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The truth is, offshore ou tsourcing is not the solution to every business problem or opportunity. Initiating an offshore strategy without carefully defined business objectives can lead to ambiguous or miscalculated management decisions, uncertain performance characteristics, and unrealized business value. In fact, an unfocused or mismanaged offshore outsourcing strategy can lead to higher IT costs, wasted resources, and lost business opportunities.
One measure of how prepared you are is to see how well you can represent your current baseline performance using the same metrics you plan to use to measure your future outsourcing performance. This baseline not only provides a point of reference for future measurement; it also clarifies which metrics are important in achieving specific goals and business objectives. Few companies have been able to hand over the keys to their IT department and walk away successfully. Replace those fabulous claims of saving 40 to 50 percent — even 60 percent — on IT labor costs by humbler projections of 15 to 30 percent, and then only after an initial startup period.
Rather, it means you need to consider this a long-term investment with considerable long-term benefits. As teams mature, corporate culture acclimates to new business processes. Unfortunately, unrealistic expectations of large immediate savings have spoiled many outsourcing engagements. A cautious, realistic set of expectations ensures continued support for your offshore strategy. You need a careful ROI analysis reflecting a conservative approach and timing of the benefits.
An ROI analysis can become a very complex calculation that brings together many variables and attempts to predict how those variables will interact with each other. In its simplest form, an ROI reflects how much a company must invest in total costs including compounded interest , the timing of those investments, and the value and timing of all benefits that come from those investments over a fixed period of time. Just as important as setting realistic expectations is that your expectations reflect all related costs.
These hidden costs add to those of the actual work:. Hidden costs can range from 15 to 60 percent of the outsourcing contract itself — sometimes more. You can minimize these costs with careful management and the right approach, but you must account for them in the total cost of an offshore outsourcing strategy before boasting of the savings to senior management. This approach provides a degree of insulation between the execution teams and the decision to embrace a certain business model.
It encourages projects to take advantage of the benefits and cost-savings of reduced labor rates without burdening early adopters with an inordinate share of the startup costs. A successful offshore strategy is well informed and employs an aggressive risk-mitigation strategy. Rather, you need to prioritize and aggressively manage your risks based on their expected impact.
Governance: a beacon for successful outsourcing - EY Consulting
Keep up-to-date mitigation plans in place, actively monitor risk development, and take proactive measures to ensure that risks do not materialize. If risks do appear, act quickly to implement the mitigation strategy or fallback plan for that particular risk. Keep senior management engaged in risk management, and escalate issues early when you have the best opportunity for corrective action. An aggressive risk-mitigation plan is thorough, well thought-out, and time-consuming to produce and manage, but it is well worth the investment when major risks are effectively managed.
An aggressive risk-mitigation plan begins with a thoughtful strategy to identify risks. Fishbone diagrams work well within a brainstorming session that includes a wide cross-section of stakeholders, from senior management to front-line developers. After the risks are carefully defined, described, and categorized, their potential impact on the offshore strategy should be fully documented. Then, these risks should be carefully rated on a fixed scale in each of the following categories:.
From these rating factors, a calculation will produce the amount of exposure that your offshore strategy has for each risk. This exposure value lets you prioritize the risks and give the most attention to mitigating the greatest risks. The final aspect of a risk-mitigation plan is a clearly defined course of action to prevent the risk from materializing, minimize its impact, and work within this context if it materializes. Some risks, such as geopolitical instability and global economic conditions, are probably beyond your control.
The corollary to counting costs is to objectively measure benefits. Let the numbers speak for themselves. If benefits are short of expectations, you need to know that to take corrective action. Some organizations prefer to level out the highs and lows in an offshore strategy and only communicate the mean results.
Of course, the overall result is what contributes to the bottom line, but failing to recognize the highs and lows is a critical misstep. You need to be able to identify and maximize best practices while you take corrective action to optimize offshore benefits and limit liability for long-term results. You can choose from a variety of outsourcing models, each with its own strengths, weaknesses, and appropriate applications. Offshore vendors may have a model they prefer to use and may tell you that this is the way to go. Models are as numerous, complex, and diverse as the companies and vendors that use them.
An outsourcing model has many variables, such as scope, distribution of responsibility, contractual flexibility, and duration, but the main variables that define a model are the distribution of responsibility between the company and offshore vendor, and the scope of the outsourcing effort. You hire contractors to perform a particular task or role, such as ABAP developer or Basis administrator.
The contractor receives work assignments directly from your company, the same as all other developers on the team, and performs the work remotely. You drive this model and the scope of the work is limited. While many companies still follow the traditional out-sourcing model, several innovators are developing new models. Some firms outsource for strategic, not tactical, reasons, to exploit more fully the business benefits of IT.
They are pursuing entirely new roles for IT outsourcing and pioneering new paths for IT outsourcing relationships. Consider these examples:. Dow Chemical realized it was losing IS staff with critical business skills, so it created a unique outsourcing joint venture to enhance career opportunities and gain access to a broader talent pool. Recognizing the benefits of providing its applications systems developers with an entrepreneurial culture and continually updated skills, Philips Electronics decided to restructure its IS organization and out-source systems delivery to a joint venture with a software and systems integration company.
As a result, it has itself become a major provider of IT outsourcing services to other companies. To make its IS operations more cost effective and leverage its back-office processing expertise in issuing policies and processing claims, CNA Insurance established a new life-insurance business processing service with its out-sourcing partner as a part of a huge long-term data-center outsourcing deal.
In another unusual deal, Swiss Bank Corporation acquired a stake in its vendor, with the intention of offering outsourcing services to other financial services companies. The study examined some of the most critical questions about IT outsourcing: How can IT outsourcing help a company achieve its strategic goals? What kinds of outsourcing relationships should it enter into? How can the incentives of client and vendor firms best be aligned through the sharing of risks and rewards?
What must senior managers do to ensure the success of these arrangements? We discovered in our research that while the academic literature and business press discuss IT outsourcing as if it were always driven by a singular focus on reducing the costs and enhancing the efficiency of IT resources, this is in fact only one of three kinds of strategic intent for IT outsourcing see Figure 1. The third category of intent, commercial exploitation, focuses on leveraging technology-related assets — applications, operations, infrastructure, and know-how — in the marketplace through the development and marketing of new technology-based products and services.
These categories of strategic intent are cumulative, not mutually exclusive: outsourcing agreements focusing on business impact generally encompass a focus on IS improvement as well, and agreements targeted at commercial exploitation usually incorporate elements of the other two. The most important message from our research is that the relationship with the vendor — for example, contract type, decision rights, performance measures, and risk-and-reward allocation schemes — must be aligned with the strategic intent underlying the out-sourcing initiative.
The literature often attributes failure to achieve the promised benefits of IT outsourcing to its intrinsic weaknesses. For example, incorporating performance measures or compensation schemes appropriate to IS improvement in situations where the other kinds of strategic intent prevail may be counterproductive. It is unlikely that contractual metrics that focus a vendor on cost minimization will lead to the development of innovative new systems and applications. Implementing these new systems demands management mechanisms that encourage and reward the vendor for undertaking the risks inherent to innovation.
Where ambitions for outsourcing encompass multiple objectives, the contracts and management mechanisms must be even more sophisticated to address the additional complexity. Moreover, as strategic intent often evolves over time, both formal and informal aspects of outsourcing relationships must change dynamically to stay aligned with the changing intent.
Will better outsourcing management improve my business?
As our business changed, our objectives for outsourcing expanded to delivering bottom-line business benefits from IT in a way that was not done before. The three strategic intents for IT outsourcing provide a framework for assessing outsourcing. In discussing each, we focus on the elements of the outsourcing relationship that organization scientists have identified as critical to the success of contractual relationships: the contract type, the performance measurement and evaluation scheme, the compensation system, and the assignment of decision-making rights to the vendor.
The company procuring IT outsourcing services must understand the economics of the production process for information services: the cost structure for the delivery of information services, and how this structure is affected by the risks to each party. The company must know how the vendor intends to achieve the desired objectives and be sure to provide appropriate incentives such as asset transfer and performance-related payments.
Companies that want better performance from their core IS resources — the hardware, software, networks, people, and processes involved in managing and operating the technology and supporting users —have the strategic intent of IS improvement. Their objectives typically include cost reduction, service quality improvement, and acquisition of new technical skills and management competencies.
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They believe that outside specialists who are better able to keep pace with new technologies and skills, and who use superior processes and management methods, should manage some, if not all, of their IT services. Our research identified four levels of ambition for IS improvement see Figure 2. The first two improve productivity of resources and upgrade technology and skills are well-established aims of IT outsourcing contracts.
The structure of the deals, however, has changed considerably as technology requirements have changed and as companies have learned from experience. While both companies selectively outsourced functions of their IS departments to three different vendors and structured separate contracts with each one that focused on tailored IS cost and productivity improvements, the underlying philosophies and management structures in the two cases were very different.
Kodak pioneered the now-prevalent model of managing outsourcing relationships as strategic alliances. The outsourcing agreements were structured to allow the suppliers to make a fair profit, and to encourage them to invest in improving the assets they took over. Separate long-term cooperative relationships covered management of its data centers, desktops, and networks, and Kodak explicitly chose to act as its own prime contractor. Contracts contained neither formal incentives nor penalty clauses, but the understanding that, if suppliers performed well, Kodak would make more use of their resources thus increasing their revenue and profit was implicit in the relationships.
Stipulations such as annual renegotiation of service levels and the requested volume of services kept the multiyear contracts flexible. The contracts emphasized service delivery, process metrics to maintain consistent performance, and early identification and resolution of problems. BPX had a more unorthodox approach.
The model of selective outsourcing to multiple vendors with one acting as the prime contractor has since been adopted by other companies such as Dupont and J. BPX frequently measures to verify continually that the services it receives match best practice in quality and cost.
Each vendor is expected to subcontract services that can be performed better by others. Contracts are shorter than usual for IT outsourcing — two years for networks and five years for data center and applications. In theory, this approach gives BPX flexibility and makes the company less vulnerable to escalating fees and outdated technology than if it were tied to a single vendor. But there are some downsides. Replacing vendors becomes difficult because a new vendor would have to coordinate its service not just with BPX but with the other providers as well.
Lastly, with a shorter horizon, vendors are less willing to invest to improve IS performance since there may be insufficient time to recoup costs. As the market for IT outsourcing matures and changes in technology continue, companies are more ambitiously pursuing IS improvement. Organizations such as Guinness, Owens Corning, and Canada Post have sought to introduce entirely new capabilities and skills. Guinness, for example, planned to transform its IS management by standardizing processes, core business systems, and technology platforms globally.
Guinness executives recognized that the company did not have the skills and resources necessary to achieve such a transformation; outsourcing was a potential solution. Each business unit negotiated its own agreement with a preferred vendor within a master framework. This approach is different again from those of Kodak and BPX. The primary motivation was the desire to implement consistent standards, technologies, processes, and management systems across the company worldwide. Thus Guinness found it desirable to work with a single vendor with the skills, scope, and leverage to implement global policies.
Although there is some risk in relying on a single vendor for an ambitious change agenda, the preferred supplier approach can be a sound choice in a decentralized company with global operations. Guinness managers believe that the company will benefit from outsourcing not just by achieving economies of scale across the total business, but by remaining current with new technologies and directing key resources to major projects.
Moreover, the benefit of its evolutionary approach to outsourcing is that each implementation can build on the lessons learned from previous ones. These and other case examples from our research demonstrate the wide variety of approaches to out-sourcing for IS improvement. Success comes through exploiting economies of scale and expertise, deploying proven processes for cost reduction and service improvement, and bringing distinctive technical expertise to bear for the client. Thus, achieving the goals hinges on technical and operational processes and skills.
Accordingly, management control mechanisms contract type, performance measures, reward and penalty schemes, and decision structures should focus on IS services see Table 2 , for example, network provision, data-center operations, applications program maintenance, and new systems development. Appropriate performance metrics include network response time, problem-resolution cycle time, cost per user, and function points.
A critical aspect of contracts for IS improvement is the pricing of technology services. Vendor compensation is typically based on a pricing schedule for a set of technology services, either specified in advance for the duration of the contract or negotiated each year. Predetermining a price schedule that will reflect future costs is difficult, given the uncertainty in future technologies and their associated costs and in business conditions.
When specifying a price schedule in advance, it is critical to create a highly competitive vendor selection process to ensure that the proposed prices are competitive. Companies must also incorporate frequent benchmarks to ensure the use of best practices and provide for renegotiation of prices if business and technology conditions change substantially.
7 Tips to Improve Outsourcing Management in Your Company
The nature of the relationship — contractual or partnership-based — should depend on the risks and uncertainty associated with delivering the outsourced services. When requirements are well defined and outcomes are observable, the relationship should have a greater focus on contractual elements. BPX exemplifies this point. On the other hand, when there is more uncertainty about requirements, a partnership approach may be more desirable, although this approach requires contractual specificity where appropriate.
Kodak recognized this necessity in its outsourcing agreement. More recently, Swiss Bank and Guinness forged flexible partnerships with out-sourcing service providers in order to accomplish similar objectives. Will these ambitious outsourcing relationships prove successful? In our view, the requirement for success is to strike the right balance between risk and reward for the vendor and client, and ensure that the client is significantly involved in the improvement initiatives, perhaps even contributing complementary competencies.
We also believe that transferring ownership and responsibility for IT assets — particularly people and technology — from the customer to the out-sourcing vendor is critical to success. Ownership gives the vendor the incentive to continue investing in those assets. Many IS organizations are struggling to develop the right mix of technical and business skills to exploit technology.
We define this strategic intent for IT as business impact. Its primary goal is deploying IT to significantly improve critical aspects of business performance. Realizing this goal requires an understanding of the business and the link between IT and business processes, and the ability to implement new systems and business change simultaneously. This form of outsourcing brings new skills and capabilities that link IT to business results rather than those related purely to technology.
Getting the strategic assessment right can minimize time spent on micromanagement and ad hoc tasks related to outsourcing. To avoid strategic assessment risks, it is crucial to integrate and align companies core objectives and outsourcing objectives. Make sure that there is a match in your culture, expectations and visions.
Incorrect outsourcing assumptions can result in major monetary losses if expectations of the expenses and investments needed are not matching the reality.
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Identifying potential risks and mitigation costs will support the assessment of costs and benefits of the outsourcing decision. It is a good idea to classify the upcoming expenses into one-time and ongoing. Furthermore, reviewing success and failures of your previous outsourcing decisions can help to identify the causes of previous issues.
Misalignment in expectations is the number one reason why outsourcing relationships fail. Following the risk assessment and mitigations steps in the first three stages of the outsourcing life cycle will make the contracting process relatively easy. Invest time in reviewing successes and failures of your previous outsourcing decisions. Rigid contracts leave no space for amendments or changes.
Moreover, contracts with inadequate provisions regarding service levels, transition management processes, SLAs, contingency plans, price protections and termination pose major risks. Clearly defined contracts enable a smooth outsourcing process, provide transparency and encourage collaboration. The contract is the foundation of your relationship. The criteria for risk intelligent contracting lies in the quality of provisions and metrics developed to monitor the outsourcing performance, compliance and global delivery. The rule of thumb is to identify performance criteria and metrics linked to business value, have mechanisms to manage variations in volume and cost, create checklist of legal, regulatory, contract, and insurance requirements and clearly stated implications for non-compliance and lastly to include termination and transition rights in the event either party wishes terminate the contract.
The last stage of the outsourcing life cycle highly depends on the success of the previous stages. However even if all the risks were managed correctly there is still some work to be done in the last stage. Transition plan needs to be formalized to secure knowledge transfer and change management. Poor transition management can result in high turnover rate and breakage of relationships with employees, customers and other stakeholders.