Outsourcing: What every company should know - before picking up that phone

Greater efficiency, cutting edge technology, motivated IT staff, guaranteed quality of service - outsourcing can mean all this. But how do the experts get it right? Ian Benn, outsourcing specialist and author of the definitive 'Strategic Outsourcing: Exploiting the skills of third parties', shares his insight…

Fourteen years from a brand new idea to a multi-billion dollar industry - no wonder there have been a few costly lessons learned along the way. It was 1989 when Kodak Eastman Corporation amazed the business world with its decision to outsource its entire IT operation.

Compare that with today. CSC and EDS have emerged as giants. Comms stalwarts such as BT are getting in on the act. Unisys, Bull and even IBM have become services companies with technology divisions. The big five accounting firms have blurred into the big [choose a number between two and four] consulting practices.

In 2003, the world is slightly older, marginally wiser and many costly lessons have enabled a lot of organisations to capitalise on real benefits from outsourcing. Sadly, many more have come unstuck with disastrous contracts and poor returns. So if you are considering outsourcing for the first time, where to start?

The first to ask question is: 'What are you hoping to achieve?' Outsourcers can bring the following benefits:

Operational efficiency Outsourcers’ core competence is the development of standard repeatable processes for handling day-to-day operation. By identifying similarities between clients they can share lessons and resources and catch inefficiencies early in a cycle.

Investment in infrastructure There may be IT operations who are flush with budget but I’ve yet to meet one. Instead, IT directors and CIOs typically struggle to operate aging infrastructures while trying to deliver new, measurable value to the business.

IT directors often complain that over 80 per cent of their budget is spent on keeping the lights on, while only 20 per cent is free for new development. Core systems running on outdated, high maintenance platforms could be replaced with far more efficient alternatives but it is a tough sell to the board:

“I need divert £2m to replace our core systems instead of funding the CRM project.” “What will it enable us to do that we can’t do today?” “Nothing, it is a straight replacement but it will pay for itself in four years.” “What if it doesn’t work as well as the system it is replacing?” “We keep spending until it does…”

Outsourcers base their business on creating the most efficient infrastructure and operating procedures. Unlike their clients, operating efficiency is their core business so they will expect to replace aging equipment up front. This investment is then amortised over five or 10 years and the cost rolled into the contract.

Employee benefits While being outsourced is one of the most stressful things that can happen in your career, research shows that most people are better off in the long term. If a company is outsourcing an operation then it must consider it a non-core part of its business. Outsourcing companies specialise in these people’s job. HR systems, support functions, career development programmes and more besides are built for them. From a career perspective, working for an outsourcer can be valuable too. What sounds better on a CV: two years as IT operations manager for a chain of abattoirs or two years as a project team leader in EDS?

Quality of service This comes in two parts. Yes an outsourcer can often deliver service quality improvements but the most important thing that it does is benchmark the expectations correctly. For example, if you run an in-house technical support hotline do you have a service level agreement (SLA) with every department? If not, you can only be benchmarked against one thing – perfection.

Sounds good but it is important to recognise what outsourcers can’t bring:

Innovation Outsourcers typically succeed by finding common processes and executing them to consistently high standards. Introducing change is not only outside of their remit but may well be actively discouraged by the SLA and contractual demands you have made on them. There are strategies to counteract this but they usually only mitigate the problem.

Outsourcing to inject new ideas seldom works. Innovation is particularly difficult in public sector engagements. For example, the outsourcer may identify a golden opportunity for the client to improve its operation. The relationship manager proposes the idea but if there is an investment required the client may be legally obliged to put execution out to open tender. Now the original supplier’s idea has been shared with all of his competitors. The vendor would have been better off keeping the idea to himself and saving it for the next time he bids for business.

A certain future As we have seen, outsourcing contracts often involve heavy up-front investment by the vendor. But all this investment comes at a price. The outsourcer must be sure of an effective return on investment (ROI) and will have written a robust contract to ensure its interests are protected. If a relationship starts to sour two years into a 10-year contract someone is in for a prolonged hard time.

It is always theoretically possible to terminate an outsourcing contract but in practice it can be extremely difficult. Once your skills base and operating procedures have moved into another organisation, getting them back can be tough. Laws that protect the interests of the employees and the client are a help but like all laws, they are open to extensive and expensive interpretation – and nobody interprets like an outsourcer’s lawyers interpret.

So we come to the frightening statistic: according to Dunn and Bradstreet (2002), 25 per cent of outsourcing contracts fail within the first 12 months an only 50 per cent make it past five years.

Getting an outsourcing contract right is clearly a complex matter but there are three simple rules that one should always follow:

1: Forget caveat emptor. Most people in business have been taught to negotiate on the basis of buyer beware – if the buyer didn’t check under the bonnet before he drove the car away it’s his own fault. But in an outsourcing relationship, you need to understand the outsourcer’s goals and profit targets.

The more risk you pile into the service level agreement, the higher the cost they will have to charge, so you need to understand how much that is worth to you. The tighter you squeeze the margins, the less flexible they will be when the requirements change. The more liability you pile into the contract, the higher the set-aside they will need to allocate and therefore the more it will cost you.

Outsourcers tend to sell small numbers of high value deals – a typical outsourcer will be delighted to win a dozen new contracts in a year. This lack of spread of risk means every deal has to be profitable if the company is to survive (and you really, really don’t want to deal with your outsourcer going out of business).

If you neglected to mention the time bomb in the operation until the contract is signed, the outsourcer will have to find a way to deal with it without making the contract unsustainable for him. If he can’t charge you directly, the savings will have to come in other ways. Either way, it will end up biting you every bit as hard as the outsourcer.

2: Build your exit strategy on day one. When the contract is signed, everyone is friends and everyone is communicating freely. Now is the time to plan for the worst. Two years from now, most of the original players will have gone and well-understood words will be puzzled over by others.

3: Get some help. Outsourcing consultants can help you to avoid costly mistakes, negotiate for the right things and focus on what’s important. If you have never done it before, a little expert help can go a long way. By contrast, if you are experienced, an outsourcing consultant may actually be an inhibitor, introducing spurious issues to justify their presence and unsettling the relationship between you and your outsourcer.

Organisations that outsource their IT can find themselves with a revitalised, modern set of core systems, a newly motivated staff and a means of measuring and demonstrating real business value to the rest of the business. Openness in negotiation and realism about long-term relationships can ensure that the relationships are in place for a lasting partnership.

Contact Ian Benn or editorial@silicon.com about this article.

Ian Benn is MD of Brass Consulting. The how-to guide Strategic Outsourcing: Exploiting the skills of third parties is available at price £16.99, published by Hodder and Stoughton.