Outsourcing
Many organisations are realising that there may be advantages in concentrating on essential core activities and using external organisations to provide (usually generic) support services. This briefing outlines some of the key issues to be addressed when considering outsourcing and when evaluating outsourcing suppliers and contractors.
Outsourcing may be used to tap into expertise and experience not available in-house (technical or managerial) or simply to identify and then reduce the costs of support services.
When thinking of whether to outsource it is necessary to consider such issues as:
- The relative costs of outsourced and in-house provision
- The space that might be saved
- The expertise on either side
- The time any activity will take to come on-stream
- The culture change that might be necessary
- The risk of losing in-house expertise and capability
According to the Gartner Group, 35% of IT budgets and 80% of business processes will be outsourced by 2003.
The first step is to understand the needs of the service and draw up a clear requirements specification. The group that does this must include representatives of the key user communities and not just the previous in-house service provider. Preparing the requirements specification may need a structured approach to getting, testing and validating users’ views.
This group should work to a steering group of the senior management of the organisation to ensure they are ‘signed up’ and understand the issues involved.
From the requirements specification and the discussions with potential outsourcers, will come a “managed services contract” which defines the responsibilities of both parties. This may include, as appropriate:
- Service definitions
- Staffing levels and qualification levels
- Communication processes
- Completion times
- Problem reporting and escalation
- Penalties for non-delivery
- Review process and schedule
- Criteria and process for early termination
- Penalties for poor performance
- Incentives for good performance / service improvement
- Procedures for handling changes to the service, initiated by either party
Choosing an outsourcing supplier is broadly like choosing any other supplier. Choose someone you can work with and whose track record is secure. It is wise to consider the use of an independent consultant in the selection process. The supplier is likely to have considerably more experience than you in the negotiation/contract setting process so it is wise to balance this with some expertise on your side.
The process of implementing the agreement is important. There should be an agreed implementation plan with firm review dates and processes. At the end, assuming all goes well, implementation is “signed off” and the agreement formally begins.
March 2000
Best Practices in Outsourcing
The following table is reproduced with permission from the joint working paper on Socially Responsible Enterprise Restructuring of the International Labour Office and the European Baha’i Business Forum
- Do not outsource only for immediate cost reduction; outsourcing is about longer-term competitiveness
- Adhere to the best practices and approaches to downsizing outlined in Chapter 4 (of the working paper)
- Do not forget the human element; inform and consult workers’ representatives; keep workers informed about intentions to outsource. Do not let rumours start; maintain clear and open communications
- Differentiate carefully between core and non-core business and avoid outsourcing activities that may become core activities
- Use outsourcing as a way to improve business focus
- Plan the outsourcing process carefully in order to avoid losing core talent and expertise
- Clarify the contract terms and expectations surrounding outsourcing and make sure all partners understand their role and commitments
- Develop a partnership with the sub-contractor; appoint an in-house contract manager to supervise the outsourcing strategy and monitor the relationship
- Help the new firm get established and ensure that you are not the only customer of the outsourcing company
July 2000
Managed Service Provision
A Managed Service Provider runs specific functions, usually IT, for an organisation that requires specialist knowledge or expertise. The term ‘managed services’ is being used to apply to a range of IT-related services. Commonly these relate to the Internet/WWW. So internet security, website or web application hosting, and network systems management are prime contenders.
Internet security services provide a good illustration of the approach. Internet security is a complex and ever-changing area. Few organisations have enough internal expertise to keep up with new hacking techniques and new viruses. Considering the vulnerability of organisations to the risks involved using someone else to provide that constantly refreshed expertise makes sense. Thus, a managed service may provide any or all of:
- monitoring and management of firewalls;
- intrusion detection systems;
- virus checking and management;
- website design and hosting;
- ecommerce capability; etc.
The company can be assured that these task are being carried out by fully-trained, competent staff and that someone else has the task of ensuring 24 hour cover, covering sickness and holidays, etc.
Managed service providers typically provide their services on a subscription basis, over a one/two year contract period. The decision as to whether or not to use managed services is a ‘standard’ outsourcing decision. The standard challenges associated with outsourcing also exist and outsourcing critical functions can result in a loss of control.
July 2001
Out-tasking – The Outsourcing Alternative
Out-tasking is best described by using an example.
Outsourcing has hit the enterprise security market. This is an area of specialist knowledge and it makes sense to hire specialists to address information security challenges. However, outsourcing may not always be the soundest approach to security. It can leave an organisation overly dependent on the managed security service provider to meet security needs and this can often mean that risks are not reviewed regularly.
Senior managers should remember that outsourcing the work does not remove responsibility. An alternative is emerging, which can be more efficient than ‘standard’ outsourcing. It is known as ‘out-tasking’.
Out-tasking is the farming out of discrete, specialised security tasks, rather than security as a whole area. Such tasks could be, for example, intrusion detection system monitoring, forensic investigations, or periodic vulnerability assessments. In contrast to outsourcing, out-tasking forces an organisation to hold itself accountable for its own security, no matter which functions are performed by staff and which are provided through a managed security service. By choosing out-tasking rather than outsourcing, the organisation makes a conscious decision to retain control over the security programme. This correctly recognises that the company itself is responsible for its assets.
Out-tasking makes the company decide which tasks are better handled in-house, and which outside. This may encourage more careful thought about overall security strategy. The out-tasking acts as a ‘strategic catalyst’. Using this mixed mode approach, the client retains responsibility for strategy and selectively outsources components of an overall process following an analysis of need and capability. Such an approach can apply to many other areas where it may be an appropriate variation on the outsourcing theme.
July 2001
Update
A recent report by Morgan Chambers suggests that 56% of the UK FTSE-100 companies have embraced the outsourcing of previously internal services. Outsourcing now accounts for £5.9 billion in revenue from the FTSE-100 alone. There is also evidence that outsourcing, as a strategic weapon, can have a positive impact on share price. The report suggests that the difference is about 5.3% above the individual sector average and 4.9% above the overall FTSE-100.
March 2002
Transformational Outsourcing
In the past, companies have outsourced non-core activities, leaving them free to concentrate on their core activities and the underlying business processes. Under a newer transformational outsourcing arrangement, a service provider takes on responsibility for business critical systems and services. This usually means also that instead of having several outsourcing arrangements for separate systems/services, clients are combining several projects into one, large contract with a single supplier. Such deals are being driven by the current economic climate and the need for cost cutting above all else. However, there are other benefits to an arrangement that spreads investment more evenly over the timespan of the contract avoiding the difficult peaks that would otherwise exist.
Transformation outsourcing builds a new business model to gain competitive advantage in times of relative uncertainty.
see also Business Process Outsourcing (also sometimes referred to as Transformational Outsourcing)
January 2003
The Costs of Managing IT Outsourcing
According to a recent study by outsourcing advisory firm Morgan Chambers, one in three UK companies are spending more than necessary on managing IT outsourcing contracts.
Spending on managing the contract: 33% said they spent more than 7% of the total annual contract value, the maximum recommended by Morgan Stanley.
23% said they spent more than 10% of contract value and at the other extreme, 25% spent less than 3%.
Common reasons are the introduction of layers of duplication and getting in the way; not letting the outsourcing company do its job. The client has to trust the supplier but this requires the supplier to work hard to gain that trust.
March 2004
UK Leads
Attenda recently undertook one of the most comprehensive outsourcing attitude surveys conducted amongst mid market companies. Fifty IT Directors amongst the FTSE 200 – 500 were interviewed and the results provided a fascinating insight into attitudes to selective outsourcing and offshore provision of IT services.
Whilst two thirds of companies said that they were open to the idea of outsourcing and 92% of those had already entered into managed services agreements, the UK was by far the preferred location with 64% having had only UK based contracts.
The principal reason for adopting selective outsourcing amongst all interviewees was to achieve cost savings (69%). However, amongst those who had already adopted some form of outsourcing, the number one motivation for outsourcing was to access skills which were not available to them (81%). These two findings reflect the concerns of mid-sized companies who are unable to support a large IT department and disparate skill sets, but must focus on delivering cost effective services to the business.
June 2004
Companies need to plan effectively if they are to maximise the benefits and minimise the risks of outsourcing, the head of outsourcing at Lloyds TSB has warned.
“There are risks associated with the financial instability of suppliers, and with any contractual disputes and the plan must include an assessment of how one would deal with the failure of a critical customer service”, said Sharon Harmer, head of smartsourcing and group outsourcing at Lloyds TSB.
In a presentation at the Outsource World conference in London earlier this year, she said, “One of the big risks is that a supplier may not be financially stable for the term of the contract.”
“I would suggest that you always include a review of the financial health of the supplier and ways in which you will get out of any outsourcing arrangement before you enter it.”
“The user also needs to consider the mechanism for taking over the running of a critical service from the supplier in the event of an unforeseen disruption, such as the financial collapse of the supplier or a natural disaster”, Harmer added.
“In addition, though outsourcing often involves a transfer of staff to the outsourcing organisation, a business should ensure it retains sufficient staff to manage its outsourcing provider and monitor its performance”, said Harmer, who is responsible for about £500m of expenditure on outsourcing services at Lloyds TSB.
“You can turn a bad deal around with good relationship management, and you can destroy a good deal with bad relationship management,” she said.
“Users also need to have realistic expectations about how much the supplier will be able to improve the quality of a service that was previously run in-house”, Harmer said.
“There is no point arguing for a service level of 99% if you have not achieved that previously in-house. It will be extremely difficult for the supplier to do that,” she said. “You have to understand that under TUPE (Transfer of Undertakings – Protection of Employment) Regulations the same IT staff of today will be working for the supplier.”
Tips for successful outsourcing
Competitive advantage
Never outsource something that gives you a competitive advantage. Something critical to a business, such as cheque processing for a bank CAN be outsourced, if it does not give an edge over rivals.
Transparency
Confusion over the price charged for an outsourced service can breed mistrust between the supplier and the user. Make sure you understand how pricing is calculated. Consider using a benchmarking service to compare the performance and charges of your supplier with others.
Managing the supplier
Organisations typically invest between 3% and 5% of the contract value in managing the relationship with the supplier. Budget for this.
Contractual issues
Use external legal advisers to help draw up and flesh out the contract if possible, as they are likely to have greater experience in handling outsourcing contracts than your in-house lawyers.
Mergers and acquisitions
Think about the medium term status of your own organisation. Being locked into a long-term contract may complicate future mergers and acquisitions.
July 2004
Outsourcing Trends
IT Support and infrastructure services are the most likely functions to be outsourced by both public and private sector organisations. In a survey conducted by PMP research, the most likely applications to be outsourced were web site and ecommerce functions (54% of respondents).
Network infrastructure was cited as a probable candidate by 53% of respondents, while 47% said they would be likely to outsource desktop systems.
47% ent said helpdesk services were something that could leave internal control, while 46% said service infrastructure could also go.
The survey predicts outsourcing services of all kinds will increase. Some 36% of respondents said they had recently increased outsourcing investment, while 38% said their outsourcing spend remained constant.
However, not everyone is convinced by offshoring. Some 30% of private sector businesses said they used offshore outsourcing but within the public sector, not a single respondent had offshored any functions.
71% of overall respondents said the main barrier to successful outsourcing deals was poor relationships with suppliers.
November 2004
Take Control
At the recent Gartner Outsourcing Summit Success, Mark Varley of Barclays told delegates that the supplier should be forced to underwrite the business benefits.
Varley led a two-year supplier selection process for Barclays, culminating in a £426m, six-year deal with Accenture in 2004 to supply the bank’s IT.
The way Barclays overcame licensing issues was to choose right-to-use contracts for software. However, this approach does mean that the business, rather than the outsourcing supplier needs to accept liability for the software, Varley warned.
Varley’s comments came as Gartner published its latest research into outsourcing. Following a survey of about 200 medium-sized and large companies in Western Europe, Gartner identified that users were increasingly forcing suppliers into more flexible outsourcing relationships.
The survey also revealed that 55% of all enterprises with existing IT infrastructure outsourcing arrangements had renegotiated the terms of the relationship within the life of the contract.
40% of firms believe they are paying too much for their outsourced capabilities.
Gartner say that if organisations continue to engage in outsourcing simply to reduce cost, the number of contracts being renegotiated will increase over the next two years.
May 2005
This year’s extension to the Outsourcing debate (should we or shouldn’t we?) has been to talk about outsourcing for quality rather than cost saving. In most cases, however, this may be a red herring. It is the business case that drives an outsourcing decision and though there might be lots of talk about quality, perhaps as a reaction to the bad press that outsourcing has received, efficiency is the key driver.
The case for concentrating on core business and letting outsourcers take up the non-core elements is a much better one and this has both cost and quality elements.
Any organisation contemplating outsourcing should be very clear about their motivation. What is the business driver? Shortening supply times? Lowering overhead and ancillary costs? Improving product availability? No doubt there will be a number of criteria, but all must be identified and measured or evaluated. If not, outsourcing may lead to surprises, not usually welcome in a well-planned business.