1 Roland Berger Strategy Consultants content Fresh thinking for decision makers IT outsourcing involves more than IT It takes management skills, strategic foresight and a capable organization Not just at the provider, but also at the client JULY 2012
2 Roland Berger Strategy Consultants IT outsourcing searching for the big prize Outsourcing contracts are not "plug and play". Quite the opposite. Provider Managing a new partner makes the work of the internal IT organization even more challenging and diverse. Kunde Kunde Kunde Kunde Kunde
3 content IT-Outsourcing "Sorry, you lose" IT outsourcing often feels like lottery where you are always drawing the wrong number. While it should be a guaranteed win, more often than not you turn out to be the loser. That is why many managers who outsource IT operations feel deceived. Often they are right. Worse still, to a large extent they only have themselves to blame. Can it be true that a fourth of all such deals fall apart? It is hard to estimate the exact number of IT outsourcing deals that fail. Even so, we know from experience that only around half of all outsourcing contracts ultimately meet expectations. Often savings are never as high as anticipated, innovation is limited and efficiency tails off. Many firms, frustrated with results, wait out the end of their contracts, giving up hope that outsourcing non-strategic IT functions will benefit their organization. But there is a better way to make sure that firms can get what they want. Only about half of all outsourcing contracts meet expectations 50% performing 50% not performing The seeds of problems are planted even before contracts are signed. Many businesses enter into IT agreements unprepared and under time pressure. Overwhelmed with IT issues and seduced by providers' promises, many businesses hand their fate over to outsourcers. They trust that their future partner will do what they say they will do and that the outsourcing process will live up to outsized expectations. They have faith that the partnership will benefit from the experience of the provider and fail to work out crucial details such as legal aspects. They forget that the provider is also out to make a profit and simply rely on hope that the deal will be in their favor. Firms inexperienced with outsourcing tiptoe through the process focused on the interim deadlines, blind to critical phases during the term of the contract. They think in terms of short-term milestones and lose sight of the long-term picture. While IT outsourcing contracts can often run for years, their fates are decided at the very beginning. A properly prepared contract lays the foundation for a well-organized handover and smooth operations, ensuring that options remain open at the end. Cutting corners by not taking time at the setup stage is like rolling the dice: a provider may fail to take advantage of contract ambiguities, but the odds of that happening are pretty low. We identify three key reasons that cause IT outsourcing to fail: unrealistic expectations, underestimating provider management, and failure to make provisions for what happens when the contract ends. 1. Unrealistic expectations Many companies miscalculate both tactics and strategy. They expect outsourcing to provide a high level of operational quality, while turning their IT system around. Companies want IT providers to take over their existing structures and modernize, automate and optimize them, while cutting overall costs at the same time. This approach the "you run my mess for less" idea has never been realistic.
4 Roland Berger Strategy Consultants Successful outsourcing means: Never lose sight of the goal Groundwork Analyze the market, pre-select providers Preparation Send out request for tender, negotiate contract, build up organization Duration Monitor performance, optimize processes Goal Evaluate options, launch follow-up projects Businesses need a reality check when it comes to what they expect from outsourcing. They need to understand that for IT providers, taking over existing systems to optimize, modernize and automate them involves major one-time investments. In the days when contracts lasted seven to ten years that investment paid off. But now, because clients want flexibility, contracts run for much less time. With contract terms of four years, a complex and expensive transformation simply no longer pays off for providers. They are tempted to avoid investing large upfront costs so that they can boost their profits, even if it comes at the detriment of the client. With that in mind companies need to define where they want to be in terms of improving the quality of their services and delivery structures before they start drawing up the outsourcing contracts. That goes for any service that they outsource. Given how fast IT is developing, if the contract is going to run for more than three years, it makes sense to define goals as much as possible without being tied to any one technical solution. Both sides must be ready to redefine and amend the contract in the face of changing conditions. Financial incentives are one way of ensuring that the firm and its provider are on the same page. There are a number of established models here: Companies can use stepped bonuses to back up content quality goals, such as reducing the number of tickets at the helpdesk or harmonizing tools so that the same software is used throughout the company. This approach allows them to measure whether agreed milestones are met. Companies need to get away from thinking that they can use a fixed unit price for each service if they want flexibility over the term of the contract. Flexible long-term agreements call for flexible pricing models. Alongside ongoing operating costs, a variable financial pricing model can give the service provider the incentive that they need to undertake costintensive transformation steps. Companies need to be prepared to pay a higher price to cover the costs of these necessary steps and avoid corners being cut. In return however, they can recoup some of their expenses by squeezing everyday operating costs. Companies should use contracts to get IT providers to do what they want, while at the same time allowing the providers freedom to maneuver in day-to-day operations. If the company can define how the "mess" is to be cleared up over the course of the contract, they can expect to have optimized IT services once it ends. The cost of managing IT providers accounts for 4%-10% of the contract value 2. Underestimating provider management Outsourcing contracts aren t an excuse to stop thinking about IT altogether. In fact it is just the opposite: companies need a comprehensive vision of how IT fits into operations. To ensure the success of a contract, firms need to take a professional approach to managing their service provider rather than letting them work without supervision. Ultimately, outsourcing doesn't make the work of a new in-house IT organization any easier, as most people assume. In fact, it makes their work even more of a challenge. You need to bring together all the IT resources you have internally: technical skills for hardware, software and networks. You also need financial and legal expertise. IT staff, attorneys, controllers and
5 content IT-Outsourcing service experts must work closely together to ensure that providers are managed at the highest levels. That means reviewing internal requirements, external services and the outsourcing partner's legal and financial claims. Companies must be able to talk to providers on equal terms, at all times. All this comes at a cost. Experience shows that managing IT providers costs 4-10% of the contract value, depending on how closely they are controlled. Managing providers requires taking care of four key tasks: Professional issues: Everything the departments want in terms of IT should be routed via the provider management team, which then prepares, implements and controls all the details of the procurement. Finance: Expected cost savings are one of the main drivers in IT outsourcing, making them a key factor when it comes to managing providers. That is why managing billing and allocating costs on to the relevant departments and projects is a key provider management task. Service: The company needs to keep a close eye on what the IT contractor is doing, day in, day out, monitoring and managing the agreed service level is required to ensure operations run smoothly. Legal matters: Outsourcing contracts are just that: contracts. That means they need to be reviewed, and perhaps extended or amended. Penalty and liability issues must be monitored, and compliance requirements must be met. Provider management has four key areas E Professional: Central contact point for all IT requests from the departments. Financial: Manage billing and pass costs on to the departments and projects. Service: Manage the agreed service level to ensure operations run smoothly. Legal: Review, extend and amend contracts with the IT provider. It is the last of these legal matters that companies usually neglect when managing providers. Often this is because of an all-too-human mistake: the belief that IT outsourcing is only about IT services. However all major IT providers know that, apart from providing services efficiently, there is another key driver in their business model: the contract. Their legal experts know their job. Because they are experienced specialists, they can use legal requirements to their own advantage. To match a provider s legal advantage the company must employ its own specialists who can keep complex outsourcing contracts on track. However even the best provider management won t be effective unless it has a handle on the key most phase of the contract: the handover of responsibility for IT services from the company to the provider. Unfortunately, many companies leave this task to the eleventh hour. Within the organization, provider management is seen as a burden it means extra work, extra costs, and at first sight, brings little extra value. Companies also tend to put all their time and effort into getting the contract up and running and making sure the handover happens on time. With the focus on meeting deadlines, setting up a proper system of provider management soon gets forgotten. Experienced outsourcers set up a provider management team when they send out the request for tender, or at the latest when contracts are likely to be signed and everyone's getting down to details. Experience shows that from that point six to nine months are left until the handover: enough time to prepare internal and external experts to manage the service provider, or recruit them from the market.
6 Roland Berger Strategy Consultants What happens when the outsourcing contract expires? There are three possible options: Extend the existing contract with the same provider Sign a new contract with another provider Insource services back into your own IT organization 3. After the party's over... Many companies, quite happy simply to hand things over to their provider, are left unsure of what to do when the contract ends. A number of options often exists and none seem too bad at first sight: Extend the existing contract with same service provider Sign a new contract with a different service provider Insource services back to your own IT organization Do a combination of the above The problem is that when the contract comes to an end, few companies are really at liberty to decide what to do about IT services. They are dependent on support and goodwill from the provider. Because outsourcing contracts are fixed-term, there's always an end in sight. Many companies forget this aspect when designing the deal. Insourcing services back again, or even switching to one of the designated partner's competitors, is not something either side really wants to talk about. But this analysis is absolutely necessary to evaluate how the firm s and providers systems work together and can be pulled apart. From this analysis firms can develop strategies in terms of what the options are once the contract ends. Many companies miss this opportunity, unnecessarily limiting their own room to maneuver. There are two critical areas that companies need to clarify with their IT providers up front if they hope to be able to negotiate from a position of strength: What staff will I need to ensure that things keep running once the contract ends? What tasks and skills will I need? At the outset companies must lay down the terms under which staff can move from the IT provider to the company, or to a competing service provider who takes over providing the IT services. What tools and equipment will I need to ensure that things keep running once the contract with the provider has ended? Providers use many different tools to manage and automate IT. Even though handing them over is critical to success, this step doesn't happen automatically. Take the service desk for example: A firm may be able to replace a provider's service management suite via the free market, but it needs to agree up front on how to access the knowledge database and related solutions. This mishmash of proprietary tools and scripts is what decides whether the outsourcing will continue being successful once the contract ends. The service provider will have integrated the company's idiosyncratic system into its own standard approach, developing special tools in the process. The provider's intellectual capital, its knowledge, is literally its power, which often makes unraveling IT at the end of the contract impossible. And any legal gray areas in the outsourcing contract are a potential minefield for subsequent disputes.
7 content IT-Outsourcing The handover process also brings up costs not priced into the original outsourcing contract. The parties should therefore negotiate what the provider will do at the end of the contract and what it will cost, as there is no way this transition can take place efficiently without the provider's help and support. The goal is to have freedom to: compare, evaluate and choose various options It is in the vital interests of companies that they secure the best possible situation for themselves, including once the contract ends. Their aim must be to put themselves in the same position after three to seven years as they were in before they signed the original contract, with complete freedom to evaluate different outsourcing options and select the one that suits them best. Make sure you're in charge No strategically-minded IT service provider would kill the goose that lays the golden eggs. But it's not their job to tell potential clients where they've gone badly wrong in designing the deal either. And that includes outsourcing so-called "commodity services", an area often considered trivial. Companies wishing to outsource any part of their IT operations need to make the proper preparations, otherwise they have little chance of getting it right. The road to successful outsourcing is paved with danger, at every stage of the deal. Few companies want to talk about what's going to happen when the contract ends while they're still in the negotiating stage. Who wants to think about divorce before the marriage document is signed? Instead, the parties focus on defining operational constraints playing right into the provider's hands. Companies tend to think about short-term matters, like handing over assets, rather than define the long-term strategic goals they are pursuing through the outsourcing. Plus companies have an innate tendency to put a positive gloss on things they have made up their minds to do, and ramp up their own expectations accordingly. It is vital that potential outsourcing clients take control over the entire course of the contract. As soon as the contract is signed, if not sooner, they need to prepare their organization for the new tasks and ramp up their legal resources. Taking the initiative and getting professional support mean that IT outsourcing no longer has to be a gamble, but can be a sure bet. As soon as the contract is signed, if not sooner, they need to prepare their organization for the new tasks and ramp up their legal resources. Taking the initiative and getting professional support are perhaps the only way of upping your chances of winning the lottery. IF YOU HAVE ANY FURTHER QUESTIONS, WE ARE AT YOUR SERVICE ANYTIME: Dr. Andreas Dietze, Partner think:act CONTENT Editors: Dr. Martin C. Wittig, Charles-Edouard Bouée Overall responsibility: Dr. Torsten Oltmanns Project management: Dr. Katherine Nölling Layout: Roland Berger Media Design Roland Berger Strategy Consultants GmbH Am Sandtorkai Hamburg
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