Outsourcing

Outsourcing can be tempting, but it will not improve efficiency without a smart, market-based procurement effort, clear performance standards and tough vendor oversight.

Many taxpayers have come to view outsourcing as a panacea for many governmental ills, such as high taxes, exorbitant operating costs and unresponsive services. While it is true that outsourcing can make some public services more effective and efficient, it can also make matters worse. Smart organizations use outsourcing like a scalpel, in limited circumstances and with great care.

There are many public services that could be outsourcing candidates, such as revenue collection, property assessment, jail management, parking, facility and vehicle maintenance, sanitation and custodial. But, every organization should employ objective criteria for determining when outsourcing offers potential for improvement. Such criteria may include the following:

• Mission - the services should not be mission-centric (e.g., police patrol) or prohibited from outsourcing (or there should be viable strategy for overcoming any known legal barriers to outsourcing);
• Competition - there must be a competitive market for the services to generate any sizable potential for financial savings, both in the short-term and long-term;
• Measurability - for contract and accountability purposes, the service must be definable and quantifiable (i.e., it must have clear performance objectives, discrete service units and reliable cost data);
• Feasibility - outsourcing the service should not only be financially feasible, but it also should offer benefits in excess of the potential costs, risks and other obstacles associated with the endeavor; and
• Other - outsourcing the service should not significantly harm important segments of the local economy, waste recent capital investments (e.g., facilities) or preclude other desired innovations (e.g., new programs).

Once it has decided to pursue an outsourcing initiative, an organization should carefully define the services it hopes to outsource (e.g., objectives, clients, service units, delivery characteristics and quality standards). To maximize competition, the entity must document its service specifications, but not in an overly prescriptive way that could deflate interest. It should distinguish mandatory and optional specifications, and determine the appropriate service units (e.g., refuse ton hauled or care days). It should structure the services in a way that will best meet its needs and, at the same time, leverage the products and services available in the market place. And, in addition to private vendors, it should consider contracting out the service to existing employees and other public agencies.

As part of its effort to define the services to be outsourced, the entity should select most appropriate methodology for costing those services. Alternative methodologies include the following:

• Resource method - determine service costs based on the services and resources consumed (e.g., time and materials) with costs tied to contract rates and formulae;
• Fixed price method - set service costs at a flat rate based on the service to be performed (if the contractor is paid for the completion of services, it may lack sufficient incentives to provide high-quality services);
• Unit price method - a simple, economical and common cost structure that calibrates service costs to the amount of resources expended for each discrete service unit (e.g., time, activity, material quantity or outcome); and
• Hybrid costing method - a blend of other methods (e.g., fixed price for mandatory services and unit price for optional services).

To the extent possible, the costing exercise should include one-time conversion costs, such as legal, consulting, vendor evaluation, contract preparation, training and other implementation costs. In addition, ongoing costs for managing the vendor (which could escalate over time) should be considered. Finally, it could be useful to distinguish avoidable costs (i.e., current costs eliminated by the outsourcing) and unavoidable costs i.e., costs that won’t disappear under the new contract).

It is vital that the public entity forego its conventional, one-size-fits-all procurement process for an open, competitive and truly market-based effort. In other words, it should make a concerted effort to attract as many vendors as possible, including aggressively marketing itself to prospective vendors and soliciting their input on the planned procurement. That approach should include the following elements.

• Define outsourcing needs – review relevant documents, conduct field work, document affected operating processes and define requirements for the Request for Proposals (RFP);
• Update market scan – contact vendors, document capabilities, gauge market interest, assess the competitive environment, update the vendor database and identify the best ways to align the market with project objectives;
• Determine procurement approach – identify legally-allowable procurement techniques, determine the best approach for maximizing competition and obtain approval before proceeding with the next step;
• Issue RFI – issue a Request for Information (RFI) or Request for Qualifications (RFQ to solicit relevant information from prospective vendors and determine the most qualified vendors for subsequent procurement activities;
• Evaluation criteria – document formal, objective criteria for evaluating all submittals and vendors (e.g., firm capabilities, project team capabilities, innovation, compatibility, service/product plan, implementation approach and cost-effectiveness);
• Prepare draft RFP – prepare the draft RFP, including performance objectives, an operational profile, vendor evaluation criteria, selection process guidelines, project requirements and key contract terms, obtain vendor input, conduct an internal quality control review of the draft RFP, refine the draft and issue for review;
• Issue final RFP – prepare the RFP documents in accord with applicable procurement rules, issue the final RFP package to vendors (ensuring adequate time for preparing submittals) and publicize the procurement.

The market scan is rarely used by governments, but it is a prerequisite to successful outsourcing. At the very minimum, it should document key information about each prospective vendor, including corporate ownership, joint ventures, similar clients, relevant products and capabilities, primary contact (with contact data), level of interest and other characteristics. Even if few vendors can meet all needs alone, they may be able to as joint ventures. To maximize competition, vendors should be recruited to submit proposals even if they are only interested in discrete parts.  

Next, any entity considering outsourcing a service should employ a thorough, phased evaluation process to identify the best vendor (and future partner). That process should entail the following tasks:

• Scoring mechanism – design a structured evaluation scoring mechanism, including evaluation criteria indicators, weighting factors and evaluation point scales, to facilitate the evaluation process;
• Review team – organize ad hoc review teams with the requisite expertise and authority to review vendor submittals and make persuasive recommendations to management;
• Initial vendor review – conduct a preliminary review of vendor proposals, including client reference checks and the validation of all relevant vendor data, schedule vendor demonstrations and document vendor responses;
• Initial vendor rankings – using formal score sheets, evaluate and rank vendors in accord with established criteria, and select a subset of the most responsive vendors for final presentations;
• Final presentations – invite a manageable number of vendors or joint ventures to conduct product demonstrations, make final presentations, answer added inquiries and submit a best and final offers; and
• Final selection – select a vendor or multiple vendors with which to commence contract negotiations.

Once the best vendors are ranked in order of preference, the organization should employ a modified competitive negotiation process to forge an agreement with that vendor. It should develop a preliminary contract document embodying the most salient terms of the procurement documents. It should then designate a lead negotiator (and assemble a negotiation support team) to lead contract negotiations with the top-ranked vendor. If negotiations with the first vendor prove unproductive, negotiations should be commenced immediately with the second vendor. Once a contract is successfully negotiated, it should be reviewed as to form by the organization’s attorney.

Finally, even if a suitable vendor is found, and an acceptable long-term contract is negotiated, the entity should not go forward with outsourcing without a qualified contract manager and a meticulous contract management system. That system, which must include reporting and monitoring elements, is essential for holding the contractor accountable and ensuring that the entity gets full value for its contract.