Forrester: The impact of cloud on outsourcing contracts

Although still in its early stages, the transition of outsourcing engagements toward cloud-based models has begun

Although still in its early stages, the transition of outsourcing engagements toward cloud-based models has begun. Suppliers admit that as recently as two years ago, virtually all outsourcing service delivery was physically dedicated infrastructure, but since the beginning of 2010, outsourcing delivery has begun to include numerous cloud-based elements, comprising as much as 10% or more of a typical outsourcing contract's scope. This percentage may grow to as much as half or more of a typical outsourcing scope during the next five to seven years, though this will differ markedly by customer and workload. Current spending plans by IT services decision-makers demonstrate this substitution effect (see Figures 1 and 2 below).

The fact that virtually all outsourcing RFPs now include some cloud content means outsourcing engagements are incorporating cloud elements at the margins. New benefits such as time-to-market join cost-related motivations as just some of the specific manifestations of cloud's impact on outsourcing transactions today.

Cloud spending

Figure 1: Cloud spending corresponds with lower spending on traditional IT

Cloud spending

Figure 2: Cloud spending corresponds with lower spending on traditional IT

Outsourcing contract relationships evolving with cloud services

Cloud services and technologies are changing the nature of outsourcing. Taken together, the changes represent a fundamental shift in the dynamics between customer and supplier.

For example, volume and resource commitments are shrinking. In line with the emphasis of cloud-based services on unit volumes and instances, outsourcing contracts are based increasingly on volumes of measurable resources, with different prices pertaining to different volumes. Increasingly inspired by pay-as-you-go pricing models, customers are starting to avoid big commitments to high volumes of consumption.

Also, cloud-based service contracts are shorter than conventional outsourcing term lengths. Outsourcing contracts still vary in length according to the amount of transformational work and other investments that must be amortised over time. But contractual commitments for cloud services such as private cloud or public cloud are quite short, ranging from one to three years for private cloud solutions to minimal if any time commitments at all for public clouds.

Finally, cloud services alter the risk equation between customer and supplier. Inevitably, variable demand models with minimal volume commitments shift more risk to suppliers. Over time, however, suppliers have proven adept at compensating for increased risk in various ways. 

Inclusion of cloud services poses challenges for outsourcing customers

The transition to cloud-oriented services promises significant advantages to customers but also poses new areas of risk. To create market-leading solutions in a rapid manner, major service suppliers are forced to rely on emerging technologies from startup entities. The result? The cloud ecosystem remains highly volatile, with acquisitions occurring frequently — acquisitions that happen with little warning or pattern. Sourcing and supplier management professionals will face a risk of service disruptions or contractual changes due to the acquisition of key service delivery chain partners by a new party, potentially dead-ending existing investments and forcing a quick substitution.

The benefits of the cloud sound great in theory, but they may not always pan out in reality. For example, transforming capital expense to operational expense is typically held out as one of the major benefits of cloud service offerings, but not all customers can accommodate a wholesale shift in their accounting practices overnight. Similarly, while improved flexibility is a tremendous value proposition of cloud services, customers cannot always accommodate high levels of unpredictability in budgeting brought by pay-as-you-go pricing.

Systems management and service integration scenarios remain fragmented. Integration between on-premises IT solutions and cloud capabilities remains immature. For example, emerging cloud orchestration models today focus primarily on integration at the software-as-a-service (SaaS) layer, much less so on integration between private cloud models and infrastructure-as-a-service (IaaS).

Take advantage of outsourcing’s transition to cloud services

Although not without risk, the transition of outsourcing to the cloud offers significant advantages to SVM professionals in crafting next-generation outsourcing agreements. Customers interested in moving to the cloud can do more by considering the following recommendations:

  • Emphasize flexibility in current outsourcing commitments. Existing outsourcing contracts are usually more inhibitor than enabler for cloud-based services. Keep contract lengths on the short side: Now is not the time to lock into long-term traditional outsourcing contracts that create long-term barriers to the cloud without good reason.
  • Keep an eye on key ecosystem partners. The cloud ecosystem remains volatile with frequent, unpredictable acquisitions of key ecosystem players and the potential for shifts in vendor alliances. Maintain visibility into your suppliers' choices, and evaluate their reliance on key infrastructure and software partners with care, including contingency plans should these partners get acquired in what results in an unacceptable combination. 
  • Review your approach to chargeback. Because cloud services make available lots of new data about consumption patterns, they can be highly beneficial in enabling cost recovery systems of high granularity. This is important because cloud services are prone to rapid and unpredictable growth in consumption levels in some cases, so it is worth emphasizing the importance of this increased visibility.
  • Consider the multisourcing aspects of cloud services. As outsourcing and cloud services converge, the result will inevitably be a multiprovider environment. This opens up some interesting possibilities in contracting options. For example, some packaged cloud offerings allow customers to either contract directly with underlying cloud technology providers (e.g., or subcontract for their services through the auspices of their primary outsourcing partner.
  • Trade commitments for concessions. Buying standardized cloud services may be a largely take-it-or-leave-it proposition, but suppliers, particularly outsourcing suppliers, are willing to trade favorable pricing or other concessions for customer commitments. Knowing what your company is willing to commit to in terms of resource unit volumes or reserved capacity will help secure advantages in pricing and other areas.

Bill Martorelli is principal analyst at Forrester Research where he serves sourcing and supplier management professionals, with primary research responsibility for application sourcing strategies

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