Beware the Commoditization of IT Outsourcing

To find real value from outsourcing, IT customers and service providers must approach deal-making more thoughtfully--and not focus solely on price. CIO.com talked to Edward Hansen, partner in the outsourcing practice of Baker & McKenzie, about the dangers of what he calls the 'over-commodization' of IT services.

By Stephanie Overby
Fri, November 30, 2012

CIO — "Faster, better, cheaper," the old adage goes. "Pick two." Indeed, in many areas of IT outsourcing, IT leaders have been pushing for faster everything--RFP processes, transition phases, time to ROI--in an effort to cut costs quickly.

But that, says Edward Hansen, partner in the outsourcing practice of Baker & McKenzie, is leading to what he calls the "over-commodization" of IT services. IT leaders say they want more than just lower costs from their IT outsourcing relationships, yet they treat the process no differently than if they were trying to get the best deal on a gross of number two pencils--with disastrous consequences.

CIO.com talked to Hansen about the dangers of treating IT services as a commodity buy, why real outsourcing value is more than the sum of its parts, and how customers and suppliers can approach deal-making more thoughtfully.

CIO.com: In what way is the IT outsourcing process over-commoditized?

Edward Hansen: Reasonable people could differ on what makes something a commodity, but I think that a commodity basically has two overarching attributes: First, it has to be something that can be completely described in a contract; and, second, the provider of the item or service is fungible.

Another way of looking at a commodity is that it has an inverse price-to-value relationship. As price increases, value decreases. This is easily thought of in terms of units per dollar spent. If you can get three number two pencils for a dollar, that's a better value than getting two number two pencils for a dollar.

The nice thing about commodity buying is that as long as a buyer can adequately describe its requirements, the buyer can add significant value to its transaction by introducing competition and driving down costs. A commodity buy process can be very efficient.

In large-scale IT projects, this inverse relationship between price and value doesn't always hold. You may very well get increasing value with increased cost. The trick then is to find that point of diminishing returns. This attribute automatically makes it worth paying careful attention to the buy process for these projects.

There are few people who are doing an outsourcing deal who would think that they are conducting a commodity buying process. But on closer inspection you often find that the buyer is actually just breaking up a complex transaction into a several individual commodity transactions. The units of exchange may differ, but the analysis holds.

So in a competitive process you may see complex scoring models on such things as costs, time to transition or service levels. Once the negotiations are complete, a scorecard can be generated that purports to weigh the individual terms, producing leading and trailing bidders. If the process is taken further, you may even have parallel contract negotiations designed to leverage the terms from one negotiation against another.

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