Choosing the right sourcing model.
In that article,1 we profiled seven sourcing business models that span the make-versus-buy decision process (shown below in Figure 1). But which is most appropriate for your situation? And how should you make that choice? After all, you don't need a sledgehammer to tap in a thumbtack. Likewise you don't need a Performance-Based relationship to buy pencils.
There's no “one size fits all”
While the short answer is “it depends,” the good news is that researchers at the University of Tennessee have been working with participating organizations to pilot a new resource/toolkit designed to help buyers and sellers answer just this question. The result is an open source (i.e. free to access) Business Model Mapping toolkit, that organizations can use to “map” their various spend categories.
Before sharing how the Business Model Mapping toolkit works, it's important to recognize that no single sourcing business model is preferable over another; there's no one-size-fits-all. Rather, most organizations probably should use multiple sourcing business models. First let's look again at the sourcing continuum, discussed in detail in Part 1 (Figure 1):
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Moving up - or down - the continuum
Sourcing business models can evolve over time as the business changes and events occur. You might start out with an Approved Provider model, and shift along the sourcing continuum to a Preferred or later even a Performance-Based relationship model. Shifting up the sourcing continuum to more sophisticated models allows organizations to move from value exchange to value creation because the deal architecture is designed to motivate suppliers to invest in continuous improvement, transformation and/or innovation, geared to reducing cost structure or other strategic business outcomes.
Simply put, each of the sourcing business models works. The key is to know when to use the right sourcing business model for the right situation as each serves a different purpose and will garner different results and behaviors from your suppliers. The Business Model Mapping Toolkit is your guide.
The two key components of a sourcing business model
A crucial part of determining the right sourcing business model for your situation is for stakeholders to answer two important questions:
First, what is the most appropriate contractual relationship framework for your situation? There are three choices: transactional, relational,3 and investment-based approaches. You will need to ask (and answer) questions spanning 14 attributes such as:
- What is the overall level of dependency associated with my spend category?
- What is the strategic impact of the spend category?
- Does this spend category provide the organization with a core competency or competitive advantage?
- What is the degree of risk associated with this spend category?
The second question is, what is the most appropriate economic model? An economic model defines how you will measure and ultimately compensate your supplier. Again there are three choices - for a quick review:
- Transactional
models pay a supplier for every transaction (per hour, per mile, per minute, per unit). The more transactions the more revenue a supplier earns.
- Output based
where a supplier's payment is tied to the achievement of pre-defined measures, such as process based Service Level Agreements (SLAs). Performance-based (managed services) agreements use output-based economic models where a buyer negotiates pre-defined efficiency or performance targets.
- Outcome-based
An outcome-based economic model is more sophisticated than one that is output-based because it typically ties the supplier's payment to mutually agreed-upon and boundary-spanning business outcomes, not just process or functionally focused performance outputs. To achieve true business outcomes, a buyer and supplier must work together in a highly integrated and collaborative fashion. There is shared risk and shared reward when business outcomes are reached.
To determine if you should use a transactional, output, or outcome-based economic model, you will need to consider 11 attributes such as:
- How much potential is there to create mutual advantage by collaborating with a supplier?
- What is the nature of the scope of work?
- What is the criticality of the work?
- What are your risk tolerance preferences?
A four-step business model mapping process
Although an individual involved in the sourcing initiative can conduct a business model mapping exercise, we recommend you think of it as a “team” approach that consists of a cross-functional group of subject matter experts and business users. Key suppliers can also provide valuable insights as they will provide an interesting perspective. The various perspectives will actually help you create a more accurate assessment of the appropriate sourcing business model to use.
There are four steps to determine the most appropriate sourcing business model for your situation:
Step 1: Select the defined spend category/categories you are sourcing or potentially sourcing. This includes products and/or services that are currently insourced, currently outsourced, or possible new products or services needed in the make or buy decision.
When most organizations consider spend categories they usually think in terms of direct spend (e.g. facilities management) or indirect spend (e.g. accounting services). For example, an organization might look at the facilities and real estate management spend and within that at four spend categories: project management, facilities management/maintenance, real estate transactions, and space and asset planning.
Each spend category should be mapped separately. We also suggest “bundling” the various spend categories to see if it will make a difference in thinking about the category from a more strategic perspective. For example, Procter and Gamble chose to bundle their real estate and facilities management into one globally integrated agreement that ultimately used a Vested sourcing business model with the goal of achieving strategic desired outcomes and driving innovation (this case study is profiled in Vested: How P&G, McDonald's and Microsoft are Redefining Winning in Business Relationships).4
Step 2: Use the Business Model Mapping template to determine the best relationship model for what you are sourcing. This will help answer questions about the business environment, such as the overall level of dependency, the risk comfort zone and strategic impact of each spend category. For example, one of the attributes to “map” is the level of supplier integration/interface. The answers (in Figure 2 below) range from none to critical.
Step 3: Use the Business Model Mapping template to determine the best economic model for what you are sourcing. As noted, the most widely-used economic model in businesses today is a transactional-based model. The reason? They are the easiest to administer - typically the supplier is paid per activity. However, as you shift along the sourcing continuum you will want to shift to more of an output or outcome-based economic model because it gives the supplier greater degrees of freedom to provide solutions that will create value and drive innovation. Figure 3 below illustrates one of the Business Model Mapping attributes when determining the best economic model–potential efficiency gains:
Step 4: Use the Business Model Mapping matrix to develop a consensus view of the sourcing business model that is right for your situation. The best sourcing model will be a combination of the relationship model and the economic model you choose. For example, if your map indicates you should use a relational contract model (column D) and an output-based economic model (column 4) - the matrix will indicate a Performance-Based agreement is the most appropriate sourcing business model for your situation. See Figure 4 below:
Conclusion
Note again that that no one model is better than another. The key is to let the Business Model Mapping process guide you to the most appropriate model. It might be tempting to think that a Performance-Based or a Vested sourcing business model sounds good because it motivates a supplier to invest in innovation and transformation. But if the mapping exercise indicates a Preferred Provider model is more appropriate for your particular situation, you will just be over-engineering your approach.
After all, you don't need a sledgehammer to tap in a thumbtack. Likewise you don't need a Performance-Based relationship to buy pencils.
END NOTES
- Your sourcing model can make or break the deal appeared in the March/April edition of Contracting Excellence.
- Vested Outsourcing business model - definition
- Relational - as defined and detailed in Tim Cummins' Commitment Matters blog, Feb 19, 2015
- How P&G, McDonald's, and Microsoft are Redefining Winning in Business Relationships
ABOUT THE AUTHOR
Author, educator and business consultant Kate Vitasek is an international authority for her award-winning research and Vested® business model for highly-collaborative relationships. Her work has led to five books. Vitasek has been featured on CNN, Bloomberg, NPR, and on Fox Business News and she has authored or been featured in hundreds of articles in publications including Forbes, Chief Executive Magazine, CIO Magazine, The Wall Street Journal, The Journal of Commerce, World Trade Magazine and Outsource Magazine.
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