publications like Forbes, Chief Executive Magazine, CIO Magazine, The Wall Street Journal, Journal of Commerce, World Trade Magazine and Outsource Magazine.

Prior to joining the University of Tennessee, Vitasek’s storied career includes positions with P&G, Microsoft, Accenture, Stream International and founding Supply Chain Visions – a boutique-consulting firm recognized by ARC Advisory Group as one of the “10 Coolest” Boutique Consulting firms.
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