Vested Outsourcing’s Rule No. 5

Obviously it’s really important to have the right governance framework in place to enable the needed insight and to implement the other four rules of Vested Outsourcing. It’s how to achieve an effective, collaborative outsourcing agreement.

For example, it is really hard to optimize pricing model incentives for cost and service trade-offs (Rule 4) or agree on clearly defined and measurable outcomes (Rule 3) without an effective governance structure in place from the start.

But what does governance in this context really mean?

As I’ve delved into this question for books and articles, I’ve discovered that the answer is not so straightforward.

For instance, my research reveals there’s not much consensus on what constitutes a good governance framework, or even how to define the term.

My book, The Vested Outsourcing Manual, which will be published by Palgrave Macmillan in June, features a chapter on governance and how to implement a Vested governance framework.

So by way of a teaser, I’ll offer some points on governance now and in subsequent posts.

A sound governance structure will provide consistent management along with cohesive policies, processes, and decision rights that enable parties to work together effectively and collaboratively. The governance framework enables the parties to manage performance and achieve transformational results throughout the life of the agreement.

There is increasing recognition that there are benefits to reaching deep collaborative relationships with service providers, but many companies lack clear direction on how to build and govern effective partnerships.

Oliver E. Williamson, the Nobel Prize–winning economist, says “all complex agreements will be incomplete—there will be gaps, errors, omissions and the like.”  He adds, “The surprise is that a concept as important as governance should have been so long neglected.”

A flexible, collaborative agreement and governance framework can address Williamson’s points by crafting mechanisms that can cope with gaps and with unanticipated disturbances as they arise.

I believe that a good governance structure should include mechanisms to enable the parties in a relationship to better adapt to business changes—in effect, to keep everyone involved aligned and working toward their desired outcomes. Mutually agreed-upon desired outcomes are in essence the mechanism the parties can use to redirect their efforts as problems arise.

But who can blame practitioners for not adopting something so clearly needed when there is not even a clear definition of governance and guidance on what they are supposed to do?

That’s where I’m happy fill that definitional void.

I define governance insight as the process of governing an organization, enterprise, or agreement through learning and understanding. A Vested governance structure uses a relationship management structure and joint processes as a controlling mechanism to encourage the organizations to make proactive changes for the mutual benefit of all the parties.

A good governance structure creates the chance to understand the business better and to make the changes that will help the company and the service provider reach their desired outcomes.

So don’t neglect a governance framework for your outsourcing agreement!  There’s much more to come on Vested governance.

I’m thinking about this book today in a couple of respects. First,  it was published about 20 years ago at about the same time that modern outsourcing began to take off as an accepted business strategy. Some food for thought there it seems to me.

Second, after about two decades we’re still trying to find the best ways to negotiate and collaborate, and I think it’s fair to say that Vested Outsourcing and it’s collaborative approach to achieving the win-win and ‘What’s in it for We’ is in many respects a modern day updating of Getting to Yes – sort of a ‘Getting to We.’

The subtitle of Getting to Yes, “negotiating agreement without giving in” is not as harsh as it might imply or as the book’s message ultimately bears out.

The problem of reaching an agreement, according to the book, is that arguing about a position leads those involved to lock-in to their positions, leading to less than optimal agreements, or no agreements at all.

The authors talk about “hard” and “soft” positional bargaining – hard being to not give in, soft being to make concessions. Neither way of course is likely to produce an optimal agreement, because doing it the hard way can damage the relationship while acting softly will produce too many concessions.  This is very similar thinking to Dr. Oliver Williamson’s description of the “muscular” and “benign” approaches to contract negotiations, which I’ve talked about in previous posts.

Playing nice will get you only so far; it’s just as important to be credible, flexible and hard-nosed when necessary.

Fisher and Ury suggest parties should negotiate on the merits of the problem, using principled negotiations while viewing the participants in a negotiation as problem solvers – not as friends or adversaries. They continue that the goal should be to achieve a “wise outcome” efficiently and amicably, not just to get an agreement or to win.

They also say: “Separate the people from the problem,” and “Be soft on the people and hard on the problem,” “Focus on interests not positions,” and “Invent options for mutual gain.”

Wise words from the past that are remarkably resonant today with Vested Outsourcing’s Five Rules and the need for credible contracting, such as focusing on outcomes (Rule 1), focusing on the what (Rule 2) and agreeing on clearly defined and measurable outcomes (Rule 3) that produce mutual benefits and the win-win.

On that note. one of my favorite philosopher-bloggers, Seth Grodin, wrote about winning recently, and especially about what winning means as we mature as people and institutions.

For example, he writes, “A toddler wants what she wants, now. That’s a win. A little later, when we’re more mature, we might define winning as getting what we want at the expense of someone else.”

Godin continues: “What happens when you define a win as getting closer to someone who wants the same thing? Or when you define it as improvement over time? Or in creating trust?

“What if the win is the ability to give a true gift?”

Is there any need to answer those questions?

As we move to the Vested Outsourcing world of cooperative, mutually-beneficial, performance- and outcomes-based contracts based on the transforming power of the Five Rules I’d suggest that the oft-used term “Contract Management” no longer really fits the bill.

In fact I believe Contract Management is a bad term. At the very least it’s outdated, larded under decades of contract legalities and precedents that struggle to account for what has happened and what may happen in the real world.

In Vested Outsourcing aren’t we really developing a flexible, anticipatory and collaborative framework and governance structure to manage a dynamic business relationship? This is straight out of Rule 5, Governance Structure Should Provide Insight, Not Merely Oversight. The Vested Outsourcing relationship works best in a framework and culture where the participants work together to ensure their mutual success.

Think of it this way: Marriage is a legal agreement, and certainly a marriage can be difficult to manage. But it is much more than a legal enterprise in which each potential event or scenario can be carefully anticipated and managed, or something that’s inherently susceptible to strict management rules. It’s a unique, vested relationship based on mutual trust, cooperation, flexibility, hope and much more.

A contract, especially a vested contract, is like a marriage in many important respects. It should be the basis of a long-term relationship in which the contract parties work, grow and prosper together.

A marriage based totally on transactions doesn’t sound like much fun for the long-haul; neither is a transaction-based contract.

So instead of Contract Management, perhaps it should be called Economic Relationship Management.

And while you’re thinking about managing that economic relationship think of it also as a flexible framework, not a legal weapon.

We all know that the world of business and outsourcing is not static; it changes and evolves over time. Dr. Oliver Williamson, the Transaction Cost Economics guru, argues that organizations that “all complex contracts will be incomplete – there will be gaps, errors, omissions and the like.”

As such, a contract should provide a framework and (I hope) a process for understanding the parties’ relationship. The framework thus must be highly adjustable or adaptable rather than prescriptively outline the detailed working relations.

Flexibility should be embedded in a contract so that potential maladaptations can be resolved or at least lessened by crafting mechanisms that deal with unanticipated disturbances as they arise.

Creating a detailed contract and associated statement of work puts the outsource provider into a box and forces the provider to stay there. Instead of being a prescriptive document, the contract should provide a flexible framework and process for understanding the parties’ relationship. In achieving this “flexible framework” the contract will never accurately or fully indicate real working relations, unless the contracting team has immense psychic talents. Instead of trying to guess about the future, it is better to indicate a rough idea of the work to be done, while providing methods for ultimate appeal.

This means that this framework/process must be highly adjustable or adaptable. And trusting. And cooperative. Like a marriage.

Stuck may not be the right word actually, it’s more like really impressed and fascinated with how his scholarship dovetails so nicely with the Vested Outsourcing concept of working aggressively, flexibly and cooperatively to achieve mutually beneficial or ‘win-win’ outsourcing agreements.

In a previous post. I talked about the implications of Dr. Williamson’s TCE research for outsourcing at what he describes as the “interfirm make-sell-buy” contract and conflict resolution level. He outlined this in a 2008 article in the Journal of Supply Chain Management (“Outsourcing: Transaction Cost Economics and Supply Chain Management”).

I was reviewing some of his work again, particularly in connection with his description of the three types of hybrid contracts – muscular, benign and credible – and I was fascinated by his discussion surrounding the common economics aphorism, “Never leave money on the table.”

Could it be, as Dr. Williamson suggests, that it’s “better to leave money on the table,” to not win every negotiating point?

Well yes; in the case of a credible, mutually beneficial contract that idea might be just the ticket for a winning and adaptable contract.

Never leaving money on the table has cache, especially in a muscular contracting arrangement, Williamson says, because “money left on the table signifies waste that can be converted to mutual gains by perfecting the bargain.” It’s an important lesson, he continues, but “as with many aphorisms there can be too much of a good thing.”

The economists’ dictum to never leave money on the table has been disputed by some investment bankers and businessmen who advise ‘always leave money on the table,’ Dr. Williamson says.

“But that sounds foolish. How could this be?” he continues.

As sometimes happens good theory (for one purpose) and good practice (for another) can part ways.

For one thing constructive and strategic contractual points are sometimes hard to differentiate. What exactly are the parties’ intentions going into a negotiation?

If there is a strategic, rather than constructive, purpose that skews the contract in one party’s favor “and if real or suspected strategic ploys invite replies in kind, then what could have been a successful give-and-take exchange could be compromised,” Williamson explains.

Asymmetry will rule the day as each party tries to gain and regain the upper hand.

This activity ”could plainly jeopardize the joint gains from a simpler and more assuredly constructive contractual relationship.

“Always leaving money on the table can thus be interpreted as a signal of constructive intent to work cooperatively, thereby to assuage concerns over relentlessly calculative strategic behavior.”

That’s a contract with credibility from start to finish. And that’s where the rubber meets the road for Vested Outsourcing.

In contrast to a one-sided muscular contract or an idealistic benign contract, “credible contracting is hardheaded and wise,” Dr. Williamson says.

The parties are hardheaded because they expressly work out contract commitments “to which mutual benefits can be confidently ascribed.” They are wise if they avoid contract provisions that “invite the escalation of strategic behavior with net negative effects.”

And they are brave and foresighted if they see the value of leaving money on the table.

After all, outsourcing may be high stakes but it’s not poker.