In depth: A complete strategy for outsourcing

Feb 13, 2001
Auerbach Analysis

No matter how technologically astute your organization is, there are probably certain tasks that for one reason or another—expense, lack of staff, lack of space—you simply can't handle. For many businesses, the response to such a problem is to outsource the function, be it IT support for your staff or the storage of your data.

But how can you make the case to your CFO that outsourcing will save you money? How can you convince your CEO that there is a business need? What should you look for when selecting a vendor?

Whether you've never outsourced before or you want to improve the relationship with the vendors with whom you outsource, Auerbach Publications' "The essentials for successful IT outsourcing" can give you some guidance.

Featured in the January 2001 issue of Information Management: Strategy, Systems, and Technologies, this article breaks outsourcing into seven steps:

Determining the business cause for outsourcing
Searching for a vendor
Choosing a vendor
Negotiating the agreement between your organization and the vendor
Closing the deal
Managing the agreement
Deciding whether to renew, renegotiate, or terminate the relationship with the vendor

To read more, continue to page two.

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The essentials for successful IT outsourcing
By Ralph L. Kliem and Irwin S. Ludin

Information technology (IT) outsourcing is the use of a third party to provide services rather than using those in-house. It has become a growth industry and will continue to grow. Today, it has become commonplace for firms to outsource at least some aspects of their IT services. Some of the more popular services are:

Application development
Data center
Desktop/personal computers
Network (e.g., LANs, WANs)
Support services/help desk
Training

The above list is by no means exhaustive and can, in fact, include many services that are not IT in nature. However, this article will guide organizations through the pitfalls that often plague IT outsourcing activities, such as:

Cumbersome transition into and coming out of an outsourcing relationship.
Incomplete or vague contracts.
Lack of an infrastructure for supporting an outsourcing relationship.
Negotiating a contract with an unsuitable vendor.
Poor communications with vendors.

Success tip #1: Determine the business case for or against outsourcing
Many firms do not thoroughly analyze the need for IT outsourcing. Instead, they seek outsourcing because it provides immediate gain, only to later realize that it delivered long-term loss. As a result, some firms lock themselves into massive, long-term contracts only to find that such an arrangement is a liability rather than an asset (e.g., delivery of services they no longer need at above market prices).

A good business case, looking at different pricing alternatives (e.g., fixed or cost plus), and varying payback periods (e.g., three, five, or 10 years) can help determine whether outsourcing will achieve savings (e.g., five to 20 percent), desirable levels of quality, and other objectives. Outsourcing should not occur, however, if the service is mission critical, can be done more effectively in-house, cannot provide a savings of five percent or more, or if fear exists over losing controls.

IT outsourcing process

When forming the evaluation team, the organization should be sure to:

Determine the required knowledge and skills (e.g., accounting, technical, or business management).
Designate a project manager.
Determine the objectives of the team.
Define each member's roles and responsibilities.

When conducting the initial review, the organization should be sure to:

Define the objectives and scope of the review.
Conduct an inventory of all assets (e.g., software, hardware, or data).
Determine which services are mission critical, which are important but not critical, and which are nonessential.
Determine existing capabilities for providing current services.
Determine core competencies.
Determine the internal service requirements.
Define the requirements of internal customers.

When conducting the preliminary external review, the organization should be sure to:

Define the objectives and scope of the review.
Develop criteria for selecting which vendors to consider.
Determine the research approach (e.g., interview or literature review).
Determine the core competencies of the firms.

When performing the cost/benefit analysis, the organization should be sure to:

Account for the time value of money.
Determine a payback period.
Determine the type of outsourcing agreement (e.g., cosourcing, outtasking).
Calculate different pricing options (cost plus, fixed price, time and materials).
List assumptions and constraints.
Develop alternatives.
Make a recommendation.

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This article first appeared in the December-January 2001 issue of the Auerbach Information Management Service journal Information Management: Strategy, Systems, and Technologies. It appears here under agreement with Auerbach Publications. For information on subscribing to this journal or to see a list of previously published topics, click here. To find out about other Auerbach publications, click here.

Success tip #2: Search for vendors
It is very important to develop criteria for selecting vendors. The criteria should include overall reputation, market share and growth, responsiveness, expertise, flexibility in the types of outsourcing agreements, price, experience, size, and history.

It is also important to ensure that the evaluation team has accepted the criteria and the selected vendors. This acceptance reduces resistance to the criteria and encourages buy-in from the team for the vendors that are selected.

When collecting information, the organization should be sure to:

Determine the criteria for looking at a group of vendors.
Select the vendors.
Determine the sources of information and their reliability.
Determine exactly which information is needed (e.g., financial or market value).
Follow a consistent approach to avoid "corrupting" information.

When compiling information, the organization should be sure to:

Organize the information in a readable, comprehensible manner (e.g., matrix, three-ring binder).
Not omit any important information.

Success tip #3: Select the vendor
Selecting the vendor should be an objective process. Unfortunately, objectivity becomes sacrificed because "exemptions" are made to the criteria when applied to a specific vendor. Bias is introduced into the process and, not surprisingly, the results are also biased. Worse, it becomes difficult to obtain buy-in from team members and senior management. Whatever the criteria being used, however, the primary criterion is whether the vendor can provide services that will help achieve the goals identified during the determination of the business case. When developing the selection criteria, the organization should be sure to:

Create a specific, meaningful criterion.
Use criteria that minimize bias and retain objectivity.
Receive consensus from the members of the evaluation team.

When evaluating candidates, organizations should be sure to:

Apply the criteria consistently to all vendors.
Follow a methodical, logical process.

When selecting the candidate, organizations should be sure to:

Receive input from members of the evaluation team.
Reevaluate the selection to ensure objectivity and consistency.
Communicate the results to all interested parties, including, for example, senior management and evaluation team members.

Success tip #4: Conduct negotiation
Effective negotiation requires extensive preparation before the event. It requires knowing as much as possible about the vendor, such as its history with other clients; the vendor's market size and growth; its financial condition, its management stability, and its reputation. It also requires that the selecting firm know something about itself, including its strengths and weaknesses, short- and long-term goals, and technological capabilities. Such information about the firm and the vendor enables development of a negotiation strategy that has win-win results.

During negotiation, it is important that all team members support the strategy. In addition, it is important that one person be the primary negotiator. If the vendor senses the opposite, then the negotiation may not have the desired results.

While negotiating, it is also important to recognize trends in IT outsourcing, including:

Keeping the duration for contracts within two to three years.
Reserving the right to review and perhaps even approve subcontractors.
Focusing on a specific, narrow set of services.
Describing circumstances for renegotiation and termination.
Requiring technology transfer.
Describing minimum service levels.
Providing for penalties, damages, and incentives.
Listing reporting requirements.
Providing governance procedures.

When forming the negotiating team, the organization should be sure to:

Determine the required knowledge and skills (e.g., legal, technical, business management).
Designate a project manager.
Determine whom to select from the evaluation team.

When developing a negotiation strategy, the organization should be sure to:

Determine the overall goals to achieve.
Develop an in-depth knowledge and understanding of the vendor's style, goals, and history.
Come prepared with facts and data to support the case.
Conduct a worst/best case scenario analysis.

When negotiating, the organization should be sure to:

Have a primary negotiator.
Seek a win-win solution.
Have the consensus of all members of the negotiation team.

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Success tip #5: Consummate the agreement
The contract is signed when the negotiation is concluded. There should be support by the entire team and senior management before it is signed. This commitment is important to ensure subsequent compliance with the contract and to communicate to internal staff the willpower to make the outsourcing relationship work.

Prior to signing the contract, it is important to ensure that it covers some basic contractual elements. Failure to address the basic elements listed below could contractually obligate the firm in a manner that fails to protect its best interests (e.g., desirable quality of services at a competitive price).

When drafting the agreement, the organization should make sure it has incorporated at least the following basic elements:

Conditions for renegotiation and termination
Governance
Intellectual property rights
Length of the contract
Penalties, damages, and incentives
Pricing
Reporting
Services to provide and their levels
Subcontractor management
Technology transfer

Before signing the agreement, the organization should:

Ensure that all clauses, phrases, and terms are clearly defined.
Ensure that there are no outstanding issues.
Obtain senior management's support.
Obtain consensus of the negotiating team.

Success tip #6: Manage the agreement
Signing the agreement is not the end; it is the start of a new beginning. The relationship with the vendor must be managed to ensure the delivery of the desired quality of services for the money being spent.

For effective management, one person should be assigned responsibility for each contract. This person ensures the existence of ongoing communications, effective controls, and performance monitoring. The skills for managing a contract are less legal and technical and more account management in nature. The person should not only know contract management and have an understanding of the technology, but also possess good communications and relationship-building skills.

In addition to having the right person, it's critical to have an infrastructure in place to manage the agreement. This infrastructure should include change management, scheduling activities, communication and information sharing, performance monitoring, and problem management.

When the organization forms the ongoing management team, it should be sure to:

Determine the required knowledge and skills (e.g., account management, contract management, business management, or scheduling).
Designate a business manager for the contract.
Define each member's roles and responsibilities.

When conducting ongoing management of the contract, the organization should be sure to:

Provide for continual communications with the vendors.
Provide the means for ongoing oversight of the services being provided.
Select software or develop a system for tracking and evaluating service delivery.
Determine the data and metrics for tracking and evaluating service delivery.
Perform a risk assessment to determine which controls should be and are in place.
Set up an infrastructure for evaluating changes that are potentially outside the scope of the contract.
Set up an infrastructure for problem management.

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Success tip #7: Determine the business case to renew, renegotiate, or terminate
Once the IT outsourcing agreement is up for reconsideration, there are three options: renew, renegotiate, or terminate. Renewal accepts the terms of the existing contract. It often occurs if the customer feels the delivery of services is satisfactory or better. Renegotiation often occurs over dissatisfaction with the contents of the contract (e.g., it is too long in duration or it is too costly). Increasingly, many firms are renegotiating because the technology is changing the needs for a service (e.g., movement from a mainframe-centric environment to a client/server one) or the pricing for services is not market driven. Termination occurs because the service is no longer necessary, is unsatisfactory, or costs too much. Terminations occur much less often than renegotiations.

Whether renewing, renegotiating, or terminating, it is important for the organization to conduct as comprehensive a study as when making the initial business case for or against outsourcing. It should use objective criteria and make evaluations using data collected during the course of the initial contract. The data may come from metrics and documentation of past service delivery. If renegotiating or terminating, the organization should make sure the team and senior management support the decision and understand the rights described in the contract to take such action.

When forming a reevaluation team, the organization should be sure to:

Define each member's roles and responsibilities.
Designate a project manager.
Determine the objectives of the team (e.g., renegotiate or terminate the contract).
Determine the required knowledge and skills (e.g., accounting, technical, legal, or business management).

When conducting the internal review, the organization should be sure to:

Define the scope and objectives of the review.
Determine if capabilities exist for moving currently outsourced services in-house.
Determine the requirements of internal customers.
Determine which services are and are not currently being outsourced.
Determine which services are mission critical, which are important but not critical, and which are nonessential.
Document the quality of the past delivery of services.
Evaluate the current delivery of services, using the metrics that were collected.

When conducting the external review, the organization should be sure to:

Define the scope and objectives of the review.
Determine the research approach (e.g., market analysis or benchmarking)
Develop criteria to determine what vendors look at.

When performing the cost/benefit analysis, the organization should be sure to:

Account for the time value of money.
Calculate the different pricing options, such as cost plus, fixed price, or time and materials.
Determine the payback period.
Determine the desired type of outsourcing agreement (e.g., cosourcing or outtasking).
Develop alternatives.
List assumptions and constraints.
Make a recommendation.

The desired results
While IT outsourcing can be beneficial, it can also devastate a company. For that reason alone, management must see to it that all the necessary actions have been taken to ensure that the former occurs. In too many cases, firms are realizing that outsourcing their IT services could have been done better or never should have occurred in the first place. As a result, everyone is frustrated and angry, and there are costs that no one ever thought would accrue. Fortunately, if the above actions are executed, such results need not happen.

Ralph L. Kliem and Irwin S. Ludin are principals of Practical Creative Solutions, Inc., a Redmond, WA, consulting and training firm.

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