Maximizing the value of a co-sourcing relationship: for middle-market companies, getting the answers to a few key questions can go a long way toward ensuring a fruitful relationship.

The thorny combination of an uncertain, if promising, economic recovery and growing regulatory demands is exerting contradictory pressures on companies. On one hand, organizations that pruned staff during the downturn now need to bolster their workforces by hiring external providers for access to deeper expertise at lower costs. On the other hand, new regulations from the major stock exchanges and the broad reach of The Sarbanes-Oxley Act demand that public companies and private entities, many of which are experiencing a regulatory trickledown effect, greatly strengthen their internal controls.

That demand can lessen the appeal of outsourcing, which has risks that tend to be more difficult to identify and mitigate. There is a solution to that dilemma, however: co-sourcing, which provides enterprises with flexible access to optimal expertise at an attractive cost without sapping the strength of internal controls.

As the hype over and use of outsourcing--the relinquishing of business processes or entire functions to external vendors--has grown in recent years, so, too, has the method's potential to fail to deliver on its value promise. This has motivated leading research and consulting firms to scrutinize outsourcing failures to identify common pitfalls.

Gartner Inc., for instance, recently listed mistakes that buyers of outsourcing services typically commit. The chief infractions included a short-term focus, poor communications with internal staff about the outsourcing engagement's objectives, failure to recognize the risk of the outsourcing relationship, and, most tellingly, insufficient resources.

Too many buyers of outsourcing services, Gartner reports, fail to plan for and budget sufficient internal resources to effectively manage the relationship as it progresses. Co-sourcing, because it does not farm out a company's control of key processes or functions, limits the likelihood of that happening. It also boosts an organization's resources and skills to address a pressing need without ceding control of the function to a third party.

Co-sourcing can provide flexible access to expertise, reduce new-hire and travel costs, help train staff, free up higher-level staff to tackle more strategic challenges and reduce external audit hours. Co-sourcing can also help reduce internal fears that often accompany full-blown outsourcing (such as, "They sent our help desk to India--are we next?"), and reduce the likelihood of internal resistance that hampers third-party relationships.

Reaping the benefits of co-sourcing requires selecting the right co-sourcing vendor and establishing an effective relationship. Organizations looking for such a vendor should consider the following questions and best practices as part of their selection process.

How does the vendor identify the scope of the work and address changes that may arise? The vendor should present a methodology with formal checkpoints to assess progress throughout an engagement, and should have monitoring mechanisms in place. No matter how effective that methodology is, "stuff happens" in the lifecycles of both outsourcing and co-sourcing engagements, as the Outsourcing Institute's fifth annual Outsourcing Index notes.

Like a construction project, unexpected changes almost always occur.

Unlike a construction project, however, those changes are rarely tangible and are often difficult to detect before they grow into more troubling problems. "We talk to you when we see we're off track" is not an acceptable way to handle changes in scope.

How does the vendor track the engagement's progress? The vendor should provide periodic updates, as determined by both parties, such as spreadsheets containing key performance indicators related to critical project dates and issues. An initial plan outlining tasks, responsibility assignments and timeframes is essential, as well, and should be developed through early conversations between the vendor and key managers within an organization.

Those efforts help identify needs and outline specific project responsibilities. The discussions should also alleviate concerns frequently sparked by "total outsourcing" engagements and go a long way toward minimizing misperceptions or miscommunications. The message of co-sourcing is a simple one: The provider is on hand to assist the staff, not to replace it.

How does the vendor track its employees' time? Expect a detailed breakdown of activities to take place during each work phase. In a co-sourcing project involving compliance work, for example, the vendor should identify contact people within the organization and determine which systems and processes need to be examined so that time is not wasted once the project starts. Such up-front planning should result in a budget that includes estimates of the number of people and amount of time the different facets of the work require.

What has the vendor learned from previous engagements? Few, if any, co-sourcing vendors consistently bat 1,000. Yet the learning curve associated with resolving difficulties on previous engagements clearly can improve the quality of service provided on subsequent projects. Given the brief history and complex nature of Sarbanes-Oxley, examples of a vendor's recent compliance engagements may be particularly ripe for learning opportunities.

Who are the vendor's references? Most co-sourcing buyers conduct some form of due diligence, but not all buyers question a prospective vendor's former or current clients. When doing so, seek out customers in similar industries. Talk to customers who have enlisted the vendor to conduct similar types of projects. If possible, track down a former or current client who has worked with the same individuals that the vendor is proposing to work with your company.

Will the people assigned to the co-sourcing engagement stay on for the duration? Turnover is a fact of life, but too much turnover during a co-sourcing engagement can slow projects. Find out about the vendor's scheduling process, retention program and success rate. Ask for examples of employees who have progressed upward through the firm's organizational structure.

Also, make sure that the individuals the vendor proposes for the engagement will be available when the project begins. Further, identify the rest of the engagement team in terms of type and length of work experience. As a buyer, you have the right to make sure that the individuals working for you have the proper experience and expertise, and have a clear understanding of your organization. Make sure they've done their homework. If talking to a prospective vendor's clients, find out whether the same individuals remained on an engagement through its completion.

How does the vendor monitor client satisfaction? Be wary of vendors who cannot answer this question. An Internet-based, client-satisfaction survey process can be very helpful here, and some firms monitor client satisfaction over the course of longer co-sourcing relationships through regular assessment meetings between key individuals involved on the buyer's side and a vendor's managers not working on the engagement. That encourages a more candid assessment from the clients about the progress and quality of the engagement.

Does the vendor offer special pricing incentives? Finding out whether a vendor offers price benefits if a cosourcer gives more work to the vendor requires diplomacy, but it can be valuable information. Ask references if they can share some general guidance about the vendor's pricing and whether the vendor is willing to lower prices in return for additional work.

Optimizing the value of any external relationship depends on using the appropriate methodology to manage the partnership. A Gartner report identifying the optimal relationship models to manage vendors reached an interesting conclusion: "Enterprises incorrectly assume that few, if any, internal resources will be required to manage the contract and relationship with an external service provider, and they do not build these resources into their outsourcing plans."

Fundamentally, any relationship a company develops with a third party needs to be managed as a co-sourcing relationship. Understanding the benefits of co-sourcing and employing the right practices to reap those gains will go a long way toward eliminating questions about the value of external sourcing relationships.

Dan Langer, CPA, is Director of Internal Audit in Jefferson Wells International's New York office and can be reached at 212.284.4889. Jefferson Wells delivers high-quality professional services and technological resources in internal controls and finance and tax operations.