OUTSOURCING CENTERS OF EXCELLENCE

OUTSOURCING CENTERS OF EXCELLENCE Observations on the Current Market Practice for Outsourcing CoEs An ISG Research Report Cynthia Hollandsworth Batty, Director, ISG, and Dianne Smock, Partner, ISG www.isg-one.com

OVERALL OBSERVATIONS ISG has performed a study of a group of twelve companies who have implemented what we refer to as an Outsourcing Center of Excellence (CoE) business management model for governing multiple service providers. This multisourcing governance model is typically characterized by an enterprise management organization charged with driving sourcing strategy, maintaining standards around sourcing contracting and sourcing lifecycle, aggregated enterprise reporting through a Balanced Scorecard for Sourcing, and advising and training the organization at large as they need support and help with their sourced services. We believe the study provides both a valuable point of comparison for the participants current state CoEs, and some guidance and thoughts for how other companies might consider shaping and developing their own CoEs in the near future. CoEs report to C-level executives, regardless of the size of the outsourcing spend (which is often less than might be expected); nearly half of the companies had a total annual contract value of less than $500 million, and more than three quarters of those had Annual Contract Value (ACV) less than $100 million While it is difficult to ascribe statistical significance to the exact percentages, CoEs we studied tend to report to CIOs (a third), and COOs (half) There are also CoEs reporting to CFOs and CPOs, generally in organizations with more than one CoE All CoEs have Application Development & Maintenance (AD&M) in their purview, and three quarters had both information technology outsourcing (ITO) and business process outsourcing (BPO). While most CoEs reporting to CIOs had an IT focus, there was one example in a financial services company of a CIO s CoE that had jurisdiction over BPO functions (which we found to be related to the role of the CIO in the organization the company had a substantial strategic reliance on IT CoEs don t solely drive contracting activities; while all do that (and nearly all are involved with contract change management), they tend to play strategic, policy, and guidance roles in most companies we studied Most CoEs have a clear division of responsibility and constructive relationship with Procurement and in the business units, with Contract and Service Delivery Management CoE positioning within organizations has been in a state of flux. Half of the companies we studied had changed the reporting line of the CoE in the past 18 months, and of these the split was about even between raising it in the organization, lowering it or laterally moving it. We hypothesize that these movements have to do with the newness of the CoE management function. OBSERVATIONS ON OUTSOURCING CoEs CYNTHIA HOLLANDSWORTH BATTY & DIANNE SMOCK 1

What is Governance? Is it Valuable? The respondents were very consistent in their statements about governance, if general in their language: Governance is essential to ensure we receive the services and value we contracted for, and that we manage our operational and sourcing risk Governance is split into two facets: The operational and day-to-day, which is performed by the Business Unit or Service Delivery organization The strategic and contractual, which the CoE has responsibility for Governance has both tactical and strategic aspects, both of which are important Governance involves establishing and maintaining control, consistency, quality, and value; and in their organizations the CoE is the control tower for these standards and policies All of the companies we studied felt the governance function provided by their CoEs added business value and helped reduce risk. But several commented that they had not yet quantified the CoEs value; this is a recurring issue across the industry as organizations work to justify the CoE governance role to internal skeptics. Outsourcing policy and regulation was mentioned frequently by financial services respondents as a driver of CoE establishment. While the insurance industry is somewhat less regulated than banking is today in the US, it seems clear that this industry will be swept up with other financial services reform in the next few years, and will find that the auditing of outsourcing standards and policies, and adherence to those rules, will be critical in the future and necessitate CoE establishment and proper management. Functions Performed by the CoE Most CoEs provide full lifecycle consulting and process, strategy, reporting, and contracting support. However, some individual companies include functions in the CoE which, while atypical, are reasonable extensions of the organization. These extensions run into provision of services often associated with Shared Services organizations. For example, we see some CoEs that have formal Program Management and Project Management functions, above what we would normally expect for the overall governance of multiple service provider engagements. In other cases we have seen a centralized invoice validation process (and an associated relatively large headcount) which brings significant value to the organization. In companies where facilities are important, the management of the facilities may also fall under the CoE, again like a shared services structure. The CoE should not be limited in its scope or services to an arbitrary or abstract notion; each company needs to set its own requirements and create its charter accordingly. As the CoE evolves, updating the charter in a formal way can be a tool to communicate to the executive the need for greater staffing resources or changing skill sets (which may also have budgetary implications). People and Skills for the CoE Our results show that while there are a wide variety of roles that appear in these organizations, the most consistent are 1) an overall executive, 2) a strategic team acting as the outsourcing advisor (which will strategize, consult to the organization, perform program and project management, and manage the aggregated reporting), 3) some contracting management and/or administrative capability, and 4) some financial analysis capability Each CoE has its own charter that defines that organization s unique relevance to its own company, and so further CoE roles tend to significantly individualize; in addition, in very large outsourcing situations there tends to be a higher concentration of administrative and metrics management staff. ISG has a wealth of material that defines the optimal traits of the staff of a Center of Excellence and the general governance team; in practice, we find our clients CoE teams conform to our models. The table below provides a high-level view of the capabilities needed for CoE outsourcing advisor roles. Nearly half of our study s respondents reported that they had staff that were serving three years or longer in the CoE role. The rest a majority of staff were serving 0 to 3 years which is useful when thinking of the potential tenure and turnover of staffing in this function. Though some members of a CoE team may elect to be involved with the management of sourced services as a career, we have observed a prevalent practice that for most roles clients treat the CoE as a way station or check box for career development for staff members in areas with sourced services. In this way, the thinking and approach of correct governance and service management is disseminated throughout the organization in an organic way. OBSERVATIONS ON OUTSOURCING CoEs CYNTHIA HOLLANDSWORTH BATTY & DIANNE SMOCK 2

Attribute Deploy multiple management styles Build trusted partners Demonstrate commercial acumen Understand what, not how Possess significant powers of persuasion Display capability in coalition building Demonstrate genuine business unit empathy Act as an informed buyer Description Understanding the use of collaboration, value generation, and so forth depending on the stage in the relationship Able to proactively work with service providers to establish them as trusted partners Able to view technology decisions in the context of commercial value/business benefits to the company rather than the elegance of the specific technical design/approach Able to focus on the what needs to be done rather than how it should be done so that attention is on the significant issues affecting the company s objectives Able to achieve objectives through persuasion rather than direct control of large numbers of resources Capable of building, directing and driving coalitions of multiple parties with potentially disparate interests Able to build significant trust and confidence with the business units being served or affected by the services Able to balance technical knowledge with market awareness to know what you are buying for the company as expressed in the agreement Specific hard skills needed for employment in a CoE managing higher-level governance and contract support for multiple service providers can be quantified somewhat by role; however in actuality most roles need most capabilities. Attribute Relationship Management/Outsourcing Advisor in CoE Financial Management Contract Management Description Experienced, big picture person Comfortable with what not how Comfortable with ambiguity and solving multiple complex problems Skilled in negotiation Strong project and program management skills Analytics skills and business reporting capability Risk taker Firm but fair, seen as an honest broker Good listener Control oriented Broad based business experience Integrity fiduciary responsibility mindset Detail oriented Organizer Strong negotiation skills Strong project management skills Legal mindset Good writing skills OBSERVATIONS ON OUTSOURCING CoEs CYNTHIA HOLLANDSWORTH BATTY & DIANNE SMOCK 3

To contrast some of the new skills required when an organization outsources, the table below shows typical activities and skills for in-house services, and for the same work when it is outsourced and on the far right column calls out the new skills required for this role. The skills required to manage an outsourced activity vary from a retained activity. These skills should ideally be part of the DNA of a CoE s staff, so that that staff can better train and advise the outsourcing organization. Managing In-house Services Managing Outsourced Services New Skills and Abilities Detailed technical knowledge critical Technical knowledge important but not critical Understanding what is important to know, and what the service provider can be depended on Personally solve problems; solve today s problem Personal execution of work Respond to demand Communication primarily to users and to manager Respond to user needs and occasional conflict Verbal and email communications Manage department budget Deliver services to best of ability Manage problem identification and resolution with service providers under terms of the Agreement Persuasion and Relationship Management skills and contract management skills to cause service provider to perform work Forecast and manage demand through Service Providers Communication in multiple dimensions: user community, service providers, and business stakeholders, all of whom will need different treatment Manage conflict that will arise between users and the service providers Develops and distributes formal written communications as needed to the service provider Understand total sourcing budget across the engagement Manage metrics and performance reporting; analytic and documentation skills to know Attuned sensing network to get ahead of the curve Ability to gauge importance of various issues and focus on key areas Persuasion skills Contract understanding what are the levers and how to apply them Ability to delegate Forecasting skills; ability to manage conflicting demands Comfort with ambiguity Ability to predict from scant data Become a trusted partner to many stakeholders Ability to keep message consistent Ability to deliver bad news Heightened sense of fairness Ability to advocate for both internal and external parties Ability to arbitrate Insight into what should be documented formally and retained as a corporate record Skilled in the nuances of communication Deeper financial and budgeting skills Commercial acumen to understand the deal and not just the cost Ability to translate data into information Focus on root cause rather than single event OBSERVATIONS ON OUTSOURCING CoEs CYNTHIA HOLLANDSWORTH BATTY & DIANNE SMOCK 4

Size of the CoE One of the most frequently asked questions in outsourcing governance is how large the organization should be and of course, it always is dependent on the size of the sourcing, the complexity, the place in the organization it is managed, what is retained, and so forth. However, in this study we were able to compare for the responding companies the number of people in the CoE to the amount of annual contract value under management. The table below shows these findings; for $1 billion in spend and under, the financial ratio was $15 million per person on average; for companies with more than $1 billion in spend, the average was $38 million per person. As a note of caution, this calculation does not include the staff retained to manage the services at the business unit/line of business level. In $1,000s $15,190 Average $1B and under, per person Looking Ahead for CoEs $38,941 Average $1B and over, per person Organizations change their expectations of the CoE frequently often month by month, as events unfold and occasionally overtake in the sourcing relationships. The most important attribute for the CoE of the upcoming decade is that it be ready to change as often as the environment requires, to meet the needs of the organizations and (as importantly) the service providers who serve them. Technology evolution, geopolitical changes, and proportions of services sourced in the company will all exert significant and immediate influence on the role and staffing of the CoE. When ISG works with companies developing outsourcing CoEs, we are focused on creating internal capability for consulting and analysis. As the CoE matures, growing knowledge, capability, and resourcefulness as an internal capability to address the complexity of multiple service provider enterprise engagements, it can take on tasks that in less mature organizations require the use of consultants. A mature and experienced CoE can focus on leveraging external market expertise in areas where external knowledge and data are essential hence making more effective use of the investments in both services and governance capability. Centers of Excellence are becoming prevalent in clients with multiple service providers. In the industry at large, the relative importance of the CoE compared to other management functions (such as procurement or a CFO organization, for example) is not yet generally accepted wisdom - so acceptance tends to rise and fall on events. When things are going smoothly, organizations tend not to focus on growing or enhancing their CoE and skills; a maturing management discipline, CoEs have not found a solid place as yet in the general management hierarchy of organizations. The absence of this core strength can lead to inconsistencies in some key management areas, such as management reporting, which in the great recession seems regrettable as companies struggle to find and save every dollar. CoEs need strong executive support to assert and reinforce the value that management reporting brings to the company in the form of controlled spend, discovery and correction of value loss, not to mention mitigate outsourcing risk. Organizations can begin to think of the CoE as performing a consultative function analogous to that of the human resources department advising and supporting executive decision-making at an enterprise level. Regardless of where the CoE reports (IT, Operations, or CFO) the functions executed have to be done somewhere, and it appears to be an emerging market tendency to coalesce these functions to report at the C level. From this position one can better maintain and preserve the roles of setting governance standards, supporting the business units with contracting, and effectively performing consolidated reporting of both service provider results and the state of internal sourcing management maturity. While CoEs are part of the IT organization at least a third of the time, they move both into and out of the CIO organization, and changing reporting structure over time is nearly the norm for CoEs in any case. The reporting structure of any CoE can reasonably be expected to change every 18 months, based on our respondents comments. In our view this phenomenon is less important than the larger matter of the preservation of the capability and the influence of the CoE in the organization at large. OBSERVATIONS ON OUTSOURCING CoEs CYNTHIA HOLLANDSWORTH BATTY & DIANNE SMOCK 5

Respondent comments: [Our CoE is a] collaborative partner with business to provide solutions at a cost effective rate in a standard manner to minimize risk... Got a perfect audit! This is the remit of the CoE, focus has been cost, labor arbitrage, now changing to broader value view including productivity, innovation etc. beyond cost, more focus on transformation. As the overall spend on third party sourced services and the strategic significance of these services to the overall enterprise continues to increase, there will be an increasing requirement to invest in management and oversight of these functions, which companies today are finding valuable in both tangible and intangible ways. The investment question for management might be: at what pace does the company wish to continue evolving its outsourcing governance capability? To fully distribute the function into multiple organizations at some point would be counter to market trend. The challenge is to balance the investment required to maintain and enhance this capability, and at the same time realistically consider the active needs of the company s business units/lines of business today. On this last point, companies would be well advised to periodically survey their stakeholders for their perspective on the function, the value, and areas of opportunity. Near-term technology changes will require even more intelligent and capable management and leadership from the CoE. During a recent ISG industry event, the Sourcing Leadership Exchange, an ISG leader stated that cloud computing will have a corollary need; as he put it, governance on steroids will be required to deal with the complexity, security, risk and value issues raised by this important technology evolution. Increasing fragmentation, the likelihood of service provider consolidation, and challenges in securing funding for BPO engagements during the recent economic turndown will present continued challenges that will need thoughtful and responsive enterprise-wide management. Finally, as IT hardware and software manufacturers continue the trend of merging with major service providers, the hardware and software vendor management organizations inside the company will need to find a way to collaborate more with the CoE and with Procurement to ensure that the company can maximize leverage with these key, multifaceted service providers. This is a substantial upcoming trend that we are observing in our marketplace. OBSERVATIONS ON OUTSOURCING CoEs CYNTHIA HOLLANDSWORTH BATTY & DIANNE SMOCK 6

KEYS TO SUCCESS Cynthia Hollandsworth Batty is a Director and Dianne Smock is a Partner with ISG. Contact the authors at cynthia.batty@isg-one.com and dianne.smock@isg-one.com. Information Services Group (ISG) (NASDAQ: III) is a leading technology insights, market intelligence and advisory services company, serving more than 500 clients around the world to help them achieve operational excellence. ISG supports private and public sector organizations to transform and optimize their operational environments through research, benchmarking, consulting and managed services, with a focus on information technology, business process transformation, program management services and enterprise resource planning. Clients look to ISG for unique insights and innovative solutions for leveraging technology, the deepest data source in the industry, and more than five decades of experience of global leadership in information and advisory services. Based in Stamford, Conn., the company has more than 700 employees and operates in 21 countries. For additional information, visit www.isg-one.com. 022812 Copyright 2012 Information Services Group All Rights Reserved