The New Age of Outsourcing
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A number of trends are changing the nature of IT and business process outsourcing, often to the mutual benefit of the buyer and the outsourcing vendor.
By Edward Gardner and Joe Hogan
The biggest business driver of outsourcing has always been cost savings. And while cost continues to influence decision-making in the IT and business process outsourcing markets, increasing and expanding demands on IT organizations are compelling them to seek more from their service providers.
As mature enterprises enter into the next generation of outsourcing deals, they are embracing new—and sometimes risky—models to achieve more than the old-fashioned "your mess for less" value proposition.
"Certainly, there is an evolution under way," says Arno Franz, a partner with outsourcing consultancy Information Services Group (ISG). "Buyers have matured to such an extent that they are looking for something quite different in the marketplace."
To get an industry-wide perspective on how practices continue to evolve, we spoke with five of the outsourcing industry's most respected consultants. We asked them about emerging trends they're seeing and the impact these changes will have on both buyers and service providers. Here’s what we learned from these conversations.
1. The Rise of Managed Services
Mature buyers of IT services are opting for managed services deals over staff augmentation arrangements, thus moving from input-based to output-based pricing. But while the potential benefits of the model, such as increased value and flexibility, are clear, the approach requires significant behavior changes from both the provider and the customer.
"In a staff augmentation deal, the client knows the people and they're used to working that way," says Ralph Schonenbach, CEO of Trestle Group. "When you take that away, it's a big cultural change. It requires a higher degree of trust, because you are allowing the supplier to take over operations to run as they see fit.” Suppliers likewise may not be used to taking such a proactive role. "They need to be much more innovative in reorganizing the way people work," he says.
These managed services deals are significant in size, ranging from $100 million to $500 million, according to Schonenbach, and the customers that pursue them are looking to cut costs by at least 20 percent to 30 percent. "It's an easy number to communicate to the market, but what comes with that is risk because you don't own the process anymore," Schonenbach says.
Clients who pursue the managed services model must spend more time upfront, mapping out the scope of the deal and the desired outcomes in the contract. Some "are going through them too fast, which creates a lot of ambiguity," says Schonenbach. "You need to spend enough time together to create a mutual understanding."
The biggest risk, however, is that the client will continue to treat a managed services arrangement like a staff augmentation project, failing to give the supplier the flexibility required to deliver the promised savings. These relationships also require strong senior management support in the initial phases. "It can't be a bottom-up type of engagement, because there’s too much resistance to this kind of change," says Schonenbach.
Managed services make most sense in operational areas, like application maintenance. Application development, however, may not be a good fit, because these are often one-off projects rather than ongoing processes.
While still in the early days, there have been a number of large deals in this space in Europe, says Schonenbach. "Everyone is looking to see how effective managed services will be for both parties."
2. Betting on Business Outcomes
When it comes to outcome-based pricing, outsourcing customers are increasingly interested in business—rather than basic technology—results. "It gives everyone a chance to benefit from that linkage of the value of what's paid to the vendor to the value that the client receives," says Ben Trowbridge, the founder and chairman of outsourcing consultancy Alsbridge. "If you can get those two to sync up, it's just wonderful."
It's a challenge for both the buyer and seller to define what those outcomes are prior to signing the contract, but early adopters and business process outsourcing (BPO) providers are hard at work in this area.
Providers who already have a business processing auto claims, for example, have a distinct measure of what it takes to process an insurance claim. "They've got a situation where they control the outcomes and it's easier for them to control the prices," says Trowbridge. "And everyone understands the metrics and pricing structures."