Outsourcing: What's the pay-off?

It might seem strange that BT should win a contract to provide all Royal Mail's network services only a year or so after...

It might seem strange that BT should win a contract to provide all Royal Mail's network services only a year or so after contracting out its own internal desktop IT support to Computacenter. The Computacenter deal was perhaps not the best advert for BT's services, but it was a striking example of a key argument companies give for outsourcing their IT to a third party.

This argument is laid out by Peter Baxter, IT services manager, at drinks retailer Thresher Group, who says, "Our commitment to outsourcing reflects a determination that everyone should be focused on achieving our core objectives as a retailer rather than tied up with overhead administration.

"The IT department's role is to manage delivery of IT services rather than deliver those services ourselves. We can achieve this by leveraging the expertise and resources of external suppliers who can also provide more flexible service than would be possible internally."

The need for such clarity of vision from the start is underlined by Les Graney, Royal Mail's IT director when it contracted out its IT two years ago and now associate director of Digital Fuel, which helps companies monitor their suppliers.

"Initially Royal Mail did not decide to outsource but rather to explore whether it would be advantageous to do so," he says. "We did not start by saying 'let's outsource', and then shortlist some suppliers. It was only when we looked at everything and got all the numbers together that I was able to recommend to the board that we went ahead. Up to then it was only an option, among others. You really must understand what you are doing and why: this is not just an idea but the basis for the future."

It is also not a way of getting rid of problems or internal failings, experts say.

"If outsourcing is driven by an attempt to fix problems that are not under control, it can be a big mistake," says Allan Frank, a senior fellow at consultancy Hackett.

"Companies box themselves into a corner that forces them to make classic bad choices in outsourcing. They do not focus on standardisation internally, so it becomes very difficult to manage projects. In desperation, they outsource. This strategy is likely to fail."

So clear, positive objectives are needed. Graney says cost savings are always likely to top the list, but related issues include new skills to exploit emerging technologies, a desire to focus on core business, a need for 24-hour support with specific service levels, and the wholesale replacement of old systems with a comprehensive business package from the likes of SAP.

Different objectives demand the consideration of different approaches.

"It all depends on your objectives and your circumstances," Graney says. "At Royal Mail we did not want one company saying it could do everything: we wanted specialists. But we did want to deal with only one company, so we went for a consortium with a prime contractor. We got good specialist companies working together, but Royal Mail only deals directly with one company - CSC.

"Selective outsourcing is another option, depending on your circumstances. If you are just outsourcing datacentre operations, for example, you can focus tightly on the services provided.

"There is a lot to be said for having several small specialist contracts rather than one big one, where you can lose sight of details and things can get swept under the carpet.

"However, you bear the risk of integrating all the separate contracts. If there is a problem between the network and the datacentre, the contractors might blame each other and it is your responsibility to make sure everything works together."

Going offshore to cheaper countries, although raising extra issues, is basically just another option, as far as Graney is concerned. "It's horses for courses," he says. "There are benefits of cost and 24-hour working, but there is extra risk. So, as always, it is a risk-management exercise."

Whatever approach is taken, it is vital to get the sums right. Hidden costs emerged as the biggest complaint among nearly half of the 25 major organisations surveyed by Deloitte Consulting - to the extent that they achieved no cost savings at all. More than half absorbed costs that they thought were their supplier's responsibility.

"Everything looks rosy when you explore the market, because the suppliers are trying to entice you," says Graney. "In addition, when it comes to bidding, they are all very competitive. But when you find a winner and examine the details, issues will come to light: perhaps a pension black hole that has not been costed."

The choice of supplier must depend on far more than cost, say users and suppliers. In particular, users must be happy that they have a true partner with a matching culture.

"Outsourcing is not a one-off purchase: it can be a long-term close partnership," says Martyn Hart, chairman of user and supplier industry body the National Outsourcing Association.

"You obviously look at cost and experience, but one of the most important issues is cultural fit. If the companies do not gel, there is little likelihood that the partnership will last. Similar working ethics, vision and expectations will ensure that the outsourcing relationship runs far more smoothly."

Baxter agrees. "Major players had plenty of pedigree but could n0t provide the reassurance we needed about our JDE application packages. Tier-one quality also comes with tier-one costs.

"Some smaller suppliers had the application experience but a company of our stature needed more confidence in their commercial robustness."

The personal involvement of Astech Consultants managing director Danny Turner swung the deal.

"He was pivotal," Baxter says. "It makes a change when the supplier's managing director is an enthusiast for your applications, is not scared to be candid when providing services, and clearly wants the agreement to work well financially for both parties."

When it comes to negotiating, users can feel they are at the mercy of suppliers and should consider using experienced external advisers.

Graney says, "Every company has a first time - which means the amateur is pitted against the big names of IT, who are professionals and have played the game 100 times. Everyone takes a position at the start and you work towards a compromise - but the suppliers know where they are weak and where they have got to dig in their heels. The user company doing it for the first time might not spot this."

By the same token, the contract and the relationship with the supplier must be managed: this is stressed time and again by users and advisers.

"Our research shows that 80% of all outsource contracts that fail do so because of poor governance," says Ian Leask, managing consultant at Compass Management Consultancy. "Governance here means that both sides have the right processes, methodologies and people in place to manage the deal."

Leask says users should allow 3% to 6% of the annual contract value for management; analyst firm Gartner recommends 5% to 10%. Some users and advisers say a senior technical expert or small team should be kept on to monitor and, if necessary, challenge the supplier's later proposals.

A final piece of advice comes from the National Outsourcing Association. Hart says, "Outsourcing seems to be in vogue at present - but it is not necessarily the panacea for all companies. The outsourcing decision is interlinked with the individual business case and often it is in the interest of the organisation, its staff and shareholders to retain the process in-house."

Steps to outsourcing success

Know your objectives.

Understand each stakeholder's perspective: suppliers, directors, IT staff, end-users.

Communicate with staff as early as possible.

Thoroughly investigate the market .

Understand the various outsourcing options.

Do not select a supplier on price alone: look for a similar culture and potential to build a relationship; look at service quality, company stability, payment mechanisms, direct and indirect costs, handling of people issues.

Negotiate a sound contract: consider using outsourcing advisers.

Consider keeping a small technical internal team.

Manage the contract and the relationship  l Constantly look for ways to use the supplier's expertise.

Be well prepared for the end of the contract. 

Source: Consultant Elizabeth Sparrow, author of Successful IT Outsourcing (Springer), and A Guide to Global Sourcing (British Computer Society).

Outsourcing options

Selective: specific IT functions outsourced, some services stay in-house.

Tactical: typically short-term for specific projects.

Strategic: longer relationship, with both parties working to develop a partnership approach. 

Transitional: supporting major changes such as an infrastructure upgrade. The supplier might manage old systems while in-house staff focus on new technology.

Benefit-based: both parties invest up-front in IT service development and share risks and rewards. 

Joint venture: services are run by a separate organisation with its own management, formed by the customer and the supplier.

Utility: systems are run remotely by a supplier at its own site and paid for according to use.  l Offshore: IT work is moved overseas.

Business process outsourcing: an entire process, both the IT and human components. 

Source: Consultant Elizabeth Sparrow, author of Successful IT Outsourcing (Springer), and A Guide to Global Sourcing (British   Computer Society).

Read more on IT outsourcing