by Jeanne W. Ross and Cynthia M. Beath

MIT Report: Achieving Sustainable Value From Outsourcing

Oct 01, 20054 mins

IT executives entering into IT and business process outsourcing arrangements seek a variety of benefits, including cost reductions, variable capacity and reduced management time spent on IT. But outsourcing succeeds only if both the vendor and the client achieve expected benefits. Often client and vendor interests are not aligned. How can clients and vendors settle into a “sweet spot” where their interests coincide? New research from the Massachusetts Institute of Technology’s Center for Information Systems Research (CISR) and CIO examined 90 outsourcing deals in 84 companies to help executives recognize opportunities for long-term benefits from outsourcing relationships.

We found that the outsourcing sweet spot depends on the nature of the client-vendor relationship. We distinguish among three types of outsourcing relationships: 1. a transaction relationship, in which an outsourcer executes a well-defined, repeatable process for a client; 2. a co-sourcing alliance, in which client and vendor share management responsibility for a project’s success; and 3. a strategic partnership, in which an outsourcer takes on responsibilities for a bundle of its client’s operational services.

This article focuses on transaction relationships, describing the kinds of services outsourced, the metrics that enable executives to assess the success of the outsourcing arrangement, and the risks to both client and vendor. In Parts 2 and 3 of this series, we will address co-sourcing alliances and strategic partnerships.

How to Make Transaction Relationships Work

Transaction relationships are appropriate for activities guided by clear business rules that are common across many organizations. These activities include commodity services—necessary but nondistinctive services—such as accounts payable processing, expense reporting, desktop provisioning, backup and disaster recovery, and mainframe processing, as well as more specialized, repeatable processes such as credit checks, online gift registry services or unique technology services.

Our study found statistically significantly greater satisfaction with transaction relationships than with either of the other types of relationship and 90 percent success rates for both clients and vendors. We attribute that satisfaction to a large overlap between what clients want from their vendors and what vendors are able to deliver.

Clients have three key objectives in their transaction relationships: access to best practices, variable capacity and the ability to redirect management attention to core competencies. Vendors address those needs by developing best practices, solid, scalable technical platforms and other valuable assets that allow them to improve service and lower costs. For example, eFunds has built a large database of debit information that is the key to its credit-checking process. This distinctive asset—which clients either cannot or would not replicate—helps to protect the vendor’s margins.

Successful transaction relationships have low management overhead. Customization, protracted contract negotiations or client interference with how the vendor performs the process will increase costs and undermine benefits for both parties. But a hands-off transaction relationship can deliver hassle-free, high-quality services to clients and reasonable margins to vendors.

Understanding the Three Types of Outsourcing

The three types of outsourcing relationships are so different that learning gained in one type of relationship does not transfer to another. We believe companies can become competent in all three types of relationships. But it is important to match specific outsourcing needs with the appropriate type of relationship.

Clients managing transaction relationships as strategic partnerships incur expensive and unnecessary overhead. Co-sourcing that isn’t treated like a team environment is sure to suboptimize outcomes. And clients and vendors in strategic partnerships who refuse to regularly renegotiate and adapt to the changing needs of their partner will become embroiled in bitter contract battles.

IT executives need to understand the risks of each relationship. Risks increase as the boundaries between client and vendor responsibilities blur and the scope of responsibilities expands. Even transaction relationships bear significant risks. We found that companies emphasizing transaction relationships had statistically significantly less mature enterprise architectures. Low architecture maturity means that a company has unnecessary variability in technical platforms, redundant systems and limited access to shared data. Companies with mature architectures can utilize outsourced transactions on a plug-and-play basis, but companies with low architecture maturity might simply reinforce application silos. In the short term, this could help a company clean up isolated processes, but over time it inhibits the organization’s ability to respond to changing market conditions.

CIOs should encourage a gradual approach to transaction outsourcing as their architecture matures and they develop standardized, low-maintenance electronic interfaces. In all outsourcing, both client and vendor should target the sweet spot to maximize benefits to both parties.