vested interests

Peter Drucker, considered by many to be the father of modern management, once said that outsourcing is not so much about cost cutting as it is about improving the quality of work that others can do better than you can.

Kate Vitasek and her team at the consultancy Supply Chain Visions and the University of Tennessee have a slightly different take on the subject: They say outsourcing is not so much about cost cutting as it is about both parties' interests being perfectly aligned. And it is on this foundation that they have built a new philosophy of outsourcing: Vested Outsourcing, or VO. Vested Outsourcing represents a totally new, collaborative method of outsourcing based on pay for performance.

In the outsourcing world, a genuinely new concept comes along only once in 10 years or so. But I have a feeling this is one of them.

To understand how VO promises to change the game, it helps to know a little about the history of outsourcing. Outsourcing has been with us since the 14th century, when the merchants of Europe and Asia stored their goods in warehouses at the port of Venice for later shipment to the New World. The concept was quick to catch on, and soon companies all over the world were contracting out warehousing and transportation. But for the most part, these early arrangements were strictly "one off" transactions. It wasn't until the 1960s that we saw our first real breakthrough with multiyear warehouse contracts.

During the 1970s, an era that saw U.S. manufacturers putting heavy emphasis on cost reduction and productivity, longer-term relationships became more common, particularly in the warehousing arena. Outsourcing got a big boost in 1980, when a relaxation in regulation made it possible for carriers and others to enter into truly innovative long-term relationships with customers.

The most common criticism of the typical outsourcing contract was that it offered no incentives for productivity improvement or superior performance, and the late 1990s saw an expanded use of gain-sharing agreements. Unfortunately, however, many of these arrangements lacked a crucial element: While they rewarded providers for enhanced performance, they neglected to include penalties for poor service or substandard productivity.

Vested Outsourcing changes all that. VO meets gain sharing head on. While somewhat similar to gain sharing, VO stipulates that the outsourcer pays strictly for performance—i.e., the successful fulfillment of those activities the two parties have agreed are necessary. A party to a VO contract does not pay for transactions. It pays for results, or in the language of VO, "desired outcomes." The agreement clearly spells out both the financial rewards for exceeding the agreed-upon "desired outcomes" and the penalties for falling short.

At first blush, VO may sound complicated, but actually it's beautiful in its simplicity. And it promises to bring collaboration to a new level, although it will require a significant change in mindset for those logistics service providers that still cling to the transaction-based business model. It requires not only a meeting of the minds or alignment of interests, but also a clear understanding of what is expected. Most important, the provider must be willing to accept the risk-reward aspect.

Perhaps the most important lesson to be learned from the 2000s is that the complacent, reactive logistics service provider is becoming obsolete. Both providers and users must be proactive, flexible, and clearly focused. I believe the sophisticated providers will understand this, as will the more enlightened outsourcers. Particularly in this economy, VO represents a wonderful opportunity for both parties to profit from a true results-oriented collaboration.

For more information, visit www.vestedoutsourcing.com. You'll find it's time well spent.