After years of outsourcing to cut costs, a global telecom service firm we'll call GiantTel launched a bold new agenda. It partnered with a large telecom equipment firm to transform its entire business. Under the deal, GiantTel outsourced its world-class, circuit-switched voice operations to InfraCom (not its real name) and additionally signed up the telecommunications equipment firm to build the infrastructure powering GiantTel's new strategy-wholesale migration to Internet Protocol (IP) transmission services. How could GiantTel manage this critical relationship to make sure it fulfilled its ambitious business agenda?

GiantTel understood its voice operations intimately. It would have been easy for the firm to drive the outsource relationship by laying out clear performance measures and awarding InfraCom cash bonuses for hitting them. But this would have been a mistake. GiantTel recognized that managing a transformational agenda required a categorically different kind of relationship- and a different way of using metrics and incentives. The partners rolled up their sleeves and spent months envisioning their future and the potential paths to success. The result? A committed plan and a set of metrics to gauge their progress toward the ultimate goal: generating wholly new revenue streams from IP offerings. To share its risk, GiantTel wouldn't pay InfraCom for the new network until it was "ready for
revenue."

Until recently, most companies locked outsourcing in the back room-using it to pass off unimportant functions and processes to competent specialists so managers could focus on more critical activities. But that's all changing. Outsourcing is increasingly making its way into executives' strategic toolkit. In an earlier research study, we identified three types of outsourcing relationships: conventional, collaborative, and transformational. Executives use conventional outsourcing to generate cost efficiencies in support processes. They use collaborative outsourcing both to upgrade business processes and to provide flexibility to respond to changing business needs. Business transformation outsourcing holds a higher standard. It's a comprehensive approach to both create new capabilities and to use them to achieve a clear strategic objective.

Metrics and incentives are an important component of all three types of relationships, but as executives use outsourcing more strategically, these become more critical than ever. In this research study, we found that each type of outsourcing relationship calls for different metrics and incentives to some extent. More importantly, executives also use the same metrics and incentives in different ways to shape the outsourcing relationship they need. Based on our in-depth conversations with executives, we conclude:

Conventional outsourcing can't generate incremental savings forever. Despite rigorous measurement and tough penalties for failure, the stream of incremental savings that conventional outsourcing delivers ultimately reaches its limit.

Driving additional value means moving toward a more sophisticated relationship. Many firms have migrated toward more collaborative outsourcing relationships in order to create value beyond simple cost cutting.

It also means relaxing the tight linkage between accountability and control. Tapping new sources of value means sharing ownership for results with an outsource partner. The more transformational the outsourcing agenda is, the more blurred the lines of accountability.

Effective firms use metrics and incentives in a whole new way to manage transformational relationships successfully. Executives who operate at this cutting edge have loosened their white-knuckle grip on control and use metrics and incentives to foster commitment.

Conventional Outsourcing
Metrics and incentives are staples of today's large-scale outsourcing relationships. All of the executives we spoke with have barometers in place for tracking their progress toward the goals of the deal.

Although they pick from a broad menu of metrics, executives with conventional outsourcing relationships generally rely on a short list of approaches. Most contracts spell out service levels-such as computer availability, call-center phone response time, and transactions processed per hour-and cost reduction targets. Vendors are compensated by fixed fees with penalties for missing "guaranteed" service levels and, in some case, bonuses for beating savings bogies.

Over time, as companies gain outsourcing experience, they learn what works and what doesn't. They revisit their initial sets of metrics and make adjustments that boost performance. Best practices they related to us include making sure objectives are clear at the outset, paring the performance measures down to a small number of critical ones, shifting from input to output metrics where possible, and making sure these are developed early in the relationship.

Armed with these best practices, executives do achieve cost savings from conventional outsourcing-to a point. Firms report a 20 to 50 percent average cost savings over the course of a long-term contract. However, the results they achieve depend heavily on the efficiency of the operation to start with. And once it has been tuned up to industry standard performance, the ability to generate substantial year-over-year cost improvements drops markedly. What do executives do to keep up the momentum? Some peg their improvement targets to industry benchmarks. Using outside experts to measure, they aim to keep costs and service levels in the top quartile, as compared to similar operations. Annual incremental savings may be flat or small, but at least the firm maintains parity with the most efficient organizations.

Other firms stoke up market incentives. These companies keep multiple vendors in the mix to foster better performance through competition. A telecommunications executive points out, "We have four or five main providers and hundreds of people asking for support. If a vendor demonstrates good service at the ground level, it's more likely to get follow-on work."

A smaller group of companies go for scale with multi-firm service centers. There's a limit to how much improvement even the best outsource vendor can achieve with your operations. To drive cost reductions even further, some organizations press their vendors to bring other firms' work into the same facility.

The architect of extensive business process outsourcing at a major resources firm explains, "We had accounting organizations dotted all over the place. When we consolidated to a single location through outsourcing, we achieved a significant cost reduction. To get the benefit of another scale change, we worked with our
vendor to pull the operations of six of our competitors into the same center."

These approaches to continuous improvement satisfy some of the firms we interviewed, but 74 percent have taken a different tack. They have shifted their outsourcing relationships to a more collaborative footing in order to expand their opportunities for value creation. One CIO on the cusp of this decision lamented, "Every month there's a metrics meeting with our IT outsource vendor. We rate them; they rate us. But when I walk the halls, everyone's really pretty unhappy with the service. I want to make IT a key strategic focus for the company, but I need all the arms and legs rowing in the same direction to accomplish this. That's just how our outsourcing works today."

Collaborative Outsourcing
A conventional outsourcing relationship gets you what you asked for; collaboration gets you what you want. Companies looking for more value from their outsourced business processes-from supply chain management to human resources-strike collaborative relationships. Unlike conventional outsourcing relationships, these can offer significant upside in the form of customer delight or an edge in efficiency.

Outsourcing complex processes with substantial upside potential means using metrics and incentives to promote collaboration. In the absence of tight controls on performance, parties in these deals go one step further. They create and document shared principles that guide the way they will jointly deal with each other-what Trevor Nagel, a partner at Shaw Pittman, calls a "constitution, not a contract." These principles not only set forth the work approach, they capture the key business goals and thought processes behind it, as well as the methodology for achieving it. The goal: to ensure the principles set the correct tone for the relationship as it evolves, regardless of the individuals involved at any time. Explains outsourcing expert Harry Glasspiegel, CEO of Glasspiegel Ventures, LLC and formerly of Shaw Pittman and CNA Insurance, "The original parties can help the relationship succeed over time by giving later participants a gift-context."

Business Transformation Outsourcing
Many organizations have pushed outsourcing beyond a conventional relationship. A few bold leaders have gone even further. They are using outsourcing to transform their businesses. Companies undertaking business transformation outsourcing (BTO) seek radical change that can rock an industry. It requires unflinching commitment to an outcome that may be years away and a partner to share the journey. Although the potential rewards are enormous, unexpected shifts in technology or the competitive landscape could call for mid-course corrections at any moment. Executives forge strong relationships to see them through this white water ride. One CEO told us, "I work side by side with my counterpart at [the partner firm] to ensure that we anticipate and confront change as it happens."

If a conventional relationship gets you what you ask for, and a collaborative one gets you what you want, a transformational relationship gets you what you need. Business transformation requires commitment because of its bet-the-ranch character. In it, both parties forsake the comfort and security of clear scope of work, defined outputs, and structured roles and responsibilities to pursue dramatic improvements in enterprise performance. They use metrics and incentives to keep their interests tightly aligned and to support deep, continuing commitment on both sides to reach their aspirations. This is a whole new game. It means establishing some new enterpriselevel metrics, crafting a gripping new set of incentives, and changing the way lower-level metrics are used.

When the goal is business transformation, the only relevant metric is business value created. Architects of BTO relationships measure:

Enterprise-level outcomes... And they set their sights on dramatic improvements in business value. Companies aim to double revenue, achieve market dominance, or completely reposition the firm. For example, Archer Financial Group, a disguised global financial services firm, doubled both operating margins and stock price through business transformation outsourcing.

...for both partners. Unlike more conventional outsourcing arrangements, BTO must create enterprise-level value for the outsourcer as well as the client company. Otherwise, it wouldn't be worth the risk. By building and running a new infrastructure for GiantTel, for example, InfraCom hopes to launch a promising new line of business for itself.

Extracted from a report by Accenture, a global leader in outsourcing, prepared by Jan C Linder, Joseph Sawyer, and Alice Hartley, based on a research by Accenture. Reprinted with permission.