Multi-sourcing: Panacea or Pandora’s Box?

January 10, 2009

As businesses look more closely at outsourcing as a means of leveraging competitive advantage, attention is increasingly being focused on outsourcing models which are adapted to achieve this. No longer simply, or even predominantly, viewed a means of reducing costs in order to allow a business to concentrate on its ‘core’ activities, outsourcing is now firmly viewed as a mechanism for delivering changes in organisational and business processes which are intended to reposition a business strategically.  It is in this context that the concept of multi-sourcing as a contracting model for outsourcing transaction has attracted considerable attention. A clear understanding of what is meant by multi-sourcing in an outsourcing context is essential if the concept is to be more than a convenient but generic label to describe the panoply of procurement models available to a business. When considering a contracting model which may be appropriate for a given outsourcing transaction, it would be unwise to overlook the limitations inherent in the multi-sourcing model.

I. What is multi-sourcing ?

(a) How did we get to multi-sourcing ?

Multi-sourcing is essentially a product of the dynamic processes that are in motion within corporate procurement departments. There are two background factors which are critical to an understanding of why multi-sourcing is attracting interest from procurement departments. The first of these is the greater sophistication of corporate procurement and sourcing teams. Whereas, in earlier times, a client would look to a single supplier to meet all its requirements through an outsourcing, the client procurement function has become more sophisticated and clients are less willing to place themselves in a position of reliance upon a single provider for delivery of contracted services. Corporate procurement professionals are increasingly looking to the most appropriate solution for a given service line which may, in some cases, involve hiring different suppliers to deliver different service lines within a given outsourcing project. This trend has, in turn, driven outsourcing service providers to specialize in niche and innovative service offerings (eg back-office, accounting, payroll management services, training), thus perpetuating the cycle towards clients seeking specific suppliers to supply given service lines and every increasing supplier specialisation.

The second factor which is fuelling the trend towards multi-sourcing is the complexity of functions which clients are looking to outsource. There is an increasing focus on outsourcing entire business processes, often in the context of a major project aimed at centralizing business processes with a limited number of suppliers in a given geographic area, but whose service delivery remit is across a client’s global operations. So whilst, on the one hand, a client is looking for expertise in given service offerings, major outsourcing projects will cover a wide range of different services, to be delivered to the client through a ‘global business services’ delivery model. A large outsourcing arrangement of this kind is one which a single supplier may struggle to deliver without subcontracting a significant portion of the services.

From a customer’s perspective, a single supplier may not be as capable of delivering an innovative and transformational service offering as a specialized supplier. Moreover, sourcing interrelated services for a given outsourcing project from a number of suppliers means that a customer is less reliant upon the performance of a single supplier and may allow the client to reduce its operational risk.

(b) Multi-sourcing: a tentative definition

This leads me to propose a tentative definition of multi-sourcing. It is a tentative definition because the very concept of multi-sourcing is apt to describe a very wide range of procurement arrangements. However, it seems that the following elements are the hallmarks of a multi-sourcing arrangement of the type we have been considering so far are:

(i) The procurement of a number of services or business functions which are intended to interoperate or are to be delivered to a client in a seamless and synthetic manner. This is to be distinguished from a series of ‘stand alone’ procurements which are not intended to be delivered to the client as a ‘packaged’ solution.

(ii) Those services are delivered by a number of service providers, each having a direct contractual relationship with the customer. This is to be distinguished from the traditional single supplier model whereby the customer contracts with the supplier for the delivery of all the services. The supplier may then decide to subcontract the provision of a portion of those services to a third-party supplier; however, crucially, the third-party supplier will not usually have a direct contractual relationship with the customer. The responsibility for the compliant delivery of the subcontracted services therefore remains with the prime contractor.

(iii) In order to ensure seamless  service delivery, the customer and the suppliers have entered into some governance agreement or framework. This arrangement is important from the customer’s perspective for two reasons. Firstly, the customer needs to ensure that there are no service gaps between the service lines of the various suppliers. Secondly, if one of the key attractions of multisourcing is its flexibility, the customer must be able to add or replace a given supplier and ensure that all the suppliers continue to deliver the services in a compliant manner, without having to negotiate changes either to the relevant governance framework or the individual service agreements.

Figure A illustrates in a schematic way the multi-sourcing model described above. Figure B outlines the governance agreement/framework model outlined in (iii) above.

(c) The advantages of multi-sourcing

As mentioned above, a multi-sourcing contracting structure can allow a customer to reduce its reliance on a single supplier, and allows the sourcing of service components from ‘best of breed’ suppliers. However, the essential value of a multi-sourcing structure is its potential flexibility.

Where appropriately drafted, a governance framework should allow a customer to replace an existing supplier without having to negotiate the framework with the new supplier or renegotiate the service agreements with existing suppliers. This allows the customer to adopt a modular or ‘plug-in, plug-out’ contracting model whereby the addition or replacement of any one or more of the contractors should not affect the customer’s contractual or service relationship with the remaining suppliers.

A further important advantage of multi-sourcing arrangements is commercial in nature. In a large outsourcing transaction, the prime contractor may not be in a position to provide all the services, particularly where these include niche or highly specific services which the prime contractor is not equipped to provide or the provision of which is simply not economically viable. In those instances, the prime contractor will subcontract the services. Multi-sourcing allows a customer to cut out the middle man and negotiate directly with the service provider, thereby avoiding the additional profit margin a prime contractor will seek to pass on to the customer over and above the actual service costs of the third party subcontractor. In large sourcing transactions, the suppression of this ‘margin-on-margin’ effect can lead to significant potential cost savings for a customer.

II. Limitations of multi-sourcing

Choosing a multi-sourcing contracting structure may well prove to be the most appropriate choice for a customer. However, multi-sourcing is not the Holy Grail of outsourcing contracting models and presents a number of challenges which a customer needs to understand and address early in the procurement process.

(a) Supplier management

Ensuring a supplier delivers a seamless, high quality service is the ultimate goal of every outsourcing transaction. In many outsourcing agreements, considerable time and effort is devoted to negotiating and implementing relationship management, reporting and contract management arrangements.

In a multi-sourcing contracting model, the complexity of this task can increase significantly with each supplier participating in the project. Suppliers may often be suspicious of each other; for example, a supplier may be unwilling to engage with another if it sees it as a competitor or if it considers there is a risk in it losing valuable trade secrets or know-how in the course of its interactions with other suppliers. Moreover, during the commercial and legal negotiations, one can expect that each supplier will try to circumscribe the scope of its obligations more precisely than in a classical prime contractor model and will be particularly concerned to exclude any responsibility for delivering services which it considers fall within the remit of one or more of the other suppliers. Finding a clear demarcation line of responsibility can be particularly problematic where different suppliers provide services which are intended to interoperate. In this respect, the multi-sourcing model may offer less flexibility than the traditional prime contractor model where the customer will be able to bring commercial pressure to bear on a supplier to deliver all required services to a customer, even if the legal obligation in the contract for the supplier to do so is less than clearly expressed (the ‘fix it now, deal with the money issues later’ approach). 

Effective management of suppliers, both during the procurement/negotiation phase of the project and during the implementation and ‘service as usual’ phases, is therefore critical and the customer will need to ensure that it retains sufficient internal resources to manage its relationships with each of the suppliers. This might mean, paradoxically, that some of the benefit to be achieved through the outsourcing is lost in a multi-sourcing structure, since the customer will need to retain competent staff to manage the suppliers.

(b) Compliance framework

Of critical importance to the success of a multi-sourcing transaction will be how the various suppliers work with each other. At a minimum, the compliance framework should deal with the following.

(i) A clear definition of the service boundaries of each of the suppliers is needed. The customer will need to pay particular attention to any gaps in services between suppliers as these may represent additional unfunded project risk which the customer may need to provide itself or procure separately once the project enters into the implementation phase.

(ii) There must be a clear obligation on the part of the suppliers to collaborate between themselves in delivering the service package. Appropriate contract and relationship management and reporting structures will obviously form part of this.

(iii) A mechanism needs to be found whereby suppliers do not blame each other for given project failures. The focus needs to be on shared responsibility by the suppliers for a defaulting service component and on providing a quick remedy for the client. To that end, issues of inter-supplier responsibility should be dealt with separately and should not have an adverse impact on service delivery to the client.

(iv) The customer must be able to add or replace a supplier without having to renegotiate the existing framework or the individual agreements with the remaining incumbent suppliers.

There are a number of strategies which a customer can put in place to ensure the suppliers work effectively in collaboration, and these may be at the project management level (ie intended to lay down operating guidelines as to how suppliers should co-operate between themselves and the customers, but not necessarily imposing additional legal obligations on the suppliers) and at the contractual level (ie setting forth contractually binding obligations with which suppliers are required to comply). The choice of the project management or the contract based approach can often be a difficult one for a customer, particularly when it does not have prior experience with working with one or more of the suppliers. My personal experience suggests that tough contracts can lead to good service delivery results, and that a legally binding compliance framework is often necessary in order to keep a multi-sourcing project from veering off-piste. But as with all contract and relationship management procedures, the quality of the management personnel the customer deploys will be important.

The relevant compliance framework will not be easy to negotiate. Different suppliers will have different priorities and, unless the customer is in a particularly strong position vis-à-vis all the suppliers, there is a risk that the document ends up as something quite different from the customer’s starting position. There is also the added risk of lost time and additional cost as the parties struggle to reach an agreement on the compliance framework. Time spent negotiating the compliance framework will be essential if the sourcing project is to have solid foundations, however the customer will need to manage carefully the time and resources which are allocated to negotiating the compliance framework.

(c) Retained risk

As mentioned briefly above, a multi-sourcing structure will usually imply that the customer is required to retain a degree of competent resources within its organisation to manage the suppliers and the project. Ultimate responsibility for the effective integration of the services in a multi-sourcing will also normally remain with the customer. The most evident risk this gives rise to is the appearance of service gaps during the project, requiring the customer to procure additional, unbudgeted services. The opposite may also arise where there is an element of duplication between the various suppliers such that the customer finds it is paying twice for essentially the same service component.

Another issue which customers need to be aware of early in the procurement process is the extent to which the multi-sourcing will deliver the anticipated cost savings. Traditionally, one of the commercial drivers underpinning the decision to outsource is the cost saving to be derived from divesting service provision and management to a specialized supplier (both in terms of actual costs and in term of opportunity costs to the customer engaging in a non-core activity). However, a multi-sourcing arrangement will usually require the retention by the customer of compentent internal resources and infrastructure to manage the suppliers and the project, which undermines this commercial driver. One way of dealing with the organisational retention issue is to appoint a separate project manager ; however, this will involve additional cost and needs to be carefully considered in the project planning and budgeting stage. The additional cost of appointing an external project manager may more than account for the cost savings achieved by cutting out the ‘margin-on-margin’ cost habitually associated with a prime contractor subcontracting the performance of a portion of the services. It is interesting to note, in passing, that the same kinds of difficulties encountered in managing suppliers very often arise where a separate project manager/systems integrator is appointed to manage a multi-supplier project.

Therefore, when compared with the traditional prime contractor outsourcing model, a multi-sourcing approach may not end up being a more cost effective proposition. Moreover, in contrast to the prime contractor model, there is no single supplier who will be ultimately answerable to the customer for the quality of the service delivered.

III. Conclusion

Multi-sourcing, where judiciously employed, can be an effective model for conducting an outsourcing. Its main advantages are that it allows a customer to seek « best of breed » service offerings from a range of suppliers, gives the customer a more direct relationship with, and control over, suppliers, and, where appropriately structured, offers the ability for the customer to add or remove suppliers. However, the model may not be adapted to every outsourcing scenario and implies a degree of retained risk, infrastructure and expertise that is likely to make it attractive only to customers who are already highly sophisticated in the manner in which they conduct their procurement activities.

Anthony Sourgnes is a senior associate in the intellectual property practice of White & Case. His practice focuses on technology transactions.