1 April 2010 | Dr Ilan Oshri 

How do you ensure your firm is getting value from IT and BPO investments? Dr Ilan Oshri outlines a method to effective outsourcing management

Businesses are now, more than ever, pressed to demonstrate returns on their investment in outsourcing.

While initial returns can be linked to one-off cost cutting, outsourcing arrangements are complex, often involving inter-related high-value activities, which makes realising the long-term benefits increasingly challenging.

But companies are no longer satisfied with the same level of service through the outsourcing lifecycle, they want business transformation and innovation in their present and future services that go beyond service level agreements (SLAs). Despite expectations, many do not know how to measure and quantify the return on outsourcing investments.

Results of research Warwick Business School conducted with IT group Cognizant showed less than half (43 per cent) of all CIOs and CFOs have attempted to calculate the financial impact of outsourcing to their bottom line, which indicates that the financial benefits are difficult to quantify.

Our study has identified seven lessons on how to achieve better results from outsourcing.

1. Work out the context of the outsourcing activity

First, examine why the firm wants to outsource a service and what resources are available to carry it out. We observed a couple of common mistakes: the bandwagon effect, where firms outsource because the competition does, and outsourcing a problem. These are the wrong motives and the consequences can be dire. 

Instead, firms should follow a systematic approach. Consider the overall goal, think about how essential the service is to competitive advantage – how dependent is it on other inputs from the firm, how will work be codified and monitored (and the precision of the metrics) and what is the firm’s experience managing outsourcing arrangements?

Exploring these areas should deliver a clear understanding of the drivers to outsource, internal resources and expectations.

Realising the benefits of an embedded service that is difficult to codify could be challenging because it increases operational risks. Likewise, outsourcing processes that are difficult to monitor (such as R&D, supply chain coordination) – especially when the firm does not have precise metrics to evaluate quality – is not recommended. In these cases, the firm should examine its experience of outsourcing. A high degree of outsourcing maturity and sophistication will allow it to devise methods to overcome certain challenges and mitigate some risks.

2. Devise the outsourcing strategy

The strategy will dictate the complexity of the outsourcing arrangement and therefore the ability to realise benefits. Our advice is simple: choose an outsourcing strategy that the firm’s resources and capabilities can cope with. That way you will be able to assess and realise the benefits gained.

Surprisingly, many firms experiment with sourcing models beyond their organisational capabilities. For example, in recent years many firms tried out multi-vendor sourcing arrangements, but few realised the benefits offered by this model. It takes advanced sourcing capabilities to effectively manage a single vendor in a particular business function, let alone multiple vendors that coordinate several transformation programmes across several business functions.

Another example is the outsourcing of a range of services within a business function (such as HR) to a single vendor. Clients might perceive this as a straightforward arrangement, in which the benefits should be easily realised, because there is only one vendor involved. In fact they need to develop sophisticated outsourcing capabilities so benefits from synergies between outsourced services can be achieved. Most fail to realise this promise.

3. Have a benchmark

Many companies rely on service level agreements (SLAs) to achieve value. These are crucial in any outsourcing arrangement but don’t offer a complete picture and can, in some cases, be misleading. Firms that rely on SLAs are essentially monitoring service performance, which can be meeting the service provisions, but offers little transformation. The challenge is to realise the impact of outsourcing on the business and not on the service performance. For this reason, companies must work out a benchmark to measure real benefits. This is usually a key success factor (KSF) in that industry – for example, time to market of a new product or quality.

Once a benchmark has been identified, SLAs can be drafted to correspond with the provisions that generate a competitive edge. This ensures the aim of the client and vendor is to improve the firm’s competitive advantage through business transformation that is monitored through a set of SLAs.

4. Realise what is value over time

Value is a dynamic concept. What you hope your outsourcing arrangement will deliver will change over time. Few firms are aware of this and even less take steps to mitigate it. When expectations change, disagreements are likely to emerge between buyer and supplier, which will eventually erode the project’s benefits.

This does not mean clients are entitled to redefine their expectations every week – there should be a joint approach. The first step is to develop ‘sensing mechanisms’ for changes in value. These are best supported through shared learning between the client and vendor. The more opportunities there are for shared learning between client and provider, the more likely that value as a changing concept will be monitored.

5. Make your CIO a strategist

Most CIOs are not executive board members and therefore many do not speak ‘business language’. Several have emerged from the IT ranks and they’ve often had little exposure to and involvement in shaping the business strategy. In recent years some have argued the CIO role is now less strategic (mainly because IT is no longer a source of competitive advantage). However, in the past 15 years, the CIO has led outsourcing projects and transformed service design and delivery.

Nowadays CIOs are more strategic than ever and the role is destined to grow. To cope with such changes, CIOs need to learn the language spoken at executive boards. They must learn to design and argue a strong business case for outsourcing arrangements at the strategic, operational and financial level. They need to know how to focus on business improvement processes rather than service improvement processes, and on business transformation rather than IT improvements.

Their role within the organisation should be more central, with a direct influence on board-level decisions, and they should become a central figure and driving force in implementing other lessons.          

6. Build the retained organisation

The CIO will not be able to achieve success alone. They can, however, build a retained organisation to monitor benefits and act as a change agent.

Most firms see a retained organisation as the minimum resource needed to support IT function continuity: this focus is a mistake. A retained organisation should be seen as a resource that drives a firm’s transformation and innovation.

For example, in many deals the client transfers staff to the vendor. A common mistake is to hang on to bright, talented staff, rather than transfer them to the vendor, particularly to help with areas the latter is expected to lead on (such as application development). At the same time, the CIO should build new expertise within the IT function to ensure its focus is on continuity, transformation and innovation.

The retained organisation should also include other capabilities which concern the wider communication between business and IT communities, such as an ability to build relationships. This will help users understand the potential of IT to create value, help users and IT experts collaborate, and ensure ownership and satisfaction from users.

This is a major challenge because of the difference in culture between ‘techies’ and ‘users’. Those building these relationships have to facilitate a shared purpose and constructive communication. Without this capability, the retained organisation will enable IT function continuity, but will fail to demonstrate the benefits of business transformation.

7. Invest in outsourcing learning capabilities

One of the most important capabilities clients need to develop is learning.

Clients tend to take a narrow approach, focusing on lessons learned from a single outsourcing arrangement, and often pay little attention to building a learning capability across multiple outsourcing arrangements. Clients also often focus on ensuring vendors meet service provisions but ignore opportunities to learn from them.

Consider the vast experience acquired by a vendor. Also consider the growing specialisation of suppliers in a particular industry or technology achieved through knowledge acquired by centres of excellence (CoEs). Experts from these CoEs have dealt with multiple outsourcing arrangements, reviewed numerous contracts, negotiated benchmark and SLAs metrics and work together with various clients to achieve success.

Some providers have perfected knowledge management systems to ensure their learning capability supports multiple engagements in an efficient manner (for example reusing certain concepts). Yet clients tend to refrain from consulting these experts, allowing an ‘us and them’ notion to inhibit learning between the two.

Removing these learning
barriers requires vision and courage. If an organisation is to become
a sophisticated outsourcing player,
it has to learn from its vendor first, to avoid mistakes made repeatedly by inexperienced clients and, second, to improve the benefits that can be gained.

All organisations want to be able to clearly present what they’ve got from their outsourcing arrangements, but many don’t know precisely what they’ve gained and
at what price. Put simply, there cannot be any shortcuts. To realise real benefits, outsourcing requires this step-by-step approach. By following these lessons, companies can take more control of outsourcing contracts and ensure they are achieving their intended, specified goals.

* Dr. Ilan Oshri is an associate fellow at Warwick Business School and associate professor at Rotterdam School of Management

More info

To read the full report, Realising the Real Benefits of Outsourcing, by Dr Ilan Oshri and Dr Julia Kotlarsky, in association with Cognizant, go to: www.quantifyingoutsourcingbenefits.com