9 Ways to Stop Your IT Outsourcing Deal From Leaking Money

If there were a relatively straightforward way for an IT leader to boost his company's bottom line by millions of dollars a year, chances are he wouldn't ignore it. But that's just what many CIOs are doing as a result of poor outsourcing management.

The typical outsourcing deal loses between five and 30 percent of its expected value each year through ineffective governance, according to outsourcing consultancy TPI. That lines up with the results of a survey by the International Association of Outsourcing Professionals, which found that 63 percent of companies believed they were losing an average of 25 percent of contract value due to poor governance. For a typical five-year $100 million contract, that's a loss of as much as $6 million annually.

"Companies make the same mistake over and over again," says Claude Marais, TPI partner and managing director of governance services. "All the effort goes into the transaction. Outsourcing governance is an afterthought."

As outsourcing investments have grown more complex-more locations, more functions, more service providers-governance has become even more important and difficult.

"The bar is constantly being raised, and for many outsourcing buyers, the capability to perform good outsourcing governance cannot keep up with sourcing ambitions," says Stan Lepeak, director in KPMG's Shared Services and Outsourcing Advisory group.

Here are nine governance tips for managing your outsourcing deal.

1. Assess your strengths and weaknesses. "The actual acts of governance may be simple, but doing it has become sophisticated," says Marais. "Everyone thinks they do it well, but very few do."

Be honest about what you're good at and what you're not and consider outsourcing the areas that are suffering or that you have no interest in making a core competency.

2. Invest in insight, not just oversight. Nothing saps the value from an outsourcing relationship like layers of management. "Most of the time when you are not seeing the value you were expecting from outsourcing, it's not because anyone is breaching a contract," says Edward Hansen, partner at law firm Baker & McKenzie. "One of the first places to look is how the governance structure is working."

The typical outsourcing management hierarchy, designed for contract enforcement, may be ineffective. Hansen advises CIOs to encourage functional communication between the customer and supplier at all levels.

"It can be helpful to turn to the people in the trenches who are working together on a day to day basis," Hansen says. "These people have worked out problems together and [may] even have ideas on how to improve [the engagement] that would bring real value to both companies."

3. Focus on high-value governance processes. Two places you get the most bang for your buck are invoice management and contract management. If you focus on those two areas alone, "that will get you a long way," Marais says.

4. Reconsider the role of service level agreements (SLAs). SLAs exist to balance what is essentially a flawed business model. "At its most basic you have two companies that are not naturally aligned economically, so the natural profit-seeking tendency is for the customer to overburden the provider and for the provider to over-charge and underperform," says Hansen. "Most SLAs attempt to make non-performance expensive for the vendor in an attempt to realign the economics."

But SLAs and their enforcement do little to protect or increase the value of an outsourcing deal. Re-examine each SLA and consider whether or not there might be a structural alternative to achieve better results. For example, a change in fee structure might be more effective in driving the desired outcomes. If you're seeking efficiency, you might shift fixed infrastructure costs to the vendor and pay per use.

"That creates an economic incentive to use the smallest infrastructure to support the activity, driving cost down," Hansen says. "SLAs would be used to ensure that the infrastructure isn't cut to the point where it puts the service at risk."

5. Define what value means to you. Is your goal to maximize cost cutting? Improve process performance? Enable transformation? Develop realistic and measureable metrics to track whether or not value is being delivered, advises Lepeak. When it's not, perform root cause analysis to determine why.

6. Recruit experienced and enthusiastic governance professionals. Most outsourcing governance groups are improperly staffed. Very senior IT professionals may get bored by some of the minutiae and perform poorly. Junior people may not have the experience to thrive.

"Performing good outsourcing governance is very different from running an internal, non-outsourced operation, yet quite often those tasked with managing an outsourcing effort have a background and skill set based on running internal functions," says KMPG's Lepeak.

Because CIOs do a poor job of incorporating the group into the overall departmental structure, they turn governance into an IT ghetto. "There is still a ways to go in terms of making governance experience a relevant and understandable step in the career track," says Liz Evans, director in KPMG's Shared Services and Outsourcing Advisory group. "Many companies struggle to find and attract the right resources internally and externally."

7. Go holistic. "Look at governance and the way you govern across your portfolio, whether that be IT or the enterprise at large," advises Evans of KPMG. If outsourcing governance is not aligned with overall IT governance, friction is bound to occur.

8. Beware of non-stakeholders in negotiations.When reevaluating a deal that is underperforming, bring problem solvers-not risk mitigators-to the table, advises Hansen.

"Lawyers are the classic non-stakeholders," he adds. "When a company evaluates a deal for renegotiation, one of the exercises typically involves handing the contract to some lawyers who then look for ways they can 'tighten it up.' To most lawyers it doesn't really matter if the deal as it was written is choking the parties to death, that the economics are not aligned or that the governance is dysfunctional."

Third-party advisors or procurement professionals could also fall into that category. A better option is to put deal leads and stakeholders in a room to analyze how to improve the relationship.

9. Commit to continuous improvement. Once there are solid governance processes in place to track performance, financials and relationship management progress, it's important to constantly measure the effectiveness of the governance organization and identify areas for improvement. "Then you can start to say, if I'm really doing this well enough in all areas, could I do it at a lower cost," says Marais. "Then it's a whole new world of opportunity."

Read more about outsourcing in CIO's Outsourcing Drilldown.

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