Governance Mechanisms for Outsourcing Contracts or Why You Should Let the Air Out of Your Tires

Posted by on May 9, 2012 | Comments Off on Governance Mechanisms for Outsourcing Contracts or Why You Should Let the Air Out of Your Tires

p>Transaction cost economics (TCE) has emerged as a common framework for understanding the choice of governance mode in economic activities. TCE suggests that in response to exchange hazards, firms either craft complex contracts or may choose to vertically integrate when such contracts are too costly to craft and enforce. As exchange hazards rise, so must contractual safeguards, if contracting is chosen as the governance mechanism (Williamson 1985).

I am at once reminded of the story of the truck that was too tall for an underpass and ended up getting stuck.

With the ensuing traffic jam growing by the minute, the city officials called in various experts to determine how to remove the truck from under the underpass and once again allow the traffic to flow freely.

They first consulted an engineer who suggested that they remove the section of the overpass immediately above the truck.  A complex exercise to be certain this, reasoned the engineer, would be the best way to free the trapped vehicle.

The city officials then turned to the head of road maintenance for her opinion.

She suggested that they dig out a trench on both sides of the vehicle and then after propping it up with stabilizers, remove the ground beneath it.  This way she reasoned the truck could either drive out of the mini-ravine or be pulled out.

While the experts were each advocating their recommended solution as being the best a young girl, who was watching the events unfold from her nearby yard, approached the city officials with a simple suggestion; “why not let enough air out of the tires so as to lower the vehicle enough so that it can easily drive out from under the underpass?”

The mere simplicity of the young girl’s suggestion makes this is a powerful story.

It also challenges the premise that traditional governance mechanisms in which rigid and for the most part unnecessarily complex and onerous conditions to ensure vendor performance are effective.

I am not suggesting that such conditions be eschewed but . . . they are far too often blindly incorporated and followed without the corresponding collaborative mechanisms being incorporated into the process.  As a result, contracts provide little more than stagnating reference points for missed SLAs as opposed to living guides that can be adjusted to ensure ongoing compliance.

This results in stakeholders focusing their energies on managing to avoid failure rather than on actually meeting the requirements that the contract is supposedly in place to ensure.  It is tantamount to a golfer trying not to miss the putt rather than making the putt.

The question is why do we do this?

To start, I think that this belt with suspenders mindset originates within the buying organization.  When there is an absence of communication between internal stakeholders, how can one expect that things will be any different when external stakeholders or partners are introduced into the equation?  Because of this disconnect contracts were, and unfortunately still are in too many instances, viewed as a replacement for real communication and collaboration.

Once again, the role of contracts should be to clearly spell out expectations and serve as a management guideline that focuses on success rather than addressing the possible remedies for failure.

What are your thoughts?

Are contracts without effective collaboration between stakeholders an effective means to ensure SLA performance?

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