Contract Procurement: Managed Services or Outsource?
A struggling economy, competitive environments, or mature industry profiles often challenge companies to seek opportunities to reduce their operating costs or significantly improve their service and quality profile. Senior management, looking for significant economies, will often react to success stories and request that their procurement team review outsourcing as an alternative. These contracts involve “farming out” a company’s entities (e.g., production, order processing, IT support) at a lower cost than it takes the company to manage the operation internally.
Often, organizations focusing on outsourcing create a sustainable business model by residing in a country with lower costs to do business, particularly labor. Over time, companies have terminated these contracts due to customer service, production, or quality challenges associated with completing work in an often less stable, foreign, or less technologically advanced environment. Thus, companies have been increasingly participating in another opportunity to reduce operating costs through the implementation of managed services contracts. A managed services contract is similar to an outsourcing contract because it oversees the work traditionally done by the company frequently at a lower cost or improved service level. Managed service providers profitably fulfill these contracts through re-badging company resources, maintaining company performance, and leveraging industry best practices to reduce operating costs. In short, they are an expert at the managed activity, and bring that expertise to bear to make their clients more efficient and effective, even after a profit margin is included.
There are several key differences between managed service and outsourcing contracts. One difference is that a managed services agreement takes on the responsibility of managing a company’s people and processes to minimize operational disruption while outsourcing contracts typically involve processes being managed by new resources, often in a lower cost environment. Shifting work to new resources may involve a learning curve that can slow production, resources with lesser capabilities, or technology that cannot as robustly support processes. Another key difference is that a traditional outsourcing contract bills based on completed projects or products while a managed service contract is billed based on meeting key Service Level Agreements (SLAs) ensuring quality of services and/or products. Managed service providers are also typically viewed as a company partner or staff augmentation to ensure delivery of services and products while outsourcing contracts tend to be managed with a formal vendor or “outsider” relationship. Finally, a managed services provider typically has a niche of industry-specific knowledge or expertise, allowing the provider to implement improvements to lower a company’s operating costs and ensure contract profitability.
When sourcing an outsourcing or managed service relationship, it can be challenging to understand which type of contract will minimize costs while ensuring low operational disruption. Each stakeholder’s process, product, level of complexity, and level of integration is unique and will require appropriate contracted terms and SLAs. If changes to a process have a high probability of impacting customers (e.g., customer service roles) a managed services contract should be considered. Employees in a managed service relationship will be rebadged to the managed service provider versus processes being handed off to new resources employed by an outsourcer. If processes involve multiple (especially internal) systems or highly technical skills, a managed service provider will be able to provide industry and company-specific expertise to enhance that skill set while outsourcing may not match current resource skill levels and may require additional training costs.
Finally, if a process requires interaction between several organizations within the company (e.g., sales, marketing, and engineering) a managed service provider will allow these relationships to remain intact, while working to improve processes and lower operating costs. Outsourcing contracts should continue to be considered by companies for low to medium skilled technical processes with highly repetitive, closed loop processes (e.g., order processing). For large multi-faceted organizations, a managed services relationship can quickly provide the capabilities to automate, consolidate, and transform business practices resulting in lower operating costs and improved service levels.
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