By Stephanie Overby
Though Dr. Oliver Williamson may not be known to everyone in IT outsourcing areas, a consortium of academics is looking forward to changing that condition. Being a professor emeritus of business, economics and law at the University of California-Berkeley, Williamson won the Nobel Prize in Economics in 2009 for his examination of economic governance. As he has spent his whole life studying transactional cost economics—the practice of accounting for the total costs of a contract, both obvious and hidden, some outsourcing researchers claim that anyone occupying in outsourcing today could learn precious lessons from him.
Kate Vitasek, who teaches in the University of Tennessee’s Center for Executive Education and is the author of Vested Outsourcing: Five Rules That Will Transform Outsourcing, worked together with three other academics for lessons by culling Williamson’s work on improving performance, reducing costs and increasing satisfaction when outsourcing. (The full white paper can be downloaded. Registration is required.) Here are seven of their suggestions.
1- Build cooperation into the contract
In an article with regard to transaction cost economics and outsourcing management, Williamson stated that “efficiency gains from trade go back to when our ancestors traded nuts for berries on the edge of the forest, [in] which exchanges were both transparent and simple.”
By contrast, Modern outsourcing relationships are obviously more complex. However, Williamson insisted on that additional gains can be achieved if the outsourcing customer and supplier, throughout the life of the deal, create processes to preserve cooperation. For instance, Vitasek says that instead of “What’s in it for me?” outsourcing partners should ask, “What’s in it for we?” “Don’t just say ‘win-win’. Contract for a ‘win-win’.”
2- Factor in hidden transaction costs
There is no outsourced project ever costing what it claims in the contract. As a matter of fact, the dotted line and the bottom line can be pretty far apart. It is tricky to figure out what an outsourcing deal will actually cost in the long run, but it is crucial.
“Every contract structure and relationship, especially in a vested, collaborative partnership, should account for risk, asset specificity, frequency and work to be done, or else it’s not much of a contract,” Vitasek says.
One-sided contracts that push all the risk on either the service provider or the customer will cost more in the long run.
Outsourcing customers, especially those who have failed in this area, may be inclined to create an overly detailed contract to cover every possible contingency. However, in accordance with Vitasek’s interpretation of Williamson, it is a mistake not to mention impossible.
Vitasek says, “It limits innovation and encourages finger-pointing when there is inevitable scope creep and changes. Instead of trying to guess about the future, it is better to indicate an outline of the work to be done and provide recourse for ultimate appeal. For work yet to be determined, focus on the process and tools to be used, not on the work to be done.”
3- Make end-of-life arrangements early
Since outsourcing partnerships can’t last forever, it’s constructive to plan for the end early on. Williamson wrote in the Journal of Supply Chain Management in April 2008 that due to “feasible foresight,” an outsourcing customer can lighten the effects of a defection from its services provider.
“It is important to recognize that business relationships may need to change due to changes in the market, and for this reason, contracts need a well thought out exit management plan,” says Vitasek. “Practitioners should clearly identify the costs associated with terminating a contract [and] create safeguards in the contract that are fair and equitable in terms of keeping either party whole in the event that a contract needs to be terminated prematurely.”
4- Create a shared vision statement
If you can imply strategic points of alliance with your outsourcer, you will minimize additional transaction costs over the life of an IT services deal. Vitasek proposes to create a shared vision statement to direct the relationship. In addition, she recommends developing pricing models that reward service providers for achieving common goals.
5- Play nice (but not too nice)
Of course, you can strong arm your supplier at the negotiating table—or be strong-armed—but either style of contracting will come back to bite you. Vitasek says that organizations, which imply what Williamson calls “one-sided muscular contracting” to gain advantage over an outsourcer, will see only short-term benefits.
Williamson said, “[They] will ultimately face higher market costs and transaction costs from switching or transitioning suppliers, or from suppliers being forced to use conventional negotiations to put in myopic and costly contractual provisions and behaviors that simply drive up hidden costs.” Furthermore, he warned against “idealistic benign contracting,” which provides an assumption that most people will do what they say—and some will do more—most of the time.
A middle ground of “credible contracting” is recommended by the Nobel owner, which he describes as more “hardhearted wise” than its extreme alternatives. Vitasek says that credible contracting is “also flexible enough to acknowledge that complex contracts, by their very nature, are incomplete and thus require cooperative adaptation.”
6- Always leave money on the table
Most outsourcing customers and suppliers suppose that leaving money on the table at best is wasteful, and at worst foolish. However, Williamson doesn’t think so. It actually costs both the customer and the provider in the long run to hard bargain negotiations to get to the lowest possible price.
Williamson wrote, “Successive ploys and counterploys of this kind could plainly jeopardize the joint gains from a simpler and more assuredly constructive contractual relationship. Always leaving money on the table can thus be interpreted as a signal of constructive intent to work cooperatively,” thereby mitigating “concerns over relentlessly calculative strategic behavior.”
Of course, he also points out that the effectiveness brought by this tactic varies based on the level of trust among those involved.