A Blueprint for Transformational Outsourcing in Government


As their arsenal of outsourcing approaches grows, some public-sector executives are learning to construct new operating models that parcel up value and risk in advantageous ways. These deals can involve creative financing like joint ventures and private finance initiatives, and they can extend public-sector activities into whole new arenas. These ventures work like breeder reactors—they don’t just capture value, they also stimulate its growth. Government executives use two forms of transformational outsourcing to redesign the way the public sector works: they make lasting commitments to transform the value equation like private-sector companies and, in what appears to be a unique approach in the public sector, they make a market for services.

Use Outsourcing Partnerships to Transform the Value Equation

Government organizations can use outsourcing to make an effective market for services when the services are relatively independent or modular. In other words, executives can outsource the copy center to one vendor and the wastewater treatment to another without worrying about how they will interact. When a government organization needs a radical improvement in systemic performance, executives take a different tack. They use committed outsourcing partnerships to transform critical processes and create new operating models.

To radically change an organization’s performance, executives out- source functions and processes that are essential to the mission through a long-term, strategic commitment. The UK’s National Savings and Investments stands as a premier example of stem-to-stern transformation through outsourcing.

Government executives also outsource to eliminate roadblocks to growth. They create new operating models by turning costs into investments and generating new sources of revenue. In the United States, 17 states have joined with a private company to build and operate state Web portals without spending taxpayers’ money. NIC, Inc., earns revenue from fee-based online services such as providing motorists’ driving records to insurance companies. It generates enough money to pay for operating and maintaining the state’s Web site in the bargain. The government of Ontario, Canada, has joined with Bell Canada to operate and maintain the province’s mobile communications towers. Ontario funds this capability by enabling its partner to use the towers to offer revenue-generating services.

The government of South Australia, identified by Outsourcing Journal as having the best government outsourcing relationship of 2000, framed a transformational approach that, to date, has been unique to the public sector. I’ll call it the quid pro quo model. The government aggregated the mainframe and mid-range computers and wide area networks of 100 agencies to attract a top-drawer IT infrastructure outsourcer. In return for the business, the vendor had to offer an attractive price and commit to providing economic development for the state. The low-price bidder didn’t win—government executives chose the vendor with the best economic development proposal—but the savings have been substantial. More important, the vendor’s operation in the area has more than tripled, spawning new support businesses and providing millions of dollars in value to the local economy.

Establishing and sustaining a transformational commitment means government executives must go beyond contract management to master relationship management. Because of its strategic importance, transformation requires leadership at the highest levels of both public- and private-sector organizations. It demands fresh thinking about how services, risk, and value can be unbundled and an intense, committed relationship between public and private partners can be developed to deliver on enterprise outcomes. To use this approach, executives come to grips with a series of management issues. They find ways to measure outcomes and outputs. They aim for outcomes, then work with their partner to craft an agenda to reach them. When they cannot get at outcomes, they use outputs as proxies. What’s the difference? Outputs are measures of service delivered, while outcomes are the consequences of excellent service delivery. For example, an output might be processing child-support payment requests within 24 hours; the corresponding outcome would be reducing child poverty. Targeting outcomes enables both public- and private-sector partners to align in doing whatever it takes to achieve the ultimate objective.

In addition, these executives measure critical inputs. For example, they carefully assess the key individuals who will be leading the charge on the outsourcing provider’s team. If these people don’t inspire confi-dence, government executives ask for replacements. These high-profile initiatives cannot afford missteps, and penalty payments don’t come close to making up for the political flak that executives will take if they occur.

Executives look for a strategic ally, not an outsourcing vendor. They use procurement processes that give outsourcing providers the latitude to make innovative proposals. They assess vendors’ capabilities and ideas, then choose a supplier who will work with them to do whatever it takes to accomplish their objectives. While some government executives retort that their procurement laws prevent establishing this kind of relationship, others have found a way to do it (see the case study, ‘‘Making a Lasting Commitment,’’ below).

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Case Study: Making a Lasting Commitment: UK Department of Social Services

In 1995, the UK Department of Social Services (DSS) turned to the private sector to supply support processes it believed were not critical to its mission: data center and technical support services for large systems. It retained applications development in-house because of this activity’s centrality to the department’s mission. After a thorough analysis, DSS awarded the contract to a large, global company and transferred 1,500 employees. The results were good. A DSS executive recounts: ‘‘The service has been perceived to be good, there were no horror stories about the money, and the people we transferred have had all the advantages we anticipated.’’

By 1997, however, DSS was embarking on a major new strategic agenda to modernize the welfare system. The executive reports: ‘‘At the start, we didn’t quite know what we wanted the partner to do, so our first step was to identify a company to work with. We advertised in the official journal of the European Commission for a strategic partner to forward welfare reform.’’ DSS selected its data center vendor as the lead service provider and began to craft a part- nership to develop and operate a new child-support system. ‘‘The degree of risk transfer we were seeking was hard to obtain on a development project in isolation,’’ the executive continued, ‘‘so we rolled up a broader deal. We combined the operational work from 1995 and added the in-house development capability. Fifteen hundred more people transferred to the outsourcing vendor, and they became our partner for delivery of all new systems.’’

DSS’s remaining organization concentrates on two functions: ongoing management of the department’s commercial relationships and negotiating new deals. It’s still early in the transformational part- nership, and results are still to be determined. But DSS is clearly counting on its outsource partner to play a major role in implementing the modernization strategy: ‘‘Our 1995 contract was for noncore business. Now we want a much broader relationship. We want [the vendor] to assist in driving forward with this major strategic change. It represents a whole set of expectations.’’

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In direct opposition to adversarial contracting practice, they insist on creating a financial model that makes a profitable business for the private- sector partner and compensates them for the risk they assume. To attract investment, government executives recognize they have to offer their partners appealing rewards. Prestige and the ability to provide a reference can bolster the value proposition, but these alone will not be enough. Conducting the analysis to build a robust model will have an additional benefit: Executives will understand what value has to be created, where the business risks lie, and who has to carry them.

To achieve high-level outcomes in a volatile environment, executives understand they need to drive innovation at the top. Both partners will want a hand on the strategic steering wheel to bring their unique skills and expertise to bear. Performance improvements accrue as the partnering relationship deepens, not just at contract renewal time. Executives will want to lead a regular, active governance process to stimulate new ideas and drive innovation.

In addition, executives will not want to underestimate the leadership challenge. If anything, executives need to focus more attention on effective operations, not less. An NS&I executive remarks: ‘‘Some managers think their problem will go away when they outsource. It never does. We knew we were just swapping one management challenge for another.’’

Make a Market for Services

As part of their transformational efforts, some government executives create a ‘‘contestable’’ market for services. This approach works in an environment characterized by multiple independent services, and is built on a foundation of market testing practices, but it goes well beyond. Executives who undertake this kind of transformation step back from the everyday, ‘‘one deal at a time’’ perspective to establish an overarching agenda to aggressively promote innovation through competition in each separate service.

Executives who use it:

  • Change their own mind-set from controlling functions to buying services.

  • Shift fixed assets to private companies so government payments can come from recurring funds, not allocated capital.

  • Recompete contracts relatively frequently to stimulate continuous improvement.

  • Track performance metrics for every service, whether it is performed in-house or by an outsourcing provider.

For example, Steven Goldsmith, the mayor of Indianapolis from 1992 to 1999, argued that his city was in direct competition with its suburbs for citizens. Faced with a reduced tax base and the need to do more with less, Goldsmith opened more than 70 services to competitive bidding in six years. Regardless of whether the current employees or the private sector won the competition, savings accrued. Goldsmith redeployed these savings to improve the government’s value proposition. He recounts: ‘‘We have reduced our operating budget by 7 percent, cut taxes twice . . . put 100 more police officers on the street, [and] invested $700 million to rebuild our roads, sewers, and other parts of the city’s infrastructure.’’[5]

Australia’s government makes service markets by institutionalizing choice. It allows government departments and agencies to choose any supplier, not necessarily the in-house organization. They also regularly measure the government’s unit cost for producing its outputs through pricing reviews and post this information, along with benchmark data, for everyone to see. An Australian finance and administration executive elaborates: ‘‘When services were in-house, costs were not explicit. When you outsource, you get a market signal about true costs. It revealed to us that government had been overinvesting for generations in areas that were marginal.’’ As a result, the size of the government workforce has been reduced by about one-third over five years. When they make outsourcing decisions, they explicitly consider how their awards will shape the vendor community to create a vibrant marketplace when contracts must be renewed. Instead of building and owning expensive infrastructure, the UK defense department makes a market for services in order to limit its investment in underutilized assets. Executives now buy flight simulator training, air-to-air refueling, ship repair, and equipment transport services from the private sector on a ‘‘per transaction’’ basis. In other words, they no longer pay to maintain and operate the flight simulator and to conduct training for pilots; they pay a fixed price for each pilot who can pass the flight test. They pay for fuel delivered down the pipe, not the equipment and people to deliver it. The UK chief of defense procurement explains: ‘‘I don’t have to pay for excess capacity—the vendor can use it to serve other customers.’’ By owning all the equipment, the outsource vendor controls all the components of performance and has every incentive to invest sensibly. This executive notes that his approach subtly changes the dynamics of demand: ‘‘There’s a magic law in life—once you have to pay for something, you always want less of it.’’ His organization improves cost significantly by managing demand in this way, and that allows them to increase resources to war fighters.

In the United States, the Defense Logistics Agency (DLA) also used this approach to transform its operation from mediocre to top-drawer. It uses a concept called ‘‘prime vendor’’ to outsource supply of military repair parts, medical supplies, and meals. Instead of purchasing and managing supplies itself, the DLA contracts with a supplier to take on this critical logistics function. The supplier is responsible for managing inventory and positioning it appropriately to fulfill demand quickly and reliably.

To make an effective contestable market for services, executives must sustain a competitive environment. Otherwise, when it’s time to renew the contract, they will have only one viable vendor in the market. To transform their operations by making a market for services, executives adopt a very different set of practices than those described above (see the case study ‘‘Making a Market for Services: UK Defense Ministry,’’ on the next page).

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Case Study: Making a Market for Services: UK Defense Ministry

If an asset doesn’t fight on the front line, the UK Defense Ministry considers outsourcing. This is a whole new way of looking at the provision of defense capability: Instead of the government’s owning the capital asset, the government buys the service. Let’s take an example: If they buy a Chinook helicopter, they have to train the crews. They know it’s much cheaper to train on simulators, but when capital funds are short, it’s normal to delay buying the simulator. So it may turn up six to 12 months later. Then they must keep it up to the same revision as the aircraft. It is staffed and maintained by people who would otherwise be on the front line, so the personnel are always changing. And they have to do it according to regulations, which can be unwieldy. The asset is almost always underused. Why? The ability to predict how much they need is difficult, and no one wants to be caught short.

This organization has learned they can do a much better job by outsourcing the service. They create a ‘‘take or pay’’ contract that stipulates they will pay for a certain number of trained pilots per year, whether or not they actually use this capacity. This kind of contract provides a solid foundation for the supplier to get financing for the asset. Today, that might represent 90 percent of the capacity, but over time it might decline to 50 percent as needs change. The out- source supplier takes responsibility for owning, operating, and maintaining the asset. The government no longer commits combat personnel to the activity, and they get other benefits as well. It saves the Defense Ministry 10 to 20 percent of the cost. Furthermore, that simulator turns up on time and gets maintained effectively because the supplier gets paid only when it turns out trained pilots.

As an isolated example, this is interesting, but not transformational. Extend the concept broadly across the Defense Ministry, and it fundamentally changes the way the organization works.

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They use fast, flexible procurement processes to facilitate repeated contracting. When they use market forces to drive improvement, the real upticks come each time the contract is tendered. Executives set their sights on a tendering process that takes no more than three months in order to maintain a healthy pace. It should also encourage reengineering to tap into the opportunity for change.

We’re talking about contracts here, not partnerships. Executives should manage the scope and complexity of each deal to minimize switching costs. The more complex and volatile the requirements are, the more difficult it will be to switch vendors when the time comes. Executives will want to craft deals with clear output requirements and explicit end-of- contract handoffs. In terms of the government’s own managerial skills, making effective transitions comes to the top of the list.

Striking avowedly short-term deals can inhibit the outsourcing provider’s willingness to invest up front. Using ‘‘take or pay’’ pricing can help. ‘‘Take or pay’’ refers to a commitment to pay for a specified volume of service regardless of whether it is actually used. For example, the UK commits to paying for two military equipment transport ships at all times, with an option to use four additional ships. Contracts to provide prison and hospital services often stipulate a basic number of beds required. Because of the risk of being replaced, vendors will be reluctant to invest in specialized assets without some volume guarantees. Executives will want to make sure their contractual exit clauses enable these assets to be transferred when and if they choose a new vendor.

In order to manage transformational service markets, government executives relentlessly measure performance. Without clear, specified outputs and visible measures of performance, they will never be able to line up a contest. They use pricing reviews, competitive benchmarks, and activity-based costing to track outputs during the vendor’s term as well as at renewal time.

These government executives are transforming the way their organizations work by making a market for services. While many government agencies outsource some processes, what sets these executives apart is that they use this approach broadly and strategically. They’re not just crafting deals, they’re orchestrating an active environment of deal making that stimulates healthy competition and inspires an entrepreneurial attitude among public-sector staff that fosters continuous improvement.

This approach is categorically different from using deep outsourcing partnerships for transformation. Why have we seen it only in the public sector, and rarely there? It makes sense only when a wide array of the organization’s activities can be packaged up as independent commodity services and purchased from any of several vendors. These must be well enough understood to be managed and coordinated by public-sector relationship managers. And they must operate in neat organizational silos to minimize the chaos and coordination costs that would mount rapidly if government executives had to orchestrate daily cooperation among multiple competing vendors. Also, this transformation model relies on the threat, if not the reality, of replacing vendors at will. So they must enter and depart like plug-and-play modules in a desktop computer. If every retender were extensive and difficult and every transition were time-consuming and risky, this approach would soon be swamped by the costs of administering it.

[5]Stephen Goldsmith, ‘‘Can Business Really Do Business with Government?’’ Harvard Business Review, May-June 1997, pp. 110–121.




Outsourcing for Radical Change(c) A Bold Approach to Enterprise Transformation
Outsourcing for Radical Change: A Bold Approach to Enterprise Transformation
ISBN: 0814472184
EAN: 2147483647
Year: 2006
Pages: 135

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