In tough economic times, organizations search aggressively for costs to cut. Outsourcing benefits administration and other HR tasks is a major cost, and therefore a prime target. But outsourcing to the right vendor—and using that vendor correctly—can save the organization money in the long run.
The key is to manage the relationship well. This involves establishing a collaborative way of working with vendors that builds trust and open communication by:
• Setting forth all expected benefits in a written business case that includes quantitative and qualitative targets.
• Using practices that have been shown to produce good outcomes.
An overview of vendor governance goals, the governance lifecycle, and key best practices is presented below.
Benefits of Vendor Governance
What vendor management “looks like” might depend on an organization’s financial situation. Organizations with strong cash flow might want to take maximum advantage of vendor capabilities and perhaps even expand their use of strategic outsourcing. On the other hand, companies focused primarily on managing cash flow and reducing costs might want to negotiate aggressively with vendors and perhaps restructure current contracts.
In either case, vendor governance encompasses much more than just "resolving issues" and approving fees. Taking a broad view, it delivers four primary benefits:
• It helps mitigate and control risk. Organizations that understand how a third-party vendor undertakes the activities it has been hired to perform greatly increases their ability to provide consistent direction, thereby ensuring that vendors meet the contractual and regulatory obligations outlined in the initial contract. If problems emerge, as they inevitably do over time, this understanding helps the organization resolve those issues quickly.
• Use of vendor governance helps maintain a win-win relationship. The traditional vendor manager is a technical or subject matter expert and not necessarily adept at managing contracts, performance and overall relations with a third-party supplier. Under those circumstances, relations between the vendor and the client organization can quickly become adversarial or strained. A structured approach to vendor governance helps organizations build trust and enhance communication so that everyone feels that they are being treated fairly.
• Organizations that manage vendors well typically create more performance accountability. This is done by establishing well-written service level agreements (SLAs) that enable clients to measure the value they get for their outsourcing dollars. SLAs help with issue resolution by providing clarity on how and when to escalate problems. They also facilitate compliance with applicable laws and regulations.
• Use of a governance approach helps ensure that outsourcing delivers the expected savings. By making it more likely that vendors will deliver their services at market, rather than inflated, prices, vendor governance creates value.
The Vendor Governance Lifecycle
Organizations go through a predictable vendor governance lifecycle consisting of several distinct phases, each of which requires a somewhat different institutional skill set.
At the pre-signing phase, organizations must evaluate the services available for the functions they wish to outsource. One of the main skills used here is the ability to write a request for proposal (RFP) to find a vendor qualified to meet the organization’s requirements. Organizations must also be able to assess a potential vendor’s true capabilities accurately. This is not always easy, as some vendors may present their capabilities as being broader than they really are.
Once it chooses a provider, the client enters the contract negotiation phase. Because large-scale outsourcing contracts typically last for approximately five years, this phase is as difficult as it is critical. Unfortunately, organizations often make several common mistakes during this stage. Foremost among these is the failure to create a well-defined agreement. This is always important but especially so during challenging economic times. Organizations entering into a new contract should carry out a heightened level of due diligence in four major areas:
• Scope of services. Does the scope fulfill or match the requirements of the organization? Who is responsible for performing all services? What work will the client perform, vs. the vendor?
• Service-level agreements (SLAs). What metrics will be used to determine whether a vendor has performed its work satisfactorily? Often these metrics will measure efficiency, effectiveness and value.
• Fee disclosure. What will the client pay in fees? If the vendor fails to perform as agreed, what portion of the stipulated fees will be waived? Are the fees based on a per-employee basis, a per-transaction-volume basis, or on a flat basis?
• Terms and conditions (T&Cs). Most vendors have a standard set of T&Cs contained in the contract they submit to clients. A major component of the T&Cs concerns the vendor’s legal liability if the vendor is negligent or cannot provide the agreed-on services. Typically, vendors want to limit their liability to the value of the contract, whereas clients want more. Other T&C elements may include disaster recovery and business continuity, technology standards, information security requirements, dispute resolution, confidentiality agreements, service locations and other matters. Often, legal counsel is involved to provide expertise in this area.
When a contract has been negotiated, the process of implementation begins. In the earliest part of this phase, outsourcing providers learn about the organization before they “go live.” Once the vendor gets up to speed, the client organization must manage the vendor by ensuring that deliverables match the statement of work and by monitoring and approving any change orders and reducing out-of-scope activities.
While these operational issues are important, they tend to overshadow another key determinant of success: managing the relationship. If this is not handled skillfully, there's a risk that relations will turn adversarial.
Approximately 12 to 18 months before the current vendor contract expires, the organization must decide whether to stay with its current vendor, search for another or take the previously outsourced function back in-house. During this possible period of vendor transition, even organizations that decide to keep their current vendors are presented with an opportunity to improve the service they receive. For example, they may want to customize their current suite of services to accommodate changes that have occurred since the initial contract was signed. They can do this by adding new services, removing those they no longer need, or tailoring existing services to their new circumstances. All of these goals can be accomplished by renegotiating the existing contract.
If the organization decides to terminate the relationship with its current vendor, it must prepare well in advance (at least one year) to prepare for the transition. Clients that intend to replace their existing vendors must analyze the marketplace, looking at what services other vendors are providing and examining their pricing structures, financial stability and market share. Buyers should also consider how to leverage their upcoming end-of-term event to get more value out of a new relationship.
Those that decide to stay with their current vendors will want to find ways of wringing additional value from their existing contracts, and during an economic downturn many clients are likely to ask for price breaks.
Moreover, vendors typically build pricing models around employee populations, which determine business volume. Corporate actions that affect the employee population, such as acquisitions and divestitures, provide a great opportunity to reevaluate pricing. For example, if a divestiture cuts the employee population in half, a client’s cost per transaction may increase, resulting in the client’s being charged for work the vendor no longer performs.
Clients whose domestic operations suddenly become international will need to know if their vendors truly can service employees based overseas. Many vendors claim they can deliver services internationally, but if the country to be served is remote, or the number of employees is small, clients may find themselves searching for a new vendor.
A final issue in vendor governance: if one vendor comes in to replace another, a very real possibility exists for tension between the two. This tension must be managed to ensure continued information exchange, and an orderly transition.
Best Governance Practices
Here are some of the most important practices in helping clients obtain value from their outsourcing relationship:
• Establish a business case for outsourcing. Organizations should document their decision to outsource, citing the quantitative and qualitative benefits expected. Quantitative benefits will center on money saved by outsourcing vs. performing work in-house. These benefits should be expressed in dollar figures and ideally will contain a return on investment (ROI) realized over a period of time. Qualitative benefits should include softer but still important metrics such as improved response times and increased employee job satisfaction.
• Have a formal vendor governance strategy. Organizations should have written policies and procedures for managing the vendor lifecycle. This documentation will spell out what activities should take place at each stage of the lifecycle and provide a step-by-step escalation sequence of actions designed to resolve issues when they arise.
• Meet vendors in person. Clients and vendors must exchange information, and it’s best to have a few face-to-face meetings to foster a collaborative process. This is especially critical at the beginning of the relationship but is important throughout the lifecycle. Sometimes clients put themselves in an adversarial position with their vendors, dimming the prospects for a harmonious and productive relationship.
• Define criteria for service quality clearly. Service level agreements (SLAs) should contain individual metrics for evaluating service quality. Limit these to a manageable number, identifying the most important and reviewing them frequently. If targets are not being achieved, find out why. The organization might not be providing the proper data or sending it on time. Frequent reviews can help the organization identify these issues and formulate a plan to address them.
• Strive for a mutually beneficial relationship. Remember that vendors have to make a profit. Very low fees lead inexorably to poor service. Shoot for the proverbial win-win.
• Openly share information and take action as needed. Usually clients maintain an “issues log” describing problems, what caused them and how they were resolved. Sharing information can prevent the occasional and short-term issues from becoming larger problems.
• Check invoices for accuracy. The fee calculations in many HR outsourcing contracts are complex. A review of vendor invoices often reveals billing errors.
Effective vendor governance can help the client organization lower its costs, reduce risk and enhance the performance of its third-party suppliers. For that reason alone, it is an investment well worth making.
Jeff Brown is senior manager at Ernst & Young LLP and the leader of the Human Resource Operational Improvement function of Ernst & Young’s Human Capital practice. He is based in the firm's Dallas office and his areas of expertise include human resource transformation, human resource service delivery and sourcing solutions, human resource financial analysis, strategy articulation, HR measurement and benchmarking. The views expressed herein are those of the author and do not necessarily reflect the views of Ernst & Young LLP.
Strategies to Maximize Your Health Care Vendor Relationships, SHRM Online Benefits Discipline, April 2009
Benefits Outsourcing Eases Open Enrollment Pain, SHRM Online Benefits Discipline, October 2008
Benefits Administration Outsourcing: A Primer, SHRM Online Benefits Discipline, October 2006
Contracting with Benefit Providers: Tap Technology, Teams to Manage Bids, SHRM Online Benefits Discipline, October 2005
SHRM Online Benefits Discipline