The Outsourcing Decision Most Firms Get Wrong

When firms talk to me about outsourcing, the conversation often starts with the service provider.

Who should we use? Who has the best technology? Who can give us the best price?

Those are legitimate questions. But there’s a more important one: Are you outsourcing the right process under the right model?

There are basically three ways most outsourcing contracts are structured: cost-plus, SLA-based and FTE-based. One model is not always the correct one.

Cost-Plus: Know What You're Paying For

Under cost-plus, the firm reimburses the provider's operating costs and pays an agreed-upon management fee or profit margin.

The advantages are transparency, flexibility and scalability, particularly when you're dealing with a new operation where volumes or scope aren't completely defined.

But here's the question: What incentive does the provider have to lower your costs?

You also need to define "cost." Are management expenses included? Bonuses? Other allocated expenses?

And make sure you have detailed reporting. Transparency doesn't mean much if you can't see the numbers.

SLA-Based: Pay for Results

An SLA-based contract pays the provider to achieve defined outcomes—answering phones within 20 seconds, processing invoices within two business days or achieving 99% customer satisfaction, for example.

The provider determines the staffing, scheduling and technology necessary to deliver those results.

For mature, well-defined operations, I like this approach because the incentives can be aligned with performance. The provider has a reason to innovate and improve efficiency because you're buying the result, not a certain number of people.

The catch? Your SLAs have to be well defined. If you don't clearly establish the metrics and scope, you're creating problems for later.

FTE-Based: Simple, but Manage It

Most outsourcing engagements we see are FTE-based. You pay a defined monthly rate for a certain number of Full-Time Equivalents.

It's predictable and easy to budget.

But remember: the provider makes a profit from each FTE.

If an efficiency eliminates an FTE, where is the provider's financial incentive to implement it?

That's why these engagements have to be actively managed. Do you have the right number of FTEs? Do they have the right skills? And are you actually receiving all of the FTEs you're paying for?

I would also have SLAs in place. Paying for people doesn't eliminate the need to measure results.

Maybe the Answer Is a Hybrid

For administrative and back-office services in large law firms, a hybrid model can often provide better alignment.

You might combine base FTE pricing for adequate on-site coverage with SLAs for performance, variable pricing for fluctuating work and continuous improvement requirements that encourage the provider to reduce costs or improve productivity.

Before you issue an RFP, start with the operation—not the provider.

What are you outsourcing? What does success look like? Who should carry the risk? And what incentives are you creating?

Get those answers right first. Then worry about who the provider is.