Discussion on Outsourcing/Offshoring; IT Portfolio Management

Chapter Twenty-Three: Outsourcing and Offshoring

Jeff Richards

OVERVIEW

In today's highly competitive global environment, many companies are asking the question: "Is outsourcing right for me?" The short answer is probably a qualified yes. Some part of almost every organization could undoubtedly benefit from an outsourcing assessment, but "which part" and "why" are the hard questions.

What exactly is outsourcing? First, outsourcing is always a service. Second, outsourcing differs from the purchase of normal services in three material ways:

1 The service is performed to a service level that is managed by the service provider.

2 Some kind of time commitment exists (e.g., fixed term or continues until terminated).

3 The buyer usually has some personnel offset.

Some examples may help clarify the idea. Some things that are not outsourcing are: purchasing and implementing an enterprise resource planning system (it is a product with installation services), FedEx delivery services (no time commitment), and staff augmentation (you manage the resource, not the provider).

Some things that are clearly outsourcing include HP/EDS operating the IT infrastructure, using Laidlaw to operate the school district's buses, or ADP handling payroll processing.

Services that can be defined either way include tax preparation and application maintenance. Each is outsourcing if the work is ongoing (has a fixed term) and the provider manages the personnel resources.

REASONS TO OUTSOURCE

There are hundreds of reasons why companies outsource. Most companies have multiple objectives targeted. The most common reasons fall into three main categories, including finance, operations, and labor. A list would include:

4 Improve quality, process, or customer satisfaction

5 Access difficult-to-source skills

6 Reduce capital requirements

7 Improve cost efficiency or facilitate low-cost entry

8 Provide disaster recovery and business continuity

9 Improve technology

10 Level resources during peaks and troughs of demand

11 Leverage international time zones

12 Focus on core business

The best reason to outsource a service is to focus on your core business (the reason you have customers, profits, and market share) and minimize the distractions. By far, the most common reason companies investigate outsourcing is the promise of financial reward.

Some of the more common financial rewards are lower cost, reduced capital requirements, improved cash flow, investment avoidance, and turning assets into cash. In the final analysis, there are not many (if any) outsourcing deals that do not have some form of financial advantage. Executive management would be neglecting fiduciary responsibilities if they outsourced a function that cost more. In the few cases where outsourcing appears to cost more, an in-depth analysis shows the cost to be less than the internal cost to obtain the same quality, functionality, or growth ability that the provider is promising.

A word of caution: Focusing on lower cost alone is usually a recipe for disaster. This is because any function can be delivered at a lower cost if quality, functionality, and quantity of service are ignored. The best outsourcing strategies focus on the non-financial reasons to outsource and use financial rewards as the ultimate tie-breaker.

The final category is labor. Common reasons to outsource are access to difficult-to-source skills, the need to scale labor, reducing human resources overhead, and gaining additional points of view and industry experience. The last point is perhaps the most important for growing companies that are focused on core business and lack the time or resources to take full advantage of advances or technology in the common business processes.

WHAT TO OUTSOURCE

"How do you decide what to outsource?" is one of the most commonly asked questions. One approach is to place processes/functions in the matrix in Figure 23.1. The horizontal axis is the organization's current competency (poor on the far left and outstanding on the far right). The vertical axis is process value (generic on the bottom and competitive advantage on the top).

Figure 23.1: Current Competency versus Value of the Process

Matrix Structure

Current competency (the horizontal axis) is usually well understood and is simply a rating of an organization's competency when benchmarked with service providers. Process value (the vertical axis) is slightly more complex. Essentially, business functions that are common to all businesses are in the bottom row (i.e., telephone services, payroll administration, IT operations, etc.). If a function is specific, but common, to an industry, then it falls about halfway up (i.e., fleet management for the transportation industry). Things that are unique to an individual organization that are perceived to add significant competitive advantage and are not commonly available in the industry are high on the scale. These are reasons a company has a market share and loyal customers.

Cells in the Matrix

Things in the bottom left cell are "no-brainer" outsourcing targets. Plainly put, an organization is not very good at them, and every business needs the function. It is easy to find a provider that can do it better and usually cheaper. The cells surrounding the bottom left corner need to be evaluated on the merits of the function and the corporate direction. The top row and right-hand column generally are not good outsourcing candidates. If there are performance issues with the processes in these cells, they probably should be fixed internally and leveraged, even spun off as business units.

Services, such as telephone management services, data center management, or other back-office functions, might appear in the lower left-hand corner. The organization performs these tasks poorly when compared to similar service providers, and they are generic to all industries. This means that managing telephone services should be considered an outsourcing target. Is it any wonder many organizations have outsourced the management and administration of telephone services?

In contrast, a customer loyalty program is unique and not generally available. If a company were to perfect such a program, become competent at delivery, and attain positive results, it would be placed in the upper right of the matrix. Outsourcing the application would probably reduce the amount of time the company holds a unique competitive advantage and could easily offset any potential cost savings.

IT application development tied to new product introduction for an organization may reside in any of the cells in the matrix. It depends on how strategic it is viewed and how well it is performed.

Finally, based on the matrix, collections should probably be evaluated for outsourcing. Some of the factors that might play into a decision are the collection rate, cost of collection, and the community service policy.

STRATEGIC FRAMEWORK FOR GLOBAL SOURCING

Several alternatives exist as to the method and location for performing business processes. Subject to certain constraints, these processes may be located anywhere in the world, and can be performed internally by the company or by other organizations. Simply put, business processes do not have to be performed by the company in the United States.

Global sourcing is a term that describes how goods and services may be obtained anywhere in the world, and also expands on the type of services that may be procured. A succinct strategic framework should be used to illustrate the alternatives for global sourcing.

Sourcing Types: In-House, Contract, Outsource

One dimension to consider is to identify who performs the work. The main alternatives include in-house, contract, or outsource. These sourcing types form the columns in the strategic framework.

In-House

In-house is the traditional, do-it-yourself work. The company maintains complete expertise in all parts of this work; the people working in the area or process are full-time or part-time employees. These employees may have a full range of benefits, including pension plans. The assets used for in-house activities may be owned by the company. Alternatively, the assets may be rented or leased. Assets that are owned must be on the balance sheet, which means that they must be financed. All standard metrics are impacted, including the analysts' use of return on investment, sales per employee, assets per employee, and so on.

Contract

For some businesses, contracting is an alternative. For example, many companies hire temporary workers as 1099 contractors. These contractors may include U.S. citizens, permanent residents, or H-1B visa workers. In any case, a company is buying labor capacity. The company is still responsible for the management and direction of the contractor's efforts. In many cases, a company may still have provisioning expenses, such as personal computers and telephones.

Outsource

Another alternative is to outsource. Outsourcing can be structured in a number of ways with the objective of having an external party take responsibility not just for the required tasks but also for results. Depending on the agreement, outsourcers are generally self-managed and use their own assets to perform the work. This is the area where the greatest possibility exists for cost savings.

Sourcing Locations: Onshore, Nearshore, and Offshore

At one time, most manufacturing by U.S. companies was done in the United States. That changed as Mexico, Japan, Taiwan, and other countries increased their abilities to manufacture based on preset specifications more consistently and as U.S.-based businesses could manage those third-party relationships more effectively. Now manufacturing is performed worldwide to take advantage of lower labor costs, proximity to markets, and other factors. Business processes, such as manufacturing, now can also be performed anywhere in the world due to advances in enabling technologies.

We segment geographic locations into three categories relative to the United States: onshore, nearshore, and offshore. These geographic locations form the rows in the strategic framework.

Onshore

Onshore refers to locations in the United States using domestic resources.

Nearshore

Nearshore can refer to two types of locations. One definition is locations in the same time zone, perhaps with a different language involved. Examples include Mexico, Costa Rica, Panama, and Canada. It can also mean relative proximity to the United States; again, Canada and Mexico are good examples. In some cases, locations outside U.S. time zones, where the language and culture are similar to those of the United States, such as Northern Ireland and Australia, are also considered nearshore.

Although the cost of nearshore alternatives may be higher, using them has advantages. The benefits of nearshore alternatives include easier access by U.S. companies due to geographic proximity and fewer perceived risks (e.g., language and cultural barriers, more familiar and similar laws).

Many companies accept the trade-off between less cost savings and less risk with nearshore locations because they are willing to pay for the risk mitigation.

Offshore

Offshore sites include India, China, Russia, and other countries in different time zones, where different languages are spoken, with different cultures and considerable geographic separation. These countries may be developing countries.

USING THE STRATEGIC FRAMEWORK FOR GLOBAL SOURCING

Assembling the sourcing types as columns and the sourcing locations as rows yields a 3 × 3 matrix that can be used to segment who performs processes and where those processes are performed.

In-house processes can be performed onshore, nearshore, or offshore. In addition, onshore processes can be performed in-house, under contract, or outsourced. The completed matrix is set out in Figure 23.2.

Figure 23.2: Global Sourcing: Strategic Framework

This 3 × 3 matrix provides a concise way to illustrate the relationships between a company and its service providers as well as to identify where the work is being performed. Using this framework allows situations to be described quickly and also shows how changes in an organization's capabilities may be needed.

If the sourcing strategy and agreements work as planned, every cell in the 3 × 3 matrix is a legitimate sourcing strategy. A common problem is for companies that intend, for example, to enter into an outsourcing agreement with an offshore service provider and, in fact, end up with an offshore contract agreement. In these situations, the companies spend more time managing the offshore service provider than originally anticipated, eroding much of the planned cost savings.

You also need to remember that movement among the cells is possible. Relationships with a service provider should be flexible, either by design from the outset or by evolution.

THE OUTSOURCING PROCESS

By now you have determined if you need to outsource and, if so, where and under what structure. This section is intended to lay out how to conduct an outsourcing transaction. If this is your first time outsourcing, we suggest that you retain a professional outsourcing transaction advisor.

A suggested methodology for the life cycle for outsourcing services is laid out in Figure 23.3. It is comprised of five phases and a total of 12 distinct and separate stages.

Figure 23.3: Phase I: Assess and Document Outsourcing Opportunities

Based on your organization's maturity, changing business conditions, or new information, it is possible to enter or exit the life cycle at any point in the process. Each entry or exit point has associated risks, costs, and benefits. What follows is an overview, rather than a detailed explanation. Each of these phases and the stages within are outlined in more detail in later in the chapter.

Phase I: Assess and Document Outsourcing Opportunities

Stages in Phase I include:

13 Organize the effort.

14 Assess outsourcing opportunities.

15 Develop strategy and requirements.

This is the preparatory phase where you look across your organization to determine what you are doing well and efficiently and what you are not, or what is not core to your business. This is where you will develop your overarching outsourcing strategy and process or geographically specific business cases for outsourcing. You can use that framework to prioritize your efforts and generate executive awareness. From there you can create detailed requirements that along with the strategy feed into the next phase.

Perhaps the largest source of value leakage in the outsourcing process is failing to articulate a clear outsourcing strategy. Why? Because most companies do not state or even understand what their "real" objectives are from outsourcing. Outsourcing usually starts as a way to reduce cost.

Much has been written that suggests focusing strictly on the financial aspects of outsourcing leads to problems. Our experience corroborates this. Outsourcing offers many nonfinancial benefits. However, frequently companies do not understand or articulate their nonfinancial objectives when working with and evaluating service providers.

Whether you elect to formalize your outsourcing strategy as a separate deliverable or not, ensure that the requirements and request for proposal (RFP) in Phase II are predicated on a clear strategy that is evident through the contents of the RFP.

It is not uncommon in this phase to find improvement opportunities, either short- or long-term, that do not require outsourcing to generate process improvement, efficiency gain, and cost reduction. You may even stop here and not proceed to outsourcing. In any case, we recommend that you have this information available so you know where the low-hanging fruit are before you open a dialog with an outsourcing service provider.

Phase II: Evaluate and Select Service Provider

This phase starts with the creation of a request for information/proposal (RFI/RFP) and concludes with the selection of a service provider (see Figure 23.4).

Figure 23.4: Phase II: Evaluate and Select Service Provider

Stages in Phase II are:

· Prepare and issue RFP.

· Service provider proposal development.

· Proposal evaluation and service provider selection.

Using the outsourcing strategy and requirements developed in the previous phase, it is time to open discussions with the outsourcing service providers. As previously noted, we believe that articulating your outsourcing strategy prior to preparing the requirements/RFP will provide the touchstone for the entire effort.

By articulating an outsourcing strategy that ties to the overall business and IT strategy, you will be able to significantly reduce the uncertainty and have a guiding document for the RFP and subsequent evaluation of responses and the service provider negotiation. Tactically, an explicit outsourcing strategy improves the usefulness of the RFP document both for you and the responding service providers.

If you have an understanding of the service provider community relative to your needs, you can move directly to a RFP with a small set (we recommend three to no more than five) of qualified service providers. Your RFP should be a well-thought-out representation of the detail developed in Phase I.

We will not go into the specific contents of an RFP in this chapter. However, you should use the RFP development stage to think through the scoring techniques before you issue it. If these techniques are not designed up front, you run the risk of losing time in the evaluation stage by trying to compare apples to oranges when reviewing submitted proposals.

If you need to develop familiarity with the service provider community, you can issue a request for information (RFI), which is just a request for capability based on a high-level requirements document. However, be advised that you will receive generic responses and put yourself on the lead tracking radar screen of every service provider to which you submit your RFI. If you go with the RFI to narrow the field of prospective bidders, you will need to iterate through the RFP to get to Phase III.

Then comes the quiet time before you evaluate the responses. This is when service providers are developing their proposals for your consideration. They will need your assistance to prepare their responses despite all of the thought and preparation that went into the RFP. Your procurement team will need to manage all interaction with the service providers for clarification questions, bidders' conferences, and so on. In the interest of fair procurement practices, we recommend that you share any question-and-answer exchanges you have with one specific bidder with all bidders.

Last, you will review the service providers' proposals, conduct site visits, and complete reference checks in order to select a service provider with which you can enter into contract negotiations. If you have done your homework properly and developed an effective RFP, it should not be overly difficult to normalize submitted proposals for comparison purposes.

We suggest three separate segments for scoring:

1 Objective. The capability is scored based on quantified facts, such as process skills, hours of coverage, technology, and the like.

2 Subjective. The capabilities are scored based on opinions and impressions, such as feedback from reference checks, meetings with service providers, executives, and so on.

3 Pricing. We recommend that service providers' pricing information be submitted separately or in a format that can be cleanly extracted from the proposals. Pricing should be reviewed only after the first two criteria are evaluated. This method will avoid contaminating the evaluation team's initial recommendations and allow them to better understand the value prior to being exposed to the cost information.

Before exiting this phase, we suggest that you advise your second-choice service provider to stand by in the event that you are unable to come to agreement with the selected service provider in the next phase.

All other service providers should be thanked for their efforts, released, and afforded the opportunity for a postmortem or loss review with a member of your evaluation team and a representative from procurement.

Phase III: Contract Development and Service Provider Negotiations

Next comes Phase III, where a contract is developed through negotiations with the service provider(s). (See Figure 23.5.)

Figure 23.5: Phase III: Contract Development and Service Provider Negotiation

Stages in this phase include:

· Develop initial contract positions.

· Negotiate contract.

This is the phase in which you develop the framework for your relationship with your new business partner—yes, business partner. If you allow your procurement or legal departments to go into the contract negotiations with a customer versus vendor attitude (us versus them) position, you will end up with a contract that focuses on you gaining an advantage and driving down unit cost. You should avoid this by focusing on life of the contract cost and not putting your service provider in a defensive position where they will work to the letter of the contract (and make it up in change orders), not the spirit of the contract.

This does not mean that you do not need a solid, detailed contractual vehicle, but it has to have mutual benefit and responsibility spelled out in addition to all of the customary terms and conditions.

Service providers have specialized teams that exclusively negotiate contracts, which gives them a substantial advantage over companies that attempt to do negotiate themselves. Moreover, service providers' draft contracts are carefully structured to give the service providers a better deal.

The best way to nullify a service provider's advantage is for you to provide the first-draft contract and to go to the table with an equally experienced team. (If you have not outsourced before or have not retained an outside advisor, it is critical to do so at this juncture.) However, an effective contract foundation is set long before contract negotiation begins.

By articulating your outsourcing strategy early on, you will know what points are important to you and what you can use as bargaining chips. For purposes of contract management in the operational phase, when the service provider is providing the contracted services, you will need to document all of these points in service-level agreements (SLAs).

SLAs are the objective means by which both parties articulate and manage their respective expectations, responsibilities, and contributions. Basic components of an SLA are: service definitions, performance metrics, upper and lower transaction volume or full-time-equivalent parameters, reporting formats and frequencies, and exception management procedures. This is not an exhaustive list but provides some insight into the purpose of an SLA.

Hopefully you have managed to get through this process without alienating the service provider, your executive team, or staff. If so, you are ready to sign on the dotted line and move to the next phase.

Phase IV: Service Transition

Phase IV is the phase in which preparations are made to transfer actual work and then performance of work by the service provider begins (see Figure 23.6).

Figure 23.6: Phase IV: Service Transition

Stages in this phase include:

· Plan service transition.

· Execute transition.

Although this phase has only two stages, it is where all of your and the service provider's efforts either come to fruition or go off the track. If the latter occurs, both parties will spend inordinate amounts of time trying to regain their credibility and repair the relationship for months to come, if not for the life of the contract. This risk can be mitigated by proper planning, process design, and skills transfer.

Service transition is another area where there is no replacement for experience. This fact should be weighted heavily in your evaluation and reference checks of service providers. Have they done this before, in your industry, using these specific processes or technologies? Do not be impatient with this stage; preparing for a service cutover takes a significant amount of time. Have contingency plans and additional resources standing by to deal with the difficulties that will unfailingly appear with the inception of services.

Phase V: Ongoing Management

Phase V indicates that the service provider is firmly in place and performing work. The task at this point is to manage the relationship with the vendor and also to manage any SLAs that have been put in place (see Figure 23.7).

Figure 23.7: Phase V: Ongoing Management

Stages in this phase include:

· Manage SLAs.

· Manage the service provider relationship.

Just because you have outsourced a process or function does not relieve you of the responsibility of managing that process. Ongoing proactive management of performance to SLAs and the overall relationship between you and your service provider is the only thing standing between you and service degradations, dissatisfaction, executive escalations, unplanned change orders, and early renegotiation or termination of the contract.

Depending on the scope and scale of what you have outsourced, you will need to assign full-time resources or a team to manage your contribution and the service provider's performance. If this relationship is treated as a partnership and if the issues that invariably arise are addressed quickly, it is likely that your contract will run its term and you will renew or begin this process again. This is an ongoing process or cycle, as shown in Figure 23.8.

Figure 23.8: Outsourcing Life Cycle: A Phased Approach

As always, we believe that a methodology is a guide to thinking, not a replacement for thinking. This chapter is an overview of the journey you need to navigate. In the interest of brevity, we have left out several branches and tributaries to the route. We hope you will find it helpful.

CONCLUSION

Some important points to keep in mind when undertaking an outsourcing/offshoring endeavor are:

16 Just because you have outsourced a process or function, you are not relieved of the responsibility of managing that process.

17 Outsourcing something does not mean it is inflexible.

18 Successful relationships require proactive management on both sides.

19 Evaluating outsourcing nearly always leads to improved business processes, either through internal improvements or outsourcing.

Although outsourcing is not for every company, nearly all companies will benefit from periodically asking, "Is outsourcing right for me?"