Outsourcing – Proceed with caution

Companies continue to outsource at an ever-increasing rate, and the press increasingly reports disappointment and disillusionment with the results. The theory remains sound: get the right specialists to provide the supporting functions, and allow the company to focus upon its own core business skills. But whereas outsourcing started with tasks such as office cleaning and receptionist services, it is now entering the more adventurous, and potentially dangerous, terrain of IT.

Receptionist services may be no less important than IT, but they are certainly easier to define, and much easier to transfer to other suppliers or take back in-house if things go wrong. In contrast, IT outsourcing may involve the sale or transfer of an expensive mainframe, the loss of highly skilled staff, and the time consuming transfer of documents, procedures, and expertise. While the value of basic services, such as cleaning, should not be underrated, they do not carry the same risk or long-term commitment as the outsourcing of IT.

The challenges seem so daunting that many do not embark on IT outsourcing and hence lose out on the very great potential advantages. This article describes an approach and framework which makes the task less daunting, more manageable, and results in a more flexible and successful agreement.

Planning for the future

One consequence of the high investment in transferring the service is that IT outsourcing contracts tend to be for at least five years. Anticipating events that are likely to affect the customer’s business over this period is difficult, if not impossible. There is a risk that the contract would never be let because of the continuing desire to cover some new angle.

The key is to set a timetable for the procurement and to set the deadline by which the outsourcing contract is to be awarded. This will inevitably constrain the amount of resource that can be applied to the procurement and hence not all topics will be covered to the same level of detail.

This means that criteria must be established at the beginning to identify the key areas which must be given priority and those areas where flexibility is essential.

By defining a framework for the procurement, it is possible to manage the process and to determine whether the original objectives are being satisfied.

Principles of contracts

As a starting point it is valuable to consider what the two parties want from a contract. The traditional view is that suppliers are always seeking “to make a fast buck” and that negotiation is all about squeezing the price.

This is a pointless exercise as it ignores the fact that the supplier is in business to make money. Squeezing his margin will only undermine the quality of work which he does for the customer and he will take every opportunity to recover the lost margin. This leads to confrontation between the two parties, and rarely leads to a successful long-term relationship.

The traditional approach may work for a one-off transaction, such as buying a car, but a contract with a life of more than a few months needs to be sustainable and this means that there must be something in it for both parties. Sales training often stresses the importance of a “win/ win” outcome but it is easy to ignore the fact that the supplier and customer have conflicting requirements – if only at the basic level that the customer is seeking the lowest price whereas the supplier is seeking the highest.

This means that some care must be devoted to structuring the agreement in a way which is beneficial to both parties.

By selecting different financial measures, it is possible to create a win/win outcome. For example, the supplier is really interested in maximising his margin, while the customer is interested in reducing the price. If both parties focus on reducing the underlying cost of the service, then the customer’s needs will be met and the supplier can be paid a higher margin which is funded by the cost savings. By selecting the appropriate measures, the two parties can work together rather than in opposition.

Contract negotiation

Contract negotiation is not a one-day meeting designed to squeeze the last few concessions from the other party. This is not a recipe for success.

For a sustainable contract, a longer, but more structured, approach is required.

The customer should identify the issues which are important to him.

However, it is unrealistic to expect that all these issues can be considered at the outset – there is not sufficient time to do so. Consequently, a phased approach should be established where there is the opportunity for a “go/no go” decision at the end of each phase. This means that there is a good measure of progress and the opportunity to stop the process if the original objectives are not being met.

The go/no go review points are:

– Intent to outsource;

– Procurement strategy defined;

– Service strategy defined;

– Contract agreed.

They are shown on the diagram below with an indication of a possible timescale.

At each milestone the key issues are reviewed and the decision taken whether to proceed to the next phase. There are three possible outcomes:

– Stop the procurement process and keep the current service;

– Proceed to the next phase of the procurement;

– Do more work in the current phase and delay the date of contract award.

Whatever the outcome, there must be agreement from all the parts of the business affected – the whole team needs to be committed to the approach.

The objectives of each milestone are described below, but the win/win strategy must be a common thread throughout.

Intent to outsource

There needs to be a clear understanding within the business of why outsourcing is being considered and what constitutes a successful outcome. The objective may be economy of scale, or accessing specialist expertise, or focusing on the core business, but it must always be clearly stated and incorporated in an outline business plan which defines the driving parameters, boundaries, and goals.

It is important to identify the key factors influencing the business.

For example, if there is a possibility that the business might be merged with or taken over by another company, then flexibility will be needed to cover this possibility.

Procurement strategy

It is essential to consider not only who the potential service providers might be, but also precisely what service they will be asked to provide.

The start point will be the capture of the current service and how the service could be improved whether through outsourcing or in its current form. This provides a baseline against which the scope of the outsourced service can be defined – it could be greater or less than the current scope.

This stage also covers an assessment of the style and structure of the contract and reward mechanisms to be used, with emphasis upon co-operative working and the appropriate win/win factors. The service provider will doubtless have his own preferred style of contract, but by including a draft contract in the invitation to tender, the customer is clearly stating the approach that is being sought.

Finally, the timetable and mechanisms for selecting the service provider must be agreed. By this stage, there should already have been exploratory discussions with potential suppliers.

Service strategy

After contract award the customer can only maximise the benefits of the service if he works closely with the service provider. Therefore, the customer must be clear how he proposes to work with the service provider and the level of resource that will be assigned to managing this relationship.

Of particular importance at this stage is the definition of the business involvement in the operation and management of the service and which aspects of the agreement must be capable of flexing in response to business pressures.

The customer’s contract manager will be the interface between the service provider and the business. He must be able to appreciate both the IT and the business issues, while knowing how to manage the inevitable changes in the contract. The size and scope of his team should be defined at this stage and their task should not be underrated – penny pinching in this area will only lead to failure to get full benefit from the contract.

Contract agreement

The Invitation to Tender needs to capture all the parameters which have been agreed during the earlier stages. The suppliers’ proposals will then be a good approximation to what is needed and should provide a sound foundation for the final contract negotiations. The proposal may also include innovative approaches which were not anticipated by the customer.

The contract agreement is the culmination of the significant work which has led up to this event, but the emphasis at this point should be upon the start of the delivery phase rather than the completion of the procurement.

Before signing up, the customer needs to be sure that all agreements and management arrangements are in place – the service baseline needs to be assembled and understood by both customer and supplier, at all levels of the two organisations. One way to test this is to work through scenarios which represent “a day in the life of the contract” and determine whether the information is available and supports the intentions of both parties.

The business case must be updated to give a more precise assessment of the benefits, costs and risks of the agreement and why the service provider was selected. Also, the customer’s management team must be in place before the contract is signed so that the customer is able to meet all his obligations from day one.

Of prime importance to this stage however is the Transition Plan from the current to the new service. This should state how the service will be transferred from the customer to the service provider. For many businesses, financial services for example, continuity of the service is fundamental and will depend upon smooth execution of the transition plan. Finally, senior level personal commitment in both customer and supplier organisations must be confirmed and a good relationship established to underpin the contract.

This article has proposed an approach which defines the framework for the procurement. The objective of this framework is:

– To define, at the beginning, the areas where flexibility is required by the business so that the contract can readily change with the business pressures;

– To focus on the issues which are important to the business, and by implication give less resource to less important issues;

– To ensure that the business “buys-in” to the procurement process;

– To be able to measure progress.

The way to measure whether the framework has been managed successful is to ask one question: “Does the agreement maximise the opportunity for a win/win outcome?” If the answer is “No” then you should delay award of the contract and work closer with the service providers. If the answer is “Yes” then build on the approach and continue to work as a team – you have the next five years to prove you got it right.

David Wootton is managing director of Per Pro, a programme and procurement management specialist.

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