5 cost levers to leverage now with your outsourced services

In times of major supply chain disruptions, it’s easy for procurement managers to think only about direct expenses. But it’s just as important to ensure that outsourced service contracts are adding value.

We live in an ever-changing world, where what was predicted to be a prosperous year for a company can turn into a struggle for survival due to one or more events beyond its control. As the world continues to rally against wave after wave of COVID-19, some companies are facing a significant reduction in revenue and/or margins, forcing them to tighten their belts and seek additional savings.

In times of crisis, most organizations follow the same pattern and focus their cost reduction efforts on salary costs and direct expenses.

Why is this the case? Companies may view their direct categories as more critical to the business, or they may believe they can get more value from them by managing their supply chain more closely. For a growing number of companies, however, outsourced services are the core business. And by focusing on the right cost levers, examining these service contracts could yield as much or more savings than direct spending.

Acting on cost levers
Structuring a service contract may seem different than structuring a traditional goods and services contract. Many professionals will go their entire career without creating a single RFP for an outsourced service.

In reality, there is not much difference beyond what is provided by the vendor. Purchasing departments still need to know that the vendors are capable of meeting the company’s requirements. A solid contract needs to be in place to ensure that services are delivered efficiently and effectively.

And when it comes to cost levers, there is no need to start from a blank sheet of paper when proven purchasing strategies will always do the trick. There are five key cost levers to highlight:

1. Pay the right price
Companies need to be a little more curious and initiate a deeper relationship with the suppliers to understand how they deliver services. This will lead to a better understanding of how the service is built, but also what drives the costs, and therefore the economic price.

Services that are in high demand, but have reduced capacity and fewer employees capable of delivering quality service, will cost organizations more. In the IT services market, the availability of the workforce with a particular skill set is the primary cost driver. As the demand for these skills decreases, the rates for outsourced services decrease.

Being clear on how the cost of labor has influenced your pricing is a great way to leverage this particular cost lever.

2. Understand the total cost
Purchasing’s review of costs must go beyond the price paid. There are other factors to consider, such as quality of support and adherence to service level agreements (SLAs). This is the total cost or TCO.

Got a good price for your basic service contract? That’s great! But did you discuss and agree on a price for after-sales service? Or agreed on the number of people assigned to your contract? Or how much you pay for secure data storage? It’s critical to understand the bigger picture beyond the base price.

If you’re only looking to save money on the base price by reducing your vendor’s margin, they’ll be looking to shift or hide costs elsewhere. No matter how good a deal you think you have at the outset, if you don’t track TCO, you will likely lose any savings you may have had at the outset and leave that cost lever unused.

3. Finding the right agreement structure
One of the key decisions a company must make regarding its services is the model or structure of the agreement. In the context of outsourcing services, a fully managed service can be very attractive to an organization with recurring operations handled by an outside specialist, leaving the company free to spend its time and effort on other tasks.

However, organizations that use a managed service must accept that they are ceding some level of control, which increases their risk. Procurement still needs to understand what is going on functionally with the outsourced service provider.

Companies can also choose to use on-demand outsourcing, where they pay for support based on the number of times it is used, or a “Break/Fix” service where they only pay for the work performed. There is no right or wrong answer as it varies from organization to organization. The important thing is to choose the right option.

4. Innovation
When it comes to reducing costs, innovation is a critical piece of the puzzle that should not be missed. And when it comes to pulling the innovation cost lever for outsourcing services, the focus should be on “Big I” Innovation (i.e., digital transformation), rather than “Little i” innovation (i.e., continuous improvement activities).

As with the other cost levers we’ve shown, the innovation that is examined in other areas of the business can just as easily be applied to outsourcing as well. Consider all the current industry favorites such as robotic process automation (RPA), AI and machine learning – they can have an impact on costs.

However, despite the growing emphasis on innovation in outsourcing, many organizations are still missing the mark. There is much to be gained by deploying this cost lever in the right way and at the right time.

5. Financial Engineering
Cost lever number 5 takes the modernization and digital transformation found in the innovation space a step further: when it comes to the concept of innovation, it’s not just about the company defining activities for different areas of its categories, but more about how it modernizes the entire solution.

Financial engineering is important to achieve the necessary impact on profits, as the initial capital outlay or investment in the overall business will be significantly higher than a service that does not include these types of outcomes. Organizations may choose to look at alternative funding sources, evaluate potential joint ventures or managed services with flexible margins (in line with traditional financial engineering). Using this cost lever means being creative and perhaps taking the road less traveled to success.

Pull the levers carefully
The 5 cost levers for outsourced services represent an individual and collective cost reduction strategy for outsourced services. Pulling just one would be effective, but using all of them in some way could also yield excellent results.