Financial Deal Management as Key to Success in the IT Outsourcing Business

Transcription

1 IT Outsourcing Financial Deal as Key to Success in the IT Outsourcing Business Active and transparent financial deal management is a major factor for the commercial success of an IT outsourcing deal. Cloud computing is reinforcing this trend. 34 Detecon Report dmr 2 / 2015

2 I T outsourcing deals continue to be highly popular, and in this age of increasing digitalization, they are a source of lucrative opportunities for companies to weather the global pressure to lower costs and raise the added value of their own performance. The large number of service providers who put intense cost pressure on their own competitors, relying as they all do on their pricing within the framework of bid management as their primary competitive advantage, is characteristic of the IT outsourcing market. This market is highly fragmented and is split up among many small and a few large, competitive service providers. The resulting price degeneration forces outsourcing providers to calculate their bids more and more finely even though the market for IT services has continued to grow steadily in recent years.1 Current projections indicate growth of the market for IT services, but pricing restraints will limit the maneuvering room for IT providers even further. The underlying cause is to be found in the advancing transition into the saturation phase and the decline in demand for IT outsourcing services that is to be expected as a consequence. Complexity, cost pressure, and decline in demand act together and lead providers to make ambitious assumptions right from the planning stage. Early steering of fiscal effects critical for success One major factor for the commercial success of an IT outsourcing deal is active and transparent financial deal management. Risks such as aberrations from agreed service level agreements, * Pierre Audin Consultants (2014): Software and IT Services Worldwide 2014 penalty payments incurred by migration delays, or technical failures can have enormous financial impact on profitability. Fiscally relevant structures and processes which discern such risks before it is too late and issue prompt alerts must be implemented at an early stage of the deal to ward off substantial losses., says Emil Matevski, Managing Consultant at Detecon, from his longtime expertise within the Outsourcing Business. Financial deal management encompasses all phases of the deal and contains both a planning and a steering component. The traditional phases of a deal include CMO(+) (current mode of operation), T&T (transition and transformation), and FMO (future mode of operation). During the CMO phase, the IT services remain unchanged in the client s original mode of operation, and while they may be maintained by the IT service provider, no modifications are made at this time. CMO+ refers to the phase in which work packages for the transformation have been successfully completed by the IT outsourcing service provider and additional packages are in progress. After successful completion of a T&T phase, the IT services are changed over to an optimized mode of operation. This phase is called the FMO phase. The T&T phase refers to the transition from the original to the optimized mode of operation after the conclusion of the deal (see Figure 1). Within the transition phase, the takeover of employees, assets and current agreements may be affected (depending on the complexity). On this basis, the implemented operating model is migrated to the planned mode of operation in the transformation phase. Figure 1: Progression and Phases of an IT Outsourcing Deal Financial Bid Financial Transition and Transformation CMO CMO+ FMO Analysis of Business Potential Bid Drafting of Contract Transition Transformation Commencement of Transition Takeover of Operations by the Service Provider End of Transition Realization Time of Target Image Source: Detecon 35 Detecon Report dmr 2 / 2015

3 In the context of financial deal management, a distinction is made between the course of the deal over time according to financial bid management (supports the optimized structure of the quote) and financial T&T management (secures commercial transparency during the migration phase). While the cost calculation and the pricing of the deal is determined during the former, the commercial steering of the deal must be considered especially closely during the latter. Another steering function is the monitoring of the contractually agreed progress; the service provider s compliance with the timeline of the deal is mandatory. Work module Financial Bid Using the cost calculation and pricing to lay a foundation for the future profitability of the agreement requires zeroing in on a comprehensive business case especially closely, including: > Consideration of the special features of the deal in terms of structure and content; > Detailed and transparent cost calculation; > Far-sighted planning and determination of potential risks and opportunities; > Competitive pricing. Detecon has developed a method to achieve these goals which can be subdivided into the following work modules (see Figure 2). Cost calculation The goal of financial bid management is the creation of a comprehensive business case. It includes detailed cost calculation, the related sensitivity analyses looking into potential risks and opportunities, and the pricing that results. As a rule, clients expect at an early point an initial indication of the extent to which the desired cost reduction (usually between 20% and 30%) and an improvement in the quality of the IT services can be realized. A top-down calculation based on the performed due diligence produces pragmatic answers to these questions. A gross assessment of the project based on limited information about the client s requirements while keeping calculation expenditures to a reasonable level becomes possible. It builds on the client s current cost structure (cost base line) and from there determines if the service can be performed within the constraints of the planned budget and whether the targeted potential for cost savings can be fully exploited. If the result is positive, a detailed bottom-up calculation building on a technically detailed solution concept and its cost elements is performed. This requires extensive information about the planned deal such as the current IT architecture, technical requirements for the target solution, and the concrete volume. The cost calculation process begins with the preliminary work of the technical service performers: the definition and preparation of the details of the services which will be performed. Relevant information for the cost calculation includes: > Detailed concept for technical realization; > The scope and quality of the service to be performed and its expected development over the full term of the agreement; > Specification of the products and services which must be procured (hardware, software, etc.); > Explicit breakdown showing standardized and customized service building blocks. The production costs encompass all of the relevant costs required to perform the agreed service in its full technical scope. A good recommendation for the preparation of the cost calculation is to divide it into the sub-categories described below, then assign them to the various phases of the deal; this will create a structured overview. The relevant cost components in an IT outsourcing deal are production costs, administrative costs, and other expenses. A high level of standardized service elements within the planned scope of the service is desirable for achieving a high degree of precision in the cost calculation. Standardized service components (standard delivery elements) that reflect predefined costs for specific services are utilized for this purpose. The total costs can be determined by compiling the required service components from the full catalog. In the case of technically individualized solutions (non-standard services) tailored to meet client-specific requirements and 36 Detecon Report dmr 2 / 2015

4 circumstances, the costing manager must work closely with the technical departments to determine the various cost drivers and their related production costs. Furthermore, the consistency between the technical solution and its matching commercial application is reviewed as part of quality assurance. A plausibility test of the assumptions that have been made and the parameters that are being used serves this purpose. Risk management The risks of both technical and commercial nature that are incorporated as highly significant factors into the business case can be anticipated in advance of an IT outsourcing deal. The probability of their occurrence and their possible commercial impact must be quantified in close consultation with the technical experts. Possible measures that can reduce or even exclude such risks must also be determined and assessed. Technical risks shown by experience to occur frequently include, for instance, a migration phase that is too strictly oriented to schedules and consequently overly optimistic. In most cases, the progress of the migration proves to be more challenging than expected owing to unforeseeable peculiarities and technical complexity; project delays are the result. A lack of cooperation on the part of the client or other service providers involved in the project as well as non-compliance with service level agreements are other potential sources of risk. Contractual adjustments and incorrect issue of invoices are classic examples of commercial risks which can appear in an IT outsourcing project. Pricing Determining a profitable and competitive price requires both the use of overhead calculation and competition benchmarking. Overhead calculation adds a lump-sum margin surcharge to the determined costs. The competition benchmarking involves conducting a market analysis according to defined quality and performance criteria as a means of determining the market price that is then used during the pricing process. Business case consolidation and quality check The pricing, the cost calculation, and the identified risks are consolidated to create a consistent business case that is then subjected to a financial stress test to check its quality. These steps ensure that any gaps in the consolidated business case are identified and that the conclusion of an agreement will lead to the profitable implementation of the IT outsourcing agreement. Figure 2: Work Modules in Financial Deal Contract Closing Modeling Profitability assurance Contract and Claim Financial Project Closure Financial Bid Costing Risk Financial T&T Financial True-up Quality Check Risk Assessment Pricing Reporting Ordering and Charging SAP Implementation Source: Detecon 37 Detecon Report dmr 2 / 2015

5 Work module Financial T&T During the T&T phase, the financial deal management s attention must be directed at the following aspects to secure successful project management from a commercial perspective: > Creation of a deal-specific controlling and reporting structure; > Coordination and implementation of the order-to-cash process; > Continuous deal controlling, including creation of forecasts and comparison with business case; > Strict risk, contract, and claim management. Within the framework of the financial T&T management, the primary focus is on the creation of a tailored controlling and reporting structure as well as its actual use. The process from receipt of the order to the issue of the invoice ( order-to-cash process ) must be coordinated and implemented with the client and any other relevant service providers/ partners so that the achieved revenues are realized and posted. Comprehensive project controlling from the commercial standpoint is secured by regular reconciliation of the business case, the forecast, and the actual values with one another. The reconciliation contrasts the anticipated business case and forecast values with the realized financial figures and determines any deviations which have appeared. A detailed appraisal of the potential risks and opportunities and of their financial impact is performed as well. A transparent cost structure for project management can be prepared on the basis of traditional work packages during the migration phase; project management office and rollout management are examples of such packages. The first step is the allocation of the proposed migration budget among the required work packages. During the course of the T&T phase, care must be taken to ensure the incurred project costs are concurrent with the targeted milestones and the corresponding degree of completion of the entire contract. The degree of completion of the milestones must be tracked using defined, measurable KPIs. Actual cost developments should be questioned at all times and, if necessary, adjusted in the forecast so that aberrations and risks can be discovered as early as possible and the appropriate countermeasures can be initiated. The regular reconciliation must be incorporated into a standardized reporting process. This coordination among all of the involved parties can be discussed at regularly scheduled points during daily business. Under the challenging conditions of today s market, structured financial deal management is the only realistic path to optimization of profitability of an IT outsourcing deal. Cloud computing accelerates dynamics and sharpens the focus on financial deal management Cloud computing is regarded as one of the greatest accomplishments of the present. Users have been calling for the dynamic procurement of IT resources oriented to consumption for a number of years. Dynamic procurement opportunities have been offered by providers for several years, but owing to the limited supply, little use has been made of them. The most important topics here are virtualization of IT structures and IT security. Virtualization has a positive effect on costs and enables optimal capacity utilization of the infrastructure while high security standards can be assumed for its provision. The security aspect in particular has a very high priority and offers opportunities for product differentiation. The unabated trend to digitalization continues to progress so that virtually every company form regardless of size, industry, and legal form will eventually fall back on digital services. It must be assumed that cloud computing will be accepted to a far greater extent and that it will have a long-term effect on the business models of IT service providers in the near future. Even today, many outsourcing deals contain dynamic contractual elements. This trend will lead to the inclusion of more and more flexibly designed components and to substantial changes in the financial risks of IT service providers. 38 Detecon Report dmr 2 / 2015

6 The competition among the providers will continue to be waged in price wars. The extremely low margins in the price calculations will force providers to rethink their internal processes and business models. The adaptation of internal business processes simultaneously includes the implementation of innovative services with attractive market potential and requires even stricter financial management. This in turn generates additional and profitable revenue sources and could, if incorporated quickly into the service portfolio, result in long-term competitive advantages. Kiritharan Gangatharan, is Consultant at Detecon since He advices clients of the ICT industry on the subjects of Financial, Innovation and Business Process. Dino Hadic is Business Analyst at Detecon. His consulting activities focus on ICT and Financial. His current range is a strategic transformation project for an international ICT Provider. Emil Matevski, Expert for Financial Deal, evaluates the current market situation as follows: Anyone who is unable to respond in timely fashion and who has not built up structured financial management will ultimately fail in continuing to operate profitably. It logically follows that every company should examine the added value of financial deal management when concluding IT outsourcing agreements and not hesitate to exploit the advantages offered by outsourcing opportunities. 39 Detecon Report dmr 2 / 2015