If you're an executive managing outsourcing relationships end-of-contract time can be difficult. One option is to cross your fingers and renew the agreement, and hope that the incumbent is delivering reasonable rates and quality services. Another is to terminate the relationship and take on a lengthy, expensive and time-consuming Request for Proposal (RFP), with no guarantee that the new deal will be substantially better. A third alternative is to revisit your entire sourcing strategy and bring services back in-house.
As the outsourcing market matures, both customers and service providers are developing a variety of tools and techniques to address these complex issues. One particularly effective technique is the “proxy bid.” By reviewing existing or proposed services quickly and at little cost to either the customer or the service provider, a proxy can accurately gauge whether an outsourcing deal is financially sound. This knowledge can spare you from, on the one hand, renewing a bad contract, and, on the other, undertaking an expensive formal competitive review when it isn't necessary.
A proxy bid can be defined as an analytical process that compares the actual price an organization pays for a “basket” of services with the prevailing market price of a comparable “basket” of services. Developed by a third party with access to detailed and granular pricing data for outsourced processes and services, and a thorough understanding of outsourcing operations and price drivers, a proxy bid can show whether the prices you pay for a certain set of services are in line with what those services would cost at prevailing market rates. Armed with this knowledge, you are much better positioned to explore the financial implications of various sourcing options: Renewing with the incumbent, going to competitive tender, off-shoring, or bringing services back in-house.
A proxy bid offers a range of bottom-line benefits. For one thing, a formal contract tendering process can cost five percent to 10% of the deal's total value, while a proxy bid exercise can cost as little as 1/10th of that. The proxy bid is particularly useful if the client decides to either renew with an incumbent service provider or enter into single service provider negotiation. By providing a low-risk, low-cost alternative to the competitive bid process, a proxy bid provides external validation for the price offered by the outsourcer.
For service providers, meanwhile, a proxy bid can assess the competitiveness of a pricing proposal relative to current market conditions, as well as define the internal costs required to deliver the services.
Case Studies
Let's look at some specific scenarios where the proxy bid model has been successfully applied.
In one instance, a proxy bid was used prior to outsourcing to help a financial-services organization achieve maximum value from outsourcing following changes in its IT infrastructure. The client had grown by acquisition over a period of several years, and had several separate IT operations, all offering different standards of support to their internal customers. Before issuing an RFP, the client commissioned a third party to develop a proxy bid to determine how internal support costs compared to industry standards, and to define market rates for similar services. In addition to addressing these objectives, the third party developed a scenario model to determine the potential cost and operational impact of consolidating two data centers and three helpdesks into one centralized operation. The model, showing the future potential of the consolidated operation, was used to set prices by the two outsourcers bidding for the contract.
In another situation, a proxy bid helped a global organization transition services back in-house after its business requirements changed. The company had experienced serious problems over the previous two years, and operations had shrunk to less than half the size of what had been outsourced, while fees continued at levels originally contracted. An untenable situation resulted, as the client lacked the resources to continue the aggressive investment program planned at the outset of the contract, while the outsourcer was not receiving the benefit of this anticipated investment. The client organization desperately needed to reduce expenditure and could no longer accept the high fixed charges of the outsourcing contract. A proxy bid was developed by a third party to assess the contract. They confirmed that the contract was expensive compared against prevailing market rates and against in-house operations of similar scope. When negotiations with the outsourcer broke down, the client decided to bring the services back in-house. A follow-on project established the manpower requirements to deliver the same services in-house and the client used this information to design and establish their internal operation.
