Outsourcing trends Real estate, construction management and facilities management outsourcing

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1 CRET Newsletter 2Q 2009 Edition Outsourcing trends Real estate, construction management and facilities management outsourcing Shifting from WHAT to outsource to HOW to outsource Much of the focus of Real Estate, Construction Management and Facilities Management outsourcing historically has centered on WHAT services to outsource. As corporate users have refined their approaches, service providers have grown more sophisticated, and technology has made it easier to collect and analyze data, there is greater interest in HOW to outsource. Of course, outsourcing is but one piece many organizations realize that the most effective service delivery model combines in-house and contracted services. of the overall service delivery model. HOW an organization approaches outsourcing can reflect its overall operating strategy and is often a leading indicator of the corporate/ service provider relationship structure. To put some outsourcing trends in context: Over time, many Corporate Real Estate (CRE) departments have migrated from a larger in-house service delivery model to a smaller, more strategic department supported by various outsourced components. However, even those organizations that outsource recognize that the most effective model often uses a mixture of in-house and contracted services (out-tasked and outsourced). To engage an outsourcing provider, there are three distinct solicitation approaches: the Traditional approach, the High Tech approach, and the High Touch approach. The approach used in solicitation often sets the tone for the corporate/service provider relationship.

2 Several decisions need to be made BEFORE solicitations. The RFP can be used to validate these decisions, but the RFP process should not be used to make such decisions as: Geographic scope: What region(s)? Bundling of services: Which services? Contracting structure: How will fees and expenses be determined? What level and types of risk will be shared in the outsourced relationship? Resources and personnel: How will both parties manage the relationship, and will headcount be transferred to the provider? Level of information sharing and technology infrastructure: What is the level of information transparency in the RFP, and how will the information be shared? Emerging practices focus on the evolution of data into information. Examples include: Distinguishing between using Key Performance Indicators (KPIs) to gauge a provider s ability to manage vs. KPIs as a performance management tool Using the RFP Financials to model indirect costs and incentives to develop specific commercial terms, payouts, and risk profiles through modeling exercises PRIOR to the contracting phase Operating model evolution: How to reflect outsourcing to service providers A CoreNet/Deloitte study in 2004 indicated that the 1980s were characterized by large CRE organizations with limited contracting for particular purposes, often referred to as out-tasking. The 1990s witnessed a downsizing of CRE departments and an increase in out-tasking. During the mid-to-late-1990s, some out-task providers were replaced by preferred vendors and alliance relationships through what s referred to as outsourcing. By the early 2000s, some organizations further evolved and developed strategic partnerships with their outsourcing providers. Despite this trend, many organizations realize that the most effective service delivery model combines in-house and contracted services. The model illustrated below recognizes that some services can be handled centrally across a geographically diverse portfolio while others can be handled locally (vertical axis). It also recognizes that services can be performed by either in-house staff or contracted staff (horizontal axis). The most effective operating model usually employs characteristics of the options highlighted in the illustration. Critical questions have evolved from Should you outsource? and What should be outsourced? to How should the entire service delivery model be constructed? and How will in-house and contracted services be coordinated? Localized On-site support In-house support at the local facility level Often fill the role of facility manager Out-task Specialized services performed by contracted employees Usually performed on a one-off basis at the local level Centralized Center of excellence Centralized real estate planning and management function More strategic function, mostly kept in-house Out-source Specialized services performed by contracted employees Leverage supplier know-how and expertise Usually contracted at a national or regional level In-house Contracted As used in this document, Deloitte means Deloitte Consulting LLP, a subsidiary of Deloitte LLP. Please see for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. 2

3 The challenge of finding the most effective service delivery model is clearly important to today s CRE executives, who recognize the key role service providers play. Engaging a service provider The solicitation process has evolved to reflect changing corporate users needs, service provider lessons, and advances in technology. The solicitation approach often sets the tone for the corporate/service provider relationship. Traditional approach RFI RFP Orals Selection Negotiation/ Contract Transition/ Implementation High tech approach RFI RFP Orals Selection Negotiation/ Contract Transition/ Implementation High touch approach RFI Preliminary RFP Solutions meetings Final RFP Selection Negotiation/ Contract Transition/ Implementation Although there are several variations, there are basically three approaches: Traditional, High Tech, and High Touch. These three approaches are applicable to other cost categories beyond real estate (RE), construction management (CM), and facilities management (FM). What makes RE, CM, and FM unique is that commodities are often bundled with specialty services, complicating the selection of the appropriate approach. and communicated via a structured data template. The invitation to Orals and Negotiation/Contracting is largely based on quantitative data comparison. Standardized template structure makes side-by-side vendor comparisons easier, while baseline-to-vendor comparisons better enable benefit quantification. In addition, every real estate category is treated like a commodity, and there are limited opportunities for service providers to differentiate themselves. 1. Traditional: In the Traditional Approach, the Request for Information (RFI) and Request for Proposal (RFP) are time, resource and document intensive. The corporate user generally creates the scope, which can be specifications driven (which dictates tasks and frequency) or outcome driven. The Traditional approach is well understood by CRE, Procurement and Service Providers, and there are standards and processes to act as a guide. However this process does not fully leverage the experience of service providers and does not adequately recognize that commodity services should be treated differently from specialty services. 2. High Tech: The High Tech approach is data intensive, and the RFI, RFP and response templates are often structured around these data needs. Similar to the traditional model, the corporate user generally creates the scope (either specification or outcome driven), but this information is organized 3. High Touch: Using the High Touch approach, the RFI is replaced with a knowledge-sharing session where service providers share lessons learned and may provide scope, SLAs, and contract structure information to help shape and create the RFP. The RFP contains several templates and seeks both quantitative and qualitative information. Providers present their solutions before closing the RFP. Knowledge-sharing sessions and constant collaboration allow suppliers to bring in expertise, and high levels of up-front collaboration usually lead to relationship building and a smoother negotiation/transition period on the back end. Where responses are unstructured however, direct vendor comparisons can be difficult, leaving the RFP open to interpretation. This may lead suppliers to withhold critical information necessary for the selection process, and may present challenges with established procurement processes that may be better suited for commodity services. 3

4 When considering the appropriate approach, corporate users should recognize that their choice could set the tone for the overall relationship. The Traditional approach could yield a conventional service provider relationship; a High Touch approach could generate a partnering relationship; and a High Tech approach could create a more metrics-focused arms-length relationship. Key decisions BEFORE issuing a solicitation Although the RFP can be used to collect market data to validate a service delivery model strategy, it is recommended that BEFORE a solicitation is issued, the company should set a strategy for geographic reach, scope and bundling of services, basic contract structure(s), and information transparency. Geographic reach Many corporate users considering outsourcing have large global portfolios; however, outsourcing efforts need not include the entire portfolio. Beyond vendor capabilities, consider the following issues: The scope of services and required service levels, with special attention to leased properties Ability to manage multiple vendors across a given geography The need and ability to aggregate and analyze data across multiple geographies, with consideration to existing internal CRE IT systems and possible interactions with Service Provider IT systems Providers with global footprints do exist, and the quality and consistency of their service have improved greatly. However, there are risks and challenges to having a single alliance with one global vendor and this portion of the outsourcing market is limited. Scope and bundling of services Once you determine which services should be contracted beyond those provided in-house, consider the types of providers and wherever possible try to bundle the service offering, as illustrated below. The services are arranged vertically by life-cycle on the left side of the figure; across from each specific life-cycle function, representative provider categories are shown in the three light blue boxes. Facility Management (FM) firms may cover the specialties of Lab Services through Food Service and Integrated Facility Management (IFM) firms may be able to support the entire life cycle. Transaction management Architecture & design Project/construction management Engineering Specialty O&M Outsourced to integrated facility management provider Outsourced to facility management provider Lab services O&M Out-tasked or outsourced to specialized service providers Security Janitorial/Landscaping/ Pest control/waste Any services kept in-house Food service 4

5 Specialty Providers, FM Providers and IFM Providers have distinct value propositions (as illustrated below). Corporate users should make a conscious decision as to what type of provider would best fit their needs, and then use this as a filter to help determine which firms should be shortlisted. In some cases, it may be appropriate to include different types of firms. This makes a side-by-side comparison more difficult, but it can be a good way to better understand the pros and cons of each model, and potentially outsource different services to different (but complementary) firms. Deep technical delivery skills Integration across space types Specialized content related methodologies Access to labor Career path Reporting capabilities Integration across services Significant IWMS technology investment Significant CMMS technology investment Large geographic footprint Specialized FM IFM No capabilities Limited capabilities Moderate capabilities Deep capabilities Information transparency The debate on whether to include detailed data on cost, staffing, Operating Expense (OpEx) and Capital Expense (CapEx) budget, and transaction deal flow in the RFP is often heated. This information could be useful for the service provider and can help them tailor their solution to add more value. Sharing information can also help reduce the due diligence and contracting periods. However, aggregating and validating this data for service providers can be time consuming, and some worry that by providing these details, a corporation loses its leverage, as the service provider may not offer the most efficient or creative solution. Organizations with abundant specialty space that may be driving up their cost structure are often concerned that service providers, who do not understand their unique requirements, will suggest the existing cost structure is excessive, making the in-house CRE team vulnerable to management criticism. However, as a general rule, corporations that truly want a collaborative relationship with their service provider tend to be more comfortable sharing information prior to the contracting phase. The approach to information sharing may be impacted by the relative maturity or sophistication of the CRE department. If newly created or centralized, it may be important for the internal organization to gain control of the information before sharing with a potential service provider. But for a more mature CRE department, it may elevate the assistance level from their service provider. Contract structure The type of service, integrity of the existing cost baseline, need for predictability, administrative burden, and requirement for further improvements often drive the decision on contracts to pursue. While fixed fee, cost plus, and unit costing (e.g. cost/sf) are still widely used, the trend is toward integrating performance-based elements where providers put some fee at risk but also can increase their payout by increasing quality as measured via Key Performance Indicators (KPIs) or through reducing cost. 5

6 Emerging trends include moving from data to information as part of outsourcing Using KPIs as an Information Indicator vs. as a Performance Indicator Motivated by formal governance structures, performancebased contracts, and the desire for accountability, many organizations have moved from tracking limited critical KPIs to tracking too many. Although the ability to track many KPIs can be a good indicator of the service provider s data infrastructure, using more than a focused group can be a burden on the corporation and the provider. A comprehensive menu of KPIs should be developed and aligned with the outsourcing project objectives. The corporation should then develop a recommended list of no more than 15 KPIs that are clearly defined and objectively measurable. Using the RFP to model commercial terms The real value of analyzing RFP Financials is NOT limited to the comparison of direct costs at a service and/or site level it is the ability to effectively model commercial terms, payouts and risk PRIOR to the contracting phase. Although direct costs make up a large percentage of many outsourcing contracts, these costs are often less flexible and rarely distinguishable among comparable vendors. In contrast, management fees and other indirect costs are usually more flexible, and vary across providers. A structured template should therefore be used for direct costs, but service providers have some flexibility in the structure of indirect costs. Recognizing that the RFP-quoted fees are not best and final offers, progressive corporate users use the RFP direct costs to model a target cost and performance level (often expressed through a KPI). This is illustrated below where the target cost and KPI are identified within the bull s eye. Progressive corporate leaders then model the base management fee and expected profit for that targeted service level and cost. Incentives such as cost and quality are then applied. If the cost of the service delivery is below the target, there is an additional payout (provided the KPI is not compromised). Likewise, if the KPI is exceeded (as illustrated with the green line), there is an additional payout. In this example, the target cost is established and the target KPI is set at 85 percent. If the cost comes in lower than target, the payout is higher. If the KPI comes in at 90 percent as opposed to 85 percent the payout is higher. Service provider payout ($) With additional incentive KPI: 90% KPI: 85% Base fee and profit Base fee 0-10% -5% Target +5% +10% Direct service costs 6

7 Key takeaways/do s-don ts/lessons learned As the CRE function evolves to a more strategic role, we find that companies are increasingly looking to outsource actions, which are non-core or which can be accomplished more effectively or more efficiently by vendors. Likewise, outsourcing relationships are evolving to better reflect value chain economics and to tailor delivery around Service Level Agreements. Here are our suggested guideposts to consider in your quest to improve your operating and service delivery model. 1. To be most effective, outsourcing should be considered within the OVERALL service delivery and operating model Recognize this is a transformative event with a need for clear communication and change management Leverage the knowledge of service providers THROUGHOUT the process The real value of financial analysis of the RFP isn t to get to a cost-by-site analysis; it s to model contract terms in preparation for negotiations Space Type (and industry) DOES matter Take the time to clearly define cost categories Take special care with O&M and Engineering Perform a risk and readiness assessment on ALL services to determine which services are core to the business and which are non-core and strong candidates for outsourcing Select the RFP Approach that is compatible with the services being bid AND the corporate strategy Evolved collaboration requires active ongoing management including review of relevant metrics and adjusting incentives over time to keep service levels and cost performance on track There IS such a thing as too many KPIs Expect changes after the contract is in place The goal of the negotiation phase is not necessarily to create the perfect contract; it s about creating a reasonable contract that can flex with expected and unexpected change 6. Don t use an RFP to define your strategy; use an RFP to refine your strategy Consider these guideposts in your efforts to better position your corporate CRE department to continue to evolve its service delivery while meeting cost reduction objectives. CRET Quarterly Partner George Bouri Contributing Editors Chris Davidson Sean Goldstein Production Manager Gale Young For more information on outsourcing, please contact George Bouri gbouri@deloitte.com or Chris Davidson chrdavidson@deloitte.com 7

8 This publication contains general information only and is based on the experiences and research of Deloitte practitioners. Deloitte is not, by means of this publication, rendering business, financial, investment, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte, its affiliates, and related entities shall not be responsible for any loss sustained by any person who relies on this publication. Copyright 2009 Deloitte Development LLC. All rights reserved.