The Two Faces of Outsourcing Problems | Article

Two FacesAlthough the things your mother never told you about outsourcing may be numerous, they generally fall into two main categories: the procurement process and relationship management. Both areas can be riddled with problems, according to Dean Davison, analyst, Meta Group.

“What can go wrong really delves into everything from expectations to actual performance, from vendor promises to actual delivery,” he says. “It gets into everything we’re trying to do.”

The procurement problems can begin with the differing goals of the customer and vendor, according to Davison. The supplier wants to make as much money as possible, and the IT organization wants to pay as little as possible.

“So we have these companies that have different needs, different objectives,” says Davison. “How do we bring those two parties into complete harmony with each other, so that the motivators, the drivers, and the needs of the IT organization cascade down into the needs, drivers, and priorities for the vendor?”

Realistic Expectations

The first step is for the IT organization to understand, before they outsource, what their objectives and expectations are, and if they are realistic. For example, a customer that decides to outsource applications development work with the expectation of achieving cost savings might want to rethink their position.

“If you’re planning to outsource applications development work, you’re probably not going to realize any significant cost savings,” says Davison. “You may get better services, you may get better results, you may have faster turnaround, but you may not end up reducing expenses in the end.”

The Competitive Process

Another potential breeding ground for problems is the customer’s approach to outsourcing.

“At Meta Group, we strongly encourage our clients to do full competitive bids,” says Davison. “I tell my clients that there’s nothing that one vendor can do today that other vendors can’t do just as well…Some of the high end vendors are still trying to position themselves as ‘holistic’ solutions providers. There may be some value to that, but for the most part, it’s just a sales pitch.

The competitive process means that the customer has to go through a ‘solid RFP process.’ Davison says that the contract should include critical terms and conditions, including such things as penalty and reward systems, termination for convenience, and escalation procedures. He also advocates what Meta Group calls an ‘adaptive sourcing strategy.’ Essentially that means having enough adaptability in the contract to cover such major events as divestitures, acquisitions, and/or significant amounts of volatility.

Recognize Sales Strategies

Davison’s strongest warning is aimed at senior management. “One of the biggest failures in outsourcing is when the vendors start building relationships with the board of directors or the senior managers,” he says. “These incestuous types of relationships always get in the way of the procurement of a good contract and a good relationship with a vendor. Rarely does such relationship building at the executive level do anything more than help the vendor close the deal.”

He also cautions against being dazzled by the star power on some of the major vendor teams.

“They have big names that are big players in the world,” says Davison. “So you get one of these people in front of you, and you tend to give these vendors a lot more credence and credibility than you would if they were someone smaller or in a different industry.”

Customers should always check references and “not be wooed or swayed by the name or visibility,” he stresses.

The Business of Management

Once the contract is signed, customers all too frequently think their work is done. That, says Davison, is the underpinning for the problems that fall in the other category: relationship management.

“It is paramount to the success of the outsourcing agreement and to the ongoing success of the IT organization that they put in place a formal management structure and process for this outsourcing relationship,” says Davison.

That management structure can be costly. Davison says that, depending on the size and complexity of the agreement, customers should plan to spend anywhere from 3 to 7 percent of the contract value annually on managing the relationship. Most of the money will be spent on staffing in three areas.

The first is a relationship manager. “The relationships that tend to fail the most are the ones where this relationship responsibility is simply tagged on the head of some existing IT director who already has a 60-hour-a-week job and now has another job on top of it,” says Davison.

He says that another portion of the budget may be spent on financial people who track the financial outlays, service levels, and performance of the vendor. Those people are charged with ensuring that the service credits (rewards and penalties) are properly allocated and that the vendor is compensated as agreed in the contract.

The third major component in relationship management is what Davison calls ‘the architectural work.’ That includes the personnel who know the technical architecture of the IT organization and ensure that the vendor meets the standards to comply with both current and future requirements.

Change: The Name of the Game

Customers should be prepared for the changes that will occur during the term of the contract, according to Davison. Service levels, for example, will evolve over time, and those changes should be accompanied by more sophisticated reporting by the vendor. Service level reporting, says Davison, should go beyond long lists of technical details to include quality of service, on-time, on-budget performance, courtesy and other such metrics to balance out the technical performance statistics.

He reminds customers that the cost of the different services likely will go up over time, just as salary costs go up. The cost of the contract also may increase as the customers give additional work to the vendor. While such increases in cost are to be expected, Davison says that part of the management budget should be spent on a third-party benchmark every one to two years to ensure that the customer is paying the current market price.

The High Cost of Cost Containment

Because purchasing outsourcing is not like buying a software package where everyone gets the same CD, Davison cautions against trying to put too much price pressure on the vendor.

“In fact, that’s an area where we often see IT organizations get themselves into trouble,” he says. “They’ll go off and put together what they require to do business. The procurement people will come in…and start hammering on price. All the vendor does is say okay, we’ll cut this out, and we’ll cut that out.”

Because the procurement people don’t understand the implications of that action, their efficiency in getting the price down often leads to situations where the IT organization is left with less than they need. They end up having to spend the incremental money anyway.

“There’s no magic way to drop the price,” says Davison. “I can’t put pressure on an outsourcing vendor to drop their price 20 percent and expect that I’ll have the same services and quality. It’s a people-based business.”

Lessons from the Outsourcing Primer:

  • Outsourcing problems generally fall into two categories: the procurement process and relationship management.
  • Expectations of outsourcing should be understood and realistic.
  • Vendor relationships with senior management can impede procurement of good contracts.
  • A relationship management structure is essential to success.
  • Too much emphasis on cost containment can result in less than adequate services.

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