When the Deal Goes Sour: How Morgan Stanley Manages Troubled Outsourcing Relationships

John Fafian, executive director of firmwide Sourcing at Morgan Stanley, believes in trying to fix broken outsourcing relationships before ending them. Listen to his views on why it’s …

John Fafian, executive director of firmwide Sourcing at Morgan Stanley, believes in trying to fix broken outsourcing relationships before ending them. Listen to his views on why it’s often better to stick with the provider you already have, where legal and procurement fit in and the process of analyzing in-sourcing options if you are looking to bring work back on-shore.

NSAM: Are today’s cost pressures putting more pressure on outsourcing relationships? If so, what can buyers do to prevent deals going bad?

Fafian: If you look across the outsourcing industry you really saw a big drop in new deals in 2009, and that put a lot of pressure on outsourcers, as they had to try to cut costs or increase revenue from existing customers to maintain profitability. That put a lot of tension in the system, as customers were simultaneously asking for cost reductions as they struggled with the same cost pressure. The drop off in new deals was driven by the economics of new deals. In most new initiatives, transition costs eat up any initial savings, process improvements don’t occur in the first year, and as a result, new deals are often expense and cash-flow negative in Year 1.

Today, while there is still a good deal of cost pressure, buyers of outsourced services are taking a longer term view, and willing to invest upfront in order to get long term savings. This has lessened the pressure on providers. (Note, Fafian spoke on many of these issues at the SIG Leadership Forum in Seattle last year.)

NSAM: Some analysts are pointing to a trend of buyers doing more deals, each of a smaller volume, than before. Does this make governance harder and thus makes it more likely deals will go bad?

Fafian: If you turn back the clock to early days, mega deals were in vogue. Customers realized over time that the prime outsourcer often struggled to manage all of the subs in order to produce seamless end-to-end service, and a lot of the mega deals were unwound. Customers also developed their own internal governance capabilities; these didn’t exist 15 years ago. This combination has led to customers being more willing to manage multiple best-in-class providers themselves. I think you will see more success, as individual relationships that sour will be smaller in scale and scope, and thus easier to remediate or replace. The impact of failures will also be more limited due to their smaller size.

NSAM: You have recommended in public talks that it is best to approach troubled deals from a joint “understand and fix” perspective rather than a “judge and punish” perspective. With so much pressure on the bottom line, how does a buy-side manager convince his higher-ups a “win-win” solution is possible?

Fafian: If one thinks about the cost of unwinding a deal either to in-source the work, or to transition to a different provider, the cost, and risk, of understanding and fixing any issues is far less. Obviously, this assumes the underlying deal cost is not out-of-whack with where it should be. I think the cost of transitioning needs to be the focus of communication. A business case to transition, or in-source, should be developed; this business case should show the cost of transition, and should help focus on remediation first. Of course, if after this process service is still subpar, a customer may have no alternative but to in-source, or transition to a new provider.

NSAM: You also mentioned that the type of remediation depends on the nature of the relationship. Do buy-side managers really not understand what type of relationship they’re in, or do other players such as legal or procurement not understand and force inappropriate metrics or value measurements on the buy-side manager?

“A company with a culture of being a “low grader” with respect to employee reviews will carry this culture over to provider satisfaction surveys, and what that company views as good grades on a satisfaction survey may be viewed by the provider as being below par”

Fafian: There are a few keys to doing this well. The most important is ensuring there is a good governance process, and that the folks involved (whether from legal or from procurement/sourcing) understand outsourcing and how to manage an outsourced relationship. This will let them identify the type of relationship they have, and how to best move.

NSAM: Speaking of metrics, you also said different kinds of value should be measured in different ways, including “leading vs. trailing indicators” and “tangible/objective vs. intangible/subjective.” Could you give some examples of these different metrics, and when each should be used?

Fafian: There are some indicators that actually measure the service. Some of these measure the quality of the service and others provide information required for the provider to run the service, but are not necessarily related to service quality. For example, if one outsources accounts receivable, Days Payable Outstanding is an objective indicator that can be measured, reflects the quality of the service, and can be used to manage the relationship. The number of customer accounts, and/or invoices generated, does not measure quality, but needs to be tracked. Metrics around customer satisfaction are an attempt to measure, and make objective, a relatively subjective measure. One needs to be careful to take into account corporate culture when constructing these metrics. For example a company with a culture of being a “low grader” with respect to employee reviews will carry this culture over to provider satisfaction surveys, and what that company views as good grades on a satisfaction survey may be viewed by the provider as being below par.

NSAM: You also mentioned that part of a problem-solving approach is an assumption that the pie can be enlarged, perhaps through innovation that cuts costs or increases revenue. In today’s economy, is this realistic?

Fafian: There are two keys to success here. The first is to have a good governance process that goes beyond a focus on current operations to a good discussion of a customer’s business challenges, and the service provider’s capabilities to meet some of these challenges. The second is that an outsourced provider may have a view across processes that a customer did not when performing the service in-house due to the customer’s internal organizational structure. For example an outsourcer may see that a small percentage of customers account for a large percentage of requests for expedited orders, returns, etc., and be able to share this information with their customer. The customer can then determine how to handle these customers, perhaps driving cost savings or identifying new business opportunities.

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NSAM: Any other points we should mention?

Fafian: I think the biggest thing folks need to keep in mind, and we touched on it earlier, is that is almost always better to remediate a relationship that is in trouble than to change providers, or in-source, unless there is some other compelling reason to make a change independent of the current relationship.

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