Why Outsourcing Fails (Part 2): Pricing, Staff Augmentation, ECFs and More

Outsourced TV Show cast photoWhy IT outsourcing fails includes a wide variety of reasons. As I described in Part 1 of Why Outsourcing Fails, industry research points to the IT outsourcing recipient’s IT maturity and IT capability as the dominate factors. But failure, even from capability or maturity, is still very complex and nuanced with variants that can fill whole books on the subject.

In today’s post I will try to offer some additional reasons for why IT outsourcing fails that are often not discussed openly as much as they should be given their critically to success. I will also share a bit more insight on capability and maturity.

IT Outsourcing Failures – Pricing

According to sourcingmag.com there does not appear to be any data on how many IT outsourcing failures are the result of mispricing, but it is estimated to be significant.  They describe the mispricing story as follows:

The service provider needs to make a profit.  So the work that hadn’t been discovered early suddenly shows up under the category of uncontracted (re: out of scope) services, billed at rates the client finds hard to stomach.  The client begins grousing, complaining the service provider is always hitting them up with hidden charges.  The grousing turns to vocal complaints – and budget overruns – getting executive attention.  Suddenly all hell breaks loose.  The contract needs to be renegotiated.

In pricing IT outsourcing services there are several cost components to be factored.  These costs fall into two categories: lifecycle related expenses and service related expenses.  The lifecycle related expenses follow the stages of the engagement and account for the start-up and transition expenses in addition to the steady state overhead costs related to the core services.  The service related expenses are priced around the deliverables and outcomes as well as cost of labor and tools required to deliver the services and should allow for the incorporation of a multiplier or premium based on site maturity and IT capability.

Pricing for the engagement lifecycle creates opportunities for providers to incentivize clients into supporting accelerated transition strategies by including price reductions at major milestones.  So, the sooner customer supports implementing IT ‘best practices’ to increase their IT capability & IT maturity, the sooner the price drops because provider costs drop. Similarly, incentives to improve IT maturity and IT capability can be used in supporting operational and technology standardizations and improvements in order to see additional price reductions which come from the provider gaining additional economies and efficiencies across their client base.

A discussion on price related failures wouldn’t be complete without mentioning the importance of transparency in pricing. From the beginning of the RFP process, IT outsourcing customers need to see pricing that is itemized for each service in order to understand the cost-benefit of IT outsourcing each service and any comparative analysis between proposals and internal cost structures. When pricing is only offered in a bundled number, the provider and recipient are setting the stage for a pricing related failure before ever entering into an agreement.

IT Outsourcing Failures – Recipient Side

IT Maturity and IT Capability

As outlined in Part 1 of this post, a significant portion of IT outsourcing fails are due to IT shops being in some degree of disarray from operational and/or financial performance issues. This is almost always related to underlying organizational issues described in the Core IS Capabilities that are likely to surface as relationship management issues around vendor management and contract administration. For instance, poor institutional governance almost guarantees poor IT governance. Poor institutional planning and financial management is a strong predictor for IT planning and IT finances under performing.

IT outsourcing recipients with any weaknesses in IT capability or maturity will likely find the issues persist under IT outsourcing because they are systemic institutional issues. Recipients are also likely to find these issues are amplified under IT outsourcing when the provider has a high maturity and capability. This manifests itself by the institution resisting best practices for operational processes, project management and governance which are essential for the provider delivering results regardless of which of the 10 drivers of outsourcing are at work.

Organizational Culture

Institutional cultures in higher education are generally relationship based while corporate culture and that of many IT professionals tends to be rules-based.  In relationship-based cultures rules are guidelines and individual behavior is governed by relationships not rules.  Trust grows from long-term relationships not because of rules. SLA’s signify a general agreement (guidelines) that can be modified based on the situation.  These general tendencies are problematic when attempting to deliver outsourced services under a contractual services agreement.

The more the client is relationship oriented, especially with a low maturity level, the greater the risk to success of the engagement. Often in these situations the recipient tries to move away from the contract and can even try to view the outsource provider as internal IT. Surprisingly, some IT service providers embrace the idea of  “college employees who just get paid by the vendor” until the questions of cost and value surface.

Why IT Outsourcing Fails – Provider Side

Staff Augmentation

As noted above, there are several IT outsourcing companies who offer a model that is fundamentally a staff augmentation model. IT staff augmentation differs from IT outsourcing in that the vendor merely delivers bodies with no specific methodology or service model behind the staff. Under this model, the customer is entirely dependant on their existing level of IT capability and IT maturity and the prior experience of the individuals assigned to the engagement. In this service approach, the client drives the IT service model and the service provider functions essentially as a body shop – much like a temp agency.

By contrast, IT outsourcing or IT managed services as some refer to it as, means the provider wraps the assigned staff in established standards and methods based on years of experience. Recipients engaged with traditional providers usually see the standard “cookbook” or “run book” during the RFP discovery then again during the transition phase where the vendor executes the implementation of the canned service models that are essentially turnkey solutions. Often these standardized methodologies are based on ITSM frameworks like ITIL. This is what enables the tier 1 IT outsourcing vendors to deliver consistent results across their client base along with cost savings to each customer.

In the end, staff augmentation customers develop a perception of a lack of value given they see nothing other the site personnel and invoices causing them to count bodies and run the division. In effect, vendors using a staff augmentation model create the environment where clients reduce their services to butts in seats and no inherent value from the company – only what comes with the people they hire. This leads to pricing failures and more.

IT Outsourcing Engagement Management

Every IT outsourcing provider should have a structured engagement lifecycle management model to actively manage the engagement over time. IT outsourcing by its nature makes account management more demanding than other client-vendor relationships because it requires the provider to continuously monitor for changes in the client drivers for IT outsourcing. It also requires intensive monitoring of service delivery and performance management. These are essential to ensuring there has not been a shift in need that no longer matches the services being delivered and its pricing.

Customers should expect a clear explanation and service levels for the engagement management model during the RFP phase in order to know the prospective vendors understand and are able to respond to the issues of relationship management and vendor management along with the balance of outsourcing management and service management. It is also not unreasonable to expect a vendor who will provide support for increasing their customer’s maturity and capability during the relationship as part of an overall strategy for success.

Remember, it cannot be overstated, one of the more critical CIO roles is vendor risk management. As such, CIO’s need a vendor who will collaborate on mitigating IT outsourcing risk.

Embedded Consulting Firm (ECF)

Although this term is not widely used, the model is quite prevalent in the IT industry. Accordingly there are a few firms that track this sector with Kennedy Consulting Research & Advisory offering some of the deepest insights.  The ECF is a “captive” professional services group within a larger organization that is often focused on supporting companies’ products. The most recognizable form of this is the a software company that also has a professional services group devoted to supporting implementations of the product for new sales. Sometimes these groups also offer additional services for customers looking for help with upgrades, customizations, and integrations.

Many IT companies, both hardware and software, have expanded their offerings to now include more traditional forms of IT outsourcing. Typical examples are printer management, application hosting services, and more traditional on-site IT outsourcing of various IT functions and including entire departments.

When it comes to traditional forms of IT outsourcing by ECF’s two major challenges can affect the customer and the provider alike. First, the IT outsourcing side of the company struggles to exercise independence from the parent organization as part of being a trusted advisor in support of the customer’s best interests. So although ECF’s in the IT outsourcing business often assert vendor agnostic services this is rarely the case as they advocate for the products of the parent company and their partner network using a variety of approaches.

A secondary effect of being an ECF is the sales executive for the parent company generally owns the client relationships where the ECF is trying to sell outsourcing services or where they are already in place. This has the potential to adversely affect the development of the outsourcing services when the sales executive tries to protect their work on developing the account for traditional product sales.

These are just a few of the ways IT outsourcing can fail. Perhaps in the coming weeks I will revisit some additional reasons if there appears to be interest.

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