Outsourcing is here to stay, but few are doing it well. Those are two key findings of a recent survey conducted by KPMG's research arm, the Nolan Norton Institute (NNI), in 262 organisations across Australia and New Zealand.
Four out of five respondents currently outsource some part of their business operations, and at least half intend to add to the base of functions already outsourced. Nor is outsourcing limited to IT. Unlike surveys of previous years, which focused solely on IT, this year's report covered a range of business functions, with legal being the area organisations are most likely to outsource. Following are information technology, facilities management, accounting and human resources.
According to the NNI study, the increasing popularity of outsourcing and its ability to allow an organisation to focus on core competencies has fuelled the outsourcing market. Much of the impetus, it says, has come from areas in which the availability of skills is limited and the required technical expertise is high. Indeed, the survey found that shortage of skills, rather than cost savings, is now driving outsourcing decisions, particularly in the IT sector.
"Outsourcing is not a passing fad; rather it is a transformation in the way people do business and a means of accessing skills you can't otherwise get. If you're outsourcing just for cost savings, you're doing it for the wrong reasons," says John Rundell, director of KPMG management consulting and practice leader for outsourcing in the Asia-Pacific region.
He adds that the survey's findings support his belief that the outsourcing market has matured and that organisations are now outsourcing for sound business and commercial reasons. According to Rundell, 60 per cent of organisations currently outsource part of their IT function, with still more to come. And while he says there are great potential benefits in outsourcing processes such as accounting and human resources, where the market is about to hit a high growth phase, IT continues to get all the attention because the deals tend to be high profile. "Government and the finance sector have embraced [outsourcing], manufacturing is now following, and it's rolling through other industry sectors," Rundell says.
However, while the outsourcing market may have matured, it seems that organisations are still not getting the mechanics right. The NNI survey found that many outsourcing contracts are taking place with little scrutiny. Customers are giving up significant parts of their in-house operations and support functions to external service providers. However, almost half of the survey's respondents (41 per cent) do not perform any type of audit of their suppliers' delivery and performance. The report estimates there is at least $200 million of uncontrolled activity in this sample group alone. Rundell attributes this to inexperience and lack of professional help.
"Most larger companies have sound control processes in place, but many smaller organisations that are outsourcing business functions are casting aside performance scrutiny in frightening numbers," he admits. "KPMG often gets called in after the breakdown of an outsourcing contract. Sometimes service levels have not been defined and perceptions differ [between the customer and the supplier]."
So what is involved in getting an outsourcing contract right? The answer, according to Ed Killesteyn, CIO, Department of Immigration and Multicultural Affairs (DIMA), is rigorous contract and service-level design up front, tempered with a bit of flexibility. As part of the federal government's IT outsourcing policy, since July 1998 DIMA has outsourced all its IT infrastructure to CSC. In Killesteyn's words: "If it has a chip in it, it's outsourced." DIMA forms part of a "cluster" of federal government agencies that are essentially involved in the same deal with CSC. Killesteyn currently chairs the cluster management committee.
Although DIMA signed the deal with CSC before Killesteyn came on board, he says the contract was detailed in specifying the obligations of both parties and the provision of service that DIMA expects from it. "The more effort you put in up front, the better off you are; and if you do it carefully, with your eyes open, you can end up with a good document," Killesteyn says. "At the end of the day the contract defines the relationship. But for the benefit of both parties you need to be flexible, because there are always some things you would do differently in hindsight and need to refine."
Down the road at the Office of Asset Sales and IT Outsourcing (OASITO), Michael Murphy says the tendering process for government outsourcing contracts is a lot more rigorous than typically found in the private sector. Murphy is a consultant with Shaw Pitman, which advises to the government's outsourcing program through OASITO and has been involved with all of the tenders awarded to date.
In the recent $350 million deal between the federal government's Health Group Agencies (comprising the Department of Health and Aged Care, the Health Insurance Commission and Medibank Private) and IBM Global Services Australia (IBM GSA), he says all of the service levels were defined before going to tender. According to Murphy, the agencies reviewed their current performance, which they then set as a benchmark. While the government expects outsource providers to achieve at least the level of service that is currently being achieved in-house, Murphy says the agencies have the option to lift the level of service in areas where they may think current performance is inadequate.
"Our experience is that companies that don't work out what they want and don't define their service requirements thoroughly before they go to contract with the tenderer often get into trouble," Murphy says. This, in fact, concurs with the NNI survey, in which 52 per cent of respondents state that in hindsight they would better define the contract requirements, service-level requirements and deliverables, and monitor for compliance.
"One of the reasons the [contract] process is lengthy and intricate is that we do all that work up front. By the time we've picked a winner, there's no negotiation left in terms of what the scope or level of service will be, and the prices are buttoned down for that level.
"Each [agency] has approached it slightly differently. But the Department of Health and Aged Care, for example, has reorganised how it delivers and charges for IT services internally. This is in order to put its IT function on more of an arms-length basis with its users, so when the outsource provider steps in, the new set of arrangements won't be totally foreign," Murphy adds.
Over in the private sector, in March 1999 Goodman Fielder outsourced the running of its SAP R/3 system, help desk and disaster recovery throughout Australia and New Zealand to IBM Global Services Australia. According to Goodman Fielder's CIO, Doug Falconer, the contract was cultivated around what service levels the company needed to run its business and what was practical for IBM GSA to provide.
"Obviously, the higher service level you seek, the higher the cost, so it becomes a balancing act," Falconer points out. "For example, New Zealand is three hours ahead of us, which impacts how IBM can provide the service New Zealand needs at 5am Sydney time. We had to look at whether we needed 24-hour support, 365 days a year, to run a plant in New Zealand, or whether we would be happy with just prime-time support."
In September 1997 the Commonwealth Bank of Australia signed the mother of all outsourcing contracts with EDS. The $5 billion, 10-year deal (with two five-year options to extend) saw EDS assume responsibility for all of the bank's IT functions, including ownership; daily operational management and maintenance of all hardware and software; communications; disaster recovery facilities; applications development, and the bank's Y2K conversion project.
Under the agreement, EDS became the bank's preferred supplier of technology-related services, and the arrangement the bank had with other IT&T suppliers came under EDS management. More than 95 per cent of the bank's 1400 IT staff, who were offered positions by EDS, accepted those offers. The bank also took a 35 per cent equity share in EDS Australia.
According to the bank, the key objectives behind the deal were five-fold:
¥ To secure competitive advantage.
¥ To reduce the risk flowing from complex change in technology.
¥ To achieve cost reductions through improved efficiency and effectiveness of IS activities.
¥ To provide new commercial opportunities through an alliance.
¥ To improve career opportunities for the bank's IT staff.
Naturally, in a deal of this magnitude, the evaluation, negotiation and selection process was exhaustive. The bank engaged GartnerGroup to assist, and from an initial list of 12 service providers shortlisted CSC and EDS. According to GartnerGroup, a key issue in the process was to then keep CSC and EDS in the competition to leverage them to negotiate to the level of detail required. Consequently, a detailed terms sheet was developed in consultation with the two vendors, sufficient to serve as a set of contractual conditions. In particular, it included full details of services required in the form of developed service-level agreements.
Maintaining close working relationships between the bank and two vendors was critical, but costly to all parties. The vendors also had to commit resources up front with a 50 per cent chance of losing their substantial expenses. However, this shifted the estimate of risks to the vendors, enabling "unknowns" to be turned into "commercial risks" as spelled out by the GartnerGroup methodology. In effect, it forced the vendors to commit with no loose ends.
Getting the contract right, though, is only half the battle; you then have to manage it and ensure service-level agreements (SLAs) are, in fact, met. And while the contract may be a fundamental document, if you need to refer to it every day, you're in trouble.
In the case of the federal government, Murphy says that ensuring compliance with service-level agreements is a function exercised by the contract management units that have been established within each agency. OASITO does not have a direct management responsibility for contracts but rather performs a general monitoring role after the agencies have gone to contract. However, according to Murphy, the contracts have procedures built into them to resolve disputes. These are informal to begin with and involve identifying the issue and, if need be, bringing it to senior levels within the two organisations. Then, if the issue remains unresolved, it can be referred to a formal dispute resolution process.
"Initially, at least, there would be a review and discussion at the operational level to work out whether we disagree as to what the facts are, or whether we agree on the facts and disagree on what the obligation is," Murphy says. "It's important to understand the cause of the problem before the parties start apportioning blame and become adversarial. Sometimes the problem's outside the supplier's domain and for which [the supplier is] not responsible."
Likewise, Falconer believes in regular meetings and communication at various levels. He himself meets once a month with Bronwyn Guthrie, IBM GSA's general manager, small and medium businesses, to review progress. He says they have struck no significant issues to date.
According to KPMG's Rundell, a big mistake is for organisations to tell the provider to whom they have outsourced the provision of a service how to deliver it. Both he and Dennis McGuire, president of sourcing consultants TPI, have reservations about organisations appointing their former CIOs to the role of IT steward or contract manager post-outsourcing, in that they may be reluctant to let go and become too involved in details.
However, Killesteyn believes in continuity in outsourcing relationships. Those who have been involved in negotiating the contract on both sides, he says, should be involved in managing it in order to build in their corporate knowledge of each other, particularly in the first 12 months. "They also need to be willing to adapt to each other's corporate cultures and ways of operating. Both sides need to understand what motivates the other, and that can take time," Killesteyn says.
Having worked on both sides of the fence, Steve Collins believes suppliers and customers have mutual obligations, if an outsourcing relationship is to work. After holding CIO positions in the West Australian government, Collins is now an account director for CSC, responsible for the company's government outsourcing contracts in Canberra, and interestingly, perhaps, doesn't think outsourcing is for everyone. He stresses the need for dedicated, qualified end-user management, but also says the provider needs to assign an account director for the lifecycle of the contract.
"The transition from bid to contract to delivery is a high-risk area, but continuity makes it much easier," says Collins, who also reiterates Killesteyn's views on culture and motivation. "While you need clearly identified dispute and escalation procedures, you should hope you should never have to use them, as there is no substitute for sitting down in the same room and ironing things out through open communication. There are two parties involved and both need to adopt a collaborative rather than an adversarial approach. Culture is an issue and can be overcome by developing the greatest possible trust between the two. This helps in all business relationships, but in one as volatile as outsourcing is even more important."
Who's Got the Skills?
Organisations may lack the necessary skills or facilities to run a function effectively themselves, but the question is whether they will actually be better off by outsourcing it. A lot of suppliers promise more than they can deliver and often face skills shortages themselves, particularly in IT where demand outstrips supply.
John Rundell, director of KPMG Management Consulting, believes outsourcing makes business sense in most cases, as organisations will still have a better chance of gaining access to the skills they require, because specialist companies are where such skills are congregating. However, he believes it's important for an organisation to pick a provider that is a good cultural match with relevant industry experience and one for which you are an important enough client, which is usually a factor of your size and location.
Goodman Fielder's SAP R/3 implementation was a green-field project as part of a major business initiative, and the system runs out of IBM's Baulkham Hills site. "It was a pretty basic decision to outsource it," Falconer explains. "W don't have a data centre that would be anywhere near capable of doing what we had to do and we didn't want to build one. Why would we when there are experts out there who already have them? We were looking for an organisation that had the skills and experience to provide what we needed."
Although DIMA's outsourcing of its IT infrastructure was federal government policy, Killesteyn says the entire lot needed replacing anyway, not least because it was not Y2K-compliant. This was a task, he says, that the department could not have done on its own, but by taking advantage of having an outsource provider there, Y2K is no longer an issue for DIMA.
Do IT Right
KPMG's outsourcing recommendations
¥ Develop appropriate service-level agreements and project deliverables¥ Get to know each other before you get married¥ Beat your competitors to the skills futures market¥ Match your outsourcing choices to the industry's state of maturity¥ Audit your outsourcing projectsWhat the Future Holds The outsourcing industry has changed much over the past decade. These changes are reflected in the trends that now shape outsourcing's next 10 years.
Business process outsourcing. IDC says BPO currently claims 60 per cent, or nearly $US60 billion, of all outsourcing spending worldwide, and non-IT executives throughout the industry are quickly waking up to the idea of outsourcing noncore functions. The next iteration is electronic BPO, as small to midsize companies that don't have the wherewithal to launch their own e-commerce ventures present a hot new marketplace for IT vendors that do.
Fall of the outsourcing broker? As companies gain outsourcing experience, they're reluctant to hire middlemen to broker their deals. One school of thought says customers don't want to spend as much as $1 million for third-party negotiation. The other counters that outsourcing deals are bigger and more complex than ever and require a specialist's expertise. Most observers agree that the real future for outsourcing middlemen is in relationship management during the life of the deal.
Global growth. According to IDC, outsourcing will top $US151 billion by 2003. This trend signifies both a greater market share to be grabbed by outsourcing vendors as well as an opportunity for remote businesses to boost their IT/business capabilities and become world-class competitors. "With one swipe of a pen, a small company will have access to the same global resources [as a big company]," Frank Casale, president of The Outsourcing Institute, a New York-based consultancy, says. "It will be hard to tell the smaller companies from the larger."
-- Tom Field
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