Prevent incremental cost in outsourced services

Transcription

1 Benchmarking & Performance Management White paper Prevent incremental cost in outsourced services Objective measuring control cycle information services By Frank de Vries Arranging service relations The fundament for successful outsourcing of Information Services (IS) is largely built during the preparation. Developing a long-term service delivery relationship between parties, however, is not so easy. Besides the design of the desired relationship and the selection from among available suppliers, attention should be paid towards the steering and control mechanisms of the outsourcing relationship. Within this relationship, certain risks and blockages may arise; these need to be identified as early as possible to prevent (intellectual) value destruction later on. Within this outsourcing context, the business and IS targets are dominant, including the accompanying steering models, the maturity of the internal IS organisation and the control mechanisms of the demand or retained organisation 1. The ultimate target is a well-balanced outsourcing decision (make-or-buy) and - more importantly - proper service delivery that is free from headaches. Sometimes, though, the results fall short of the expectations. This white paper reflects our philosophy on benchmarking and performance management in relation to IS outsourcing based on our core competencies. How can benchmarking and performance management add value to your organisation on the edge of management and information systems within the sourcing domain? D a r e t o c h a l l e n g e

2 This white paper attempts to answer that question, but first: a general overview on the subject of sourcing, including a few typical accompanying problems, is in order. Performance management addresses the steering of internal and external IS organisations. Steering is typically aimed at organising IS in an efficient and measurable way (the underlying aim of this white paper), creating an effective and measurable alignment of IS delivery, and the strategy of the enterprise as a whole. Benchmarking aims at comparing the internal IS organisation of the external service provider (ESP) with peers, where the quality of IS delivery and the accompanying cost level is scrutnized. Benchmarking supports organisations by creating a transparent, objective and marketconforming framework to test the performance of the external IS organisation. The Market Alignment Framework provides client organisations with a transparent, measurable steering model for both internal and external IS delivery, which can be checked for market conformity at any time. It is a solution which provides both client and supplier with an objective reference model, safeguarding the mutual relationship from unfounded and biased discussions and undesired additional costs. Organisations are provided with a clear business case for improvements and can make better make or buy decisions based on objective quantitative (financial) and qualitative analyses. Market overview - sourcing Outsourcing is related to one of the classic and fundamental organisational dilemmas: the make or buy decision and the question of how inter-organisational relationships, which arise as a result of this decision, should be structured and managed. This dilemma is not new. Before the industrial revolution, the predominant way of structuring inter-organisational relationships was through contractual relationships. After the industrial revolution, vertically integrated organisations took over, partially as an answer to increasing interventions by the government and new expensive technologies. Towards the end of the 20th century, vertically integrated organisations were challenged by the introduction of new, hybrid and network based organisation structures. Outsourcing was booming and two important forms of outsourcing began to emerge: IS outsourcing and Business Process Outsourcing (BPO). Besides these, another trend that was beginning to gain popularity was outsourcing services to low cost countries: offshore outsourcing. One of the primary challenges for most organisations is obtaining and sustaining a competitive advantage over its peers in the fast changing business environment. Organisations need to maintain continuous access to information to enhance decision making in order to sustain a competitive advantage. Sourcing; approach in 7 phases Quint Wellington Redwood always uses the Seven Phase Model when IS outsourcing is considered by its clients. The model tracks, in a process oriented way, the complete outsourcing life cycle. Every phase recognises specific targets and decision making moments for both business and IS management regarding the continuing outsourcing process. Going through all the logical, successive steps, results in a higher probability of a decent and mutually acceptable end result. FHASE 1) Strategy 2) Scope 3) Selection 4) Due Diligence 5) Contracting 6) Transitie 7) Contract management CONTENT Clear definition of the business case and rationale behind outsourcing Definition of services to be outsourced. Selection of prospective vendors; Mutual checking of the submitted offers; Formal record of contracts, agreements and service levels; Fine-tuning of the outsourcing relationship Continuous management, monitoring and control of the outsourced services. GOALS ICT sourcing strategy; Blueprint smart buyer function Operational justification model ICT Services; Vendors; Scenarios Minimum frame of reference; Evaluation criteria; Vendor selection Detailed analysis of vendor proposals; Evaluation of references; Final selection report Master agreement; Agreement per type of service; Working documents (SLA's, PID's etc.) Transfer of staff; Operational smart buyer function; Transition of service delivery Contract evaluation & evolution; Innovatie & change control; Audit operational performance 2

3 A lot of companies are familiar with the term IS outsourcing. A recent international survey by the Quint Research Center shows that 79% of respondents already have, or anticipate to have, a close relationships with ESPs. Only 21% have no existing IS outsourcing relations nor plan to do so anytime soon. The total amount of money involved in IS outsourcing will increase from $176.8 billion in 2003 to $235.6 billion in Organisations engaging in offshore outsourcing show mixed to extreme results. Offshore Some companies experienced cost reductions of more than 30% while others saw outsourcing the productivity effectively drop by 100%. These findings underline the wide spread immature believe that offshore outsourcing is still relatively immature. An indication that the market may be increasing in maturity is that more local (Western) ESPs are creating offshore propositions for IS delivery. Also occurring in parallel are offshore parties developing a local presence in Western Europe and North America by hiring local employees. Quint expects a swift development of East European countries becoming important suppliers of cheap information services for the Western European market, so long as wages stay substantially below Western European standards. Both Western and leading Indian IS suppliers are increasing their delivering capabilities in East European countries. Sourcing issues In general, the perceived quality of service delivery - before and after outsourcing - increases from 5,8 to 6,9, on a scale of 1 to 10 in our survey. From this, it can be deduced that outsourcing is worth considering. There are, however, several issues within an outsourcing relationship which occur quite often and these need proper attention: Clients are rarely content with the price quality ratio delivered by the supplier. This can be translated as a gap between the expectations of the client regarding the service and the actual service delivered by the supplier. On one hand, this effect is caused by unreasonable expectations by the client and, on the other hand, by unfulfilled promises by the supplier during negotiations. Retained or demand organisation The outsourcing relationship needs to be anchored within the client organisation in a planning and control function (see figure below). This retained organisation needs to be operational directly after the transition of the of the information services to the ESP and focuses on managing the contract. This retained organisation (also called Smart Buyer Function ) supports the business and IS management via smart purchase decisions and controls the delivery of IS by both internal and external service providers. The retained organisation supports the value chain by managing and steering the suppliers on both policy making and on an operational level. The functional needs of the client are translated into a demand for IS and the complete life cycle of IS is managed by it. After transition of the internal IS to the ESP controls the retained organisation, the actual delivery of services is based on service reporting, supplemented by periodic audits. The mission of the retained organisation depends on the business and IS strategy of the client organisation and an optimal orientation of its own expertise. 3

4 Sourcing goals are not met. The survey by the Quint Research Center shows that the outsourcing goals to get more insight into the quality of services is not successful in 41% of cases. In 29% of cases, such objectives are not realized. Increasing innovative capacity was successful in 43%. Cost savings were realized in only 47% of cases. Another major finding is that suppliers indicate that customer s retained organizations are usually insufficiently organized and staffed (see text box). Even though this poses a serious obstacle to a smooth and successful outsourcing relationship, suppliers do not see it as their problem to solve. Changes in contracted services causes additional charges. In total, 65% of the outsourcing relationships are disrupted by changes. Most of these take place between the first and second year of the contract (33%). In 16% of the cases, the contract already goes through changes in the first 6 months of contracting. This primarily results in changes of prices (27%), price mechanism (20%), service packages (29%) and service levels (23%). Difficult monitoring of outsourcings business cases. The decision to outsource is, in most cases, supported by a financial business case that has been presented to an executive management. However, changes in the contracted services make it very difficult to monitor the initial business case over the contract term. Backward justification of the outsourcing - in case of contract renewal- is mostly a case of comparing apples and oranges. Discussions regarding the success of outsourcing can be very complex and has a lot to do with politics within and between the user organisation and supplier organisation. Additional charges when the contract has been signed. Additional, non-transparent charges after contract has been signed are a source of anxiety among many executive managers. Due to commercial lock-in - 41% of clients have a single vendor situation - demonstrable competitive prices offered are sometimes dubious and often questioned. The key is to determine marketbased prices and service quality targets that enable clients to receive transparent value for money, while allowing outsourcing vendors to sustain a reasonable profit.. Improvement of service levels and the infrastructure adrift. 33% of the customer organizations aim to improve the productivity of the organization by outsourcing services, and 59% aim to improve service levels. Appointing areas to support these improvements are very difficult due to a lack of information and material for comparison. Changing market prices are not always reflected in the outsourcing transaction. Many outsourcing transactions contain fixed price elements. However, in the course of time market prices may go down. A shining example is the costs related to data communication (wide area networks) which shows a considerable yearly drop. Unexpected changes in the business environment or technology innovation can put the outsourcing relationship in another light. The question is whether or not these changes have an impact on scope, service volumes, services levels and costs charged. Bottom line: it comes down to whether or not the client and outsourcing vendor have agreed on a clause that covers these kinds of unforeseen circumstances. 4

5 Sourcing: de facto conflict of interests There are per definition (financial) contradictions within an outsourcing relationship between the client, the demand side, and the external supplier, the supply side. This is because the main aim of the client is to buy information services for relatively low market prices whilst the aim of the supplier is to maximize its own profit. The outsourcing market is a competitive one. This forces suppliers to engage in deals with very low profit margins or even at a loss. The winner s curse materializes: The supplier who wins the deal succeeds at what is an undesirable or impossible price (Wilson and Van Heck, 2002). Regardless of all the fancy talk about strategic partnership and so forth, a commercial supplier s goals are sales and profit maximization. After the deal has been closed, the supplier will attempt to achieve a higher yield by supplying lower quality, increasing prices or and this happens frequently increasing the scope to generate additional work. In the end, entering into deals that are insufficiently lucrative for the supplier is of no benefit to the client 3. Both the client and the supplier of IT services have an interest in delivering 3 steering means the appropriate service at the agreed price and with the desired service level. The external supplier also desires a healthy financial return for his services, and can do so by using three control instruments to influence services: Increasing the price of the service delivered: this may be possible, depending on the scope and degree of freedom of underlying SLA s (Service Level Agreements); Lowering the service level within the range allowed under the SLA; Changing the scope (extent and content) of the service thus creating opportunities for more work and allowing additional charges to be made to the client. Clients should be aware that most outsourcing suppliers are actively trying to improve their returns by applying the control instruments mentioned. This fundamental difference in goals raises the following question: How can benchmarking and performance management add value to your company on the leading edge of management and information systems within the sourcing domain? 5

6 The added value of performance management for sourcing In order to be able to manage the tension resulting from the issues mentioned above, a couple of key words need to be mentioned: transparency, objectivity, measurable sourcing steering and market conform pricing. On the leading edge of management and information systems, benchmarking and performance management adds substantial value towards your organisation. Many organizations (demand-side) that have decided to outsource parts of Procedure similar their organizational activities 4 bring the desired services to the market with expectations help of a Bid Book or Request for Proposal. In this document they describe the desired services portfolio (scope),and service levels (quality) for which they eventually have to pay a price (fixed tariffs). After due diligence, both the demand-side as well as the supply-side know exactly what they (can) expect from each other. The outsourced scope, service levels and prices are consequently written down in a Master Services Agreement which contains schedules such as service level agreements, governance, value added tax, charges and a change control procedure. After this transition, a steady state service delivery of the outsourced services begins. See the accompanying figure for a graphical representation. When the demand-side has invited tenders to bid for the contract, they receive transparent value-for-money services based on market prices. After the deal is signed and delivery starts, the customer organization monitors performance by means of supplier service reporting and periodic audits. However, many contracts don t anticipate unexpected changes in the business environment. Shake-ups or expansions create changes in service volumes and service levels which may be an immediate cause for heated discussions: how do we deal with the additional cost? In the end, it comes down to whether or not the client and outsourcing vendor have agreed on a mechanism that takes care of these kinds of unforeseen circumstances. Another situation is that the outsourcing environment is so complex, high in volume or highly distributed that a sourcing strategy based on covering all aspects up front is doomed to failure. The moment the last problem or infrastructure is covered, the first problem covered is not in its actual state anymore, and probably has changed. An approach based on uncertainty instead of certainty is, therefore, much more pragmatic. 6

7 To overcome these contentions, the demand-side should make use of a standardized Products services catalogue on behalf of service volumes for known services. The services and service catalogue lists all of the known services provided, default service levels and options catalog so far nothing new. The next maturity level is that this catalogue is linked up directly to an international benchmark database which contains detailed metrics on business and IS performance. In this way, the services described in the services catalogue can easily be benched for market-based prices without any difficult and costly transcriptions. The Master Services Agreement should contain project & procedures to initiate a benchmark. In the contract, a procedure will clarify the consequences of the outcome of a benchmark. To benchmark market prices of both the services provided and the services catalogue, a performance management reporting framework should be available for demand organizations. On the one hand, this framework should give insight in the quality of service delivered and related costs of application chains. An application-chain is a set of ICT assets supporting a specific business process. The application chain consists of the application, the workstations providing access to the applications, the local area network, the databases), middleware, operating systems and the underlying hardware required to exploit the application. Ultimately, a customer is only interested in having functionality available against certain service levels and specified costs. The framework should also provide insights into the separate entities that make up the application-chain and needs to be planned and controlled by the retained organisation of the client. Typical activities that remain within the client organisation are determining standards and arranging the internal infrastructure. These internal departments or competence centres, for example the competence centre Network or Servers & Databases, may however need information of parts of the application chain that is outsourced in order to deliver a proper functioning infrastructure. Reporting on separate IS clusters, which make up the applicationchain is therefore necessary. This does not discharge the supplier from its integral responsibility regarding IS that has been outsourced. On the other hand, the retained internal IS organisation of the client should restrain itself from looking too much into the kitchen of the ESP. 7

8 Based on transparency, objectivity and market-conforming prices, services are selected from a benchmarked service catalogue and performance management reporting framework. This allows the client to directly influence subjects like improving service levels and the IS infrastructure, monitoring the realisation of the original outsourcing business case, reporting on, and acting on unsuspected changes in the business domain. It also improves the capability of managing any additional costs which pop-up after signing the contract, thanks to a professional retained organisation. However, this is only valid for known services. How then to deal with innovation on the demand-side and supply-side where Innovation it concerns unknown, future services that are not covered by the product against marketconformable prices services catalogue? These unknown services could be delivered with help of new technology innovations that also should be delivered based on market prices. For these kinds of services, the demand-side and supply-side should agree on innovation arrangements clauses for improvement of IS service delivery and infrastructure. These clauses should contain incentives to innovate the infrastructure (e.g. shared benefits) and procedures that dictate how to incorporate the new modernized services in the services catalogue and performance management reporting framework. The supply-side will be an integrated part of planning cycle of the demand-side in which new developments are discussed, evaluated and initiated. Benchmarking supports organizations in transparant, objective and market compliant audits of supplier performance. Based on the services catalogue and the performance management reporting framework, both quality and costs can be assessed. Benchmarking, in an outsourcing context, serves multiple goals: To understand current levels of service performance (cost and quality) and to quantify and qualify improvement opportunities (initial baseline). To drive continuous improvement within client organisations (periodic benchmark) To assess value for money in a proposed outsourced contracts often an extension of an existing contract (proxy bid) To assess value for money in existing outsourced contracts typically, an invocation of a benchmarking clause (outsourcing value analysis) To keep suppliers on their toes. Research shows that it is the threat of competition that drives performance improvements and cost reductions (Domberger, 1998). Objective benchmark results offer the customer openings for negotiation. 8

9 The level of detail of benchmark results (application chain components) allow techniques such as root cause analysis to pinpoint non-market compliant components. In that way, discussions and negotiations can focus on facts and on the right issues. Measurable experience shows that organisations which perform regular audits on Structurally market conformity regarding the performance of their IS and composition of their IS lower costs infrastructure achieve - over a period of five years and depending on the scope - an average efficiency increase of 30% to 49%. Typical organisations need on average 3 to 4 years to achieve a performance level comparable to its peer group (world-best-in-class) 5. An important end product of the benchmark is the follow-up steps. These follow-up steps represent the true value and should be aligned with the organisational (business) and outsourcing targets. These recommendations can then, using Root Cause Analysis, be resolved into optimizations on the lowest operational level, for example the cost of a router. This makes sure the focus of the discussion is on the proper subjects. Management cyclus and performance management The strategic position of an organisation should be anchored in a series of specific activities aimed at creating value. Positioning does not only determine the activities an organisation should perform and its configuration, but also which activities are inter-linked. Based on the overall strategy of the organisation creates the demand side an IS vision and IS strategy aimed at aligning the IS activities with those of the business. If the demand side decides to outsource part of the IS value chain, then will the introduction of performance management support the actual realisation of the outsourcing value. Therefore, the performance management framework needs to be incorporated within the management cycle of the organisation (Deming cycle: plando-check-act). PLAN Based on the overall strategy of the organisation and the IS vision, the demand side defines IS targets, IS strategy, outsourcings targets, critical success factors and strategic key performance indicators, which indicate whether targets are met and the IS is aligned with the business activities. The plan focuses on the design of the information architecture, IS architecture, IS infrastructure and IS security baseline which can be steered and monitored using operational key performance indicators, project procedures and innovation agreements. 9

10 DO In the realisation phase, effort is put into the actual delivery of IS. These services are described in the service catalogue, presenting an overview of all known services that are or can be delivered to the client. The service catalogue is directly linked to an international benchmark database which provides detailed metrics regarding business and IS performance. In this way, services can be delivered, described in the service catalogue, that can be benchmarked easily regarding being market conform, without the need for difficult transcriptions that are often required to perform a objective benchmark. CHECK Benchmarking and customer satisfaction surveys can be conducted on a regular basis to determine whether innovation projects and service delivery is in line with the strategic key performance indicators and operational key performance indicators. Market conformity and the outsourcing relationship should also be audited. ACT Based on the communicated results to, example, the service level managers or IS financial managers, plans can be drawn up for improvement, resulting in new guidelines which may have impact on the current strategy. Penalties may be part of the contract and can lead to suppliers issuing a creditering. The Market Alignment Framework Transparency, objectivity and measurable sourcing steering and market conform prices within a sourcing relationship can be enforced by implementation of the Market Alignment Framework Quint s vision on sourcing and performance management. On the edge of management and information systems, it is benchmarking and performance management that can add true value towards your company. 10

11 Market Alignment Framework: Standardised service catalogue for common information services to support creating volume based IS agreements. Reporting framework which enables demand organisations to audit on market conform delivery of IS. Model using key performance indicators enabling the demand organisation to steer on agreed scope, price and service levels of the IS. Cost (allocation) models that enable creating end-to-end and modular prices for the IS and composition of the IS infrastructure. Standard benchmark clauses for outsourcing contracts. Innovation agreements and clauses for improvement and renewing of the IS and IS infrastructure. Especially useful when confronted with new and unknown technologies and solutions, in relation to obtaining market-conforming prices from suppliers. Blueprint of the design and functioning of the whole Market Alignment Framework. The Market Alignment Framework provides clients with a transparent, measurable Objective steering mechanism for both internal and external IS suppliers, taking into account frame of auditing on market conformity of the services delivered. This solution provides both reference clients and suppliers with an objective reference framework, thereby safeguarding the relationship of undesirable discussions and unsuspected additional costs. Organisations get an unambiguous business case for improvements and improved qualitative and quantitative (financial) information for make or buy decisions. The Market Alignment Framework is based on actual experiences gathered by Quint consultants during outsourcing assignments for clients in multiple vertical industries and in countries around the world. In order to further enhance the ability to deliver the Market Alignment Framework, Quint Wellington Redwood has strengthened its relationship with the British Compass Management Consulting. This agreement allows Quint to deliver services from Compass to the Benelux-market. Over the last 25 years, Compass has developed an advanced benchmarking methodology and has a high quality database at its disposal. The combination of Quint and Compass enables clients to quickly identify possible improvements in their internal and external IS. One of the new, combined service offerings is the innovative Market Alignment Framework. Conclusions How can benchmarking and performance management create value for your organisation with regard to the management and information systems within a sourcing context? In order to be able to manage the tension between demand and supply, managing issues regarding failing to achieve outsourcing targets, ill-equipped retained organisations or additional costs after signing the contract, demonstrates a clear need for the following keywords: transparency, objectivity, measurable sourcing steering and pricing that is market-conforming. On the leading edge of business and IS, it is benchmarking and performance management which can provide real value. It needs to become an integral part of the management cycle of organisations. Referenties: 1 R.W.F. de Vries, Sourcing, geen overhaaste beslissing, Management Executive, 2 Source: Gartner. 3 Quint Wellington Redwood, White Paper Smart Buyer Function, December For instance based on an initial baseline benchmark to understand current levels of service performance (cost and quality) and to quantify and qualify improvement opportunities (baseline). 5 Source: Compass Management Consulting. 11

12 About the author Frank de Vries is consultant at Quint Wellington Redwood. He is specialised in advising on outsourcing, benchmarking and performance management, is co-author of the Handbook ICT sourcing for the Dutch City Councils and author of various publications in the field of performance management and sourcing. Quint Wellington Redwood: specialist IT management queries Quint Wellington Redwood - or Quint - is an organization consultancy that specializes in the resolution of management queries in the field of IT. Our people are organization consultants with a wide knowledge of IT. From eleven international offices we provide services in more than twenty-five countries. Quint clients are leading profit and non-profit organizations that rely heavily on IT. We try to achieve two goals for our clients. We provide support that results in successful information services (IS). More importantly, we help to make your business effective and successful by correctly converting information services into operating processes. This twofold mission is summarized as Creating Business & IS Results. Our slogan is Dare to Challenge. Our people constantly challenge themselves and each other to be more efficient and creative. We also challenge you about the organization of your information technology and the provision of IT services to your clients. In doing so, Quint positions itself as a service provider that is not afraid to view business from a different angle Copyright 2005, Quint Wellington Redwood. All rights reserved. No part of this publication may be reproduced, transfered and/or shown to third parties without prior written consent of The Quint Wellington Redwood Group.' Q UINT W ELLINGTON R EDWOOD AMSTERDAM ANTWERP BANGALORE FRANKFURT/ MAIN HELSINKI KUALA LUMPUR MADRID MEXICO CITY MIAMI SAO PAOLO TOKYO TORONTO info@quintgroup.com