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Outsourcing-Making the right choice |
Issues
to consider before tyou take the outsourcing
plunge. |
Published September 01, 1999
By
David Burkett | |
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.
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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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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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