Plenty of Strings Attached

Managing the outsourcing relationship ain't no picnic and comes with no convenient guidelines, but it is absolutely critical to the venture's success.

It requires dedication, insight, an excellent understanding of psychology, a clear delineation of responsibilities, a full comprehension of potential pitfalls and continued hard work. It's also difficult to get right. Of the 221 CIOs responding to a 1995 Gartner Group survey, 47 per cent who had been in a relationship more than two years dubbed their outsourcing experiences a "mixed bag", while 12 per cent deemed them outright failures. The research suggests management is one factor that can make or break such deals.

Outsourcing veterans say making outsourcing ventures work depends as much on the art of the relationship as it does on the science of the contract. And managing the relationship starts long before any ink hits that contract, with decisions about the nature of the outsourcing relationship and the best ways to achieve desired outsourcing goals.

Along the way, those in the hot seat must answer many questions, among them: How much do I outsource? How do I know I'm getting the right vendor in? How do I know the outsourcer is using the best suppliers and best technology? How do I maintain relationships with suppliers? How do I retain my company's intellectual capital so I'm not locked into that vendor? How close do I let the outsourcer get to my business? How do I protect my competitive edge?"The difference between successful outsourcing and a complete nightmare experience is contract management," Forrester Research group director IT strategy service Stuart Woodring told CIO magazine on a recent visit to Australia. "And I am being very particular here: it's contract management, not contract negotiation. The negotiation at the beginning is only setting the stage. That's only setting up the pieces on the game-board.

"Making sure this thing is a win for the company that is engaging the outsourcer demands constant involvement on all levels around contract management," says Woodring "It requires vigilance because there's no way that I can sit here and predict what my organisation will need five years from now, with very, very few exceptions."On the shoulders of the management of the outsourcing relationship can hang the success or failure of the entire outsourcing venture, and it must be handled by a highly trained individual in the internal IT group. After all, as Meta Group analyst Mo Marburg says: "The outsourcer can be responsible for something, but the internal IT group will always be accountable."It's a lesson the Commonwealth Immigration Department learned the hard way, after telecommunication costs rose to 20 per cent over budget during the 18 months after they were outsourced. The outsourcer had guaranteed volume discounts of 15 per cent and undertook and delivered the management of the department's accounts.

"What happened was that people stopped taking management responsibility and the volume of traffic went up so significantly that the thing was out of control within 18 months. It took us another six months to get it back under control," first assistant secretary Vincent McMahon told a Senate hearing earlier this year, adding the experience highlighted the need for continuing close management scrutiny to carefully monitor traffic levels. "It simply illustrated the dangers of moving into an outsourced arrangement without making sure that there was active management and clear understanding about the responsibilities," he said.

Contrast that with the successful outsourcing experiences of another Government department, Veterans' Affairs (DVA), where good relationship management brought big benefits.

A recent Australian National Audit Office investigation showed the department had not only achieved costs savings of between $10 and $12 million after outsourcing its computer centre to Ferntree in 1992, but that contract management itself had led to other significant benefits. These included improved communications via structured meetings and a more professional attitude from data centre staff, including a greater focus on service delivery.

DVA information manager Colin Stubbings, who joined the department as a self-confessed outsourcing sceptic, says the key to the venture's success was the recognition that the outsourcing relationship must be a partnership. "The reality was that in the 18 months that I had been here having a relationship with them, there was never ever any need to go and have a look at the contract.

We had a firm business relationship about what we paid for and what they delivered," he says.

And proving that outsourcing doesn't necessarily lock an organisation in to any one outsourcing vendor, DVA handed its new $65 million desktop-to-mainframe outsourcing contract to ISSC after the contract with Ferntree expired. After experiencing some difficulties with the transition, this time it has included a transition-out agreement in the contract to allow ISSC staff working on the DVA account to be possible candidates for employment with whoever the next service provider might be.

Sinking the iceberg

How close should you let the outsourcer get to your business? Forrester Research answers the question with a model it calls "Sinking the IT Iceberg".

Consider all the skills and capabilities and demands that are put on an IT organisation as an iceberg, stacked from the lowest level of competitive advantage at the bottom to the highest level of competitive advantage at the top. "The goal around sinking the IT iceberg is to push the low competitive advantage situations below the waterline," Woodring says.

"The issues that are really going to change my business fortunes are the issues above the waterline and those are where I really spend my time and that I focus on," he says. "But if it is just something simple, what I want to do is standardise it, I want to get it organised, and then I want to forget about it." Anything below the waterline can be safely outsourced. Few companies run their own janatorial crews, Woodring points out, and for good reason.

"If I am a bank, I might hire somebody to clean my offices, I'll hire someone to water my plants and I'll hire someone to do a variety of non-critical activities. But when we're talking about the strategic direction of the bank, well I'm probably not just going to willy-nilly outsource that," he says. "For the technology issues where I can identify the service levels I need, then outsourcing makes all the sense in the world, but it's not easy to do it well.

The devil is in the detail with outsourcing."According to Woodring, it's one thing to engage an outsourcer to handle all desktop computing, owning the desktops, handling all the service and maintenance, managing the help desk and upgrading all desktops every three years. It's quite another to outsource application development. "I don't think you can stop the outsourcer getting too close to the strategic side when you outsource development. Outsourcing development is probably about the last thing you should do," he says.

"You should take the issues where there are definable service levels, where you can set clear performance metrics about what is acceptable and what is not.

With running a data centre, I need certain up time, I need certain response time, I can define what those are. With my desktop support I need certain bandwidth to the desktop, I need power on my desktop, I need help desk support that provides a certain level of support and I can define what those things are. How do I do that with applications?"Woodring notes many companies are now trying to figure out how to handle the customer self-service opportunities offered by the Internet, recognising these could provide real competitive advantage. Capitalising on the tantalising promise of the Internet also requires creativity. Anything that inherently requires some level of creativity and that can influence business performance should be the last thing to get outsourced, Woodring says.

"Companies don't outsource the most important things that distinguish them from their competitors," he explains.

Sharing the risk

Protecting your organisation's intellectual capital can be equally critical to your competitive edge. The DVA has ensured it won't lose intellectual capital to the new outsourcer through a contract stipulation protecting any commercial opportunities. And DVA's attitude to post-outsourced purchasing highlights an important point about successful outsourcing relationships.

At some stage early on, most CIOs are going to have to decide how "hands on" they should be about technology purchasing once the outsourcer has stepped in.

Meta Group says there is no inherently right answer.

"What we are trying to do is maximise probabilities that the user gets services that best suit their need," Marburg says. "That being said, I think users that outsource strategic decisions like which hardware platforms and software they are buying will ultimately, over the course of 15 years, end up losing so much control of their technology environment that as a business they are going to suffer -- and I'll explain why.

"There is no such thing as a partnership with an outsourcer unless there is some sort of shared risk in the business outcome of the arrangement, and very few deals today have that shared risk that would make a partnership."Where there is no shared risk, CIOs must recognise that purchasing decisions are an important part of strategic control or else expose their companies to serious risks.

"Outsourcers are predisposed to buying certain products, for example, based on their core competencies but not necessarily based on what would be best for your company," says Marburg. "During the first couple of years, sure, maybe you can leave them to do that. But as you move five or 10 years down the road, if you start losing touch with what is going on, how are you going to understand how to apply technology to the business environment to create some unique competitive advantage?"Woodring agrees. "I don't think any smart organisation is going to feel comfortable just abdicating complete control to someone who is outside their organisation who also has a vested business interest that may not be identical to theirs," he says. "Outsourcing is not about abdicating decision-making."Veterans' Affairs, with a mechanism in the contract requiring ISSC to provide a cost-effective service (including "some streams in the contract that encourage them to do the best deal possible for DVA"), says it is happy to leave purchasing to ISSC precisely because it does share the risk. The contract with ISSC focuses on business outcomes rather than specific technologies, Stubbings says, and merely stipulates a technology platform capable of running the "current version minus one of any software". It also works on a profit sharing basis.

"We sought to encourage ISSC to provide us with efficiencies over the course of the contract which would provide an opportunity for us to share in any savings," says Stubbings. "We got them to factor into their contracting price those technologies that they had included as part of their price, and we also said we would share in any savings over and above those.

"For example, it's not unreasonable to say that voice and data services will be integrated in the fairly new future. What we would expect to happen is that they would put forward a proposal to save us X dollars a year by integrating voice and data, then we would share in the savings 50/50," he says.

Indeed the contract requires ISSC, as a technology partner, to bring forward valid proposals for savings equivalent to a specified percentage of its service fee during the first two years of the contract. Contrast that approach with that of AMP Retail Financial Services, which embraced wholesale outsourcing in 1993 to the point where it had outsourced more than 50 per cent of its IT in terms of spend by May 1996.

The company has now moved into a co-sourcing arrangement after forming a joint venture with Andersen Consulting.

CIO Jack McElwee says until the joint venture, the company always played a proactive role in IT purchasing done on its behalf by outsourcers, and maintained close relationships with IT hardware and software vendors. Not only has this helped his company avoid losing skills and the risk of vendor lock-in, McElwee says it was equally important to the IT vendors.

"The vendors typically want to continue to make the ultimate beneficiary of their products, who is still the outsourcing customer here, aware of their product advances," he says. "Just because there's an outsourcing relationship with a third party shouldn't sever the interaction and inter-relationships between primary vendors in the marketplace and the ultimate customer."Upon close observationMost outsourcing contract managers will spend considerable time monitoring Service Level Agreements to ensure the outsourcing relationship is driving the organisation in the right direction. Meta's Marburg says this can require considerable resources, since monitoring should be done on two levels.

It's not enough to do weekly appraisals of any operational deviation from service levels, nor even to supplement this with efforts to identify ways to motivate staff to consistently improve the services being delivered. Companies must also engage in continual evaluation of the changing technological environment.

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