A well-balanced contractor operating model is key to significantly reducing costs and risks associated with outsourcing.
Many current contractor operating models stimulate a perverse vicious cycle, leading to additional costs for both the contractor and the contracting company. When not correctly managed, there is a transfer of operational and management inefficiencies of the contractor, through the contract price. Contractors also lose in margin: aggressive price negotiations between the contracting company and the contractor could cause a reduction of the contract price, drastically reducing the margin of the contractor.
The standard management model often leads to additional costs for both the contractor and the contracting company.
A common model, leading to a vicious cycle: there is a transfer of operational and management inefficiencies of the contractor, through the contract price. Contractors also lose in margin. On the contrary, aggressive price negotiations by the contracting company with the contractor could cause a reduction of the contract price, drastically reducing the margin of the contractor.
Consequently, problems like the lack of commitment to plans and deadlines, quality problems and rework, increasing extra costs, penalties application, and what is even worse, lack of trust between contracting party and contractor undermining the relationship, will convert the model into something unsustainable.
On the contrary, a business model with a positive impact on business for both parties can be proposed: A “win-win” model
A healthy contractor’s management model is possible, based on mutual trust and commitment. And what it is more important: this model is built on a win-win collaboration base, increasing margins and reducing costs for each of the involved parties. A win-win approach leading to an increased profitability of the contracts, which offsets the lower price.
The win-win approach results in increased profitability of the contract, which offsets the fall in the contract price. The model lays the foundation for the development of a long-term relationship between the two parties
Action levels for improving the management of contractors:
There is a wide range of additional levels to act upon for improving the management of contractors. The contractors operating model is just one level for potential improvement in the contractor-client relationship. These levels are shown in the following scheme:
This pragmatic model provides a framework for finding a tailor-made solution for every possible situation, categorising and condensing most common problems into a reduced number of concepts.
The steps for designing and implementing a win-win contractor’s management model vary from client to client, mainly depending on the starting situation of the client, and its level of evolution. But the two most logical approaches to start the journey of improvement are the bottom up approach (placing the basement at the operating level, and continuing building following layers on top) or the top down approach (deployment of the strategic definition of the model). The starting level will depend on the evolution the client has reached within the model. What kinds of situations can the management model address at each level?
• At strategy level: decision-making criteria definition and process implementation to respond systematically the question of “do it internally or subcontract?”, according to an organizational capability evaluation. Once subcontracting is the decision, provide answers to questions like the adequate volume to be subcontracted, the targets to be achieved, the degree of dependence and commitment with selected contractors, how many subcontractors, among others.
• Concerning the contracting level, respond to questions like what is the fair price for a subcontracted service; what factor(s) should be considered for the remuneration model; define the adequate number of suppliers, disaggregated by geographical area; if the activities should be done by generalist or specialist contractors; etc.
• Management of Materials is key within the contractor’s management model. It answers questions like if the contractor will provide the materials or better synergies of purchasing can be achieved via consolidation; better equipment planning; etc.
• Finally, at the operating level: design the operational model that proactively evaluates activity, productivity and quality levels, as well as cost optimization.
The win-win model for contractor management achieves excellent quantitative results:
- Improved productivity of contracts (20-25%)
- Reducing material stocks by 35% and equipment by 25%, achieving substantial improvement in service levels
- Up to 20-25% reduction in the cost of contracts
- 70% reduction of the required parameters for adequate compensation
- Stabilizing of “K” factor, allowing a more accurate and fair value, by activity
- Identification and implementation of new business opportunities to turn cost centres into profit centres
… as well as significant qualitative results:
- Allows greater control over activities, ensuring compliance with deadlines
- Improves the quality of work / services performed
- Improves the relationship between both parties: contracting and contracted
- Improves the performance and brings greater value to the activities carried out by teams, from both parties
- Increasing management capacity through the use of activity KPIs, allowing greater visibility and transparency
- Starts a long term relationship
In summary: this simple but powerful model can address the problems most commonly found in client-contractor relationships. It can also help to transform the current contractor relationship model into a differentiating competitive advantage.
This post is a fragment of the white paper “Perspectives on Contractor Management” written by Alfa Consulting in collaboration with other members of the Cordence Worldwide Alliance.To view the entire white paper, click here to download the file.