These days, firms are, more than ever, pressed to demonstrate returns on their investment in outsourcing. While initial returns can always be associated with one-off cost cutting, outsourcing arrangements are complex, often involving inter-related high-value activities. This makes the realisation of long-term benefits from outsourcing ever more challenging. Executives in client firms are no longer satisfied with the same level of service delivery through the outsourcing lifecycle. They seek to achieve business transformation and innovation in their present and future services, beyond satisfying service level agreements (SLAs). The business world is facing a new challenge: creating an outsourcing delivery system of high-value activities that demonstrates value over time and across business functions. However, despite such expectations, many client firms are in the dark when trying to measure and quantify the return on outsourcing investments. Results of research Warwick Business School conducted with Cognizant in 2009 show that less than half of all chief information officers (CIOs) and chief financial officers (CFOs) (43%) have attempted to calculate the financial impact of outsourcing to their bottom line, as well as indicating that the financial benefits are difficult to quantify (51%).
There is no doubt that client firms need to improve their ability to measure the benefits of outsourcing. These benefits go beyond the one-time cost saving. They strongly relate to the firm’s competitive advantage and therefore often represent the key success factors (KSFs) in a particular industry. Our research has led us to identify seven lessons that will help executives to achieve better results from their outsourcing engagements.
Lesson 1: Context of the Outsourcing Activity
A good starting point is to understand why the firm would like to outsource a service and what resources are available to successfully carry out an outsourcing project. We observed a couple of common mistakes in this regard: a bandwagon, in which firms outsource either because the competition does so (also known as ‘me too’ strategy) or to manage a ‘problem’ business area. These are the wrong reasons to outsource a service, and the consequences can be dire.
Instead, firms should follow a systematic approach to analysing the context of the outsourcing activity. There are several criteria that a firm should examine, including the overall goal, how critical the service is to competitive advantage, how dependent the service is on other input from the firm, how work will be codified and monitored (and the precision of the metrics) and how mature the firm is in managing outsourcing arrangements.
Exploring these areas should deliver a clear understanding of the drivers to outsource, internal resources and expectations. Realising the benefits of an embedded service that is difficult to codify could be challenging, as it increases operational risks. Likewise, outsourcing processes that are difficult to monitor (e.g. R&D, supply chain coordination), especially when the firm does not have precise metrics to evaluate quality, is not recommended. In these cases, the firm should examine its maturity level in outsourcing. A high degree of outsourcing maturity and sophistication will allow the firm to devise methods that overcome certain challenges and help to mitigate some operational and structural risks.
Lesson 2: Outsourcing Strategy
The outsourcing strategy will dictate the complexity of the outsourcing arrangement and therefore the ability to realise benefits. Our advice is simple: choose an outsourcing strategy that the firm’s resources and capabilities can cope with. By doing so, you will be able to assess and realise the benefits gained from your outsourcing arrangements.
Surprisingly, many firms experiment with sourcing models that are beyond their organisational capabilities. For example, in recent years, many firms have experimented with multi-vendor sourcing arrangements. We noticed that few firms can actually realise the benefits offered by the multi-vendor model. It takes advanced sourcing capabilities to effectively manage a single vendor in a particular business function, let alone multiple vendors that coordinate several transformation programs across several business functions. Another example is the outsourcing of a range of services within a particular business function (e.g. HR) to a single vendor. While the client might perceive this as a straightforward arrangement in which the benefits should be easily realised as there is only one vendor involved, the client will in fact need to develop sophisticated outsourcing capabilities to allow the benefits from synergies between outsourced services to be achieved. We have learned that most clients fail to realise this promise.
Lesson 3: Identify the Benchmark
Many firms rely on SLAs as the main means through which value from an outsourcing arrangement can be realised. SLAs are critical in any outsourcing arrangement. However, they don’t give the entire picture and in some cases can be misleading. Firms that rely on SLAs to realise the benefits from outsourcing arrangements are essentially monitoring service performance, which can be meeting the service provisions; however, this offers little transformation. Therefore, the challenge for firms is to realise the impact of outsourcing on the business and not on the service performance. For this reason, firms must figure out the benchmark to use when measuring real benefits, usually a KSF in that industry – for example, time to market of a new product or quality. Once a benchmark has been identified, SLAs can be drafted to correspond with the provisions that generate a competitive edge. This ensures that the aim of the client and the vendor is to improve the firm’s competitive advantage through business transformation that is monitored through a set of SLAs.
Lesson 4: Value Over Time
Value is a dynamic concept. The desired value to be delivered from an outsourcing arrangement set by the client and vendor at the beginning of the project is destined to change over time. Few firms are aware of this and even fewer take steps to mitigate this risk. By not sensing the changes in value over the outsourcing project life, disagreements are likely to emerge between the parties, which will eventually erode the project’s benefits. At the same time, the dynamic nature of value does not mean that clients are entitled to redefine their expectations every week.
There should be a joint approach to address this challenge. The first step is to develop sensing mechanisms for changes in value. Sensing mechanisms are best supported through shared learning between the client and the vendor. The more shared learning opportunities are created between the client and vendor teams, the more likely it is that value as a dynamic concept will be monitored. Our research found that value is best sensed when the outsourcing arrangement is based on relational value. Under such circumstances, efforts are put into the development of the supply network relationships by responding to the changing nature of value.
Lesson 5: CIO as Strategist
Many CIOs do not ‘speak the business language’. Most of them are not executive board members. Several have emerged from the IT ranks and often had little exposure to and involvement in shaping the firm’s business strategy. In recent years, some argued that in fact the role of the CIO is now less strategic, mainly because IT can no longer be considered as a source of competitive advantage. However, in the past 15 years, the CIO has led outsourcing projects and transformed the way services are designed and delivered. The boundaries of the firms have been redefined and sources of innovations have been reconsidered. Nowadays CIOs are, if anything, more strategic than ever and their role within firms is destined to grow. However, to cope with such changes, CIOs need to learn. They need to learn the ‘business language’ spoken by the executive board. They need to learn to design and argue a strong business case for an outsourcing arrangement at the strategic, operational and financial level. They need to learn to focus on business improvement processes rather than service improvement processes and on business transformation rather than IT improvements. Their role within the organisation should be more central, with a direct influence on decisions made at board level. A CIO should, therefore, become a central figure and a driving force in implementing the other lessons.
Lesson 6: Build the Retained Organisation
The CIO alone will not be able to transform the firm and deliver value from outsourcing arrangements; however, the CIO should monitor delivery by the retained organisation. Most firms consider the retained organisation as the minimum resource needed to support IT function continuity. The mistake in this approach is the focus on IT function continuity. Instead, the retained organisation should be perceived as the resource that drives a firm’s transformation and innovation. For example, in many outsourcing arrangements, the client transfers staff to the vendor. A common mistake is for firms to keep bright and talented staff in-house, rather than transfer them across to the vendor in those areas that the vendor is expected to take leadership, for example application development. At the same time, the CIO should build new expertise within the IT function to ensure that its focus is on continuity, transformation and innovation.
But the retained organisation includes other capabilities, such as relationship building, which concern the wider communication between business and IT communities. It involves helping users understand the potential of IT for the creation of value, helping users and IT experts collaborate, and ensuring users’ ownership and satisfaction. For most firms, this is a major challenge, simply because of the tremendous difference in culture between ‘techies’ and ‘users’. Role holders with this capability have to facilitate a shared purpose and constructive communication among people engaged in both the business and the IT function. Without this capability, the retained organisation will enable IT function continuity, but will fail to demonstrate the benefits of business transformation.
Lesson 7: Invest in Outsourcing Learning Capabilities
One of the most critical capabilities that outsourcing clients need to develop is learning. And still, clients tend to take a narrow approach to learning by focusing on learnt lessons from a single outsourcing arrangement and often paying little attention to building a learning capability across multiple outsourcing arrangements. Furthermore, clients often apply all their resources to ensure that vendors meet the service provisions while ignoring opportunities to learn from them. Consider the vast experience acquired by a vendor over time in a particular industry.
Also consider the growing specialisation of vendors in a particular industry or technology achieved through the knowledge acquired by centres of excellence (CoEs). Experts from these CoEs have dealt with multiple outsourcing arrangements, reviewed numerous contracts, negotiated benchmark and SLAs metrics and worked together with various clients to achieve success. Furthermore, some leading vendors have perfected their knowledge management systems to ensure that their learning capability supports multiple engagements in an efficient manner (e.g. reuse of concepts). And yet, clients refrain from consulting with these experts. The notion of ‘us’ and ‘them’ still inhibits learning between clients and vendors.
Removing these learning barriers requires vision and courage. If a firm is to become a sophisticated outsourcing player, it has to learn from its vendor, first to avoid mistakes we have seen made again and again by inexperienced clients and, second, to improve the benefits that can be gained from an outsourcing arrangement.
Any firm would like to clearly present the benefits from its outsourcing arrangements. However, many firms will eventually realise that they don’t know what exactly they have gained and at what price. The simple reason for that is: the journey to realising your benefits from outsourcing arrangements cannot allow any shortcuts. Being in a position to realise the real benefits from outsourcing requires a step by step approach, as has been outlined above. By following the lessons, firms can take better control of outsourcing contracts and ensure they are achieving their intended, specified goals.
Reference
‘Realising the Real Benefits of Outsourcing’, Dr. Ilan Oshri and Dr. Julia Kotlarsky, Warwick Business School, in association with Cognizant.