Outsourcing-Making the right choice: Page 2

Posted September 1, 1999

David Burkett

(Page 2 of 3)

The step-by-step approach To negotiate a deal focusing on commodity services (quadrant A), you first need to understand existing operational costs and service levels and efficiencies. Then you need to understand how those numbers compare to top performers in comparable environments. A preoutsourcing analysis shows you what you're paying for IT and how those costs compare to other companies. Without this understanding, you can never know whether the outsourcer's proposed prices are reasonable or outrageous.

The logic is simple: If you don't know how well you're running your IT operation or how much you're paying to run it internally, then you can't rationally evaluate the outsourcer's proposal. From a different perspective, if you know how much your IT operation costs, but don't know what other organizations pay, then you can't evaluate your internal IT management, much less make an informed decision about outsourcing.

It's also important to understand future requirements and industry trends when negotiating long-term deals. For example, Compass America Inc., in Reston, Va., recently saw an organization seriously underestimate CPU growth requirements when negotiating an outsourcing deal for its 3,000 MIPS data center. Because of a migration to a distributed client/server environment, this company assumed its mainframe use would decline or, at most, stay flat. Based on this projection, the outsourcer proposed 3% annual unit-cost reductions, and the client budgeted accordingly.

However, instead of shrinking, mainframe workload grew, as users of the new system accessed legacy data and uploaded stored information for batch processing. As a result, the company's data center costs grew by 12% instead of declining by 3%, as planned. This 15% budget variance represented about $5 million. The company was upset with the vendor for the cost overrun, but the fact is that poor forecasting caused the problem.

Anticipated cost reductions must also be put in the proper context. If an outsourcer commits to reducing annual costs by 10% percent, that may sound appealing-until it turns out that others are achieving 20% reductions.

Focus on strategy

If the outsourcing negotiation focuses on a value-added strategic partnership (quadrant C), such as that required for an e-commerce initiative, the client organization's key preoutsourcing task is to define a value proposition for the outsourcer to fulfill. For an on-line clothes retailer, an example of a value- added proposition might be to use IT to focus marketing efforts on existing customers likely to spend an average of $25 more per purchase.

The client must take ownership of "stakeholder analysis." More specifically, the IT organization and the business units must work together to define criteria for business value, focusing on IT alignment with business objectives, effectiveness metrics, and outsourcer capabilities.

To take the retailer example, the business units must define the criteria-such as zip code, demographics, past purchasing frequency, or past purchasing amount-that qualify a customer for targeting. The outsourcer can implement a datamining application that selects the individuals who meet the business unit requirements. Follow-on tracking can measure how efficiently IT reaches the select customers, as well as the effectiveness of the initiative. In other words, were the targeted customers actually willing to spend more?

Value-based measures and links between IT application systems, critical processes, and strategic objectives can track the impact of IT systems' business success. The client organization can then use these links to manage an outsourcer and build a strategic partnership.

To take a different example, consider how IT affects processing a life-insurance application. Workflow software can generate value by speeding forms processing and producing internal cost savings. You can measure the value of a prospect database that targets and profiles potential buyers in terms of reduced internal cost-per-policy sale. You can also measure the value of an artificial-intelligence application that prequalifies applicants in terms of reduced approval time, enhanced customer satisfaction, and-ultimately-increased revenue.

Although both clients and vendors emphasize the importance of strategic IT value, linkage happens all too rarely. Many companies enter an agreement incorrectly assuming that the outsourcer will take the lead in understanding and delivering IT value. When it doesn't happen, the client's unrealistic expectations aren't met and the relationship sours.

In other cases, the contract might briefly state a mutual intent to identify and execute opportunities to enhance IT value, with the details to be worked out later. Those details quickly give way to day-to-day management and operational issues, and the goal of enhancing IT value inevitably gets pushed to the back burner.


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