Finding the hidden costs of outsourcing

Media coverage of IT outsourcing projects abounds but there are too few failed engagements that ever see the light of day. But what causes failures among these massive projects that for all intents and purposes appear like well-thought out engagements by virtue of their dollar value and multi-year lifespan?

According to Jerome Barthelemy, a professor of strategic management at Audencia Nantes graduate school of management, companies choose the outsourcing path for the right reasons – reduce operating cost, focus on core business, reduce risks associated with new processes, and protect against technology obsolescence.

In a survey of 50 companies that outsourced part of all of their IT operations, companies missed out on three key areas: finding the right vendor, drafting an appropriate contract, and managing the engagement throughout its lifecycle.

Marketing hype coupled with forecasts of big savings often blindside management paying attention to the details that should be part and parcel of any purchase. First timers to outsourcing are particularly vulnerable to missing out on the things that would cost the company more than what is written on the contract because there is no information available out there to guide them through the process.

Vendor search and contracts
The Boy Scout motto of "Be Prepared" is apt in outsourcing. It is easy enough to get hold of a list of vendors offering a whole gamut of services. Finding the one vendor that best fits the needs of the enterprise is where failures begin to rear its ugly head.

Enterprises need to spend an appropriate level of time and resources to the selection process after all when you are planning to give away all or part of your operations to an outside firm and be willing to pay millions for that, it's only prudent to investigate all options.

There is an associated to cost to searching for the right party and many enterprises underestimate this cost together with negotiating and contracting costs. Unfortunately there are no industry standards for such because there are too many variables to consider. Anecdotal evidence, however, suggests that by spending appropriately on the search process, enterprises are able to lower the other hidden costs.

It is so much easier to use the vendor that everyone else is using. But Mr. Popular may not be Mr. Right for your business. An agreement with a trusted vendor presents a number of advantages including fairness and flexibility. A trusted vendor, keen on protecting its reputation, is more willing to fill any gaps fairly even if it's tempting in the short term to be opportunistic. Test your vendor. If your vendor can handle a series of contracts involving commodity activities like providing programmers to give the business more flexibility in staffing systems development, it is more likely to be able to handle sensitive IT activities, such as a company's core applications development.

Don't be shy about asking for references – past and present, successful and not-so successful. Your peers are your best resource for information that will be important to pursuing strategic initiatives.

Next to the vendor itself, the contract is probably the most important part of an outsourcing engagement. Many companies go into outsourcing with a vague idea of what they want the vendor to do. But when you deal with technological uncertainties, can you afford to leave your future in the hands of a third party – even a trusted one? While some amount of uncertainty is inevitable – predicting what technologies will be available after five years or the economic forces that will determine the size of your business in three years.

It is always cheaper to stay vague about your expectations and sign the vendor's standard contract than to develop clear expectations and build them into the contract. It is cheaper to go with the convenient vendor, rather than research the vendor's suitability. The true costs for such shortcuts come at the end of the term of the contract or when you want to opt out and you are presented with the bill for early termination.

Consider including these clauses into your outsourcing contract: Evolution clauses apply to both technology and to the price and the scope of the outsourcing contract; and Reversibility clauses gives the company the option to repurchase premises and equipment from the vendor; and allow the company to hire employees from the vendor. Without such clauses, the company or a new vendor may have to rebuild the entire IT department.

Transition costs
Very little has been documented about the cost of making the switch from in-house to the external vendor. It can take months before the vendor becomes intimately familiar with the company in the same way as the IT department. The transition period is usually measured in months and the associated costs are generally unknown. What is clear is that the transition will mean service disruption and productivity loss due to delays in getting back on track. The more tailored the service to specific needs of the company, the higher the cost to pass it to a vendor that must take time to learn the activity.

The best way to reduce transition costs is to be aware of it. Know what you want from the outsourced activity, and clearly communicate your needs to the vendor. Get a guarantee from the vendor that critical employees who are absorbed into the vendor's organization as part of the engagement need to have a waiting period during which time they must remain assigned to the company to ensure appropriate transfer of skills and knowledge.

Managing the effort
Just because you've outsourced part of your operations does not mean you give up responsibility for the delivery of associated services. Service Level Agreements provides guidelines for the delivery of agreed upon services. But only by carefully monitoring such delivery can expectations be ensured. Because of the uncertainty in business model and technology evolutions, you will also encounter periods when you need to renegotiate changes into the contract to accommodate changes in the business. Management costs, including performance analysis meetings, are internal to the vendor and only get highlighted when the bills are presented.

Experience is the best remedy for reducing the cost of managing the relationships. Another way to reduce cost is to cultivate trust in the vendor relationship. You do this by making that both sides' objectives are clearly understood. You also need to foster good communication through discussion of potential problems as they arise and through collaboration on problem solving.

Transitioning after outsourcing
So months or years after the contract was signed and services delivered, you've decided its time to call it quits and you need to move on. When a company decides to outsource to a specific vendor, little regard is given to the idea of bringing back staff that migrated to the vendor or moving to another vendor. Either move is conceding failure. Regardless, if you do decide to bite the bullet and move to another vendor, the costs involve will cover finding the vendor, drafting the contract and transitioning resources. If you decide to bring back the services in-house, the costs involve building a new internal IT team to take up the activity.

Again the best defense against post-outsourcing transition cost is awareness. Ending an outsourcing contract is expensive – make no mistake about it. How do you reduce the cost? Calling back employees that have moved over to the vendor will reduce the cost. Keeping a sufficient level of IT expertise in-house will also help reduce the costs.

Hidden costs occur somewhere between the point when managers first conceived the idea to outsource and the end of the project, when a company is looking to bring back the services in-house or switch to another vendor. Understand what goes into the costs and when to expect these, and you get an idea of the trade-offs before deciding to outsource. Manage the four costs proactively and holistically, and spend the extra time and resources in the early stages of the outsourcing effort. Companies that spend the time and resources early on will fair better in achieving successful outsourcing projects.

[via http://www.enterpriseinnovation.net/]