The “Services Aggregator” Model
Overview.
Some of the key benefits of outsourcing stem from the aggregation of customer demand for well-defined services. In May 2002, SAIC, based in San Diego, California, offered a “new model” for outsourcing: the services aggregator model. Under this paradigm, the services provider would not only offer managed services for in-scope work, but also manage non-subcontractor third parties hired by the services aggregator’s customers. Experience in the healthcare industry for aggregation of purchases by hospitals and healthcare systems suggests that this model merits attention but is not without faults.
The Services Aggregator Model.
Services aggregators offer a variety of services that the customer might handle directly:
- identification of functions that might be effectively outsourced.
- definition of requirements for obtaining third-party services.
- procurement management services, including preparation of RFP, due diligence, selection, evaluation, negotiation, transition management, effectiveness assessment, optimization planning and iterative realignment and re-design of functions and services to be outsourced.
Customer’s Retained Skills and Scope.
Customers planning to outsource to a services aggregator should understand some of the limitations of this model. With suitable retention of skills and retained scope, these limitations may be managed. The question to ask is whether the use of the services aggregator reduces the risks or costs, or improves the quality, of sourcing services as compared to the customer’s use of its employees (or even a third party other than the aggregator) to manage the customer’s services providers. In a large company environment, this question merits extensive analysis. In a mid-sized or smaller company, the convenience of a reliable services aggregator can be obvious.
Strategic Alternatives within the Services Aggregator Model.
Within this model, there is flexibility for various approaches to determining the scope, degree of management authority delegated to the services aggregator, compensation structures and other operational issues.
Strategic Alternatives to the Services Aggregator Model.
Aside from this model, customers have the choice of managing a multi-vendor environment on their own, seeking advisory assistance from a third party, seeking management assistance (from a services aggregator) or joining a buyer’s consortium or group purchasing organization. The latter may have antitrust issues to be resolved.
Legal Regime of the Services Aggregator Model.
The services aggregator model consists of a mixture of other classic free-standing business relationships. Depending on the situation, the components of such a mixture can include:
- Straight outsourcing of a business process to the services aggregator.
- Outsourcing of a business process to another services provider, coupled with a management services contract describing the processes, payments and performance criteria for the services aggregator to manage the other services provider, including oversight of integration of the other services provider’s activities into the customer’s business and the services aggregator’s business.
- Strategic business consulting for multi-vendor sourcing, with a mandate for the services aggregator to use its skills in sourcing, project management and subcontractor management as agent to implement the vision. One may ask why the customer does not adopt this “consulting” function as one of its own operations. The answer might come from the customer’s limited resources and the decision that to acquire and maintain the skills needed is not within the customer’s immediate capability.
- A teaming agreement among multiple parties that agree to bid jointly as a consortium for a customer’s work.
- A contractual joint venture of the services aggregator and the customer, limited in scope and duration, for joint benefit by giving the customer “better” management of external services and by giving the services aggregator the chance to purchase (or control the purchase) of third-party services in bulk, for the benefit of the customer and the other customers of the services aggregator.
Novel Aspects of Outsourcing under a Services Aggregator Model.
Like any business relationship, a services aggregator agreement follows a life cycle from beginning to end. What’s novel about this model, however, is that it inserts an intermediate level of external services. This intermediation creates new dependencies and risks affecting the customer’s value chain. As a result, a customer needs to adopt unique control and contingency planning mechanisms.
Contracting Cycles.
The services aggregator provides the most value, it argues, when it has a reasonably long time horizon for the planning and implementation of the model. This elicits the question why the customer might consider its interests are best served by hiring the aggregator’s services continuously for a long time horizon. Conversely, given the novelty of this model, for the first time customer, the customer might be interested in it as a short-term opportunity. As such, it could be a test for a longer-term relationship. Or it could be merely a transitional service, as a purchase of assistance to transform the customer’s management processes upon completion of the services aggregation life cycle.
As a legal matter, it is critical to identify the character and intent of the relationship before getting started. For example, the statement of work, the performance metrics and the financial incentives and reward structures will differ if the goal is a short-term transformation instead of a long-term alliance. Even within a “long-term” alliance, the exigencies of a changing competitive environment will dictate that the customer should have exit strategies. And, for each of these exit strategies, the selection of the appropriate strategy itself may involve the need for pre-identified processes and procedures to facilitate dialogue and transitions.
Customer Control.
One basic premise of the services aggregation model is that the customer would, by not using this model, be misallocating its resources by juggling the multi-vendor environment. As a corollary, the customer is relying on the services aggregator to make certain operational decisions. The delegation of authority will be limited, therefore, so that the customer may retain legal control over all non-subcontractor service providers. Limited delegation of authority is consistent with best practices that ensure the customer’s board of directors retains authority to manage the business as required under fundamental principles of corporate law. Without such retained control, the services aggregator faces daunting potential legal liability for the nonfeasance or malfeasance of the third-parties that the aggregator “manages.” Even if such liability might be allocated under an “alliance contract” among the services aggregator and the other services providers (or between the customer and the other services providers), multilateral alliance contracts are costly to negotiate, take time to plan and leave all sides uneasy with “risks.” As a result, the delegation of authority and right of audit and supervision should remain with the customer at least to the extent the services aggregator functions as an agent.
Knowledge Management Processes and Human Resources Cycles.
The services aggregator faces the task of providing consistent quality over time. Replication of quality processes requires an initial investment in process design and training. To the extent that the services aggregator has acquired unique domain knowledge of the customer’s business, and such domain knowledge resides in employees’ heads instead of digital repositories accessible by effective triage tools, the replication is at risk. Typical outsourcing relationships are designed for periodic attrition and redeployment of key personnel of both parties. In the services aggregator model, however, the knowledge management tools must not only manage the customer’s knowledge base, but also a knowledge base about the performance and operations of third-party contractors and the interaction of a constellation of third-party contractors to achieve lasting shareholder value for the customer.
Contingency Planning.
Effective contracting processes should include attention to contingency planning, with separate risks being identified at the different links in the customer’s value chain.
Conflict of Interest.
Multiplying the number and character of business relationships heightens the potential for conflicts of interest. Conflicts might be expected to arise whenever someone:
- engages in multiple relationships with one party, such as acting as agent (with a duty of loyalty and a duty to give priority to the principal’s interests over the agent’s interests during the agent’s execution of delegated tasks).
- has relationships with multiple other parties whose interests are potentially adverse to a customer or supplier, such as when the agent has a fiduciary duty to one customer to manage Vendor X and simultaneously the agent has a potentially conflicting customer relationship or investment relationship (directly or indirectly) in relation to the same Vendor X.
- adopts methodologies and processes to avoid or mitigate conflicts of interest, including “distant early warning” systems and protocols for reporting and administration.
- acts in two roles, such as direct services provider and judge of the quality of services of others. Savvy customers should manage this conflict by appropriate contractual and operational precautions.
Risk Management.
Vicarious Liability.
Under general legal principles of agency, a principal is liable for the acts of the agent. Accordingly, the scope of authority must be delimited, and “apparent authority” must be circumscribed.
Joint and Several Liability.
Third parties suffering from injury or loss caused by the common tort of two or more “joint tortfeasors” have a claim against each of the wrongdoers jointly and severally. The laws of different jurisdictions address the degree of contribution for comparative fault, exoneration due to settlement of claims by one tortfeasor without settling with the other, and other issues. Prudent customers and services providers should deal with this issue.
Claims by Customer’s Customers and others Affected by the Customer’s Outsourced Operations.
In any outsourcing operation, the services provider needs to identify and manage risks that the customer’s customers (or others) might be adversely affected by the outsourced operations. Similarly, the customer has an interest in managing this risk as well. This is a “normal” outsourcing issue.
Claims by a Non-Subcontractor Services Provider against Customer and the Services Aggregator.
In the services aggregation model, a new relationship arises between the services provider (who delivers services to the customer) and the “services aggregator,” who only coordinates and supervises such services. By introducing an intermediary, the customer raises the issue of how the intermediary becomes liable, or not, for acting as the customer’s agent.
Claims by the Services Aggregator against the Non-Subcontractor Services Provider.
Similarly, in the triangular relationship, there might be claims by the services aggregator against the parties “under management.” This is normally handled as a question of contractual privity and by agreed allocation of risk and liability on a bilateral basis between the customer and the services aggregator.
Conversion process from a Non-Subcontractor Services Provider to a Subcontractor of the Services Provider (“Back to the Beginning of Time”).
In any life cycle process, dislocations may arise from paradigm shifts. Services contracts with providers directly may need to address whether the service provider could be managed by the customer or by an agent of the customer. Savvy customers should manage this conflict by appropriate contractual and operational precautions.
Innovation.
As with any outsourcing, the customer and its suppliers need to identify opportunities and processes for continuous improvement, if not continuous innovation. This is particularly challenging in outsourcing, where scalability and repeatability dictate routinization, and where shifts in the value proposition might come only at the expense of additional capital investment. Managing innovation over long-term contracts is one of the art forms in outsourcing as a management tool and requires thoughtful planning and implementation.
Relationship Management.
To the extent that a services aggregator manages the customer’s other service providers, the customer must nonetheless maintain direct links to avoid surprises and maintain some controls. The nature and degree of such relationship management should be spelled out.
Pricing.
Traditional outsourcing services providers aggregate purchases of technology and other inputs, wrap them in an envelope of proprietary services and deliver the package to the customer. Implicit in this bundling of goods, technology and services is a cost-savings of bulk purchasing. In a “services aggregator” model, such bundling is done in the customer’s name but may have benefits for the services aggregator as credits for purchase volumes that reduce its own costs.
Competitive Restraints.
Competition law in the United States, Europe and elsewhere seeks to limit the adverse economic impact of an abuse of dominant market position or attempts at monopolization. If a services aggregator is large enough to be subject to the Sherman Act or the Clayton Act or is engaged in price discrimination under the Robinson-Patman Act, the customer might be concerned. The well-drafted services aggregation agreement will address this issue.
Analogies to Buying Group Model.
Customers considering hiring services aggregators need to understand the financial model that produces revenue for the services aggregator. By analogy, buying groups that aggregate demand by hospitals and negotiate price discounts for member hospitals can create huge volumes. But, according to a narrowly focused preliminary study by the U.S. General Accounting Office in May 2002 that targeted only two products out of thousands, buying groups might result in higher costs because of participation fees charged to suppliers, administrative fees charged to customers in the buying group and long-term lock-in effects of long-term purchase contracts.
Best Practices for Services Aggregators.
Conflicts of Interest.
If the services aggregator is paid by fees by the services providers under its management, there would be a conflict of interest in the incentives for compensation. Healthcare purchasing groups that charge fees based on a percentage of sales to the purchasing groups customers have an ostensible conflict. On one hand, they serve the group members (purchasers) because they generate captive volume. On the other hand, they are subject to promoting one vendor’s goods (or services) over another depending on which vendor might pay the higher “participation” fee. The customer should understand the inherent conflicts with a view towards risk mitigation.
Adding Value.
A services aggregator adds value to its customers if it has experience in performing the services and in managing others who provide the same or similar services. This enables the services aggregator to stay within the “sweet spot” of its own core expertise. But a services aggregator that is fundamentally incompetent in either providing or managing the relevant services adds no value and risks incurring liability for negligence, breach of contract, or other customer disappointment. These adverse results can be predictable when the non-subcontractor third parties fail to perform as contracted, fail to meet the customer’s expectations despite proper performance, or fail to be integrated into the value chain of the customer.
Value for Money.
If the customer is as competent as the services aggregator at hiring and managing external service providers, then the value delivered by the services aggregator might be limited or nill. The fees charged by the services aggregator should reflect value for money, and not merely an unnecessary burden on the customer’s budget. If the services aggregator charges an administrative fee of, say 3%, of the charges of each service provider “under management,” then the customer loses the opportunity to negotiate such savings directly with its the non-subcontractor services providers.
Price Management.
An effective services aggregator may obtain favorable prices, as agent for the customer, by negotiating long-term purchase contracts. But a long-term contract, without flexibility or market-driven options, can defeat the customer’s interests. Without an effective mechanism for gaining access to reduced market prices over time, the long-term purchase contract becomes an albatross around the customer’s neck. Consequently, effective purchasing practices need to have a means of
- obtaining market prices if prices decline, and
- a means of rewarding the service provider if the quality results in better bottom-line financial results for the customer.
- renegotiation of prices.
Open Entry, Open Exit.
If the services aggregator charges based on administrative fees and incentive payments, the customer can be locked into the services aggregator. The value proposition depends therefore on whether the customer, at any given moment, and on a cumulative basis, would be in a better situation by not having the services aggregator. Openness of exit depends on many negotiable considerations.
Transparency in Pricing.
The customers need to have access to market price information as well as contract price information. The services aggregator, acting as agent and fiduciary for the customer, should meet with the customer frequently to manage trends and opportunities for adjustments in sourcing.
Optimal Customer Profile.
Experience with other industries suggests that larger customers might be able to negotiate lower prices than smaller customers or a buying group. Smaller customers, without financial leverage, tend to get lower prices by using a buying group than by making purchases alone. Accordingly, the services aggregator model might be most effective for mid-sized companies that lack the ability to generate reduced costs and more efficient operations.
Get Help.
Parties contemplating a “services aggregator” relationship will benefit from the advice and assistance of experienced outsourcing advisors.