2013 began with a flurry of articles about companies insourcing work or rethinking their sourcing strategies. The reasons for this vary by company, but often include a perception that outsourcing has not delivered the cost savings, innovation or other value the companies had hoped to realize, particularly in information technology outsourcing (ITO). In contrast, we continue to see high levels of satisfaction among companies that have outsourced facilities management and other real estate functions. This makes us think the ITO industry might benefit from some of the best practices used in FMO deals.
First, let's define what we mean by FMO. FMO involves the outsourcing of functions necessary to keep a company's leased and owned buildings operating. FMO deals typically include core functions like maintaining building systems, performing repairs, and handling custodial and landscaping work. They will often also include higher value services like energy demand management and procurement, space planning and support for critical facilities like data centers and lab space. They may also be part of larger outsourcing relationships in which a company outsources responsibility for managing construction projects, lease administration or brokerage transaction management. For companies with sizable real estate portfolios, the annual spend covered by an FMO deal can be in the tens of millions of dollars.
Now let's outline some of the key reasons we think FMO deals seem to have a relatively high success as compared to other types of outsourcing.
Transparency. FMO pricing is usually open-book. The supplier will perform the services using a combination of its own employees and networks of third party providers. The customer will reimburse the supplier for the salary and benefits of each supplier employee and for the actual costs paid by the supplier to the third party providers (with no mark-ups). The customer has visibility at all times into what resources are working on its account and what each of them costs.
Supplier Pricing. FMO pricing structures can vary, but the most common structure is for the supplier to charge a management fee for each square foot of real estate it manages. Management fees typically range from $0.05 to $0.20 per square foot depending on the size of the deal and the type of space to be managed, and include all supplier profit and non-reimbursable overhead. Because supplier employee and third party provider costs are passed through without mark-up, the supplier has no incentive to increase these costs (and equally important, no disincentive to reduce them). The supplier receives the same management fee whether it uses 5 or 10 employees to perform a particular function. This creates a very different dynamic between customer and supplier than the unit price x quantity (PxQ) pricing structures that often discourage ITO suppliers from proposing to automate services, virtualize servers or implement other innovative solutions that may benefit their customers but ultimately reduce the number of "units" they can charge for.
Risk/Gain Sharing. ITO suppliers often talk about risk/gain sharing mechanisms, but they almost never come to fruition, in part because of how ITO deals are structured. With a PxQ pricing structure, it is very difficult to create "gain" that benefits both parties and even more difficult to measure it when the supplier does not share its underlying costs. In contrast, FMO deals often include "savings targets" that focus both customer and supplier on reducing the customer's costs. For example, assume the customer and supplier have agreed to a cumulative savings target of 10% in year 1. If the supplier exceeds its target, it might receive a bonus (e.g., 20% of incremental savings); if the supplier fails to meet its target, it might share in the pain (e.g., reduce its management fee by 20% of the variance between actual costs and the savings target). The contract must include clear guidelines about how "savings" are to be measured, but in general this type of risk/gain sharing structure can align customer and supplier interests, motivate supplier account teams, and allow both parties to "win" when they are able to reduce the customer's costs.
Customer Satisfaction. Like ITO deals, FMO contracts typically include quantitative service levels (or key performance indicators) that are measured on a monthly or quarterly basis and obligations for the supplier to provide a credit against its management fee if it fails to meet them. However, unlike ITO, FMO suppliers will often also put a significant amount of their management fee at risk (typically 25% to 35%) for meeting the expectations of customer leadership. In other words, at the end of the year if the customer is not happy with the supplier's performance, the supplier will receive a significantly lower fee even if it is meeting the quantitative service levels and technically fulfilling its obligations under the contract. If the supplier exceeds customer expectations, it might receive 100% of its fee and a bonus that is to be distributed among the employees working on the customer account.
There are certainly inherent differences in ITO and FMO deals and in many cases good reasons to have different deal structures. Nonetheless, FMO provides some interesting alternatives to consider for customers that are unhappy with their existing ITO relationships and for suppliers that are looking for new ways to build trust and expand relationships with their customers.