The Contract Scorecard

ARCHITECT ENGAGE OPERATE REGENERATE The Contract Scorecard Module 8 of the outsourcingtoolset outsourcingtoolset.com

Contents 1 ABOUT THE OUTSOURCING TOOLSET AND THIS MODULE...1 1.1 THE OUTSOURCING TOOLSET...1 1.2 THIS MODULE...3 2 INTRODUCTION...3 2.1 PURPOSE OF THE CONTRACT SCORECARD...3 2.2 ROOTS OF THE CONCEPT...5 2.3 TIMING...8 2.3.1 2.3.2 Point in the Lifecycle...8 Critical Timing to Manage Bargaining Power...13 2.4 PLANNING AND PREPARATION...15 3 THE QUALITY QUADRANT...15 3.1 PRECISION...16 3.2 RELIABILITY...18 3.3 SPEED...20 3.4 EFFECTIVENESS...21 3.5 SATISFACTION...23 4 THE FINANCIAL QUADRANT...25 4.1 HISTORICAL...26 4.2 BUDGET/TARGET...27 4.3 MARKET...28 4.4 TCO (TOTAL COST OF OWNERSHIP)...31 4.5 INVOICING AND PAYMENT...33 5 THE RELATIONSHIP QUADRANT...34 5.1 UNDERSTANDING POWER-BASED VERSUS PARTNERING-BASED RELATIONSHIPS...34 5.2 DEFINING THE RELATIONSHIP BEHAVIORS YOU WANT...36 5.3 ASSESSING THE RELATIONSHIP BEHAVIORS...38 6 THE STRATEGIC QUADRANT...41 6.1 INNOVATION...42 6.2 BUSINESS CONTRIBUTION...43 6.3 ALIGNMENT WITH CORPORATE VALUES/INITIATIVES...44 6.4 UNDERLYING BUSINESS PROCESSES...45 7 DETERMINING THE DETAILED KPIS IN A SEVEN-STEP PROCESS...47 7.1 OVERVIEW...47 7.2 STEP 1: ASSIGN PARTY OBLIGATIONS - IDENTIFY WHO IS ACCOUNTABLE FOR WHAT..48 7.3 STEP 2: ASSESS STAKEHOLDERS - DISTINGUISH WHO CARES ABOUT WHAT...50 7.4 STEP 3: LIST KPIS - GET THE BIG PICTURE...53 7.5 STEP 4: SET KPI THRESHOLDS PINPOINT THE CARE POINTS...54 7.6 STEP 5: GENERATE CALCULATION METHOD SPECIFY THE MATH...55 7.7 STEP 6: PROTOTYPE REPORTS - DESIGN THE PUBLICATION...57 7.8 STEP 7: CONDUCT TESTING MAKE SURE IT WILL WORK...58 7.9 OTHER ISSUES TO CONSIDER...59 2009 The Cullen Group outsourcingtoolset.com ii

8 SCHEMES FOR THE CONSEQUENCES OF KPI PERFORMANCE...62 8.1 EXPLORING THE BASIS FOR KPI SCHEMES - RECOURSE VERSUS REWARDS...63 8.2 TIMING...66 8.2.1 Regular rebate/bonus schemes...67 8.2.2 Intermittent schemes...71 9 ADOPTING THE CONTRACT SCORECARD...74 9.1 THE SCORECARD PERSPECTIVES CHOOSING YOUR QUADRANTS...75 9.1.1 Value for money perspective...75 9.1.2 Context perspective...76 9.1.3 Operations perspective...76 9.1.4 Agenda perspective...76 9.1.5 Adoption based on the perspectives...77 9.2 THE CONTRACT SCORECARD BLUEPRINT PLANNING WHAT GOES WHERE IN THE CONTRACT...78 10 CONCLUSION...81 APPENDICES...83 A. Contract Scorecard Development Project Plan...A1 B. Forms for Progressive Intervention... B1-B5 Figures and Tables FIGURES FIGURE 1: THE OUTSOURCING LIFECYCLE...1 FIGURE 2: THE BASIC COMPOSITION OF EACH MODULE...2 FIGURE 4: THE BALANCED SCORECARD...5 FIGURE 5: CONTRACT SCORECARD - QUADRANTS...7 FIGURE 6: CONTRACT SCORECARD - CONTENT...7 FIGURE 7: TIMING IN THE LIFECYCLE...9 FIGURE 8: BARGAINING POWER AND THE LIFECYCLE...13 FIGURE 9: QUALITY KPI TYPES...16 FIGURE 10: FINANCIAL KPI TYPES...26 FIGURE 11: UNDERLYING DRIVERS OF BEHAVIOR...35 FIGURE 12: POWER VS PARTNERING RELATIONSHIPS...36 FIGURE 13: RELATIONSHIP KPI TYPES...37 FIGURE 14: EXAMPLE RELATIONSHIP SCORING SYSTEM...39 FIGURE 15: STRATEGY KPI TYPES...42 FIGURE 16: PARTIAL EXAMPLE RESPONSIBILITY MATRIX...49 FIGURE 17: KPI THRESHOLDS...54 FIGURE 18: KPI DEVELOPMENT WORKSHEET...56 FIGURE 19: EXAMPLE OF A HIGH-LEVEL SCORECARD DASHBOARD...57 FIGURE 20: THE REPORTING PYRAMID...58 FIGURE 21: PROGRESSIVE INTERVENTION PYRAMID...65 FIGURE 22: EXAMPLE ESCALATION OF AT RISK AMOUNT WITH INTERVENTION...69 2009 The Cullen Group outsourcingtoolset.com iii

FIGURE 23: EXAMPLE POINTS SCHEME PROVISION...70 FIGURE 24: EXAMPLE EXTENSION PROVISION...72 FIGURE 25: EXAMPLE STEP-IN PROVISION...73 FIGURE 26: EXAMPLE TERMINATION PROVISION...74 FIGURE 27: SCORECARD PERSPECTIVES...75 FIGURE 28: INCREMENTAL ADOPTION OF THE CONTRACT SCORECARD...77 FIGURE 29: BLUEPRINT EXAMPLE...79 FIGURE 30: THE CONTRACT DOCUMENTS...80 FIGURE 31: FREQUENCY OF CONTRACT DOCUMENTS USE...81 TABLES TABLE 1: MODULE QUICK-REFERENCE TABLE...3 TABLE 2: EXAMPLE KPI DELIVERY TO SPECIFICATION...16 TABLE 3: EXAMPLE KPI COMPLIANCE WITH POLICIES...17 TABLE 4: EXAMPLE KPI ACCURACY OF RECORDS...17 TABLE 5: EXAMPLE KPI MEETING MILESTONES...18 TABLE 6: EXAMPLE KPI EQUIPMENT AVAILABILITY...19 TABLE 7: EXAMPLE KPI RELIABILITY OF EQUIPMENT AT DELIVERY...19 TABLE 8: EXAMPLE KPI FAULT RESPONSE AND RESOLUTION...20 TABLE 9: EXAMPLE KPI ORDER AND DELIVERY CYCLE TIME...21 TABLE 10: EXAMPLE KPI EFFECTIVENESS OF SALES FUNCTION...22 TABLE 11: EXAMPLE KPI CUSTOMER SATISFACTION...25 TABLE 12: EXAMPLE KPI COST REDUCTION...27 TABLE 13: EXAMPLE KPI MEETING BUDGET...28 TABLE 14: EXAMPLE KPI WITHIN MARKET BENCHMARKS...29 TABLE 15: EXAMPLE KPI REPLACEMENT COST...32 TABLE 16: EXAMPLE KPI INVOICING AND PAYMENT DEADLINES AND ACCURACY...33 TABLE 17: EXAMPLE KPI INNOVATION FEASIBILITY STUDIES...43 TABLE 18: EXAMPLE KPI COMMERCIALIZED APPLICATIONS...44 TABLE 19: EXAMPLE KPI DEMOGRAPHIC UTILIZATION...45 TABLE 20: EXAMPLE KPI SAFETY...46 TABLE 21: EXAMPLE KPI STAFF CONTINUITY...46 TABLE 22: SEVEN STEPS FOR DEVELOPING KPIS...47 TABLE 23: EXAMPLE STAKEHOLDERS AND THEIR EXPECTATIONS...51 TABLE 24: EXAMPLE CONTRACT SCORECARD METRICS...53 TABLE 25: EXAMPLE KPIS (PARTIAL) - ORIGINAL...60 TABLE 26: EXAMPLE KPIS (PARTIAL) - REVISED...60 TABLE 27: EXAMPLE KPI STRATIFICATION STANDARD VERSUS NON-STANDARD HOURS...61 TABLE 28: EXAMPLE WRITE-UP OF THE PROGRESSIVE ACTIONS...66 TABLE 29: EXAMPLE REBATE SCHEME PERCENT METHOD...68 TABLE 30: EXAMPLE REBATE ESCALATION SCHEME...69 TABLE 31: POINTS EXAMPLE, TELECOMMUNICATIONS CARRIER...70 2009 The Cullen Group outsourcingtoolset.com iv

1.2 This Module This module covers the development of a Contract Scorecard. It provides an overview of the Contract Scorecard, its four attributes, and the four perspectives that can be taken by your organization in any particular deal. Information about how to develop Key Performance Indicators (KPIs) and report the Contract Scorecard is also included. A number of cases are presented to help clarify the intention of the techniques offered. The tools provided for this module, in addition to this guide, are: Appendix - Project Plan (MS Project TM); and Presentation slides (MS PowerPoint TM). TABLE 1: MODULE QUICK-REFERENCE TABLE Lifecycle Position Objectives Key Processes Deliverables Resources required Architect phase Building Block 4 Provide a holistic view of the outsourcing arrangement 1. Marshal team with most suitable skills 2. Determine appropriate quadrants for scorecard 3. Determine KPIs and incentives 4. Confirm scorecard quadrants and metrics with stakeholders 5. Determine reporting regime Contract Scorecard blueprint and report Staff/consultants with the most appropriate skills and experience relative to the scorecard quadrants and metrics to be developed 2 Introduction 2.1 Purpose of the Contract Scorecard Why do some contracts disappoint? When do they succeed? Different people have diverse beliefs as to what successful contracts are. Some would consider a contract successful if it did not end up in court. Others believe it to be successful if they did not need to manage the contractor too much. However, in this module, success means that the people in your organization got the results they were seeking. In this context, the Contract Scorecard concept comes into its own. 2009 The Cullen Group outsourcingtoolset.com 3

FIGURE 4: CONTRACT SCORECARD - QUADRANTS Quality Relationship Finance Strategy FIGURE 5: CONTRACT SCORECARD - CONTENT Service Quality Effectiveness Precision Reliability Financial Speed Satisfaction Historical Baseline Budget/target Competitiveness (benchmarking) TCO (total cost of ownership) Relationship Communication Conflict resolution Creative solutions Fairness Integration Strategy Objective achievement Innovation Business contribution Alignment to client business practices Positive interaction Proactivity Time investment Each one of these quadrants, with example measurements, is described in the next four sections of this module. 2009 The Cullen Group outsourcingtoolset.com 7

FIGURE 9: FINANCIAL KPI TYPES The financial metrics are also incorporated into the contract documents, most commonly as part of the financial schedule. In that schedule, for example, an organization may, along with the quoted prices, set a KPI for reducing the level of reimbursable expenditures by 5% per annum or keeping to +/- 5% of the budget. 4.1 Historical Historical financial measurements compare amounts paid to the provider to past fiscal points. These past fiscal points can be either past periods, such as the previous month or year, or the specified baseline costs that would typically be what the work had cost under previous service-delivery regime, such as when the work was conducted by your organization (this is known as insourced), or when the work was conducted by a previous provider. These historical measurements usually specify one of three things: 1. that the prices must decrease by a specified percentage; or 2. cost no more than the previous fiscal point; or 3. cost no greater than a specified percentage. Table 12 is an example of a KPI that specifies a 5% reduction from the baseline costs (the cost of the last year when the function was operated in-house). The reduction, in this case, was offered as part of the provider s bid when the contract was competitively tendered. 2009 The Cullen Group outsourcingtoolset.com 26

4.5 Invoicing and payment Invoicing and payment measurements are primarily designed to motivate the provider to bill accurately and on time. Contrary to the beliefs held in some quarters, client organizations really do want providers invoices on time, so that their accounting staff can close out accounts and/or projects. Very few organizations actually look forward to receiving surprise invoices when the books have been closed. Many clients have reporting getting invoices years after the work has been performed. It is also imperative for all kinds of organizations that they get invoices on time for budget purposes. If the provider is subcontracting any of the work, you may want to ensure that these subcontractors are also paid on time. This is not only to ensure the subcontractors stay solvent, but also because in some countries there are laws that may allow a subcontractor to seek compensation from the client if the provider does not pay them. Examples of invoicing and payment KPIs are provided in Table 16, where, in this case, the client s finance people were adamant about making sure all invoices were on time, were accurate and that no outstanding liabilities might exist regarding payments to subcontractors. Accordingly, the client set up three related KPIs to ensure finance would be satisfied. TABLE 16: EXAMPLE KPI INVOICING AND PAYMENT DEADLINES AND ACCURACY Calculation KPI KPI Minimum Standard Frequency Formula Source Data 1. Invoicing deadline 2. Invoicing accuracy Invoice received by the 4th day of each month No inaccuracies Received date = date stamped by Client s accounts payable As determined by Client s accounts payable function Client s accounts payable records 3. Subcontractor invoices and payment All Subcontracted work is invoiced by the Subcontractor and paid by the Contractor no later than one (1) month after work is completed Monthly Invoice date = date on Subcontractor s invoice Payment date = date payment cleared Contractor s bank account Subcontractor s invoice Copy of payment advice submitted by Contractor 2009 The Cullen Group outsourcingtoolset.com 33

Academics who study contracts have recognized that it is not the contract, or contract law that is really worth studying, but relational theories about people s behavior. 5,6,7 Legal rationality has been marginalized by the recognition of the complexity of relationship behavior. Fundamentally, while the contract plays an important part in developing behavioral norms both within and between the parties, the actual practice itself forms the total contracting behavior. In fact, a study by Oxford and Melbourne Universities of 235 Australian client organizations credited good relationships as the third most important factor just behind the supplier delivering to expectations and good contract management by both parties. 8 In that study, a good contract per se was not mentioned, although good relationship management techniques were - such as flexible working arrangements, the ability to change, and open, frequent, and effective communication. As Figure 10 demonstrates, the contract is an important, but superficial driver of day-to-day behavior. The deep behavior drivers are the underlying values and attitudes held by the individual parties and the people involved in the agreement. FIGURE 10: UNDERLYING DRIVERS OF BEHAVIOR Easily observable Contractual documents Two separate enterprises Superficial drivers of behaviour More difficult to observe Communication orientation Conflict resolution orientation Relationship orientation Strategic orientation Values orientation Deep drivers of behaviour 5 Stinchcombe, A. and Heimer, C. (1985) Organizational Theory and Project Management: Administrative Uncertainty in Norwegian Offshore Oil, Oxford University Press, Oxford. 6 Collins, H. (1996) Competing Norms of Contractual Behaviour in D. Campbell and P. Vincent-Jones (eds.) Contract and Economic Organization: Sociolegal Initiatives 7 Campbell, D. (1997) Socio-legal Analysis of Contracting in P. Thomas (ed.) Sociolegal Studies. 8 Cullen, S., Seddon, P.B. and Willcocks, L.P. (2001) IT Outsourcing Practices in Australia, Deloitte, Sydney 2009 The Cullen Group outsourcingtoolset.com 35

Relationship KPIs measure the behaviors exhibited by each party as seen through the eyes of the other party. Eight typical types of relationship measurements include: 1. Communication the degree to which the parties communicate frequently and honestly. 2. Conflict resolution the degree to which the focus is on fixing problems, not apportioning the blame. 3. Creative solutions the degree to which the parties continuously search for better ways of doing things. 4. Fairness the degree to which the parties act fairly toward each other. 5. Integration the degree that the services value chain appears seamless to the end customer. 6. Positive interaction the degree to which the parties enjoy working together and have respect for one another. 7. Proactivity the degree to which the parties are proactive to each other. 8. Time investment the degree to which the parties provide management time and focus for each other. Figure 12 gives examples of the KPIs you might find in each type of relationship measurement. FIGURE 12: RELATIONSHIP KPI TYPES 2009 The Cullen Group outsourcingtoolset.com 37

relations and, preferably, want the entire supply chain of your organization to operate with the same key values. Accordingly, if this is a perspective chosen, the most useful people to get involved in the design and management of the scorecard will be those operating at a strategic level within your organization regarding all contracts and the financial aspects of contracts. 9.1.5 Adoption based on the perspectives The only success criterion for infrequent transactions such as bulk equipment purchasing may be price. However, as a deal becomes strategically more important and longer in duration, then one should consider using more of the scorecard incorporating speed and accuracy of equipment delivery (value for money perspective). The expectations for a 10- year whole-of-it deal, for example, will typically be more than purely financial, and success will be based on at least the value-for-money criterion, if not the entire scorecard. If the nature of the deal is to provide equipment over 10 years and work with the client to specify the ongoing equipment needs of the organization, the strength of the relationship and the provider s ability to contribute to strategic goals will become increasingly important (all the perspectives and quadrants). Figure 27 shows how you may choose to incrementally adopt the various perspectives depending on the two axes: Strategic importance of the deal the deal s potential effect (both risk and benefit) on business as well as the number/importance of stakeholders concerned or effected. Duration the degree to which the deal is a single isolated transaction or is an ongoing requirement in nature. FIGURE 27: INCREMENTAL ADOPTION OF THE CONTRACT SCORECARD Strategic Importance Low High Contract Agenda Contract Operations Value for Money Financial Once-off transaction Ongoing operations Duration of Outsourcing Solution 2009 The Cullen Group outsourcingtoolset.com 77