Tracking whether outsourcing pays off

One key motivation for outsourcing functions, services or even entire departments involves reaping some semblance of a decent return-on-investment for the organization, whether they represent a core competency or a dispensable operation.

So how can supply chain executives determine the ROI for their outsourced contracting decisions?

First and foremost, they should define why they want to outsource something and then make sure those drivers are shared with the outsourcing company as performance metrics, insisted Angie Haggard, Vice President, Supply Chain Services Operations, Owens & Minor Inc. “It is very common to measure outsourcing partners on savings,” she said. “However, savings is not always the primary benefit of outsourcing. Many times there is not a financial return on investment when you outsource, but there are other ROIs. Before outsourcing, there should be an internal alignment at the executive level as to why there is a need to outsource and the expected non-financial ROI.”

Haggard insisted that outsourcing should not be a department-level decision, but there should be executive-level sponsorship and human resources involvement. “When you are outsourcing, you are potentially taking away jobs from your organizational structure, so there needs to be a very strong reason as to why you want to outsource a service or function,” she added.

Further, Haggard indicated that outsourcing most likely won’t last “forever” but may be limited to a three-to-five-year engagement “to get people trained and processes in place and then transfer the services back in house.” Anything less than three years may be classified as either a consulting engagement or a temp agency arrangement, she added.

Recruit the finance department to evaluate proposals for sound accounting principles, according to Michael Bohon, Founding Principal, Health Care Solutions Bureau. In fact, supply chain should be proficient in competing an ROI study and negotiating a contract as it is a normal part of their regular function to perform these detailed analyses, he added.

“This review should include a thorough comparison of the services and products offered by the outsourcing company as well to ensure that there are no hidden surprises of any kind,” Bohon said. “I recall a hospital in the southwest that outsourced their food services to a company based in the south. Imagine the uproar when the company replaced some of the Latino food in the cafeteria with grits. The CEO said that resulted in the most and loudest employee complaints he had ever received.”

Healthcare organizations also should not depend on the contracted company’s human resources systems either, Bohon insisted. “They should vet the employee candidates for inclusion in the programs as closely as they vet their own employees including extensive interviews and background checks,” he said. “This is not only to judge for themselves their operational and management capabilities but also how well they performed financially in previous assignments.”

Rosalind Parkinson, Founding Principal, Parkinson Logistics Associates LLC, stressed the HR considerations for ROI measurement.

“Most healthcare organizations hope to hold vendors accountable to train new vendor-hired personnel and also reduce turnover in jobs HCOs find most vulnerable to these expensive processes,” she said. “HR at the HCO may be able to help here by estimating costs of turnover specific to the positions that are outsourced. Also, if vendors are able to hire, train, and maintain employees in positions where they pay hourly wages and benefits that are less costly than those offered directly by the HCO, a direct calculation comparing expenses on an annual basis can be calculated. Contracts with vendors should make specific reference to how the savings will be measured and at what frequency data will be shared with the HCO to track performance.”

The best model for determining return-on-investment for outsourcing is simply projecting cash flows against the initial contract term of 5-10 years with [net present value] built against current client cost of capital, according to Dave Gawthrop, Senior Director Business Development, Life Sciences & Healthcare, DHL Supply Chain. In addition to net impacts to cash flow, healthcare organizations can look at the following factors: Labor efficiencies with productivity stemming from a required lower headcount, labor rate improvements, management cost of a third party compared to the current structure, material total landed cost reductions, delivery optimization, systems cost improvements, cost avoidance (i.e., for an outsourced warehouse and warehouse footprint optimization and expansion of services within current cost / footprint), and offsets, such as severance or startup costs.

John Weiss, President and CEO, The Audit Group, proffered his own ROI equation for outsourcing.

“Net your contracted results, which should be clearly identifiable and quantitatively measurable, against all contracted costs that are clearly defined and scheduled for actual disbursements,” Weiss noted. “Next, identify your current net cost of internal delivery. When you factor in the true total cost of the agreement, netting your contracted results against actual costs scheduled for disbursement, you can take that number and divide it by the current net cost. If your current net cost is greater than one, then you have a positive ROI.

“Management must then decide how much above one is required in order to make the deal worth the internal time and effort needed to implement it,” he added.

“Start with documenting or ‘baselining’ the current scope of duties and costs and quality/level of services pre-outsourcing, recommended Doug Heywood, Managing Partner, Ron Denton & Associates LLC. “Then, measure and track new duties and costs and quality/level of service under outsourced vendor. Be sure to quantify and document any and all savings opportunities created and expense reductions implemented with the outsourced vendor. Finally, hold periodic Business Review Meetings (e.g., quarterly) with the outsourced vendor to review and address any gaps in performance and value delivered. This is also a good time to review current scope against the baseline. It is important to develop key metrics to assist in measuring activity.”

Despite the obvious focus on hard-dollar savings by securing the best talent available at favorable rates, healthcare organizations really should concentrate on the soft-dollar, process and satisfaction opportunities, according to Jack Datz, Managing Principal, Vizient Inc. Those opportunities include fill rates, service rates and satisfaction scores.

“The fill rate should measure the percentage of filled needs (numerator) out of identified needs (denominator).” Datz said. “Part of this measure is to define what ‘filled’ means and what constitutes an ‘identified need.’ This should be identified and confirmed in advance to ensure accurate metrics to ultimately confirm ROI. Service-level agreements are paramount, but understanding how they will be calculated within the ROI is just as important.

“Satisfaction metrics, including time to fill, service satisfaction from managers and candidate quality scores should be explicitly written into vendor agreements,” he continued. “In addition, seek feedback and insight from the contract labor staff who work at your organization. This information can be extremely valuable not only in identifying areas where you can improve to recruit and retain contract labor, but it also highlights how the organization’s overall culture and operations vary from others across the country.”