Identifying the right outsourcing strategy

For far too long, the issue of outsourcing versus insourcing has had the proportions of a religious debate between often fanatical supporters and opponents of both.

For far too long, the issue of outsourcing versus insourcing has had the proportions of a religious debate between often fanatical supporters and opponents of both.

But this highly partisan passion is not helpful. There are no absolute rights and wrongs when it comes to how to source IT.

“Sourcing is not a strategy in itself – it has to be the business strategy that drives the sourcing decision,” says Bob Carlson, former group head of IT and telecommunications at HSBC, with 25 years experience at the bank – a major user of outsourced IT.

"Business strategies can vary hugely – and therefore so will IT sourcing strategies. For example, a key part of HSBC’s business strategy is to acquire other companies, and integrate their customer base, which in turn requires integrated IT systems, whether those systems are sourced in-house or out, onshore or offshore,” says Carlson. “Contrast this with GE, whose business strategy is buying and selling businesses which they therefore do not want to integrate.”

Any sourcing strategy has therefore to take into account two such divergent views on integration. Business strategy can also change totally, and sometimes very swiftly indeed, as radically new competitors arrive in a market to transform it. 

“Kodak used to be in the photographic film business,” says Carlson. “They got overtaken by Nokia  – a telephone company they assumed had nothing to do with them but which were now selling mobile phones that could take digital photos.”

IT sourcing strategy must, therefore, map to business strategy and be flexible enough to allow the business to make radical changes to adapt to changing market contours. One key advantage of outsourcing, for example, points out Carlson, is to support a business strategy of rapid expansion without time-consuming scaling up of internal IT and the up front costs that requires.

“Outsourcing can give you the opportunity to play on a global scale,” he says.

However, even when the business strategy does make outsourcing a compelling sourcing strategy, such as when accelerating globalisation, it is essential, says Carlson, to appreciate the risks as well as the opportunities.

“Outsourcing is not a panacea. The worst option is to do with great efficiency what should not be done at all,” he says.

Some things should not be outsourced. “Do not outsource your own core competences,” warns Carlson. Moreover, “Never outsource a problem – often, the quickest way to get a big problem is to outsource a small one.”

Sort problems out first, internally. "Since IT automates processes, always look at the processes first,” says Carlson. “Look at the end-to-end flows of information and follow the transactions all the way along, find where value is added – often half of  all the stages in a process can be totally unnecessary.

Process re-engineering can cut stages, time and cost, says Carlson, “Ford, for example, used to have a huge building in Michigan that just did accounts payable and receivable and purchase orders all day. Then someone realised that since Ford built cars, and cars were easy to count, if a thousand cars were shipped then the company simply needed to pay for four thousand tyres, without tracking every purchase order. It saved them a fortune, counting cars instead of tyres.”

Any process re-engineering required should be done in house, says Carlson.

“Compared with programming, which is a piece of cake, process change is hard to outsource, “ he says.

Where processes and systems impact corporate governance, says Carlson, even greater caution must be exercised.

“Sarbanes Oxley makes it illegal to outsource risk,” he says. That means that for any such outsourced systems and processes, he says, “Sufficient in-house competence is needed to recognise that the outsourcer is competent to meet your corporate risk requirements.”

Assessing outsourcer competence is essential when it comes to issues of corporate risk, but it is also essential from a commercial consideration as well.

“Outsourcing fails where there is poor governance and the wrong expectations of it,” says Carlson.

One very popular expectation is that outsourcing will cut IT costs.

“The outsourcer has to make a profit, and to pay tax – and what if the law changes and outsourcing becomes liable to value added tax, which can of course be applied retroactively?  So the outsourcer has to be highly efficient at running your IT if they are to pay their costs and cut yours as well,” he says.

Moreover, even if the outsourcer does reduce their clients’ IT and process costs it may not be the user that benefits. Carlson says, “IT costs savings always devolve to the customers.”

This is because if any company in a market sector can cut its costs, then so can all the others. Those savings are then passed on to all the company’s customers in order to win their custom. The commercial advantage of any savings in IT costs that an outsourcer can bring, therefore, are only ever temporary.

Users all too often have expectations that they will remain the valued customer they were at the contract bidding stage. The outsourcer has to grow his business, and get new customers – so will he lose interest in your work?

Another potential dangerous expectation is that outsourcers will see the world the same way as their users. That may not be so, especially if there is a difference in nationality and culture..

“Offshore outsourcing is very different from onshore,” says Carlson. “The issue of cultural fit is critical – you must have shared business values, not just between the outsourcer and the user, but with the user’s own customers. Moreover, never underestimate the amount of coordination that will be required – everything always takes longer with distance. The more distant the offshorer, the more management effort it will take.”

Whether the outsourcer is on or offshore, emphasises Carlson, managing the relationship with him is not only vital, but inevitably it is another cost to consider.

“Relationship management  is critical and must be well defined,” he says. “Flexibility and goodwill are far, far more important than service level agreements and price, which are not important issues in comparison because everything about the contract will inevitably change over time, often rapidly, making renegotiation necessary.”

But, critical though relationship management is to ensure outsourcing is successful, it is not the first thing that should be addressed when outsourcing.

Carlson is blunt about the first priority any outsourcing contract must engage with. “The first clause of the contract you write is the exit clause,” he says. "It’s imperative to agree how the contract will terminate while the supplier is still selling and negotiating with you. If you can’t get the exit conditions at that point, you're doomed.”

A key aspect of any exit clause, irrespective of the financial implications, is what happens to your IT.

“It’s critical you have a way to recover your intellectual property, your data and your systems. Remember too, that if your supplier is in trouble, you are in trouble. Law courts simply pick over the bones of both. The judge won’t have a clue about IT, neither will the jury. You might as well roll the dice in Las Vegas as go to court for a resolution,” says Carlson.

Nor is it an option to avoid thinking about the end of the contract. “All contracts terminate at some point,” says Carlson.

This reminder should be borne in mind especially if those who sign the contract at the user end do not intend to be there when it concludes, leaving a  messy termination for others to sort out. 

The second clause to set out, says Carlson, is the one dealing with the governance, principles and relationship management.

“The relationship should be equal,” he says. “It will be a case of ‘we have a problem’. There has to be a clear escalation process to take the heat out of any problem, early on, and to find solutions.”

Nor is there any point assuming that won’t be necessary. “You have to go into outsourcing with the idea that there will be problems, or you will get meltdown,” says Carlson.

The other assumption you must accept as a de facto part of outsourcing is that the contract cannot be static.  “You must include change management clauses because everything will change during the outsourcing term,” he says.

Not only will IT requirements inevitably change to track business changes, but also there will be personnel turnover on both sides.

“The people will change,” he says. “In a year, the guys who set up the contract won’t have anything to do with it any more. You’ll hit problems that are not covered by the contract and those who devised it will have moved on.”

It is imperative, therefore, to have mechanisms and management structures in place that will last for the duration, and that these processes are adequately staffed and resourced.

Only, says Carlson, when the issues of termination and relationship and contract management have been dealt with, should issues about what the outsourcer will actually do, and to what standard, be discussed.

“The last thing to talk about is the work, the price and the service levels,” he says. “Those are the easy parts.”

Essentially, because outsourcing is such a key decision, running part of the organisation that is critical to daily operations and future survivability of the business by enabling business change, the key to successful outsourcing, says Carlson, is the relationship.

“If you’re building a relationship, keep the purchasing people away,” he says. “They add value by checking that the contract covers everything, and that is very good in a purchasing relationship, but not in a partnership relationship.

"Far better to bring in your own company’s marketing people because not only will they get on with the outsourcer’s marketing people that you are dealing with during contract set up, but also, most importantly, they will have the skills to recognise the outsourcer’s own marketing ploys that you  may not.”  

“Be in no doubt,” says Carlson, “that the decision to outsource is a major one, carrying significant risks as well as potential benefits, and should never be undertaken without  due cognisance.”

“When you outsource IT it's still your business. It’s not a transaction, it's a commitment,” he says.

But it's a commitment that must be reciprocated.  “Outsourcing is a joint venture whether you like it or not – you both have skin in the game.”

Outsourcing checklist

• Business strategy is the key driver in the outsourcing decision

• Don’t outsource a problem –  re-engineer your processes before outsourcing them and the IT that runs them

• Don’t seek to outsource risk – corporate governance regulations disallow it

• Don’t allow outsourcing to dangerously deskill your company in vital competencies

• Outsourcing risk increases with the distance of the outsourcer

• Costs must factor in the outsourcer’s marketing costs and profit margins

• Any cost savings will eventually be passed on to customers thanks to competition

• Business and requirements will change, so build in flexibility and renegotiability

• Detailing work, service levels and price are less important than setting out  partnership, relationship and problem resolution terms

• The contract and the relationship must be designed to be independent of those that initiate them, because people will move on

• Engage your own marketing people in contract negotiation – they will be able to spot the supplier’s ploys

• All contracts will terminate – write your exit clause before you agree any other clause, when you still have power to negotiate strongly

• All outsourcing is a joint venture – insist on both sides having skin in the game.

Comment on this article: computer.weekly@rbi.co.uk

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