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Contracting for innovation: how, what, who, when?

Contracting for innovation: how, what, who, when?
  • On April 16, 2014

Innovation has been prized within business for as long as I can remember. However when applying this science, process and culture to the outsourcing environment, it is clearly still in its infancy. There is seemingly a major lack of understanding of how innovation can be realised. That’s not surprising: innovation is complex and a bit like ice cream in that it comes in many different flavours. That said, IT leaders must take a systemic approach and ensure innovation is integrated holistically across all echelons of their business – again, no easy feat. In contrast to the lack of knowledge internally today, there doesn’t seem to be much in terms of external help either: many consultants are relatively clueless when it comes to innovation through outsourcing. As a result, ITOSDA is conducting with several partners a major study into the inhibitors of innovation through outsourcing and will produce an innovation monitor designed to shed light on this increasingly important business objective.

I caught up with one of our partners involved in the research: David Frydlinger, Partner at Lindahl.


Alexander Reay: David, who are Lindahl? And what’s your role?

David Frydlinger: Lindahl is one of the largest law firms in Sweden and one of the market leaders in IT and outsourcing. We assist customer and suppliers in the Nordics with all legal and contractual aspects of the outsourcing cycle, from the strategy phase to transition, transformation and re negotiations.

AR: Innovation in outsourcing is a major challenge for most companies: how is Lindahl responding to assist their clients achieve this outsourcing objective?

DF: We take an active role in finding ways to help our clients to meet this challenge. We are the first law firm in the world to become a Center of Excellence for the Vested™ business and contract model. The model is based on research at the University of Tennessee on highly successful commercial partnerships involving companies such as Procter & Gamble, Microsoft and McDonald’s. Vested is based on a combination of an outcome-based business model and a relational contract and is, in our view, one of the most powerful ways to ensure innovation in any outsourcing deal, based on factors such as deep collaboration, clear goals and objectives; a pricing model that gives the supplier the correct incentives to innovate; and, not least, a governance model to actively manage innovation in the relationship. The innovation activities that we see in outsourcing relationships based on the Vested model are amazing.

But innovation in IT outsourcing has proven to be surprisingly difficult. Therefore, we are now also taking an active role in a research project on the subject in partnership with ITOSDA and a major academic institution. Based on the knowledge acquired through that research, we will be able to assist our clients even more to achieve innovation in outsourcing.

AR: In terms of innovation how many contracts do you see in your work that reflect or even mention innovation?

DF: In fact, it is not as uncommon as you might think. But it is also obvious, based on how those contracts are drafted, that people in general don’t have a clue how to achieve innovation. Not least many lawyers seem to think that as long as you make innovation a contractual obligation, innovation will start to happen. They completely fail to see what a complex process innovation is and which structural components need to be put in place for innovation to happen.

AR: Who is to blame – vendors or end users – if innovation is not realised?

DF: Both, no doubt about that. Many vendors lack innovation processes internally and are rigged for standardised processes based on economies of scale. But some vendors are good at coming up with innovative ideas. Sadly enough, the very same customer who asked for innovation in its contract is often not prepared or ready to implement the innovative ideas.

AR: In terms of investing into innovation, should this cost be absorbed by the buyers or the sellers?

DF: Well, there is no definite answer to that. Many innovations may need investments on both the customer and the supplier side so the question is really who should ultimately carry the supplier’s costs. The supplier may have an incentive to carry those costs if it can use the innovation also in relation to other customers. Otherwise, it seems unlikely that innovation will happen if the supplier is not compensated for the costs. It is also necessary to consider indirect costs in terms of lost volumes due to higher efficiency as a result of the innovation. If those volume losses hit the supplier’s margin too hard, innovation will, again, in general, not happen. What is crucial is that the parties together create a model for innovation and that it is not dictated only by one party.

AR: How do you see the Nordic region being different to other regions in terms of outsourcing maturity and achieving innovation?

DF: I see a mixed picture. The degree of outsourcing is high in many segments, although there still is much that is not outsourced. But if you by maturity mean understanding what kind of relationship and incentive models are needed to achieve innovation in outsourcing, we live in the Middle Ages. Many outsourcing consultants don’t have a clue. And, again, many lawyers still believe that they do a good job by shifting as much risk as possible to the other side of the table where in fact they only show an embarrassing lack of understanding of what risk is and how an inappropriate risk allocation will only hit their own clients as hidden transaction costs and a complete disincentive for any form of innovation. So, in that sense, the Nordic region is quite immature.

AR: How can we use contractual agreements to support innovation through outsourcing?

DF: In many powerful and also scientifically proven ways. Innovation will happen in partnership, so first the outsourcing contract needs to be a relational contract based on fundamental principles such as autonomy, loyalty, equity and integrity. All clauses in the contracts must be aligned to such principles. Furthermore, the governance model for innovation must be agreed upon and documented. And perhaps most importantly, the business model and therefore the suppliers incentives to innovate must be clearly described.

AR: How important do you feel “end user”-driven organisations such as ITOSDA are in the Nordics in terms of best practice, global knowledge sharing and fostering innovation?

DF: Such organisations are very important indeed. Lack of knowledge is a main cause for lack of innovation and lack of both incentives and time within the end-user organisations are in turn a main cause of lack of knowledge. Here, organisations like ITOSDA can fill an urgent need to gather information from many sources and make it easily accessible to the end users.

AR: How has ITOSDA helped you with your marketing and strategic direction?

DF: They have greatly helped us with organising our approach to the end users we need to talk to. Their events have been very successful for us and they continue to offer us ongoing marketing support in this area. Their assistance with our strategy to become thought leaders in innovation and sourcing has been a prized relationship we will treasure for years and years to come. Their dedication to best practices and industry insight has been gratefully welcomed in our organisation and I would recommend working alongside them for any forward-looking organisation within the sourcing industry looking to stay and get ahead.

This article originally appeared in Outsource magazine Issue #35 Spring 2014.

About the Author

Alexander Reay 150Alexander Reay is the President of ITOSDA.

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