Vendor Relations
Key Criteria for Selecting
an Outsourcing Partner

by Leland E. Modesitt

   Increasingly, companies are shutting down internal operations and seeking specialists to provide core services. The imperative for growth has forced even some large companies to evaluate the merits of retaining large-scale, extensive operations that tie up capital and management resources.
   The decision to outsource is important, difficult, and contentious. Worse, it is a decision that immediately involves an even more important, difficult, and contentious process: selecting a partner. As more firms decide to close cost centers and begin searching for outsourcing partners, they would do well to structure their selection process using a disciplined framework of relevant criteria. Based on our experience conducting over 100 outsourcing engagements, First Annapolis has developed a framework that works well in guiding companies through the partner selection process. Our partner evaluation framework includes the following criteria: economics, conversions, commitment to the business, features and functionality, and service.


   Price is generally the most important criterion to the executives of an organization. Companies should compare fully loaded costs down to the expense per relevant metric (e.g., cost per transaction, per account, per invoice, per customer, etc.). Organizations should consider all elements of cost; up-front bonuses, price escalators, annual fees, minimums, reporting costs, and pass-through items. Pricing structure differences among vendors can also cause confusion. A thorough evaluation will also test for a wide range of likely growth scenarios and compare expected costs to market benchmarks and existing internal cost structures.
   More importantly, the cost analysis needs to consider the impact of the technology on the interdependent back office expenses. That is, the effect of productivity gains from using a better-designed operating platform can far exceed the differences between vendors' direct processing costs.
   Conversions Management typically sees a conversion effort as high risk/high visibility. The skewed risk/reward equation for a conversion is also problematic: a smooth conversion results in no external benefit, but a troubled transition has an immediate and unpleasant effect. Companies should make conversion requirements explicit in the selection process and should push for financial incentives where justified by execution risk. Accordingly, careful due diligence prior to final negotiations is critical.

Commitment to Business

   The chosen vendor should have a proven industry track record, a high level of corporate stability, and a clear strategic direction. The risks here are not as immediate as conversion risks, but an uncommitted vendor will eventually fall behind in technology investments and productivity. Eventually, these failures will have a financial impact on the client and will lead to another conversion. Here also, careful, due diligence and a contract with built-in protections can help minimize the risks.

Features and Functionality

   We have found that in most vendor selection processes, nothing is discussed as thoroughly as features and functionality. This is because they are most important to operational managers. In our opinion, however, features and functionality are often ascribed a priority out of proportion to their importance. We have found that in the end, most serious vendors invited to participate can support the truly critical processes, and it is the differences in future capabilities that distinguish one party from another.


   This is a priority for operational managers, since they have to live with the chosen vendor on a day-to-day basis for a long time. Service levels are difficult to judge in advance, but there are some steps that may help a company anticipate results before choosing a vendor:
   Conduct careful reference checks at multiple levels, at a minimum with managers who interface with the vendor daily.
   Incorporate service level benchmarks, reporting, and financial remedies into the vendor selection process. Remedies must be material; keeping score only matters if it changes behavior.

   A company contemplating an outsourcing decision should remember that these criteria are more than just a random list; they comprise a framework to be used across the organization (see Figure 1). The low-cost provider may be the low-cost provider because it's the most efficient, or because its solution does the least, or because its managers are sacrificing future technology improvements on the altar of business development. Conversely, going with the most feature-rich system and highest service levels may be going with the industry leader, or it may be so expensive that it invalidates the original decision to outsource. Lastly, companies should keep in mind that this framework and these general guidelines are no substitute for expert industry knowledge. The more familiar an organization is with the current industry structure and standards for pricing, features and functionality, the better prepared it will be to solicit and evaluate proposals.