A Fortune 500 multi-national called us recently—they thought they might be in over their heads. They had engaged an F&A BPO provider to assess and provide a quote for the outsourcing of most of their finance functions to include: A/P, General & Fixed Assets Accounting, T&E, Invoicing, Collections and Cash Applications.

The provider’s solution was replacing the client’s staff of about 475 people with their own. This was a large deal, with preliminary pricing for a 7 year contract worth over $200M. The provider, and to be fair, the client as well, had jointly decided to carve up the work based upon how willing the local functional owners were willing to “give up” the functions.

So was there a problem with the deal? You bet. Alsbridge assessed the offer against 200 similar deals using our proprietary assessment tool called the “Market Reality Assessment” (MRA). The MRA describes the ideal “landing zone” for a solution along more than 150 different attributes in 10 best practice categories. Too “high” in any category, and the deal is too stifling for the provider. Too low in any category, and then the deal is too favorable to the provider. The landing zone is therefore seen as the “sustainable relationship zone.” We assessed this deal with the following results:

Not a single deal attribute was in the “landing zone.” But what was wrong? Both the provider and the client sincerely wanted a win-win, so why was it not going in that direction?

Although there were many factors, by far the largest contributor was the “solution shape.” The proposed solution was at its core a staff augmentation. There were no performance measures other than broad productivity and customer service measures. There were no financial incentives and penalties tied to performance. There was no governance model defined. There were no work drivers described, and no forecast of volume over the life of the deal.

Finally, there were no responsibilities defined for discrete measurable sections of work. Two years into the contract, the client would have found themselves managing the provider’s staff with little guidelines by which to manage other than each person’s individual performance. If this client had gone ahead with the deal, the work (and the relationship) would have been impossible to manage, expectations would have been cloudy, and contract disputes would have been a daily routine. So how does a CFO ensure a “good” and market-based deal?

The key is to ensure the solution is performance-based. That is, outsourced responsibilities must be clearly delineated as producing individual outputs and deliverables. The client must not manage the work of the provider. Rather, we want to manage the quality and performance levels of the outputs. In order to do so, the outsourcer must be clearly responsible for the sections of work that drive those outputs. For example, if we want to outsource accounts payable, then we must structure the solution in a way that the outsourcer is solely responsible for invoice cycle time. That would mean that the provider must own all the work that drives that cycle time. Practically speaking, the client would own the receipt of the invoice, perhaps the imaging, perhaps even the approval process. But once handed off to the provider, they must own all the work processes until it is handed back off to the client. Now we have set up a situation where we can clearly measure where their responsibilities start and end, have measurements associated with that cycle time, and hold to standards for delivery.

Sounds easy right? Well it really is if we construct sound “Statements of Work” (SOW) that become part of the outsourcing contract. The SOW is a roles and responsibilities matrix that looks like the following:

How we get to this point is of course key. The right stakeholders need to be present to craft the SOW, and this should be done in conjunction with the provider to ensure they have the capabilities to perform the work as described. This should be done for each discrete process that will be measured separately. Often in an F&A outsourcing assessment, there will be twenty to thirty sections to the SOW that sum all the work currently being performed, with clear associated work splits between the client and provider.

Once we have crafted the SOW’s describing the discrete processes, then we move on to service levels and resource units, around which we will base the deal pricing and contract terms. Service Levels describe the level of service the provider will be contractually obligated to perform. Resource Units are the discrete work drivers that the price will be based upon, for a given volume of work and level of service.

Resource Units have two parts: the units of measure and the volume projections. In this example, the resource units are fairly straight forward: number of non-PO and PO invoices. We simply forecast that work over the next five years (understanding that there will likely be a range) and place that forecast within a “deadband”. The deadband is that level of volume that will drive the contract price. For example, we may agree to a contract for $10M for 5 years for 100,000 invoices per year, plus or minus 10 percent. As long as that volume stays within 90,000 and 110,000 annually, then the price remains unchanged. Should the volume in any given contract month falls outside that band, we would then agree to a price/unit charge. Notice in this example we do not structure the deal to buy people from the Provider. We are in fact indifferent about how many people they bring to the deal. Rather, we are basing the deal upon volumes of work.

Service levels are the associated level of service we expect for the volumes we have forecasted. Obviously, the higher level of service we demand from the outsourcer, the higher will be the price. The service levels must be simple, measurable, and importantly, controllable by the outsourcer. In this example then, the provider would be held responsible for cycle time and error rate. We would want to baseline our current level of performance and, generally speaking, set that as the minimum standard for the outsourcer. Should they fail to meet that level of performance, then we contractually obligate them to pay a penalty in the months that they miss those minimum standards.

What we have now is something we can contract around that will hold the provider responsible for outputs and service levels, not the work itself. The final piece of the puzzle then is to ensure we have the mechanisms in place to manage and monitor the relationship and performance. This is called Governance. Clients are strongly advised to establish a new organization (but small) whose sole responsibility is managing the contract, the relationship and the development and growth of the function. The general rule of thumb is that Governance models be staffed at a cost of about 3 percent – 5 percent of the contract cost. So if a contract has a value of $20M annually, then we would expect to see Governance staffed with about 3-5 in-house managers.

We hope this has helped clarify the value of a performance based deal. It was designed to be high level. Of course, the details and work associated with Statements of Work, Resource Units, Governance, and contracting overall is much more complex and typically take 4-5 months to work through, and we strongly recommend the help of an outsourcing advisory firm philosophically aligned with structuring a win-win. Bottom line: be careful out there!