Outsourcing-Making the right choice

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Chart: Outsourcing scenarios

To survive the relentless competition of today’s global economy, companies need to constantly cut costs and improve efficiency. A good way to do this is by outsourcing IT services. However, many organizations select an outsourcing vendor and negotiate a contract without a clear understanding of their business objectives or the quality of their in-house IT services. The result is often an agreement that fails either to address strategic requirements or to maximize operational efficiency.

Before you make any decision on outsourcing, you need to gather all the facts by undertaking a thorough preoutsourcing analysis of business objectives, internal performance, staffing levels, and vendor capabilities. You must foster a dialogue between IT and business units to define specifically how the outsourcer is to deliver value, and you need to undertake detailed measurement and benchmarking of existing costs, service levels, and market and industry trends. Performing these steps gives you the information you need to find the best vendor for the job.

Organizations undertaking a preoutsource analysis are better positioned to negotiate an effective agreement and to establish the foundation for a long-term partnership. In some instances, organizations that evaluate their internal operations discover-to their surprise-that outsourcing isn’t necessarily the best approach to IT management.

Regardless of the outcome of the process, a thorough preoutsourcing evaluation allows organizations to develop a baseline of IT objectives, establish benchmarks, define improvement targets, introduce commercial discipline to internal IT management, and assess staff and skill requirements.

In this article I’ll explain the important factors to keep in mind and the steps to take before you decide to outsource. Remember-a little work beforehand can save you huge amounts of time and money later.

Defining objectives

The first question to ask before outsourcing is a simple one: What does your organization want from this agreement? Does your business require no-frills commodity IT products and services-boxes, wires, and basic maintenance? If so, then you should focus on a relationship that delivers efficiencies at the lowest possible cost. For example, mainframe data centers and data communication networks are becoming increasingly available; so outsourcing negotiations involving these two areas should focus on cost and efficiency, rather than strategic value.

In contrast, the preoutsourcing evaluation for a business requiring a strategic partner to deliver value-added services and competitive advantage must address IT alignment with business objectives, effectiveness metrics, and industry-specific outsourcer capabilities. A good example of this is an e-commerce solution designed to build market share and customer loyalty.

The chart below, illustrates possible outsourcing scenarios. The vertical axis represents scope of services, such as network availability, desktop maintenance, and application development, while the horizontal axis represents cost. Only quadrant A and quadrant C (the lower-left and upper-right corners) represent viable agreements. In quadrant A, the client receives commodity products and services at the lowest possible cost. In quadrant C, the client pays a reasonable premium for value-added services.

Many outsourcing relationships don’t work. In quadrant B, the client gets-or expects-value-added services at commodity cost. In quadrant D, meanwhile, the client pays top dollar for commodity service. Neither scenario is fair or viable over the long term. These problems often result from inadequate-or nonexistent-
preoutsourcing evaluation and analysis.

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.

Senior management support

The support and commitment of senior management is another key element to making a strategic outsourcing partnership successful. According to the 1999 Compass IT census, CEOs who report their senior IT executive plays a prominent role in strategy development are much more likely to view IT as a significant contributor to business value.

Senior executives who consider IT a poor relation or a burdensome cost center are more likely to view outsourcing solely as a cost-cutting tool or to neglect the relationship altogether. Conversely, CEOs who see potential value and competitive advantage in IT are more willing to take ownership of the outsourcing relationship and to dedicate the resources needed to identify opportunities for enhancing IT value.

Staffing for strategy

The challenges of managing outsourcing relationships raise a variety of staffing issues for both vendors and clients. When a company decides to outsource its IT operations, the role of remaining IT staff (the “retained function”) changes dramatically. Rather than “doing IT”-developing applications, maintaining and upgrading systems, and troubleshooting-the retained function’s primary responsibility becomes to manage the outsourcer.

Unfortunately, pure technical expertise doesn’t necessarily translate into business or managerial acumen. Put more bluntly, the guy running your data center may not necessarily have the skills to manage your outsourcer. This lack of management skills and experience often leads to general outsourcing problems and is especially toxic to deals aiming to achieve strategic value.

If retained IT staff are unprepared to tackle the new, challenging management and business-oriented tasks the outsourcing relationship demands, they’ll often revert to their “comfort zone” by performing traditional IT duties. This results in duplicated effort and a poorly managed relationship.

You can solve this problem by making sure IT staff members in retained function have the necessary management and administrative skills. Don’t assume that skilled technical staff members will be good managers. You may have to recruit new employees or train your existing employees to perform these new tasks.

Client organizations, meanwhile, should recognize that an effective retained function brings two distinct perspectives to outsourcing management. First, technology management ensures that links are established between IT and business objectives. In most organizations, applications development commands the in-house business expertise this role requires. Typically, this group understands business issues and can identify and define relevant performance indicators.

Second, the retained function must possess the relationship management skills to implement and execute the strategic initiatives defined by aligning IT to business objectives. This job requires administrative, contractual, and people skills-qualities rarely attributed to the techie types in most IT shops. As mentioned above, the existing IT staff may have to be trained or outside talent may have to be recruited to fulfill the relationship and management requirements of a strategic outsourcing deal.

Strategically outsourcing parts of your company’s IT group can yield significant business benefits. It’s not a silver bullet, nor do the benefits magically and effortlessly appear. For outsourcing to be effective, you must plan carefully, define your goals, and establish objective measures to gauge success.//

David Burkett is president of Compass America Inc., a Reston, VA-based consulting firm specializing in IT and business performance improvement.

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