In 2003, the University of Tennessee (UT) began a research project funded by the U.S. Air Force to answer this question: “Is there a better way to outsource?”

The answer was an overwhelming “yes.” The research conducted produced what has been dubbed the “Vested” outsourcing model, which was first compiled and outlined in the book, Vested Outsourcing: Five Rules that Will Transform Outsourcing in 2010.[1] Contract Management Magazine first featured an article on the Vested model in November 2010.[2] 

So, what has changed since that original article? The biggest change is not in the “Five Rules” (which remain the same), but rather in the adoption and in how UT researchers are helping drive change by teaching practitioners how to create Vested deals. 

When the first book on Vested was published, there were many skeptics and naysayers who called Vested a “fad,” “gainsharing with a new skirt,” or “too fluffy.” But almost 10 years later, the results speak for themselves. Vested has evolved into a movement that includes over 354 companies that have sent nearly 1,600 people to study Vested at one or more UT courses offered in its Certified Deal Architect program. Today, there are 70 deals around the world and 84 Certified Deal Architects who have become champions within their organizations to effect change in how companies negotiate outsourcing and procurement relationships. Indeed, one company, the Swedish Telco provider Telia, has five Vested deals.

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The Early Years: The Research Phase (2003 – 2009)

As previously stated, the birth of the Vested methodology stemmed from research funded by the U.S. Air Force. Researchers studied some of the world’s most successful outsourcing relationships — including Procter & Gamble, Microsoft, and McDonald’s. 

Researchers saw common threads in these successful relationships. These successful companies created a radically different type of business relationship with their suppliers and service providers — relationships that transcended traditional buy-sell transactions that focus on one party “winning” while the other “loses.” They found relationships where the parties worked together toward shared goals to drive innovation, create value, and reward success. These were true win-win relationships with a foundation of trust and (most often) extreme levels of transparency. Researchers described their observations as a “Vested” mindset because of the true win-win nature of the relationships between the parties — which were based on mutually defined desired outcomes. Simply put, a “win” for the buyer was a “win” for the service provider (i.e., the parties were vested in each other’s success).

While these relationships seemed radical, or at least very different from many typical business relationships, the researchers also found that these companies were leveraging Nobel Prize–winning concepts, including John Nash’s equilibrium theory and Oliver Williamson’s Transaction Cost Economics principles. The research team coined this new business model “Vested Outsourcing” — or “Vested” for short.

Codification of the Methodology (2009 – 2011)

UT’s next phase of research centered around codifying a repeatable methodology that organizations could follow to improve their outsourcing relationships. This research led to the creation of the “Five Rules,” which are required to be followed to implement a true Vested business model. FIGURE 1 illustrates how the rules work together to create win-win business relationships.

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Rule 1: Outcome-Based vs. Transaction-Based Business Model

Traditionally, many outsourcing arrangements are built around a transactional model. Under this conventional method, the service provider is paid for every transaction — whether it is needed or not. The more inefficient the entire process, the more money the service provider can make. Vested, by contrast, operates under an outcome-based model: The service provider aligns its interests to what the company actually wants — i.e., success against strategic business goals.

Rule 2: Focus on the WHAT not the HOW

Adopting a Vested business model does not change the nature of the work to be performed. At the operational level, there is still a need for material to be stored, orders to be managed and fulfilled, calls to be answered, and goods to be delivered. What does change is the way in which the company purchases the outsourced services. Under the Vested model, the buyer specifies “what” it wants. It is up to the service provider to figure out “how” to put the supporting pieces together to achieve the company’s goals. This enables the service provider the creative room to challenge the status quo and seek the best solutions to get the job done.

Rule 3: Clearly Defined and Measurable Desired Outcomes

The third rule of Vested is to clearly define and measure desired outcomes. Desired outcomes are jointly developed by the buyer and supplier and represent true boundary spanning business needs, not simply task-oriented, service-level measures. For example, does it matter that the supplier “cleans” the restrooms every two hours if they are not actually “clean”?

Desired outcomes are often also externally facing — i.e., measured by the success of how the end customer views performance. A good example comes from the Rocky Flats contaminated nuclear site cleanup. In 1995, The U.S. Department of Energy (DOE) projected the Rocky Flats cleanup at the 175-acre site would take 75 years at a cost of about $37 billion — unacceptable numbers on both counts. Eventually, DOE and Kaiser-Hill Company agreed on an incentive-laden, collaborative, performance-based contract that transformed the site into a wildlife refuge in about 10 years and some $27 billion below the original cost estimate.

Rule 4: Pricing Model with Incentives that Optimize the Business

The fourth rule centers on structuring a pricing model with incentives that reward the service provider for optimizing the business. A key goal of the pricing model is to incentivize the service provider to drive continuous improvement and to invest in innovations that are linked to the parties’ desired outcomes.

There are two principles for establishing a pricing model:

  • First, the model must balance risk and reward for both parties — The agreement should be structured to ensure the service provider assumes risk only for decisions within its control (e.g., a transportation service provider should never be penalized (or rewarded) for the changing costs of fuel, nor should a property management service provider ever be penalized for an increase in energy prices); and
  • Second, the pricing model needs to link incentives to the desired outcomes — The more effective the service provider is at achieving the desired outcomes, the more incentives (or profits) it can make.

Rule 5: Insight vs. Oversight Governance Structure

The Vested model shifts from a culture of oversight to one of insight. Simply put, the buying organization turns its focus to managing the business with the service provider, not just managing the service provider. Why? If you’ve done a good job of selecting a right partner and aligning their interests by using Rules 1–4, then the service provider will have a vested interest in performing because its success depends on achieving success for the buying organization.

Of course, there were still many skeptics who said, “nice theory, but you can’t really put a theory into a contract.” This sparked the UT researchers to work with the International Association for Commercial and Contract Management and lawyers to lay out how the Vested “Rules” could be incorporated into a contract. The result was a second book, The Vested Outsourcing Manual.[3]

The Vested “Rules” work in conjunction with 10 contractual “Elements.” FIGURE 2 provides a conceptual overview of the Vested methodology, showing the links and interaction between the Vested Five Rules and the 10 Elements that are essential to create a Vested Agreement.

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Working in conjunction with each other, the Five Rules and 10 Elements address and resolve the structural flaws that can emerge in transaction-based agreements. For example:

  • A buyer wants “innovation,” yet the contract with the supplier has an 800-page statement of work (SOW) with exacting detail on how the supplier should perform each of the activities in scope;
  • The buyer wants “outcomes,” yet the contract spells out hundreds of “service level agreement” metrics;
  • The buyer outsourced to the expert and wants more “insight,” yet the buyer left an army of people on staff to provide “oversight” to manage the supplier;
  • The buyer wants the supplier to implement “productivity improvements,” yet its transactional pricing scheme inherently incentivizes the supplier to have more transactions; or
  • The buyer wants a “partner,” yet the contract has a 60-day termination for convenience clause.

Proof of Concept Phase (2011 – 2014)

Of course, there were still skeptics. One such skeptic was Rob McIntosh, now Senior Vice President, Dell Global Fulfillment, Logistics and Trade. He explained in an interview why he was skeptical,[4] but he also described why Dell ultimately decided to pilot Vested for their reverse logistics operations.

Dell was one of the first companies to pilot the Vested methodology (Intel onboarded to Vested with a DHL contract in Costa Rica the same year). [5] Dell and its strategic partner, the reverse logistics provider Genco (now part of FedEx Supply Chain Services), followed the Five Rules with great success.

The Dell/FedEx relationship was longstanding and was expanded in 2009 when Genco agreed to acquire Dell’s buildings, assets, and people under a three-year outsourcing contract. The problem was that it was a strategic relationship, but the transactional structure of the agreement was far from strategic: It was a typical transaction-based contract in which Genco assumed the risk of meeting a set “price per activity” while maintaining service levels. The agreement worked reasonably well for a time, but Dell’s leaders continued to face cost pressures and they insisted on an “every dollar, every year” procurement principle — even though under the contract Genco assumed much of the risk under the contract terms.

The seeds were sown for a difficult ending unless the companies could transform their relationship through trust, collaboration, and Vested’s “what’s in it for ‘we’” (WIIFWe) mindset. Dell and Genco structured a strategic commercial agreement that followed the Vested Five Rules:

  • Rule 1: Focus on Outcomes, not Transactions — Instead of buying transactions, Dell and Genco created a joint shared vision and six desired outcomes to set the tone for what they would focus on for the relationship. This helped the parties avoid the “Activity Trap” in which suppliers are paid for performing a task or activity regardless of whether it is needed. Applying this rule enabled the parties to not only create a strategic partnership, but craft a deal around true business outcomes.
  • Rule 2: Focus on the “What” not the “How” — A conventional buyer-supplier relationship has a detailed SOW that dictates how the supplier should perform the work. Dell and Genco replaced their detailed SOW with a taxonomy and workload allocation that clearly showed how the parties would work together to achieve their shared vision/desired outcomes.  
  • Rule 3: Agree on Clearly Defined and Measurable Outcomes — Traditional outsourcing agreements have detailed service level agreements. In a Vested agreement, all metrics are clearly aligned to the desired outcomes. For Dell/Genco, this meant reducing the number of metrics from over 100 to 20 clearly defined metrics that aligned to six desired outcomes.
  • Rule 4: Pricing Model Incentives that Optimize the Business — The Vested business model does not guarantee higher profits for suppliers. Rather, suppliers take a calculated risk to link their profitability to performance to mutually agreed desired outcomes. Dell’s agreement incentivized FedEx to make strategic investments in processes that would help them achieve the desired outcomes. Using a pricing model with incentives enabled the parties to “grow the pie and share the pie” when value was created. The more effective Genco was at achieving the desired outcomes, the more incentives (or profits) they earned. A true win-win economic model.
  • Rule 5: Governance Structure that Provides Insight, not Oversight — Dell and FedEx established a flexible and credible governance framework that enabled all the rules to work in sync. The focus shifted from managing the supplier to managing the business — with the supplier. Together, the parties built a governance structure based on transparency about how operations are developing and improving.

The results were transformational. In the first three years, Dell and Genco were able to collaboratively find ways to reduce costs by 44%. And service and quality did not suffer at the expense of costs. In fact, they increased. Quality levels [6] reached an all-time record and the parties reduced the scrap level of old and damaged hardware by 67%. Genco also benefited with a tripling of its margins.

John Coleman, then-Genco’s general manager of operations for Dell’s reverse logistics business, explained the power of a collaborative win-win approach: “It’s like we broke open a new innovation piñata. Genco employees now know that we will share in the reward for good ideas.”

Building a Movement (2014 – 2018)

Today, Dell is one of more than 50 organizations that have applied the Vested methodology to spend categories as diverse as facilities management, reverse logistics, third-party logistics, environmental services, fiber optic network management, and labor services. Vested is also now piloted by international governmental organizations as well — such as Vancouver Coastal Health, Island Health, and Stedin (the Dutch utilities provider).

The UT research library dedicated to Vested has also expanded to include six books, 17 white papers, and 14 public case studies that document the success stories of organizations such as Intel (third-party logistics), Dell (reverse logistics), Vancouver Coastal Health (environmental services), Discovery Health (insurance claims management), Island Health (labor services/union contract with doctors), and the Dutch utilities Stedin.

Bonnie Keith, co-author of the book, Strategic Sourcing in the New Economy: Harnessing the Potential of Sourcing Business Models for Modern Procurement,[7] sums it this way:

All organizations have strategic suppliers. Simply put, strategic suppliers should have strategic contracts. The UT researchers have cracked the code with the Vested methodology to truly help teach companies how to architect strategic deals.

Conclusion

One theme is common to anything one might read or hear about Vested: It is easier to win when you have a win-win deal.  

Change takes time. History tells us new concepts often take a while to cross the chasm. Take, for example, the cell phone, which evolved from large, cumbersome, and expensive gadgets to slim, pocket-sized multimedia devices that have virtually replaced landlines. Once the momentum starts, it’s impossible to go backward.

The bottom line: Change is inevitable—even change in how companies outsource. The tried and true buy-sell, I-win-you-lose, non-transparent, power-based methods that became ingrained in the last century no longer work for today’s complex and global sourcing challenges. CM

Kate Vitasek

  • International authority for her award-winning research and the Vested business model for highly collaborative relationships
  • Author of six books on Vested
  • Faculty member at the University of Tennessee
  • Lauded by World Trade Magazine as one of the “Fabulous 50+1” most influential people impacting global commerce
  • She has shared her insights on CNN International, Fox Business News, Bloomberg, and NPR

Endnotes

[1] K. Vitasek with M. Ledyard and K. Manrodt, Vested Outsourcing: Five Rules That Will Transform Outsourcing (New York: Palgrave Macmillan: 2010, 2013). (See http://www.vestedway.com/vested-outsourcing/.)

[2] Kate Vitasek and Mike Ledyard, “Vested Outsourcing: A Better Approach for Better Results,” Contract Management Magazine (November 2010): 66.

[3] K. Vitasek et al., The Vested Outsourcing Manual (New York: Palgrave Macmillan, 2011) (see http://www.vestedway.com/the-vested-outsourcing-manual/).

[4] Robert McIntosh, interview; SupplyChainBrain.com (January 10, 2014), available at https://www.supplychainbrain.com/articles/17881-dell-embraces-vested-outsourcing.

[5] The Dell and Intel case studies are available for download at the University of Tennessee’s dedicated website to Vested (www.vestedway.com).

[6] As measured in DPPM.

[7] B. Keith, K. Vitasek, K. Manrodt, and J. Kling; Strategic Sourcing in the New Economy: Harnessing the Potential of Sourcing Business Models for Modern Procurement (New York: Palgrave Macmillan, 2016).