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BPO Journal

Thursday, November 30, 2006

Do contracts matter?

Ousourcing contracts are largely viewed as control mechanisms that allocate (outsourced) process risk between the client and vendor. This allocation of risks and rights establishes cooperative intent between the firms and precludes each firm acting in its own self-interest. So, (hypothetically), if the client firm was to trust the vendor implictly (reiterate, hypothetically), does it imply that the relationship would still need a contract?

My analyses over the last few days scream an emphatic yes. This is because contracts don't address issues of incentive conflict alone in the outsourcing relationship; they also address issues of cognitive conflict. Cognitive conflict refers to the fact that although the client and the vendor might share cooperative intent, they might not have a shared understanding of process workings or the responses required to enact such intent and adapt effectively to process contingencies. Cognitve conflict in the outsourcing relationship is largely addressed by sharing of information, not risks, rights and rewards.

And how does the contract help in this regard? Well, the contractual specification of task and reward interdependence influences patterns of interactions and therefore, strength of ties between the firms. For example, outsourcing initiatives where the user firm and the service provider jointly own the outsourced process often formally specify modes of integration such as steering committees, executive dashboards and cross-functional teams that meet regularly to resolve process issues and discuss project updates and progress, thereby, creating norms for collaboration that are conducive to joint action and information sharing and dissemination, all of which help mitigate cognitive conflict. So, as some researchers are pointing out, the codification of knowledge and information sharing routines in the contract helps build relational capital and collaboration capabilities. A knowledge repository, if you will, for effective coordination between the firms.

Funny, we've made it all about trust so far. The lower the trust levels between the firms, the more complex will be the contract. Not any more.

But again, here's how my discussion of this post with an outsourced process owner went earlier this week:
Me: "Assume you trust your provider completely..."
He: "Deepa, there's no such thing as trust in business..."

My research's moot.

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