The 1990s fashion for all things virtual has seen a steady rise in the IT practice of outsourcing. As business managers streamline their virtual organisations, they are keen to get experts to look after their business and administrative systems so they can focus on core activities.
According to Birmingham-based outsourcing specialist ITnet, the UK outsourcing market grew 22% between 1996 and 1997, and is currently worth more than #308m per year. The biggest growth, it says, was among finance and investment institutions, 11 of which outsourced for the first time in 1997, with contracts worth a total of #23m.
ITnet noted the average value dropped to #2.1m from #3m in 1996. ‘Many organisations are becoming more strategic and selective in their outsourcing, choosing best of breed for specific IT areas,’ says ITnet commercial director Peter Williamson.
‘Using different suppliers to manage different functions such as data centres, networks, desktop systems and applications management is an increasing trend as finance companies become more sophisticated and demand added value from suppliers.’
Aside from removing technology from their direct control, outsourcing forces managers to confront a new set of issues. First, they need to decide which operations are suitable to outsource, and then they need to work out appropriate performance and cost comparisons to assess supplier bids.
Once the partners consummate their relationship, the traditional technique of picking up the phone and berating the IS manager no longer applies. Instead, the client has to manage a commercial contract typically based around service level agreements.
Parallel rise of consultancy
Given the complexity and value of outsourcing contracts, it will come as no surprise that a burgeoning consultancy industry has grown up to advise firms on outsourcing relationships.
They range from Big Six consultancies, some of whom offer the full service, to IT and business performance specialists such as Compass of Guildford and Staines-based TBI Europe.
This article brings together advice from all three sides of the outsourcing triangle – clients, suppliers and consultants – to help companies and their advisers appreciate the full extent of potential benefits and pitfalls.
As with any current IT investment decision, the year 2000 and European economic and monetary union (EMU) are major factors. Anecdotal evidence from consultants and suppliers indicates the double trouble they are likely to cause is encouraging more companies to look for someone else to sort their systems out.
Solving before outsourcing
In the words of KPMG consulting partner Nick Griffin, ‘The management that wants to outsource those problems to get rid of them is a disaster waiting to happen. You’ve got to solve the problems first before you outsource.’
KPMG principal consultant Bob Aylott adds: ‘People are standing in the headlights waiting to be run over by outsourcing.’ KPMG’s management consultants base their comments on personal experience and a survey conducted last year of 123 outsourcing organisations in manufacturing, commercial and public sectors.
In particular, the study revealed a high level of dissatisfaction among ‘first generation’ outsourcers who were coming to the end of their contracts.
‘The statistics indicated that suppliers were managing them, rather than them managing the supplier,’ says Aylott.
One of the frustrations of outsourcing is that objective measures of success are hard to find. None of the suppliers or consultants approached for this article were willing to present objective figures on which outsourcing’s cost-effectiveness could be judged.
Simon Scarrott, head of consulting for Compass, an independent consultancy which advises potential and current outsourcing clients as well as the vendors themselves, gives a reasonably unbiased summary of the argument.
‘Comparability depends on how much functionality you are buying for how much cost,’ says Scarrott. Citing the example of automatic teller machines, he draws a distinction between the services – and costs – Barclays may provide through its outlets compared to Lloyds TSB. ‘At the technical level at which you can measure performance, it undertakes a different function,’ he says.
Compass has a history of IT performance measurement, but is now modelling business performance in banking, insurance and retail industries – some of the most enthusiastic outsourcers. By the end of the year, the consultancy hopes to be able to benchmark the cost of processing an individual insurance claim, he says.
The only viable comparison a potential client can make is between the costs of providing the same services in-house to those offered by the outsourcer, explains Scarrott. ‘You can construct almost any unit of service measure,’ he says. ‘The reference points are determined by what the organisation wants to achieve. If you want to reduce the cost base, it will be best to use cost indicators to manage the contract.’
Joining the innovation trend
The current trend is towards buying in innovation to re-engineer business processes. ‘We’ll measure the infrastructure cost, but compare that element against the business benefits the outsourcer will help achieve.
The problem is that it is still a subjective judgement. In retailing, for example, the corporate data warehouse will make less of a contribution than a sunny day to increasing your turnover.’
KPMG has charted a different course to some of its Big Six rivals. Where Deloitte & Touche subsidiary CSL (see box) and Andersen Consulting act as outsourcers, KPMG positions itself as more of a troubleshooter.
The firm’s research confirms the need for on-going relationship management.
While the firm’s survey respondents were generally satisfied, 75% reported dissatisfaction with some element of their contract, the most notable reasons being inflexible and ambiguous contracts.
The danger of an outsourcing contract driven entirely by cost is that to win deals, suppliers tend to bid on the basis of low margins, which they look to make up further down the line, says KPMG’s Aylott. ‘There has been a huge amount of client naivety,’ he says. ‘But it’s not in the supplier’s interest to tell the client that. It’s a conspiracy that doesn’t work in either’s interests.’
From discussions with clients, the lack of ad hoc service was irritating and created bad feelings on the suppliers’ side. ‘It’s important to maintain a professional relationship built on mutual respect,’ says Aylott. ‘There is a danger suppliers won’t want to rebid – the nightmare scenario. If they don’t, will anyone else?’
Both KPMG and Compass emphasise the negotiation and liaison skills needed to sustain a productive outsourcing relationship. Clients should seek contracts that tie supplier incentives to their own measures for business success, say both Scarrott and Aylott.
‘The responsibility should sit with the finance director and a specific negotiating team,’ says Scarrott. ‘Many relationships fail because clients think they have outsourced responsibility lock, stock and barrel.
‘IT is only an instrument for competitive advantage. Clients still need to control the direction of their IT. The relationship should be the same as for insourcing IT.’ Compass client ASDA, for example, appointed a manager to liaise with its supplier IBM.
The idea of sharing risks and rewards with suppliers is becoming increasingly popular but, once again, measurement is the main stumbling block. Is success due to fine weather, or the outsourced data warehouse?
Scarrott refers to a major tour operator which put its application development programme out to a leading US outsourcer, along with its IT infrastructure. While the development programme is said to be two years late, the travel company has prospered, and the outsourcer has shared in that success, in spite of missing its deadline.
‘People have to be able to see whether the relationship is still working down the line,’ says Scarrot. ‘The supplier prefers it as well because it focuses them on what they can deliver.’ He stresses the need to have a clear view of the desired business benefits and an idea of the cost of delivering a similar level of efficiency in-house.
Client requirements change over time, and a sharp supplier will cater for that, says Scarrott. The supplier should also pass on savings as it reaps the benefit of improved technology and its own internal efficiencies.
‘We try to set a relative performance indicator to show clients where unit costs are reducing,’ he says.
A way round skill shortages
Accountants should be familiar with some of these issues, as many firms have long provided payroll management services and out-of-house financial departments for clients. It is not a panacea, but in a market that will experience increasing skills shortages, IT outsourcing can fill important gaps.
Outsourcing will help many companies overcome short-term problems such as the year 2000 problem, but its real value lies in helping businesses modernise the way they operate and deal with customers.
But the advice from the experts is clear – buyers need to know where they are going and then manage the outsourcing contract very carefully.
CASE STUDY: BDO STOY HAYWARD
Last year, BDO Stoy Hayward signed a contract to hand over its financial and time management applications to Harlow-based Axis Resources for two years.
After winning a competitive tender, Axis technical staff came into Stoys’ London head office and carried off its IBM AS/400 minicomputer, which it now operates in Harlow.
According to Stoys’ IS director Liz Pearce, the outsourcing arrangement will give the firm the chance to create a replacement system, to which it will migrate its legacy data when the outsourcing contract expires.
‘It was a case of expediency to remove the day-to-day issues,’ says Pearce. ‘The rationale was to buy time for our in-house team to do strategy work.’
Stoys staff has full access from its terminals and is still in control of the system, says Pearce. But she adds no matter how good the outsourcer, it will never be as good as an in-house team that built up years of experience with the system.
Pearce says the firm outsourced the underlying systems, not the finance department itself. The only difference management accountants have experienced is that they have to work to more rigid regimes to produce their reports, which Pearce does not view as a terrible disadvantage.
On the plus side, she says, the outsourcing arrangement has given the firm a much more robust disaster recovery ability than it could have provided for itself.
The contract is based around a service level agreement based on the supplier’s turnaround time for reports, system availability and response times to helpdesk calls.
‘We have monthly account management meetings and stipulated a six-monthly review of the total scenario to cope with changes in our requirements for service levels,’ says Pearce. ‘If you look at your business processes and get them nailed down and written into the contract, it should then just be a case of managing the supplier like any other.’
CASE STUDY: CSL
Deloitte & Touche’s outsourcing subsidiary CSL specialises in handling financial services, such as accounts payable, receivables and payroll management services. CSL business development director David Bowles reports growth of around 75% over the past year.
The rise of reliable telecommunications links and enterprise applications such as Oracle, SAP and PeopleSoft have made it possible to route information from centralised service centres on to manager’s desktops, explains Bowles.
The private sector is turning to outsourcing more to improve organisational efficiency and innovation than to cut costs, he says, but some of the group’s most spectacular successes have come in contracts from public-sector clients such as the Lord Chancellor’s department and Sheffield city council.
With the drive to resource management, plus the best value and private finance initiatives, central government is creating the characteristics in the public sector that are pushing private companies to offload their application development and transaction processing, says Bowles.
If anything, he says, ‘The public sector is being more innovative and creative. The private sector is only now beginning to catch up.’
The shared service centre (SSC) is a key element in CSL’s strategy. The SSC may start as a high-volume transaction processing centre for a single client, but as its expertise and capacity grows, the firm will place new clients with each centre.
The company has centres in Croydon, Milton Keynes, Kingston and Newport, (left) which specialises in resource accounting and budgeting work for public-sector clients.
Bowles says the cost savings range from 10% to 40%. However, the initial savings may not be that high if the customer needs major investment, for example to tackle year 2000 problems or previous under investment. ‘But if you put in a good technical base, it can drive the organisation forward to make future savings,’ he adds.
However, CSL maintains the market is not driven purely by price. ‘The overwhelming majority of our clients are looking looking for a balance of cost and quality,’ says Bowles.
In his view, outsourcing is moving away from traditional IT facility management and more to business process-based contracts.
‘An increasing trend is to outsource IT and finance functions at the same time,’ says Bowles. ‘People need to come to outsourcing with a clean sheet of paper and open mind.
They should think “out of the box” about what they can do to add value to their business by minimising the cost of things that are not the core of their business. The more innovative they are, the more we can do to minimise both their risks and their costs.’
With the SSC taking on the core finance functions, CSL clients can extend efficiencies into their wider organisation. Procurement is a major area for savings. An automotive manufacturer could use outsourcing to buy parts with an electronic receipt and settlement system, for example, and CSL has helped a chemical company to lower the cost per transaction of its raw materials purchases.
But like most outsourcers, he is shy of detailing the precise transaction costs. ‘They’re our trade secrets,’ he laughs.
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