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Focus on Outsourcing | September 1, 2007
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Outsourcing updated
Once pursued mainly to reduce costs, outsourcing is becoming a path to differentiation and value creation
Tom Friedman may not have started the outsourcing trend but he certainly made a lot of people sit up and take notice. Friedman’s book, The World Is Flat, charts his voyage to India, where he found companies taking on work for their Western world customers, shifting information across oceans in the blink of an eye. He realized what a lot of people in boardrooms across the country are now realizing: that the Internet really did make the world a smaller place. Work can be done from anywhere and companies can take advantage of price differentials, regional centres of excellence and multi-site backup operations as they never have before. These developments helped accelerate the interest in outsourcing in recent years—and Canadian companies, among others, are reaping the benefits.
John Simke, president of outsourcing educational institute the Centre for Outsourcing Research and Education (CORE), has seen four key shifts in the outsourcing market in recent times. “Firstly, cost reduction is no longer the sole objective for outsourcing,” he said. “There are now several things that people want to achieve and cost reduction is one of them, but it is not the most important anymore. Now, organizations are looking for outsourcing to provide additional capacity and skills that are in scarce supply.”
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This has helped create a third major shift in the outsourcing community, which is that customers are beginning to recognize the importance of partnership, rather than solely technical competencies. “The ability to partner with a customer effectively is becoming a differentiator,” Simke said. “Customers are beginning to say that there are, perhaps, four service providers who could deliver the required service, but they want the chemistry to be right. They want the right partner in terms of attitude and willingness to customize, in addition to assuming some of the risk.”
All of these factors have contributed to the fourth broad shift in outsourcing. Companies are beginning to manage the process as a large-scale transformation initiative that goes directly to the heart of the business, rather than treating it as a tactical service contract in which both the risks and the benefits to the business are limited in scope. However, this pertains more to sophisticated companies that are beginning to explore the benefits of business process outsourcing. It brings considerable challenges, such as business process re-engineering and change management.
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Next-generation deals
In practice, this is affecting the way some deals are structured in the outsourcing community. “The clients have become a lot more knowledgeable and savvy. They have to build internal capacity to enter into these deals and manage them,” Simke said.
Experience is also a factor. Many companies embarked on outsourcing projects for the first time some years ago and those deals are now coming up for renewal. “Clients are going into these renewals with more capabilities, and therefore are cutting better deals for themselves,” he said. Some are engaging in discussions around collaborative outsourcing, which is emerging as a next step; a more sophisticated type of deal than the traditional service-focused infrastructural projects which are already complex to manage and require a significant upfront investment. Therefore, the progression to next-generation deals will be an iterative one for many. “Clients are more careful about how they do that, perhaps defining milestones along the way, for example. They also have very capable people in their teams who are managing the outcomes of those deals,” Simke said.
The question Canadian companies should ask first, however, is why outsource at all? Cost considerations certainly play an important part in most companies’ perceptions of outsourcing, especially among small businesses. Sheryl Boswell, director of marketing at ADP, has compiled direct evidence of the cost savings involved in outsourcing non-core functions such as payroll in a small to medium-sized enterprise.
Boswell is in a good position to know; ADP provides outsourced administrative business services for clients, handling functions including payroll, time and labour management, occupational health and safety services, and human resources management.
According to a survey of 150 small Canadian businesses conducted by ADP, businesses spend 11.7 hours per employee each year on payroll processing. In 43% of the companies surveyed, high-value employees such as the CEO or financial controller were bogged down in payroll processes.
“Those findings were eye-opening in terms of the resources that the small business uses to handle payroll inhouse, as opposed to outsourcing with a company like us,” she says. “There are many hidden costs that come with handling payroll in-house in terms of who is doing it, and the time that they take.”
ADP calculated that 30 per cent of the 152 hours spent by the average 13-person company can be eliminated by outsourcing their payroll. Assuming a salary of $35,000, this equates to almost $1,000 worth of time. But cost isn’t the only benefit, she says. Handing off this business can also help to reassure companies that they are compliant with regulatory standards. “We assume that compliance risk for you, so you won’t be worried about tax penalties for late remittance, for example. That removes the headache for many employers,” she advises.
But perhaps the biggest benefit, especially for smaller companies with limited resources, is that divesting non-core tasks such as payroll enables a company to concentrate on growing the business through sales, while developing a longer- term vision for growth. “It allows them to focus on what they need to do best, without worrying about the other tasks,” explains Boswell.
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Focusing on value generation can produce benefits such as business resilience, risk management and agility, said Kim Stevenson, vice-president for global enterprise service management at EDS. EDS has noticed that the location of the work is shifting, along with who does it and how it is executed.
This virtualization of labour is an inherent part of the modern economy and it is reflected by an increased focus on broad supply chains, rather than on individual businesses. “It’s not about one company; it’s about the business that you’re trying to get done,” she said, “and business ecosystems will dominate how IT is run.”
In an always-on world, business processes, applications and IT infrastructure are interdependent and must holistically align the business needs with the enabling technology. EDS works with its clients to understand and ensure the alignment is right—then it designs with an end-state in mind that delivers new capabilities now.
To realize these benefits, an outsourcing project must be built on robust, reliable systems coupled with sound operational processes and governance model. This is why EDS built the EDS Agility Alliance to create a seamlessly integrated platform that delivers robust, relevant and value-driven technology services to clients around the globe.
At the core of this Alliance is the deep collaborative engineering that occurs between EDS and its partners, such as Cisco, Oracle and Sun Microsystems. “How well you run an infrastructure, how robust it is and how well you maintain and upgrade it—these are crucial factors in being able to react and respond to the customer’s business needs,” she said.
Tying in business value
The gradual sea change in the outsourcing sector is creating two tiers within a contract, said Greg Gulyas, IBM’s vice-president of business development and outsourcing sales, and a CORE founding member. “There’s the straight technology solution, and then there’s a big opportunity for business innovation to deliver real client value,” he said. “Businesses should look at their processes, the management systems they are using and their organizational structure. Business innovation will allow them to compete on a global scale.” He argues that smaller Canadian companies are beginning to use these services to make themselves more scalable and engineer growth. “One of the opportunities for Canadian companies is to be innovators, not just within Canada, but beyond national boundaries,” he said. “However, investing in the right skills and infrastructure is critical.”
The statistics bear this out. Baseline figures for Canadian productivity produced by the Institute of Competitiveness and Prosperity show that in 1981, per-capital GDP was $3,300 less than that of the U.S. In 2005, that gap had widened to $9,200. Experts have suggested that at least some of this is due to lack of Canadian investment in ICT. It has been shown that tangible benefits do exist after investments in ICT and, particularly, outsourcing. In a report recently released by IBM, companies engaged in outsourcing contracts were shown to have lowered their annual growth in expenses by 10 per cent and increased growth in earnings by 12 per cent.
By outsourcing tasks that don’t lend themselves to in-house innovation, companies can focus on their core competencies, freeing up expensive management time so executives can concentrate on what they do best: driving business strategies and providing real differentiation.
As the focus on value rather than pure cost increases, the underlying parameters for the business relationship can change to reflect different goals. As an example, contracts can be crafted to focus on top-line business revenues, rather than bottom-line costs. Gulyas said that working more closely together on strategic value-focused deals can lead to innovative pricing models designed to turn both parties into stakeholders in the project. “We see more deals where there has been an interest in an implementation of business metric pricing,” he said. “In these situations, pricing isn’t purely calculated in the traditional way, such as per-head or per-megabyte. Instead, we tie the pricing to a customer’s business metric. The outsourcing contract is linked into real business value.” For example, IBM has crafted outsourcing deals with insurance companies that are tied to the number of processed claims.
Bringing outsourcers in
Whenever business and strategy come together, companies will find their relationships becoming increasingly intimate. This is driving businesses to renegotiate the terms of their contracts in more creative ways. Flexibility is a key issue in their conversations because dynamic businesses will tailor their strategies to market conditions. The more dynamic and agile the business, the greater its chances of success. “As an outsourcer you have to be in touch with the pain points of the client so you can flex to the greatest degree,” said Roxanne Fairweather, CEO at Innovatia, a knowledge management outsourcing expert. “This requires building up the relationship with the client to ensure there’s trust. Then, you need the flexibility to move within the contract.”
Innovatia, which provides outsourced knowledge management services, meets all of the table stakes associated with professional outsourcers, such as 24/7 operation, a state-of-the-art infrastructure and subject matter expertise. It uses electronic delivery as much as possible when providing services such as technical documentation and knowledge-based management, because this helps drive efficiency into the relationship. However, there are other requirements to ensure an outsourcing relationship is truly effective, Fairweather explains. “When people are outsourcing it can’t just be about price. Price breaks down pretty quickly if you’re not connected strategically to what your clients are trying to accomplish,” she said. “That’s why every time I talk to a client, I always start at the top of the value chain and look at what the key deliverables are.” But with providers and customers negotiating contracts that are so sensitive to their business, it is crucial that advisors are involved at every stage of the process. “It isn’t simply a case of coming in at the end and writing it down. In the projects that are most successful, we’re integrally involved as part of the project team,” said Andrew Foti, a partner at Gowlings whose Sourcing Group professionals across Canada provide legal services to support both new outsourcings and triage of existing relationships that may not be working. “Ultimately, governance is mostly in the agreement. So it’s critical for advisors to take the time to understand both the client’s operations and what they’re trying to achieve. This is essential to develop a framework that supports a constructive long term relationship, seamless initial transition to the supplier, and appropriate ‘safety mechanisms’ if it does not go well.”
As the co-head of the national IT practice and head of the outsourcing practice at Blake, Cassels and Graydon, a CORE founding member and legal advisor, Richard Corley has personally mediated hundreds of millions of dollars worth of outsourcing contracts. He uses the Harvard methodology as the basis of his mediation process. “It’s about transparency and avoiding unnecessary interpersonal conflict. It’s based on trying to better understand the underlying drivers that lead parties to request things, and to see if there are creative ways to satisfy those needs,” he said. Expertise in negotiations must be complemented by skillfulness in contract writing. “There must always be layers of appropriate safeguards and checks and balances in the agreement so that parties don’t find themselves in adverse situations.”
But occasionally, some remediation may be necessary, Corley said. “We can set up a more consistent governance structure where you have consistent meetings, and look at what can be done to turn the situation around and improve it,” he said. “In some cases you may have to disassemble and reassemble the deal to help the provider focus on areas they’re really good at.”
However, for this to happen, both companies must be willing to discuss the situation with a degree of transparency, warned Richard Coleman, the partner leading the outsourcing practice at Osler, Hoskin & Harcourt LLP. “It’s like a patient going to a doctor. It does the patient no good to mislead to the doctor or hide the true symptoms. If doctors are to treat patients successfully, they have to know what they’re dealing with.”
Strategic relationships
Another approach to risk management is multisourcing. This is becoming increasingly common in outsourcing as a way to spread risk and encourage competition. Customers outsource their business to more than one provider and build contracts in ways that allow them to shift tasks fluidly between different providers. This gives them a contingency in case a particular supplier runs into problems, and also enables them to optimize the service they’re receiving. “A company here picked three vendors and qualified them all for broad application outsourcing,” said CORE’s Simke. “They said ‘As we develop our needs, we’ll come to all three of you and get you to compete with each other. You’ll probably all get some work, but there will be constant competition between you.’”
Ideally, said Yvon Audette, national service leader in IT effectiveness at KPMG, such contracts can be used as a source of further value as companies ease their way into the relationship. When well written and based on a mutual understanding of the relationship, these contracts can form the basis of dynamic relationships that grow organically as business demands change. “Customers can use the existing vehicles available to them in most legal terms and conditions such as ‘right to audit’ clauses, turning them into an opportunity to gain greater understanding of the issues and concerns that exist with such arrangements and developing an approach and action plan to resolve those issues,” he said. “Instead of asking merely whether they’re reaching their contractual obligations, you can take that to the next level and turn it into a true performance review, examining what business stakeholders are saying about that agreement, and finding out how to improve the services that are being delivered.” It is natural that such relationships should be flexible and dynamic because they are based on people. A significant outcome of a recent KPMG report was that companies were increasingly aware of the people-driven nature of outsourcing arrangements, Audette said. This was particularly true as companies moved into more sophisticated strategic relationships, and often mapped onto business process outsourcing arrangements where providers and customers worked together in an environment where business outcomes were considered less of a commodity. “This is why in most business process outsourcing relationships you are getting into contracts where companies are looking not just at the IQ of the providers in terms of their technical competencies, but also at what KPMG calls the EQ (emotional intelligence) of the people involved,” said Jason Morsink, KPMG Canada’s lead in global sourcing advisory services. “How well are they able to work together? How well are they able to understand business needs, rather than pure technical requirements?”
However, it is important to recognize that different types of outsourcing contracts will require different levels of cultural fit, Morsink said. The more value-focused the contract, the more significant EQ becomes in the equation. “The extent to which a project highlights technical competency versus people depends on which side of the market you’re talking about,” he explained. “You can often pick that up in the terminologies used. Some companies talk about procuring services from a vendor. Others talk about developing a business plan that they will deploy with a service provider, and that mentality helps to describe what kinds of services people are looking for.”
“The difference between success and failure is often driven by who’s involved and the mandate you’ve given them,” said Richard Coleman, partner at Osler, Hoskin & Harcourt LLP. Consequently, it is important that the people managing the deal are given the time and space to operate effectively. A CFO who is an instrumental part of the team setting up the outsourcing arrangement cannot be expected to do his day job in addition to the complex and challenging tasks involved in an outsourcing negotiation, Coleman explained.
All about the team
The continuity of the deal team after signing is also important, said Daniel Logan, partner at Osler, Hoskin & Harcourt LLP, specializing in outsourcing. The team negotiating an outsourcing deal will be immersed in that task for some months. “We’ve seen scenarios where that deal team then goes away during the transition, and a set of new people come in who weren’t part of the process,” he said. “The objectives and benefits that had been secured by the original deal team are often forgotten or unwound by the new team. The continued involvement of the champions of the deal can be critical to success.” “You need a sufficient stayback team with the right skills and operational knowledge to manage the supplier relationship,” says Regina Corrigan, another member of Gowlings’ national outsourcing practice group. “In some cases, the whole organisation goes across to the supplier and there’s really no-one inside ‘minding the store’ and to properly interface with the supplier. It’s important that there be internal support not only at the operational level, but also in the C-suite, to give the relationship a decent chance at success and to resolve problems which inevitably will occur.”
Looking forward
So, what does the future hold for outsourcing as a business model? Innovatia’s Fairweather sees more geographies entering the market for outsourcing services. “The global marketplace is expanding from India toward the Pacific Rim—not just in China, but also into places like Vietnam,” she said. “There may be developing nations in places where you can get transactional work done, for example.” Even in countries like Rwanda, pilot outsourcing projects are already in operation.
CORE’s Simke expects to see more customers getting together on the client side to form shared outsourcing contracts, essentially creating shared service centres to handle specific parts of their businesses. Companies in the same vertical sector may find benefits in refining best practices and sharing resources provided by an outsourcing partner who becomes intimately acquainted with that sector’s operating model. But before that can happen, relationships between customers must mature, he said. “You need governance structures that all the parties feel comfortable with, and that provide the prerequisite degree of transparency.”
But perhaps the most significant development is simply an increasing acceptance that outsourcing can change businesses for the better. IBM’s Gulyas has identified a tidal move toward outsourcing as more companies recognize its value. “There were lots of companies testing the water, but now we have some very big organizations jumping in all the way,” he said. “People who were not considering outsourcing before because they couldn’t make the value proposition are looking at it again and getting on the bandwagon both for infrastructure outsourcing and for tasks including application development and maintenance.” If the new world really is flat, more pioneers are gathering to explore it.
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