05 Aug Caveat Emptor – Terms to Avoid in your Outsourcing Deals
Insight by: Steve Martin
According to a recent study produced by Zion Market Research, “the global Healthcare IT Outsourcing market…is estimated to grow to about USD 96.9 billion by 2028.” This would represent more than a $30B increase from the 2021 figures – nearly a 50% uptick in spend over the seven year study period. While the numbers may be no easier to validate than the actual scores of a group of high handicappers at Pebble Beach on a windy Saturday afternoon (other studies (e.g., iHealthcareAnalyst) peg the projected figures at around $64B) , we can all agree that outsourcing spend is a) significant, and b) growing at a non-trivial pace. The motivation for outsourcing has been well documented, with cost savings (through a combination of labor arbitrage and outsourcers bringing high efficiency tools, techniques, and processes); ability to extend the talent pool in the midst of a scarcity of on-shore resources; and platform/infrastructure investment avoidance topping the list. What hasn’t been as clearly documented is how to avoid the landmines and traps that could completely offset the anticipated benefits of outsourcing. In the category of caveat emptor, here are three terms that healthcare providers should avoid being “sold” by their prospective outsource providers.
- Gain Sharing – These always seem enticing on paper – the outsourcer “invests” in operational cost reduction initiatives (e.g., Electronic Medical Records (EMR) upgrade, server virtualization, asset management leading to the retirement of unused devices) and both parties share in the spoils – the outsourcer takes half (or more) of the reduction in the form of their own reduced cost and the customer gets half (or less) of the reduction through reduced charges, due to, for example, lower application maintenance charges or a reduction in the quantity of managed devices. A savvy customer will negotiate these outsourcer investments as part of their (i.e., the outsourcer’s) cost of doing business – in other words, as a table stake to winning the contract. Hence, the capture of these savings should be contractual obligations of the outsourcer, not margin entitlements – it’s part of what they’re selling. In those situations where a significant investment may be required by the outsourcer to generate material savings, customers may agree to fund the upfront expenditure through a clearly defined project but should not feel compelled to share the benefits with anyone but their shareholders.
- Performance Incentives / Bonuses – Let’s call this one “Gainshare’s Baby Brother,” where the outsourcer attempts to capture bonuses or incentive payments for exceeding SLA targets, representing them as outcome based performance improvements that provide commensurate upside to both parties – i.e., benefits the customer through improvement in service levels and provides reward to the outsourcer for exceeding their targets. In practice however, these types of incentives are tantamount to higher fees (or in many cases, merely an offset to the outsourcer’s payment of SLA credits). While beating SLA performance targets may create certain operational benefits to the customer, they do not typically translate to meaningful, let alone quantifiable value in terms of reducing expenses or increasing revenues. The bottom line is that a vendor’s reward for exceeding service levels should be they get to keep providing the service!
- Vendor’s Governance and Staffing Models – This is probably the most dangerous of all of the outsourcers’ schemes, usually starting off with a speech that goes something like this: “We are accountable for hitting the committed service levels and executing the documented processes – how we do it, the level and number of resources we need, and how we govern the work should be left up to us.” The flaw in the argument is that the consequences to the outsourcer for failure to meet their contractual obligations are generally capped at penalties that equate to 15% (or less) of their fees (typical worst case for failure to meet service levels), which translates to an erosion of their hefty margins (often 30-40%), but far from an economic crisis for them (of course, they could be subject to termination for cause, damages, etc., but those outcomes are rarely pursued by customers). On the other hand, the consequences to the customer for such failures can be catastrophic – e.g., patient data breaches, loss of EMR data, billing, and payment system outages. Customers should be highly prescriptive in their outsourcing contracts related to staffing models (identifying the skill sets, experience levels, and number of resources delivering the services and ensuring retention of those resources is included in the terms) and governance (clearly setting the foundation for meeting cadence, reporting requirements, problem identification and remediation, and escalation procedures).
Suffice it to say, whether by preference or not, IT outsourcing in the healthcare sector is here to stay – at least in the near term. That being a virtual certainty, customers need to be mindful of the common tricks of the trade.