Incentives

Transformational outsourcing requires that executives set new metrics and use conventional metrics in new ways. It also demands a specialized approach to incentives. The bonuses and penalties that often accompany conventional outsourcing have a role to play, but they take a different shape. Money should not change hands for hitting—or missing— everyday service levels and project milestones. That would distract both sides from the larger agenda. What some organizations do instead is simply share the revenue that results when they are successful. For example, a heavy equipment manufacturer has strategic partnerships with a few companies that provide critical subassemblies for its products. Instead of paying for these subassemblies as pieces, the company gives its partner an agreed-on percentage of the revenue from each equipment sale. This inspires both partners to take responsibility for making sure the joint product or service fills a market need at a price customers can afford.

Committed partners also share risk by betting their own money on the outcome. Both partners put resources at risk, and they both share the benefits when their strategy pays off. Remember the Spanish bank? It asked an outsourcing partner to help it implement new systems and processes to change it from a small mortgage lender to a full-service bank in less than one year. How did the outsourcing provider get paid? It received a percentage of the bank’s assets under management. The more successful the bank became, the more benefits accrued to its partner.

Transforming executives do offer their outsourcing partners ‘‘interesting money’’ as a reward for significant or surprising accomplishments. Thomas Cook has a million-pound ($1.66 million) bonus awaiting its provider if the latter can provide a step-change improvement in the shared service center’s cost structure by the end of the third year of the contract. GiantTel agreed with its provider that it would pay the entire development cost for the new Internet protocol network when it was ‘‘ready for revenue.’’

Some executives insist on charging their providers penalty payments for missing service levels or project milestones. Most would agree, however, that the purpose of this mechanism is to make sure providers pay attention to minimum standard levels of performance. In transformational outsourcing, if the vendor isn’t paying enough attention, the initiative has already failed. Furthermore, a penalty payment is cold comfort when what executives really want is delivery of a critically important service. A more useful role for penalties in transformational outsourcing is to compensate the company for a catastrophic failure. Neither partner welcomes this out- come, but the penalty provides some protection for the company’s shareholders.

Transformational outsourcers ensure that real incentives flow directly into the hands of key individuals. Leaders put the entire weight of both companies behind these initiatives by linking transformational outsourcing performance to bonuses, raises, promotions, and recognition for the individuals involved. For example, TiVo gave its outsourced customer care agents the product to use in their own homes and provided direct incentives to individual agents to motivate them to ‘‘think like a TiVo customer.’’

Money is not the only useful form of incentive in transformational outsourcing. The participants take motivation from other incentives that touch them emotionally. For example, committed partners put their names on the line. They announce their intentions and stake their reputations publicly on their ability to deliver the results they project. As one CEO quipped to his board, ‘‘If this doesn’t pay off, I’ll never work again in this industry. And neither will our partner.’’

I used to work in an organization that was led by inexperienced executives who believed that ‘‘management is measurement.’’ No seasoned leader would make this mistake. Companies in committed relationships believe that relying on metrics and incentives alone can even undermine their intentions. Veterans of sophisticated outsourcing initiatives stress that success is all about people. And that means managing not only what they do, but how they feel.