IT leaders have to change the way they structure and manage outsourcing agreements if they are to benefit from supplier innovation as a third generation of outsourcing accelerates.
Research carried out by Warwick Business School, sponsored by IT services firm Cognizant, reveals that 70% of CIOs believe innovation from service providers contributes to their financial performance. But it also reveals that few CIOs measure the innovation they get from outsourcing contracts.
250 respondents across Benelux, France, Germany, the Nordics, Switzerland and the UK, split equally between CIO and CFO. All companies had revenues of over $500m; 51% over $1bn; 25% over $5bn.
Building in value
According to Warwick Business School associate fellow Ilan Oshri, who is also associate professor at the Rotterdam School of Management, the third generation of outsourcing contracts increasingly create partnerships between suppliers and customers, with a major shift from focusing on cost to value.
He says the first generation of outsourcing contracts were about experimenting and cost-cutting, and the second generation saw maturity being built around processes. "We are in the third generation and the big issue is how to get innovation from suppliers."
He says suppliers have their own ideas and businesses must find ways of tapping into this knowledge.
But there are major hurdles. The report revealed that only 35% of businesses measure the innovation they get from suppliers. "Clients have needs but must be savvier about what they get in return for their demands," says Oshri.
Pushing the boundaries
One company that has benefited from supplier innovation, in this case from offshore supplier Cognizant, is Torus Insurance.
Jeff Smith, group CIO at Torus Insurance, says innovation is simple, but being able to deliver it before ideas are no longer innovative is complicated. He believes a lot of companies fail to achieve supplier innovation because they are afraid to push the boundaries. "By the time they have the idea, get it approved and push it through a life cycle, it is out of date."
Torus needs to get new insurance products to the market quickly. Smith says the company would need a huge application development resource if it were to do this itself. "We use offshore suppliers to make the innovation we come up with a reality. If we maintained the software development resources to deliver as fast as offshore suppliers we would be a software company with 90,000 staff. There is no point us doing what other people can do."
Cognizant recently built a new portal for Torus. It took five months and used 50 to 60 developers at any one time. There were also about six business analysts and a couple of project managers. Smith says Torus would have spent ten times more money if it had done it in-house.
Innovation as a joint venture
Oshri at Warwick Business School says contracts need to be structured differently to enable innovation from suppliers. According to its research, about 78% of businesses use fixed price contracts with SLAs attached. These do not allow for any innovation from suppliers. It found that another 42% use contracts paying for time and materials, which allow some differentiation of services.
But to get real innovation Oshri believes contracts should be joint ventures. The research found that 20% of respondents currently use this type of contract.
Public sector has to catch up
The UK government is currently seeking innovation from IT suppliers as it attempts to cut costs of IT and IT-enabled services. Warwick Business School associate fellow Ilan Oshri says it has some catching up to do if it is to enable supplier innovation. "The public sector is a bit behind the private sector in terms of capabilities to allow them to benefit from innovation."
Smith at Torus understands that to achieve its innovation goals Torus has to work closely with its supplier. "Innovation is two way. If you just rely on the supplier for innovation you will fall at the first hurdle. If you just rely on yourself for innovation you will also fall at the first hurdle."
He says to ensure Torus has a close understanding of its offshore software development partner Cognizant it engages it on large-scale projects and has a division in India with 100 people.
Support for outsourced ideas
Peter Brudenall, partner at UK law firm Lawrence Graham, says businesses have to ensure they have the right approach to managing a project if they want innovation. "People have been too focused on cost savings and have not really wanted innovation. The service providers have also become more sophisticated in the past five to six years so they are better placed to innovate.
Offshore innovation opportunity
Oshri says there is an opportunity to offshore innovation, but a lack of awareness of this means businesses are missing out on it. He says technology is not an issue when it comes to offshore innovation, but businesses need to manage it better. They can start by measuring it.
There is a saying that if you don't ask for something you won't get it. This can be applied to innovation in IT outsourcing contracts. In the past, businesses have outsourced to cut costs, and as a result contracts are drawn up to ensure costs are cut. But businesses need to learn how they can support outsourced innovation. While 70% of the executives surveyed by Warwick Business School recognise that suppliers can innovate, many are failing to allow their suppliers to do so.