Outsourcing Metrics: Key Performance Indicators

Good outsourcing contracts contain service level agreements, which define performance parameters of the services companies procure from their vendors. In previous popular articles, we addressed the general structure of Outsourcing Vendor Metrics and provided more detailed information on Operational Service Levels and Metrics. However, operations are data rich environments with a multitude of metrics that an experienced vendor manager could use to manage the vendor. While typically 4-7 different metrics will be memorialized in the contract as formal service level agreements that trigger penalties and incentives, these alone are insufficient to effectively manage the vendor.

The rationale is quite simple. Believe it or not, but outsourcing vendors have tremendous pricing discipline. They analyze Net Present Value and Internal Rate of Return on their investment in the client contract. All factors are included, such as labor, facilities, technology, telecommunications, etc. More importantly, savvy vendors develop probability models of anticipated performance against service level agreements (which is what they do with your internal performance metric data – if you give it to them). They use SOX-driven corporate guidelines when developing these models which force them to assume some degree of failure. This failure is then built into the price – essentially allowing the vendor to obtain desired financial performance even when performance fails to meet client expectations. This dramatic difference in rewards and incentives between clients and their vendors should encourage clients to drop “partnership” and “partner” from their lexicon, except for the fact that overcoming this financial gap requires true relationship building.

In a nutshell, service level penalties are insufficiently severe to drive vendor performance. That means successful vendor managers must use other levers to compel vendors to perform. One of those levers is a comprehensive key performance indicator program.

A key performance indicator program is a continuous process that focuses the vendor on a variety of leading and trailing indicators of process performance. The contractual operational metrics are a subset of these indicators – there are many other metrics and a clear process you should leverage.

Indicators – The choice of indicators you use largely depends on the business process or technology that you have outsourced. Besides the contractual operational metrics, business process outsourcing indicators should include forecasting accuracy, staffing accuracy, schedule adherence, attrition, inventory, quality calibration accuracy, loaded cost per transaction, and invoice accuracy.

KPI Achievement Index – With so many indicators to deal with, it’s hard to summarize vendor performance. A simple measure of success is an achievement index, which is calculated by dividing the number of metrics met or exceeded by the total number of metrics. There is no weighting of the indicators because it’s too complex given the number of metrics and leading indicators could cause other metrics to fail. With that said, measure the achievement index weekly or month to date, with a year to date measurement, too.. As severe as that may seem, that’s what a good operations manager should be doing, if not daily – being brilliant at the basics.

Formalize Review – In daily or weekly operations meetings, the indicators and achievement index should form the foundation of the meetings. Meeting between 1-3 times a week, even when achievement is high, should be required. Formalize the agenda to include discussion of all indicators. The discussion should not just focus on failure but also on deterioration of operational performance. Use formal root cause analysis processes. Never be lulled to sleep just because the metric is above the line. We recognize that the frequency and standing agenda may get boring over time, but excellent outsourcing executives understand that management is repetitive. It’s this repetition that drives performance.

Forced Remediation – Good outsourcing contracts give vendor managers the ability to obtain root cause analyses operational metrics, but sometimes leave out either key performance indicators and deterioration. Be sure to include language in your contract which requires the vendor to perform root cause analyses on missed or deteriorating operational metrics and key performance indicators. If your contract doesn’t contain the language, vendor managers can still manage using these metrics by explaining the need for this level of management with the vendor account management team. If they are still reluctant, escalate with a tone of “positive, collaborative focus on sustained process performance.” Eventually the vendor will agree that this level of client involvement will ensure better performance, which means increased profitability and better client satisfaction levels.

Do you use key performance indicators in your outsourcing contracts and vendor management process? Share your thoughts with us as a comment or send us a note.

Related posts:

1. Transformational Metrics: Governing Outsourcing’s Lure
2. IT Outsourcing Metrics: A Good Example of Management Controls
3. Outsourcing Vendor Metrics
4. More on Outsourcing Vendor Metrics: Operational Metrics
5. Outsourcing Governance and “Who Owns Supplier Performance Management?”