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Penalties in Outsourcing,Incentives in Outsourcing Services,Penalties and Incentives in Outsourcing

Penalties and Incentives in Outsourcing

Introduction

It is a time honored approach to motivation to punish bad behavior and reward good behavior. However before we set out to mete out rewards and punishments, it is important to define expectations and parameters well in advance and also specify consequences for not meeting them. If managed well, this method can go a long way in managing an outsourcing contract to make it a mutually beneficial arrangement.

How to Set Penalties

Let us start by dealing with the unpleasant part first. It is important that the client does not resort to the principle of penalties as an excuse to pay less or as a method of punishing. The aim of imposing a penalty is to fix a problem and ensure that it does not recur.

That said, the penalties should not leave any scope for taking them lightly. The penalty should be huge or troublesome enough that it acts as a deterrent to shoddy work. Not only that, the penalties should increase with recurrence of the same transgression. This way, the vendors take interest to fix problems early on. The penalty should be immediate, payable the next month after the failure occurs and not at the end of the quarter or financial year. This helps to establish a direct relation between poor work and penalty and puts sufficient pressure on the vendor to take corrective action immediately.

In most cases, you do well by defining penalties early on, as it shows the importance of the services. The toughness of the penalty depends on how critical the outsourced service is to your business. You may also choose to penalize a general downward trend observed in a few months at a stretch, rather than any one particular event.

Take care to avoid loopholes where penalties are defined in the contract. Some vendors may use their negotiating abilities to spread the penalties over a wide range of targets. This can be misleading, as it gives the impression of being detail oriented whereas actually the vendor is only taking attention away from the top priorities. Therefore effective penalties have to be shaped around the most critical aspects and also be huge enough to make the vendor focus on what's really important. In other words, what matters is where you focus your penalties on.

No Averages

Some vendors might propose to take average performance over a period of time as the parameter for incentives and penalties. Steer clear of this. The vendor has to provide you a consistent service level day by day. Going by averages prompts the vendor to overachieve some of the time-which is quite useless to the client- and then use that to average out their underachievement-which has a negative impact on the client's business.

Also, be wary of setting only the boundary for a penalty in matters of outages. For instance, if you specify the maximum allowed outage as 40 minutes in a month, you must also specify different levels of penalties for outages that cross this limit- a certain level for penalty for outages between 41 and 60 minutes, a higher amount for 61-90 minutes and so on. Another way of looking at penalties is to consider the number of users or sites affected.

There should also be provisions in the contract that enable the client to terminate the contract for repeated failure. The boundaries for such events should be clearly defined.

Defining Incentives

Incentives are crucial to motivation, nevertheless they can be trickier than penalties in contracts. The right way helps to foster healthy competition and a mutually beneficial arrangement. Like penalties, the terms for incentives have to be clearly defined in the contract, and the more closely linked they are to the most vital business objectives, the better. The terms for incentives have to be documented and handed out to all concerned parties.

One potential area for rewards is finding and working on cost saving opportunities. Rewarding vendors who implement initiatives or improve services leading to business success is also a good idea. However you are advised to stay away from incentives for meeting the service levels- you are already paying for it. Rewards are for situations where the vendor exceeds your expectations.

Such achievement related rewards are typically one-time payments- the rewards may be for completing the work earlier than the stipulated date, a higher service level that was committed to and so on. Incentives can be given to either the vendor company as a whole or individuals who have made a significant contribution, based on nominations or other criteria that were agreed upon earlier.

Use Judiciously

The system of incentives and penalties is a power-packed tool that, used the right way, creates effective and mutually rewarding outsourcing relationships. Focus on key areas that are vital to the business, make it large enough and be consistent in your dealing. The vendor takes to attach less seriousness to the penalties when you do not impose it right from the beginning. The same holds true for incentives. This in turn reduces credibility and undermines the relationship.

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