Plenty of Strings Attached
- 28 August, 1997 16:38
Managing the outsourcing relationship ain't no picnic and comes with no convenient guidelines, but it is absolutely critical to the venture's success.
It requires dedication, insight, an excellent understanding of psychology, a clear delineation of responsibilities, a full comprehension of potential pitfalls and continued hard work. It's also difficult to get right. Of the 221 CIOs responding to a 1995 Gartner Group survey, 47 per cent who had been in a relationship more than two years dubbed their outsourcing experiences a "mixed bag", while 12 per cent deemed them outright failures. The research suggests management is one factor that can make or break such deals.
Outsourcing veterans say making outsourcing ventures work depends as much on the art of the relationship as it does on the science of the contract. And managing the relationship starts long before any ink hits that contract, with decisions about the nature of the outsourcing relationship and the best ways to achieve desired outsourcing goals.
Along the way, those in the hot seat must answer many questions, among them: How much do I outsource? How do I know I'm getting the right vendor in? How do I know the outsourcer is using the best suppliers and best technology? How do I maintain relationships with suppliers? How do I retain my company's intellectual capital so I'm not locked into that vendor? How close do I let the outsourcer get to my business? How do I protect my competitive edge?"The difference between successful outsourcing and a complete nightmare experience is contract management," Forrester Research group director IT strategy service Stuart Woodring told CIO magazine on a recent visit to Australia. "And I am being very particular here: it's contract management, not contract negotiation. The negotiation at the beginning is only setting the stage. That's only setting up the pieces on the game-board.
"Making sure this thing is a win for the company that is engaging the outsourcer demands constant involvement on all levels around contract management," says Woodring "It requires vigilance because there's no way that I can sit here and predict what my organisation will need five years from now, with very, very few exceptions."On the shoulders of the management of the outsourcing relationship can hang the success or failure of the entire outsourcing venture, and it must be handled by a highly trained individual in the internal IT group. After all, as Meta Group analyst Mo Marburg says: "The outsourcer can be responsible for something, but the internal IT group will always be accountable."It's a lesson the Commonwealth Immigration Department learned the hard way, after telecommunication costs rose to 20 per cent over budget during the 18 months after they were outsourced. The outsourcer had guaranteed volume discounts of 15 per cent and undertook and delivered the management of the department's accounts.
"What happened was that people stopped taking management responsibility and the volume of traffic went up so significantly that the thing was out of control within 18 months. It took us another six months to get it back under control," first assistant secretary Vincent McMahon told a Senate hearing earlier this year, adding the experience highlighted the need for continuing close management scrutiny to carefully monitor traffic levels. "It simply illustrated the dangers of moving into an outsourced arrangement without making sure that there was active management and clear understanding about the responsibilities," he said.
Contrast that with the successful outsourcing experiences of another Government department, Veterans' Affairs (DVA), where good relationship management brought big benefits.
A recent Australian National Audit Office investigation showed the department had not only achieved costs savings of between $10 and $12 million after outsourcing its computer centre to Ferntree in 1992, but that contract management itself had led to other significant benefits. These included improved communications via structured meetings and a more professional attitude from data centre staff, including a greater focus on service delivery.
DVA information manager Colin Stubbings, who joined the department as a self-confessed outsourcing sceptic, says the key to the venture's success was the recognition that the outsourcing relationship must be a partnership. "The reality was that in the 18 months that I had been here having a relationship with them, there was never ever any need to go and have a look at the contract.
We had a firm business relationship about what we paid for and what they delivered," he says.
And proving that outsourcing doesn't necessarily lock an organisation in to any one outsourcing vendor, DVA handed its new $65 million desktop-to-mainframe outsourcing contract to ISSC after the contract with Ferntree expired. After experiencing some difficulties with the transition, this time it has included a transition-out agreement in the contract to allow ISSC staff working on the DVA account to be possible candidates for employment with whoever the next service provider might be.
Sinking the iceberg
How close should you let the outsourcer get to your business? Forrester Research answers the question with a model it calls "Sinking the IT Iceberg".
Consider all the skills and capabilities and demands that are put on an IT organisation as an iceberg, stacked from the lowest level of competitive advantage at the bottom to the highest level of competitive advantage at the top. "The goal around sinking the IT iceberg is to push the low competitive advantage situations below the waterline," Woodring says.
"The issues that are really going to change my business fortunes are the issues above the waterline and those are where I really spend my time and that I focus on," he says. "But if it is just something simple, what I want to do is standardise it, I want to get it organised, and then I want to forget about it." Anything below the waterline can be safely outsourced. Few companies run their own janatorial crews, Woodring points out, and for good reason.
"If I am a bank, I might hire somebody to clean my offices, I'll hire someone to water my plants and I'll hire someone to do a variety of non-critical activities. But when we're talking about the strategic direction of the bank, well I'm probably not just going to willy-nilly outsource that," he says. "For the technology issues where I can identify the service levels I need, then outsourcing makes all the sense in the world, but it's not easy to do it well.
The devil is in the detail with outsourcing."According to Woodring, it's one thing to engage an outsourcer to handle all desktop computing, owning the desktops, handling all the service and maintenance, managing the help desk and upgrading all desktops every three years. It's quite another to outsource application development. "I don't think you can stop the outsourcer getting too close to the strategic side when you outsource development. Outsourcing development is probably about the last thing you should do," he says.
"You should take the issues where there are definable service levels, where you can set clear performance metrics about what is acceptable and what is not.
With running a data centre, I need certain up time, I need certain response time, I can define what those are. With my desktop support I need certain bandwidth to the desktop, I need power on my desktop, I need help desk support that provides a certain level of support and I can define what those things are. How do I do that with applications?"Woodring notes many companies are now trying to figure out how to handle the customer self-service opportunities offered by the Internet, recognising these could provide real competitive advantage. Capitalising on the tantalising promise of the Internet also requires creativity. Anything that inherently requires some level of creativity and that can influence business performance should be the last thing to get outsourced, Woodring says.
"Companies don't outsource the most important things that distinguish them from their competitors," he explains.
Sharing the risk
Protecting your organisation's intellectual capital can be equally critical to your competitive edge. The DVA has ensured it won't lose intellectual capital to the new outsourcer through a contract stipulation protecting any commercial opportunities. And DVA's attitude to post-outsourced purchasing highlights an important point about successful outsourcing relationships.
At some stage early on, most CIOs are going to have to decide how "hands on" they should be about technology purchasing once the outsourcer has stepped in.
Meta Group says there is no inherently right answer.
"What we are trying to do is maximise probabilities that the user gets services that best suit their need," Marburg says. "That being said, I think users that outsource strategic decisions like which hardware platforms and software they are buying will ultimately, over the course of 15 years, end up losing so much control of their technology environment that as a business they are going to suffer -- and I'll explain why.
"There is no such thing as a partnership with an outsourcer unless there is some sort of shared risk in the business outcome of the arrangement, and very few deals today have that shared risk that would make a partnership."Where there is no shared risk, CIOs must recognise that purchasing decisions are an important part of strategic control or else expose their companies to serious risks.
"Outsourcers are predisposed to buying certain products, for example, based on their core competencies but not necessarily based on what would be best for your company," says Marburg. "During the first couple of years, sure, maybe you can leave them to do that. But as you move five or 10 years down the road, if you start losing touch with what is going on, how are you going to understand how to apply technology to the business environment to create some unique competitive advantage?"Woodring agrees. "I don't think any smart organisation is going to feel comfortable just abdicating complete control to someone who is outside their organisation who also has a vested business interest that may not be identical to theirs," he says. "Outsourcing is not about abdicating decision-making."Veterans' Affairs, with a mechanism in the contract requiring ISSC to provide a cost-effective service (including "some streams in the contract that encourage them to do the best deal possible for DVA"), says it is happy to leave purchasing to ISSC precisely because it does share the risk. The contract with ISSC focuses on business outcomes rather than specific technologies, Stubbings says, and merely stipulates a technology platform capable of running the "current version minus one of any software". It also works on a profit sharing basis.
"We sought to encourage ISSC to provide us with efficiencies over the course of the contract which would provide an opportunity for us to share in any savings," says Stubbings. "We got them to factor into their contracting price those technologies that they had included as part of their price, and we also said we would share in any savings over and above those.
"For example, it's not unreasonable to say that voice and data services will be integrated in the fairly new future. What we would expect to happen is that they would put forward a proposal to save us X dollars a year by integrating voice and data, then we would share in the savings 50/50," he says.
Indeed the contract requires ISSC, as a technology partner, to bring forward valid proposals for savings equivalent to a specified percentage of its service fee during the first two years of the contract. Contrast that approach with that of AMP Retail Financial Services, which embraced wholesale outsourcing in 1993 to the point where it had outsourced more than 50 per cent of its IT in terms of spend by May 1996.
The company has now moved into a co-sourcing arrangement after forming a joint venture with Andersen Consulting.
CIO Jack McElwee says until the joint venture, the company always played a proactive role in IT purchasing done on its behalf by outsourcers, and maintained close relationships with IT hardware and software vendors. Not only has this helped his company avoid losing skills and the risk of vendor lock-in, McElwee says it was equally important to the IT vendors.
"The vendors typically want to continue to make the ultimate beneficiary of their products, who is still the outsourcing customer here, aware of their product advances," he says. "Just because there's an outsourcing relationship with a third party shouldn't sever the interaction and inter-relationships between primary vendors in the marketplace and the ultimate customer."Upon close observationMost outsourcing contract managers will spend considerable time monitoring Service Level Agreements to ensure the outsourcing relationship is driving the organisation in the right direction. Meta's Marburg says this can require considerable resources, since monitoring should be done on two levels.
It's not enough to do weekly appraisals of any operational deviation from service levels, nor even to supplement this with efforts to identify ways to motivate staff to consistently improve the services being delivered. Companies must also engage in continual evaluation of the changing technological environment.
Since service levels must constantly evolve to keep up with technology, it is essential that there are people in-house capable of understanding the technology and the ways it is changing. According to our analysts, Australian companies treading the outsourcing path have tended to allocate insufficient resources to managing the outsourcer.
Meta Group recommends companies allocate between 3 and 7 per cent of the contract value to manage the outsourcer. Forrester ups the ante even further, saying companies should expect to allocate somewhere between 5 and 10 per cent of the contract value to managing the contract and should charge their "star players" with managing the contracts. "Now that's a lot of money," Woodring says. "It's easy to hit a contract value of $100 million or even $200 million dollars, so we're saying 5 to 10 per cent of that could run to $10 million.
"Many people say: 'No, you don't understand. We are doing this to cut costs.' My point is that you are being penny wise and pound foolish if you think there's any way to create an outsourcing arrangement that is going to succeed without devoting enough resources to managing the contract," says Woodring.
"Clearly that varies based on how commodotised a service it is. For example some data services and network management isn't as complex as managing a distributed client/server environment. But generally, in large outsourcing deals we've seen clients on the lower end of that scale be very disappointed and run into a lot of problems with the outsourcer," he says.
And ideally, the "star players" set to managing the contract should be very good indeed at human relationships, particularly when the outsourcer is responsible for new and emerging uses of technology. That's because in the latter areas the company can only set parameters rather than define SLAs and those parameters must be continuously monitored and modified.
"Under those circumstances, if we don't have a good working relationship between me and the outsourcer we're dead. It will just never work," Woodring says. "After all, you are engaging in this activity because you need some help and hopefully you're building a successful partnership. So if you look to the contract as defining your relationship, you've doomed yourself to mediocrity at best."DVA says it paid as much attention to human relationship as to technology issues prior to awarding its latest contract, mindful that its happy partnership with Ferntree had been built on compatibility between individuals.
"One of the things we did during the tendering phase was to insist that all the tenderers should put in front of us those staff that we would deal with on a day to day basis," says Stubbings.
"We emphasised the importance of the chemistry, if you like, of how we would interact with people. So we asked all the vendors to make sure that their project manager and their transition manager and all of their senior management team that would in effect be responsible for providing services to DVA, were party to the process." A mechanism in the contract seeks to make sure the successful tenderer does not take its leading lights away from Vets' Affairs work to work on other tenders.
AMP's McElwee says the most important lesson he has learned so far about his company's outsourcing efforts is that, as with the maintenance of any relationship, both parties have to continue to work at it. "And that also implicitly means that you have to work at managing the expectations, and both parties have to do that. I think that really is critical to the success of the whole thing," he says.
Although McElwee can't put a dollar value on the cost of managing AMP's outsourcing relationship, he "totally agrees" with the range of the Meta and Forrester estimates. "You have to put the resources in, put the effort in and both parties have to make it work. A lot of organisations don't and they seem to assume that it'll be okay. That's exactly what I'm talking about," he says.
All the right moves
After being involved in numbers of outsourcing exercises from both sides of the fence, Coopers & Lybrand director Keith Reitsema says too many Australian companies are outsourcing for all the wrong reasons. Reitsema spent five years in Europe before returning to Australia 12 months ago. During that time he was not only involved in the management of outsourced projects but also outsourced activities for numbers of clients. So it's with the authority of experience that he puts the view that the simplistic model most people call outsourcing is almost nonsensical.
Reitsema says any outsourcing model that specifies maintenance of existing service levels (for instance that prescribes penalties if response times drop below a certain level) is bound to create friction as organisations realise the outsourcing vendor is making its profit by basically running the same operation with far fewer staff.
"After all, why give away super profits to an outsourcer? Just because you are incredibly inefficient, that's not enough [of a reason]. You could do a lot of work to fix that up and reduce your costs and increase your efficiency rather than outsource. If the issue is reduced to efficiency, then for the outsourcer it's a simple formula. They come along and say: 'We can do the work for the same price or slightly less,' and then do it for enormously less and make a huge profit." Reitsema calls that bad commercial practice, but says it happens all too frequently as companies sick and tired of internal IT management problems jump on the outsourcing bandwagon without realising they are giving away a plum.
"That is, unfortunately, where outsourcing is at the moment," he says. "It's grown out of the 'I can't be bothered worrying about IT any more' syndrome, where management has dropped the bundle completely and said that information technology is a commodity.
"If you consider IT a commodity you are not using it right -- you're not treating it as an enabler. I think the terminology is rather wrong when people say they are outsourcing IT. They are not doing that at all; all they are doing is outsourcing the computer operations or outsourcing the help desk."At the least, companies should develop a common commercial benchmark platform to help them understand how "realistically competitive" their internal IT organisation is before giving it away, according to Reitsema. They must also decide what to outsource. Reitsema says companies should never outsource IT strategic planning because to do so is to risk losing the impetus of aligning the IT investment with corporate objectives. Nor should they outsource the IT awareness process, particularly at board level.
"In other words, you need to continue to have an activity inside the organisation that is constantly looking at making top executives in the operational areas aware of what is possible with information technology. For example the marketing director can only think about how he can gain competitive advantage using IT if he is aware of what the competition is doing internationally in terms of utilising IT for marketing. He needs to be constantly educated and needs to be driven by someone within the organisation.
The same goes for production and the same goes for finance. You simply can't outsource that," says Reitsema. "What can be very successfully outsourced is the systems maintenance activities, the hardware processing and management and the communications network."But companies must also develop clear objectives before they outsource, whether outsourcing is seen as a way to improve the cost structure of the organisation or a means to build a better career path for IT staff.
"You're finding the huge multinationals are saying: 'Well hey, we want to outsource IT because basically the functional operations of this thing are not core business. We want to have an expert group of people whose objective in life is to develop and maintain excellent information technology. On the other hand, we want to have our cake and eat it too. We want to have our finger in the pie because we want to have a pretty strong say about what these people are doing out there, since after all they are doing something very important for our business'."Such an approach, where the company really understands the potential of IT for the organisation and then decides to outsource it, can lead to an outsourcing partnership with full risk and benefit sharing. Reitsema says the classic partnership is where the company wanting to outsource takes a shareholding in the outsourcer. He cites the Lend Lease/ISSC deal in Australia and the EDS arrangement with General Motors and the Philips arrangement with Origin internationally as classic examples. Such partnerships ensure both parties have a vested interest in the success of the arrangement.
"I think the partnership is all about developing a mutual trust relationship," Reitsema says, "where there's a joint commitment and where there are some definite goals and objectives that you're trying to meet together in order to gain some form of competitive advantage. You're really in business together." The other potential model is the "factory approach", where companies keep all the IT strategic functions in-house but outsource the basic hardware and maintenance functions. Reitsema says unless organisations are conscious of the differences between the two models they will end up being frustrated.
So how can companies set up a partnership with the outsourcer? The first step is to define objectives clearly, recognising that the best partnerships are not based on contracts. "If you have to rely on the contract it's probably a disaster," Reitsema says. "I think that you've really got to work towards a genuine business partnership where mutual trust is essential to the development of the opportunities. That means working together to decide what you are trying to achieve.
"If I'm in the motor car industry, what do I want in my business and how can you people, with all your computer knowledge, help me in terms of going right through the organisation over time? Are you able to make my production more efficient? Okay well let's look at that."This means when targets are set, they must be shared targets, which are the responsibility of both parties to achieve together. If the said car company wanted to increase car production from 1000 to 1500 a day, using a new IT system as an enabler, then both parties would share in the profits and costs.
If the aim were to reduce inventory via IT systems, the two parties would need to find ways to share both the costs and the net benefits of reducing inventory.
"That can go into personnel productivity, various enhanced customer service levels, improved competitive position -- basically all the things the company is trying to achieve in terms of its corporate objectives."According to Reitsema, the entire impulse towards outsourcing by large corporations initially was to overcome the problems of rapid technology advancement, management confusion, legacy systems and staff with obsolete skill sets.
"By having an outsourced partnership you should be able to avoid that scenario completely because you are dealing here with an organisation whose objective is to stay in the mainstream of IT. They are, as one of their very basic objectives, constantly retraining and updating their staff because that's their business. And at the same time they are going to be upgrading the hardware for the same reason," says Reitsema.
In that scenario, outsourcing can at last make real sense and bring the big benefits that have been promised for it all along.