Engaging with the Market to Leverage your Buying Power - Full Notes

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Engaging with the Market to Leverage your Buying Power

Walter AdamsonDigital Investor Pty [email protected]

Advanced IT Contract Management and Negotiation Conference, November 2003

Profile Walter AdamsonWalter Adamson is the founder and principal of Digital Investor – a Melbourne-based consultancy. Walter’s skills lie in augmenting the strategic thinking and implementation capacity of his clients, with a focus on IT services.

For IT service companies he helps drive business portfolio redesign and alignment to deliver customer value commitments and superior partnering programs. For CIOs he helps develop the commercial maturity of their company's IT strategy with a focus on business-IT alignment and more effective provisioning of IT services through strategic sourcing.Prior to establishing his consulting practice, he was the business architect of BHP Information Technology -where in 1989 he founded and led the Systems Integration business unit.

In 1999 he was asked by BHP Billiton, a global US$19b resources business, to architect a new IT sourcing strategy for the next decade – despite the fact that the company controlled the largest Australian-owned IT services business with 2000 employees. Based upon Walter’s new strategy for the next decade BHP IT was sold to Computer Sciences Corporation in 1999.

Walter is an Associate of George Hara of Defta Partners, a visionary global investor in early-stage ubiquitous personal communications ventures, and is a Director of Defta (Australia). He is also an Associate of MTGP Group, based in Edinburgh, a leading strategic advisory and operational management group for digital media and enabling technology ventures.

Walter holds a BSc in Mathematical Statistics, an MSc in Computing Science, has several Australian patents, and attended the Advanced Management Program at the Mt Eliza Business School. He was a founder of the EDP Auditor’s Association in Australia. He recently received a “Friend for Life” Award from Berry St Victoria for his contributions over more than 20 years.

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©2003 Walter Adamson

Enhancing alignment and value for IT investments

Contents

� Strategic Sourcing – what does it mean?� What factors influence the decision-making

process?� Assessing different models for streamlining

buying and effectively structuring procurement� Effectively managing risk while delivering

business value and constructing back-to-back deals

� Expanding the sourcing options to include offshore in-house.

The slides cover the first two items in relative depth, and then introduce a model for assisting in steamliningand structuring procurement in some detail.

In the ‘managing risk’ context I discuss just one key issue of back-to-back contracts, but since this one issue arises from a recent very significant court judgement it is a very significant single issue to bring to your attention.

Finally, I wrap up with an explanation of the option of selecting an in-house off-shore option to complement other outsourcing choices.

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Strategic sourcing – what does it mean?

�Strategic sourcing requires a new question �Tactical sourcing is inefficient, and often

ineffective�A common cause for current disappointments�Future sourcing will be more complex

1.1

IT outsourcing is approaching second and in some cases third generation experiences for companies, and yet in some ways the decisions have not progressed beyond the types of purchasing-driven and cost-driven selection processes of the first rounds.

It has been considered good practice to specify mutually-agreed upon deliverables and metrics across a multi-year plan. If service providers met or exceeded the metrics it was considered to be excellence. However in a changing world of relationships and business dynamics those static agreements and relationships can no longer deliver, and this is placing stresses on both customers and outsourcing providers alike.

The future of outsourcing lies with contracts and relationships build from core strategy, and with provisions for change and innovation while maintaining the integrity of the business value for both parties.

The era of tactical outsourcing has come to a close, and in fact in retrospect it is not hard to see that much of this tactical-driven outsourcing has been inefficient and ineffective. We will discuss the reasons for this in more detail later.

Looking back, and not necessarily with hindsight as this has been a known issue from day one, there is one issue that stands out behind the cause of many of the disappointments in outsourcing. This common problem stems from the lack of intent and capability of the client company to effectively staff and manage the relationship with the service provider. However, the cause is not one-sided, and we will discuss this in turn.

Whatever the past of outsourcing, and the successes and failures, the future will be more complex. The relationships will be more complex, the services more intertwined between the customer and supplier, the breadth of contact across the customer’s organisation will be wider, and the success of many key operations of the customer’s business more dependent on the service provider’s performance. All this, and not even to mention the irreversible trend to global sourcing and partnering, with its added complexities.

The added complexities make it all the more important that organisation’s adopt a strategic approach to IT sourcing.

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Strategic sourcing requires a new question

Gartner - 30% of companies are unprepared

“What is the best source for every IT service” NOT “What do I have in IT that

seems appropriate for outsourcing”

“What is the best source for every IT service” NOT “What do I have in IT that

seems appropriate for outsourcing”

1.2

Tactical outsourcing is framed around questions which are IT-centric, whereas strategic ITsourcing is framed around questions that are business-centric.

Perhaps counter-intuitively, there tends to be an expectation on the part of tactical-outsourcing clients that the service provider will take the lead in understanding and delivering IT value. On the other hand, strategic-outsourcing clients know that they have to take this lead. I brand this counter-intuitive because the tactical-outsourcing clients often retain more IT skills in-house than the strategic-outsourcing clients, and the former often claim that many aspects of IT are too important to outsource yet they fail to deliver real business value from those they keep or those they outsource. This, in a manner, points to the mental challenge of crossing the bridge to the acceptance of full strategic outsourcing.

In this latter respect Gartner, in recent reports, has said that it believes that some 30% of companies do not possess the management skills and competencies to handle the more complex and more strategic outsourcing that will be required in the near future.

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Tactical sourcing is inefficient and often ineffective

�Bottom-up view of the role of IT�Often aided by IT’s reaction:

– IT efficiency-focused in fear of CEO/CFO– Over-segmented and fear of loss of control– Often aided by ‘advisors’ who generate work

• Complicates relationships• Hidden management costs

1.3

Tactical IT outsourcing is characterised by two extremes. At one end we see the division and dissection of IT services into functions and activities that are then put to the market one by one and case by case. At the other extreme we see the complete whole-spectrum of an organisation’s IT needs, from consulting to applications development, to operations, and even combined with other vaguely similar organisations needs, put out to one service provider.

Neither of those extremes can be logically successful as a business strategy, yet they are not uncommon. The latter approach was infamously the one taken by the Australian Government in its outsourcing binge of the late 90s.

The route of tactical outsourcing does not mean that the initiating decisions have necessarily been taken at a lower level. In fact many have probably been taken at a CEO or CFO level, but nevertheless they can still be knee-jerk and fad-based, and without having any real understanding of the alternatives and IT options for their business. For example, these C-level executives may have been sold on the idea by a good service provider, but where the motivation of the service provider’s sales goals and rewards did not match with the longer term needs of the client. When such decisions are reached without real input and business advice from the IT group, the natural reaction is for them to scan their operations for ‘candidates’. At the same time they will also tend to over-segment the operational services in a kind of means to ensure that some part of the operation survives. They can also readily make the systems architecture and relationships and technology seem complicated enough, and the risk of failure sufficiently high, that the higher level executives back away from bigger plans and accept partial tactical outsourcing.

The irony of such segmentation and of tactical outsourcing is that it involves many relationships with and between many service providers in order to coordinate the total service. For example segmentation into desktop support, and server support, and enterprise systems support, and network support requires complex and costly management which all stems form a organisational view of the IT department and not a business-value delivery view of IT services. The point of the irony is that if a client has not learnt to manage one relationship successfully then how they can expect to manage many successfully from day one?

Because this tactical approach requires many contracts and multiple negotiations and difficult interfaces it is also a boon for advisors and consultants. This work is tactical, it is work that can be reused across many clients, and there is a large portion of ‘grunt’ work that does not require business value add or strategic thinking from the consultants and advisors. That said, there are many advisors who know better, but yield to their clients and make accept the revenue stream generated by tactical outsourcing.

Finally, in reviewing tactical outsourcing as a potential cause of missed expectations, the cost of managing such programs is often hidden within the accounts and departments of the client organisation. It is not at all inconceivable that such costs would exceed 20% of the contract value if they were correctly identified. The costs on the service provider’s side are also higher than for one larger strategic relationship. Consider the Pharmaceutical industry where outsourcing has long been practiced: in 2003 survey 64% of firms said that their outsourcing management costs were now below 10% of the total contract values. Five percent said that their costs exceeded 20% of the contract values. IT outsourcing client’s, in my observation, claim that their management costs are a small fraction of those from the pharmaceutical companies, but there is substantially more reason to believe the pharma companies’ figures because of their outsourcing history and experience.

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A common cause for current disappointments1.4

The single most common mistake is that organisations did not identify, and then

build and retain, the strategic, management and complementary

operational skills needed to create and capture the potential benefits of

outsourcing.

Walter Adamson

Whether an outsourcing project has been driven strategically or tactically, not identifying and recruiting and retaining the right combination of in-house skills is the biggest mistake made by clients, sometimes aided and abetted by short-term thinking on the part of service providers.

The service providers think that will retain more power and control by encouraging their clients to reduce the number of staff retained inhouse by the client. But in the longer-term this always backfires. This is because the service provider later finds themselves on the wrong side of changing expectations from the key business users without having a internal buffer or group to assist in managing those expectations.

Clients, starting from tactical cost-cutting motivations, naturally see the retention of extra in-house staff as extra and unnecessary cost going ‘against the point of the whole outsourcing exercise’. It is often poorly explained to clients that the “retention of staff” exercise is not about preserving the IT department as it was. It is about building a strategic IT capacity, along with a sourcing management capability which combines a broad range of cross-disciplinary skills. The vast majority of current IT staff will not be suitable, and new people will need to be recruited and placed in the new unit to build a strong cooperative relationship with the service provider.

The single biggest risk in outsourcing, to shareholders, is that a client does not understand and does not build a strong internal new management capability to work with the service provider. This group, plus the re-formed IT group, have to take prime responsibility to identify and oversee the delivery of IT value – through the service provider.

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Future strategic sourcing will be more complex

Strategic sourcing is a growth industry:� US$68.5b business growing to $100b in 2007� More knowledgeable buyers� New pressure for growth and innovation� BPO a new global growth market� Offshore in more complex forms

→→→→ More complex, cross-functional relationships

1.5

Although outsourcing, and offshore outsourcing, are the subject of debate and argument about their effectiveness, there is absolutely no doubt that the trend is growth and the industry is a growth industry. In that case, the arguments would seem to be more within the IT industry itself, since CEOs and Boards, from all reports, are committed more than ever to more outsourcing.

The future, towards strategic sourcing, will be built not only on the back of some missed expectations from past performance but also on the back of those lessons learnt. Buyers are now more knowledgeable and there is some shift in power from the service providers to the buyers.

However something new, and for which there is little prior experience, is that sourcing from the CEO level is being pushed to go far beyond cost-cutting and to now be used as a vehicle to enable build growth in top-line revenue and in business innovation. This latter is particularly tricky and troublesome under the style of tactical contracts that have been used in the past. It is not clear how to build innovation into outsourcing contracts without severely disadvantaging the service provider, and not clear how to reward cost-saving initiatives from the service provider. One solution is through a jointly funded innovation review group, which I will not cover today but which is the topic of a paper on my website entitled “How Innovation can be Built Into Outsourcing”.

Growth in the BPO demand, and the increase in cross-functional and value-chain oriented outsourcing, and the move to more innovative offshore outsourcing, are all trends which support a clear case for the future of outsourcing being bigger and more complex than the past. To cope, requires equally comprehensive and thorough thinking, in response.

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Factors influencing decision-making

Three key dimensions:

�Business-level decision-making�New organisational models – outtasking�Extended options – going global

2.1

In this Section 2 we discuss some of the major factors which influence the decision to outsource and in particular the trend towards strategic IT outsourcing.

Firstly, more future decisions about outsourcing will be made and executed at a business-level, not a departmental or IT-only level.

Secondly, new organisational models, such as the networked organisation, will be enabled by effective outsourcing.

Thirdly, decisions will be influenced by the wider choices in going global for outsourcing solutions.

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Business-level decision

Benefits from the tactical approach exhausted:� Cost , competencies , assets � Focusing on contract yields no benefits

Future requires holistic strategy:� Improve business risk, value chain, EVA� More cross functional and “extended enterprise”� Deliver value as a strategic management tool

2.2

The business benefits of tactical outsourcing are beginning to fade. The costs have been reduced, access to competencies in some core technologies improved, and assets moved off the books.

From here on in, focusing on the details of the contracts, and the excessive number of contracts, will not yield business benefits that are aligned with the future business direction. The savings from tactical outsourcing have been made, and the costs of running tactical outsourcing are coming to light.

The direction towards strategic sourcing needs to get back to basics which are know but have not been implemented. These principles have remained consistent and relevant and need to be bought to the table again: (1) IT sourcing polices need to be set strategically, (2) Sourcing trade-offs need to be analysed holistically across the enterprise, and (3) Service provider management needs to be cross-functional and expert in their field.

(See my 2-page IT Executive Insight “When Will Outsourcing Grow UP” on my website.)

By adopting these principles clients will improve their management of business risk, and improve service across the value chain, and also be able to focus their investments in areas which yield a substantial increase in, say EVA, as against investing in support or content functions of the organisation. The value delivered through strategic IT sourcing will then contribute to an intrinsic organisational strength, which will in turn (as a secondary effect) enable the organisation to more effectively compete and serve its customers. This is all very high-sounding but the point is that these words have some meaning in a business context and they bring focus onto the fact that many of the past approaches to outsourcing cannot bring benefits at this level.

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New organisational models

Most advanced thinking is Cisco’s ‘outtasking’:� Extending the organisation ‘deeply’� Cisco holds the keys to the overall data

architecture and systems interfaces� Clear thinking about the customer value chain� Clear thinking about core and non-core� Sophisticated alliance relationships� Clear performance metrics

2.3

John Chambers, CEO of Cisco, has spoken out about ‘out-tasking’, framing a new word to escape the stigma of outsourcing. A new word is useful to create fresh thinking. The essence of the difference between outsourcing and out-tasking is that out-tasking means that clients “maintain control over the strategy and implementation, and their out-tasking partner executes on it”.

Crucially, because Chambers is so passionate about his supply chain, the out-tasking client remains completely in control of the overall strategic systems architecture and the data architecture.

The out-tasking partner has to operate to the common data architecture – this is one critical key to being able to achieve productivity and profit business goals in multi-source out-tasking relationships.

Chambers explains: “The company of the future is the networked virtual organization that retains work associated with its core competencies and out-tasks contextual work to trusted partners. But out-tasking is not outsourcing—it requires that the company retain strategy and control implementation. And it requires standardization of data and network systems, and the partners have to be ready to embrace it.”

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New organisational models - 2

Key concept, mission critical can be outtasked:

2.4

Non-mission-criticalMission-Critical

Out-task – Type 2In-houseCORE

Contract SourcingOut-task – Type 1CONTENT

Sourcing and Implementation Strategy

This is how Chambers then moves to identify which functions should be kept in-house and which functions are candidates for out-tasking:

- Look at what your sustainable competitive advantage is, can call it “core”;

- As for the things that other people can do better, call them “content”.We then add the dimension of mission-criticality.

For mission-critical functions that are not core the objective is to move to Type 1 out-tasking, meaning the most rigorous implementation of shared strategy, objectives, risk and dependencies. Type 1 out-tasking is focused on superb operational capabilities and relationship management skills – a strong outsourcing relationship.

Type 2 out-tasking also must be executed with exceptional skill, since it supports core functions, but here the emphasis may not be on operational excellence. It could be on customer intimacy and product/service innovation, where, for example, these are not considered to be mission-critical core functions. For Type 2 out-tasking the relationship is sometimes characterised as ‘partnering’ as compared to the outsourcing relationship of Type 1 out-tasking. The difference is more a question of relative priorities, and how the out-tasking relationship is measured.

“Contract sourcing” refers to a performance-based commodity-resourcing contract.

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Extended options – going global

The global options cannot be ignored:�Moving from tactical to strategic�Moving up the value chain�Moving across functions - BPO�Rapidly improving offshore capabilities�Not restricted to 3rd party outsourcing

→→→→ More complex, cross-functional relationships

2.5

The final factor which will play a bigger role in influencing future decision-making is the offshore option.

The offshore outsourcing debate is unfortunately imbalanced because of the current poor state of employment in the IT industry. If the industry was over-employed, such as in 1999/2000, the use of offshore resources would be applauded as a sensible way to keep up the moment of delivering productivity improvements.

If we take that perspective, we can see that the current debate is centred on fear and anxiety, whereas the real questions for which a solution is needed is centred on business (and national) strategy.

The Australian Computer Society has expressed alarm about the outsourcing trend to India, and fear for the future of IT graduates and jobholders in Australia. It has also expressed considerable concern about the lack of core IT industry development and export capacity within Australia. I disagree with their former stance and I agree with their latter stance.

But in fact these two positions taken by the ACS, and others, should be seen as connected. They are connected because the lack of clear differentiation and ability to create wealth from world markets does make Australia more vulnerable to cost and skill-based competition from other countries.

The trend to outsourcing is not going to go away. There is every sensible reason to suspect that it will and should increase, in order to deliver cost-competitive and innovative new solutions to business. Australia's challenge is to define our role in the value chain of supplying IT services to deliver business outcomes.

Whatever way the debate swings, the need to get on and manage the more complex relationships, and perhaps the more complicated politics, remains and is increasing in importance.

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Assessing different models for structuring procurement

ManagementManagement BenefitsBenefits ROIROIContractContract

3.1

The funnel is often the other way around!

In some outsourcing arrangements the contract seems to become the overriding focus of the client. In this case then the contract must also become the focus of the service provider, resulting in attention diverting from the real objective of delivering value.

Of course, there are times when the relationship breaks down and contracts are pulled out of drawers and fights start in earnest. But this should be the exception rather than the rule.

When outsourcing is approached tactically the contracts tend to take a bigger role than when approached strategically. For one reason this is because the number of contracts and relationships in tactical outsourcing are greater than in strategic outsourcing. In strategic outsourcing there is also a view to the longer-term and a higher-level desire to focus on the big picture.

One of the aims in the shift in thinking towards strategic outsourcing is to ensure that the funnel faces the right direction!

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Strategic sourcing relationships3.2

Fee-for-service Contract/Relationship Risk/Gain Sharing

(new vision)Transformation

(market breakthrough)

(value-chain reengineering)

Effectiveness(process integration)

(service)

Efficiency(cost)

VALUE

REPEATwhat they know

RE-APPLYwhat they know

RE-INVENTwhat they know

Need moreflexibility to

cater foruncertainty

The highest level at which to think about procurement structures is related to thinking about relationship structures. The charts on this slide and the next are somewhat unique and if studied will give insight into the true structure of strategic sourcing relationships and the reasons why.

Relationships and contracts are intertwined. For example it is futile to have a detailed contract with detailed low-level metrics if contracting a major transformational consulting activity. On the other hand, while it may be useful to require proof of competition for the supply of commodity hardware items it is inefficient and ineffective to seek full open global tenders for every systems development activity.

An effective framework for considering contracts and service providers is to categorise the type of knowledge they bring and the different levels of value they bring to the client.

For delivering efficiency service providers repeat what they know, and the contract is detailed about service outcomes, and with less flexibility For delivering effectiveness outcomes the service provider has to re-apply what they know, and needs some mutual flexibility, and there are more unknowns that the contract cannot specify. For delivering transformational outcomes the service provider has to re-invent what they know for each specific client’s circumstances, and the contract is more based around objectives and strategy outcomes, with larger risk factors.

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Multiple service provider3.3

(new vision)Transformation

(market breakthrough)

(value-chain reengineering)

Effectiveness(process integration)

(service)

Efficiency(cost)

VALUE

Traditional ContractualRelationships

Teaming & PreferentialRelationships

Advisory and Trusted Relationships

Boutique Fit for Purpose(No prior contract)

Relationship Best of Breed(Panel Contract)

Long-termCompetitive Contract

Fee-for-service Contract/Relationship Risk/Gain Sharing

Following from the previous slide, if we consider the skills to manage a service provider who is providing efficiency outcomes, versus effectiveness outcomes, versus transformational outcomes, then the relationship management and contractual management skills for each are all quite different.

For example, efficiency outcomes can be well described, based upon a fee-for-service, and relatively easily benchmarked, even as an objective exercise required of the service provider. It is more difficult to do that for efficiency service outcomes, and even more so for transformational outcomes. These latter two, in the realm of service provider contracts, tend to move towards a risk/share because the service cannot be easily quantified and benchmarked from the beginning.

It makes sense, in my thinking, to manage contracts at the three levels of (1) efficiency outcomes, (2) effectiveness and (3) transformational outcomes. For example the efficiency outcomes can be most cost-effectively and efficiently provided by one global service provider, who may or may not participate in the other levels. This approach is very different and perhaps opposed to the idea of splitting the efficiency providers into different contracts for different small segments of those services e.g. desktop, support, network, servers, etc. These contracts have a like nature, can be combined and provided by many qualified service providers, and can be easily benchmarked for competitiveness as a condition of the contract. The efficiency contract would be let through a highly competitive tendering process, would be for a longer-term, and require significant capital investment and recovery from the service provider.

Effectiveness contracts are a unique group, and different to efficiency and transformational contracts. In IT sourcing this level is about supplying and implementing application systems, and other significant systems for the client organisation. The contract form is most effectively organised as a pre-qualified panel, with best-of-breed service providers pre-qualified. The challenge is that pricing cannot be readily compared in advance for systems developments, and therefore unlike efficiency service providers, the effectiveness service providers should compete for each major project. The panel process improves the management and efficiency of this process.

For trusted advisor and transformational service provider relationships a case by case contracting approach is most effective. This is because the dynamics and circumstances and decision-making around these selections can be quite unique case by case, and, for example, least influenced by price. It is not a good idea, and is inefficient and ineffective, to mix contracts and supplier management teams for these different levels of relationships and contracts, but unfortunately such mixing is very often an outcome of a tactical outsourcing approach.

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Contracts reflect relationships3.4

Multiple relationships are needed:� Different relationships suit different purposes and

responsibilities and measures and expectations� Axiomatically no one IT service firm can provide best

of breed at all levels of the value creation and capture hierarchy

But not within the one relationship level !!

In summary of the efficiency and effectiveness section – multiple relationships are needed because, despite what they might say, no one IT outsourcing company of any stature can provide all the services of efficiency, effectiveness and transformation at the same high level of best of breed. The trick is to learn over time how to separate and manage the different levels. On the road to developing these skills a client may choose to go with one total outsourcing service provider as a tactic, as part of a strategy to move towards multiple service providers.

Beware terminology problems: The current fad towards multi-sourcing should not be confused with strategic or selective sourcing, in the traditional use of that word. Multi-sourcing appears to be totally tactical and aimed at splitting the “efficiency” layer into smaller chunks – each chunk then being put out to tender and often won by different suppliers. This multi-sourcing will not gain any strategic benefits. On the other hand, as a tactic as part of a journey to an objective to regain control of a broader relationship that has gone wrong multi-sourcing may have temporary value. When control is regained, the need for strategic thinking will resurface as the key issue.

Multiple service providers means, in my context, not the technically-driven segmentation of parts of the ‘efficiency’ layer, but the differentiation between the layers of efficiency service provers, effectiveness service providers, and transformational service providers. The hypothesis is that is it most effective and efficient for the client to have one provider at the efficiency level, a panel of best of breed at the effectiveness level, and free choice based upon management needs and contingency at the transformational level.

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Managing Risk and Back-to-Back Contract Construction

Client Service Provider

Contract Terms and SLAs

4.1

In this Section 4 I will discuss risk management and an example of back-to-back contracts in the courts. Back to back contracts are an important part of managing risk, and yet we still see some fundamental mistakes emerging in the market and through the legal system. I will only give one example, a recent lesson, because others today are better experienced than me to address this issue further.

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A recent lesson in back to back#

Effective variations although not “in writing”�Contract required variations “in writing” �Actions of parties reflected new intentions�Subcontractor failed to show that failure to

provide “in writing” terminated sub-contract� “Agreement to vary” enforceable contract� “Real intention” prevailed over written

#GEC Marconi Systems Pty Ltd v BHP Information Technology Ltd Feb 2003

4.2

The case of GEC Marconi versus BHP Information Technology ran for 5 years and resulted in a judgement of nearly 500 pages. The core event was that GEC withdrew from a subcontract claiming that BHP IT had not failed to vary the contract in writing and thus in simple terms, causing the contract to be terminated.

Partly on the basis of the very detailed and well managed project notes maintained by the BHP IT project team the Judge found against GEC. A clause in the contract required that any contract variation be in writing. The Judge concluded that ‘nowithstanding the writing requirement, it is open to the parties to express oral agreement or by contract from conduct to impose further or different rights upon each obligations upon each other from those contained in the original contract”.

BHP IT was therefore able to successfully content that by its actions prior to declaring the intention to withdraw from the contract GEC had “accepted the changes” even though no formal amendment document had been executed by the parties.

In his opening remarks the Judge attributed the genesis of the whole case to the effect that the customer and the sub-contractor (GEC) had made contractual commitments which they subsequently regretted and sought to resile from.

In terms of back-to-back contracts and risk management you should all read this judgement.

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Expanding Sourcing Options to include Inhouse-Offshore

Benefits of off-shore plus control of inhouse:� “Inhouse Offshore” IHOS� Capture economic value directly� Smooths integration of offshore process� Reduced relationship costs vs outsourcing� Knowledge retention

IHOS not a panacea but complementary

5.1

In assessing an inhouse-offshore (IHOS) strategy companies are seeking the benefits of offshore plus the control of inhouse.

The prime benefits of offshore remain the cost savings, along with the supply of highly educated staff. Where companies want to take advantage of this but also retain in-house control of their data, security, staff and procedures the IHOS option is attractive.

It also helps smooth the integration of the offshore processing when the same internal company procedures and standards are in force.

In each category of outsourcing, including the new IHOS model, time has to be invested in getting comfortable with the new partners and new arrangements. Even for an IHOS model the Indian staff and many of the management will be new. And even though the processes will be the company processes, managing them across borders into a new processing centre requires time, effort and patience.

A key to success is the interaction of the in-house processes and the offshore processes.

In a normal offshore outsourcing deal the friction between processes can cause significant extra cost, can lead to overrun budgets and under-run savings, and much personal angst for the executives running the program.

Typically, companies going through traditional offshore outsourcing leave the process definition and meshing too late. The outsourcing gets into full swing, yet the interaction of the processes has not been fully defined. Even more seriously, when the real diagnosis starts it is discovered that what superficially appeared to be a good match has some key points where synchronisation is inefficient, ineffective and costly.

One of the key benefits of the in-house offshore model is that the process definition, documentation and training are much less complicated and less expensive compared to offshore outsourcing. This is because the offshore unit is a company unit, with the same process and quality and standards requirements.

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Inhouse offshore risks

The risks are different to outsourcing:� How to set up offshore - government, tax, legal� Establishing management, performance goals� Training, staff exchange and career management� Systems interfaces and data management� Finding a reliable local partner & advisor

5.2

Among those firms with long experience, for typical offshore outsourcing relationships, it costs around 5 percent of the contract value as an investment in the continuing relationship.

This includes the continuous improvement of quality assurance, the automating of many new processes, as well as the metrics to monitor them. This is the cost of keeping the relationship alive and functioning effectively.

Compared to this the IHOS cost will be much lower - thus adding to the economic value captured by the firm itself by owning and operating its offshore unit.

The case for in-house offshore is clear: sustained knowledge retention, better rate negotiation, speedier ramp-up times for new projects, increased productivity, economic value capture, standardised security, and less wastage on unnecessary standards and certification.

However there are some areas that need to be carefully managed, such as the recruiting and staff orientation, and the management and business performance metrics need to be clear.

The financial and taxation aspects also need more careful and more thorough attention if the full economic benefit is to be gained.

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Resources for IHOS

Manage the risk of setting up offshore:� Investment capital� Domain expertise� Structured deals, risk offsets, and exits� Local review and audit of process

London-based and other firms e.g. Ariadne Capital

5.3

The inhouse-offshore model has a one risk which is significantly different to the offshore outsourcing model –the client company has to know how to set up business in India.

To meet that need a number of specialist firms are offering their services, including Ariadne Capital in London, who helps European companies "arbitrage" rather than just "outsource" its cost and skill sets to a subsidiary in India.

Ariadne, through a service offer named “ArbitrageIt” uniquely provides interested western companies with investment capital, domain expertise and management talent to help companies set up their own "IndiaCo.”This allows western firms to better manage workflow practices, safeguard intellectual property, control transfer pricing, capture cost savings and get tax benefits that are restricted or lost when business is outsourced to a third party.

ArbitrageIt finances the infrastructure costs, navigates local regulations and manages human resources for western companies setting up their Indian units.

ArbitrageIt allows companies to get all the benefits of outsourcing - reduce people costs, overheads, maintain quality, lower attrition and scale resources - without losing the accountability, quality control and corporate culture that are often sacrificed when dealing with third party outsourcers. These can be in areas of Information Technology, Business Processes and Customer Services.

Moving to an inhouse-offshore sourcing model is not a panacea for previous difficulties in establishing other outsourcing models, nor is it a solution that will displace the other outsourcing models.

It is a complementary sourcing option as part of an overall sourcing strategy - ideally suited to those companies that have had experience with previous models and can now more readily differentiate the strengths and weaknesses of the various options.

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Contact:

Walter [email protected]

+61 403 345 632

5/45 William St, Melbourne 3000

In conclusion:

We have reviewed why future outsourcing will be more complex than in the past and the need to address it strategically not tactically.

We have reviewed the common failures of tactical outsourcing and understood why these have led to high rates of executive dissatisfaction.

Emphasis has been put on the need for competent broad-skilled cross-functional teams to manage outsourcing contracts, and the opinion put that the lack of such teams is the biggest single cause of outsourcing failure to deliver business value. This is true whether the outsourcing decision and implementation was strategic or tactical.

In terms of relationships and their relationship to contract structures and purchasing effectiveness we have reviewed a new mental model which clearly shows why and how different classes of outsourcing partners should be engaged. It also provides a framework to place various fads and trends in outsourcing, including the current fad towards multi-sourcing and splitting efficiency layer contracts into smaller functionally-oriented units.

Finally, we have seen a sketch of the new option of in-house off-shore outsourcing which provides a relatively new alternative for consideration.

Relevant references available at my website as free White Papers:

> When Will Outsourcing Grow Up?> How to Understand the Business Model of Outtasking> How Innovation Can be Built into Outsourcing> The Traveller's Guide to Offshore Insourcing

Plus see the CIO Series of White Papers including “The CIO’s Leadership in Business Innovation”

Please feel free to contact me with any questions, suggestions, or for discussion of the above or other IT Business issues.

Walter AdamsonMo: 0403 345 632

Engaging with the Market to Leverage your Buying Power - Full Notes

Economy & Finance

Transcript of Engaging with the Market to Leverage your Buying Power - Full Notes