IT Outsourcing: Is it Really an Innovation Crisis?
It is one of the most common mistakes that many information technology outsourcing (ITO) buyers make: anticipating that the outsourcing deal into which they entered with providers would yield the expected results just because the outsourcing provider meets all its contractual service level agreements (SLAs). Nothing is further from the truth.
"A significant gap exists between the benefits sought and those realized by ITO buyers, particularly in the areas of innovation and flexibility," says Ben Trowbridge, CEO and senior executive at Dallas, Texas-based global advisory firm, Alsbridge. "The gap is causing a majority (57%) of ITO buyers to consider renegotiating their existing contracts before they come to term."
The question thus arises: who should pay for innovation?
"The buyer," Trowbridge asserts; adding that there wouldn’t be providers if buyers didn’t pay. "The dilemma is how to keep the attention of the buyer and the provider," he concedes. "There should be understanding and trust between the two."
What is the Innovation Crisis?
According to Alsbridge, buyers have become more sophisticated, are fairly competent, and focus on continuous cost reductions and improving processes. They also make greater capital investments and realize the importance of IT to their overall success; want to have some form of risk/reward that actually is effective; and are more satisfied the longer their company engages in outsourcing. In addition, buyers have increasingly complex governance structures with dedicated executives in these roles, and recognize the wisdom of planning and reviewing existing contracts/relationships in advance.
Outsourcing provider services, on the other hand, have become routine. Delivery is frequently reactive rather than proactive, with new sourcing opportunities, improved technology solutions, advanced supplier capabilities and emerging off-shore locations reserved only for new agreements. Additionally, according to the combined experience of Alsbridge consultants many contracts substantially fall below industry best practices and most long-term agreements are left unchecked, running on cruise control. Furthermore, diminished productivity as a result of constant movement of provider staff has become the norm, and outsourcing contracts not reviewed and/or renegotiated in advance, substantially favor the provider.
Alsbridge asserts that provider motivation is based on:
- cash flow
- market share
- assets (people, hardware, software, facilities)
- other interests (system integration, transformation)
- financial year
- sales bandwidth
A recent Alsbridge ITO buyers' survey reveals that eight percent of buyers were very satisfied with their providers, while 60 percent were "somewhat satisfied"/"very dissatisfied". The remaining 32 percent did not respond.
Alsbridge acknowledges certain changes in buyer behavior, such as:
- price being the key factor in negotiations, but innovation is expected after the deal closes
- sophisticated buyers looking beyond SLAs and contracts to shared responsibility for business value (i.e. revenue, customer satisfaction, churn, etc.)
- satisfaction with ITOs are not at acceptable levels
- "somewhat satisfied" does not sustain a long-term relationship and renewals are at an all-time low: 57% said they were considering renegotiating existing ITO contracts
- clients "see green but are feeling red."
According to Alsbridge Research 2007 Buyer Viewpoint on Information Technology Outsourcing, August 2007 survey, the chart below shows that more than 60 percent of the respondents believe that "Cost Effectiveness" is the most important quantitative metric for ascertaining the performance of the service provider, followed by other important metrics such as "Service Availability", "On-time Delivery" and "Defect rates." The results clearly displayed that "cost" is still the most critical factor for evaluating the service provider and quality still lags behind cost, even though it is the most critical challenge faced by companies using IT service providers.
Factors for Success: Factors for Measurement:
Service provider 50% Cost-effectiveness 64%
Flexiobility with provider 45% Service availability 58%
Well-defined objective 43% On-time delivery 48%
Executive sponsorship 34% Continuous improvement 35%
Quality of ITO contract 28% Bottom-line impact 15%
That said, it appears off-shore is driving redefinition of the outsourcing industry space, according to Alsbridge. Gone are the early years defined by unsophisticated buyers, which ushered in new market entrants with a price focus and the advent of the buy-side outsourcing advisor.
While much talk is given to the rising inflation rates in offshore locations such as India, the real impact on pricing has been the weakening US dollar. The leading providers in India are emerging with higher margins, but equal pressure to produce results. We are at a new stage of the outsourcing industry where we will redefine everything from how deals are priced to how they are measured. It is not just about lower labor costs. It is about innovation, defining new business metrics to measure success, and synergistic relationships being built between buyer and provider.
Alsbridge’s Thesis for Change:
- get innovation and value
- understand value loss
- jointly develop detailed vision with a provider
- be descriptive, not prescriptive
- avoid games designed to "prove something"
- define and document process and services
- ask yourself, "am I a good customer?"
- actually manage the value of the relationship
- benchmark your relationship (contract/governance, operational, relationship)
Trowbridge asserts: "You may not need innovation. But if you do want more out of your outsourcing strategy than just cost reduction, you will have to pay more attention to the relationship."