The Fallacy About Cost Plus Outsourcing Contracts

There is a large national law firm outsourcing RFP project that is in progress now where the RFP project management vendor is prescribing a Cost Plus Model for the contracted services. Generally, labor costs make up 75-80% of an outsourcing services contract, so this is primarily in an attempt to “reign in” labor costs. The theory behind a cost-plus labor contract model (or any cost plus model) is that you know what the supplier’s true costs are and you can control their overhead and profit on top of those costs.  The problem is, that’s rarely the case.

Outsourced labor costs as provided by outsourcing provider are laden with a bevy of miscellaneous costs all that fall under the umbrella of “fringe benefits”  which include anything from leave/vacation costs to guaranteed replacement costs (to replace out/sick staff), investment plans, training plans, education reimbursement, facilities costs, etc., some of which get plugged into a nebulous “overhead” cost, which may also include sales commissions.

But how does one know how many of these “benefits” apply to the rank and file staff members actually assigned to the client? And the salary figures, which are often “plugged” numbers (because the actual salaries of the employees are unknown until they are actually hired) are also not carved in stone. Are they revised when the actual names/faces are hired at whatever those wages are?

In short “cost-plus” model contracts rarely accurately depict the vendor’s actual cost due to the tendency to “bury” all kinds of costs in the figures, therefore is not an effective tool in reducing or controlling/managing those costs in an RFP process. But what’s worse is, the cost plus model may identify the initial costs but what happens over time if the supplier doesn’t turn over the staff at the client site? The Cost Plus model, merely allows the vendor to give raises/increases to staff with impunity because the client will simply pay the increase. Moreover, the client also pays the increases in medical or other costs. And all of this would have to be perpetually verified by the vendor/client (where’s the consultant now?) in an on-going basis unless you continually pay a vendor to do it for you, every quarter or so.

In contrast, the traditional “bill rate” model, where the vendor combines all their costs into a proposed bill rate, hourly, weekly, monthly, for each employee position/rank, which can be bench-marked against similar vendors in similar markets is the model that has gotten far more traction in recent years. This is for a good reason–the bill rates are locked in for a 3-year term with only a margin, indexed increase (typically the CPI, generally 2-3%/year).

So indexed increases minimize the up charges to the contract and actually puts the onus on the vendor to contain costs at the client site, by promoting prominent staff to other sites and even by turning over staff, to stay within their costs and margins.   There is simply no better alternative to benchmarking costs through a competitive bidding process.  In conclusion, in RAS Consulting’s view, cost plus is not an effective tool for limiting cost increases when those costs are highly variable.

 

Please also visit our website at www.ras-consulting.com   To sign up for our blog, please click here.

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