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Engaging with the Market to Leverage your Buying PowerWalter AdamsonDigital Investor Pty Ltdadamson@digitalinvestor.com.auAdvanced IT Contract Management and Negotiation Conference, November 2003Profile Walter AdamsonWalter Adamson is the founder and principal of Digital Investor – a Melbourne-based consultancy. Walter’s skil s lie in augmenting the strategic thinking and implementation capacity of his clients, with a focus on IT services.For IT service companies he helps drive business portfolio redesign and alignment to deliver customer value commitments and superior partnering programs. For CIOs he helps develop the commercial maturity of their company's IT strategy with a focus on business-IT alignment and more effective provisioning of IT services through strategic sourcing.Prior to establishing his consulting practice, he was the business architect of BHP Information Technology -where in 1989 he founded and led the Systems Integration business unit.In 1999 he was asked by BHP Bil iton, a global US$19b resources business, to architect a new IT sourcing strategy for the next decade – despite the fact that the company control ed the largest Australian-owned IT services business with 2000 employees. Based upon Walter’s new strategy for the next decade BHP IT was sold to Computer Sciences Corporation in 1999.Walter is an Associate of George Hara of Defta Partners, a visionary global investor in early-stage ubiquitous personal communications ventures, and is a Director of Defta (Australia). He is also an Associate of MTGP Group, based in Edinburgh, a leading strategic advisory and operational management group for digital media and enabling technology ventures.Walter holds a BSc in Mathematical Statistics, an MSc in Computing Science, has several Australian patents, and attended the Advanced Management Program at the Mt Eliza Business School. He was a founder of the EDP Auditor’s Association in Australia. He recently received a “Friend for Life” Award from Berry St Victoria for his contributions over more than 20 years.1ContentsStrategic Sourcing – what does it mean?What factors influence the decision-making process?Assessing different models for streamlining buying and effectively structuring procurementEffectively managing risk while delivering business value and constructing back-to-back dealsExpanding the sourcing options to include offshore in-house.Enhancing alignment and value for IT investments©2003 Walter AdamsonThe slides cover the first two items in relative depth, and then introduce a model for assisting in steamliningand structuring procurement in some detail.In the ‘managing risk’ context I discuss just one key issue of back-to-back contracts, but since this one issue arises from a recent very significant court judgement it is a very significant single issue to bring to your attention.Final y, I wrap up with an explanation of the option of selecting an in-house off-shore option to complement other outsourcing choices.2Strategic sourcing – what 1.1does it mean?Strategic sourcing requires a new question Tactical sourcing is inefficient, and often ineffectiveA common cause for current disappointmentsFuture sourcing wil be more complexEnhancing alignment and value for IT investments©2003 Walter AdamsonIT outsourcing is approaching second and in some cases third generation experiences for companies, and yet in some ways the decisions have not progressed beyond the types of purchasing-driven and cost-driven selection processes of the first rounds.It has been considered good practice to specify mutual y-agreed upon deliverables and metrics across a multi-year plan. If service providers met or exceeded the metrics it was considered to be excel ence. However in a changing world of relationships and business dynamics those static agreements and relationships can no longer deliver, and this is placing stresses on both customers and outsourcing providers alike.The future of outsourcing lies with contracts and relationships build from core strategy, and with provisions for change and innovation while maintaining the integrity of the business value for both parties.The era of tactical outsourcing has come to a close, and in fact in retrospect it is not hard to see that much of this tactical-driven outsourcing has been inefficient and ineffective. We wil discuss the reasons for this in more detail later.Looking back, and not necessarily with hindsight as this has been a known issue from day one, there is one issue that stands out behind the cause of many of the disappointments in outsourcing. This common problem stems from the lack of intent and capability of the client company to effectively staff and manage the relationship with the service provider. However, the cause is not one-sided, and we wil discuss this in turn.Whatever the past of outsourcing, and the successes and failures, the future wil be more complex. The relationships wil be more complex, the services more intertwined between the customer and supplier, the breadth of contact across the customer’s organisation wil be wider, and the success of many key operations of the customer’s business more dependent on the service provider’s performance. Al this, and not even to mention the irreversible trend to global sourcing and partnering, with its added complexities.The added complexities make it al the more important that organisation’s adopt a strategic approach to IT sourcing.3Strategic sourcing requires a 1.2new question“What is the best source for every IT service” NOT “What do I have in IT that seems appropriate for outsourcing”Gartner - 30% of companies are unpreparedEnhancing alignment and value for IT investments©2003 Walter AdamsonTactical outsourcing is framed around questions which are IT-centric, whereas strategic ITsourcing is framed around questions that are business-centric.Perhaps counter-intuitively, there tends to be an expectation on the part of tactical-outsourcing clients that the service provider wil take the lead in understanding and delivering IT value. On the other hand, strategic-outsourcing clients know that they have to take this lead. I brand this counter-intuitive because the tactical-outsourcing clients often retain more IT skil s in-house than the strategic-outsourcing clients, and the former often claim that many aspects of IT are too important to outsource yet they fail to deliver real business value from those they keep or those they outsource. This, in a manner, points to the mental chal enge of crossing the bridge to the acceptance of ful strategic outsourcing.In this latter respect Gartner, in recent reports, has said that it believes that some 30% of companies do not possess the management skil s and competencies to handle the more complex and more strategic outsourcing that wil be required in the near future.4Tactical sourcing is inefficient 1.3and often ineffectiveBottom-up view of the role of ITOften aided by IT’s reaction:– IT efficiency-focused in fear of CEO/CFO– Over-segmented and fear of loss of control– Often aided by ‘advisors’ who generate work• Complicates relationships• Hidden management costsEnhancing alignment and value for IT investments©2003 Walter AdamsonTactical IT outsourcing is characterised by two extremes. At one end we see the division and dissection of IT services into functions and activities that are then put to the market one by one and case by case. At the other extreme we see the complete whole-spectrum of an organisation’s IT needs, from consulting to applications development, to operations, and even combined with other vaguely similar organisations needs, put out to one service provider.Neither of those extremes can be logical y successful as a business strategy, yet they are not uncommon. The latter approach was infamously the one taken by the Australian Government in its outsourcing binge of the late 90s.The route of tactical outsourcing does not mean that the initiating decisions have necessarily been taken at a lower level. In fact many have probably been taken at a CEO or CFO level, but nevertheless they can stil be knee-jerk and fad-based, and without having any real understanding of the alternatives and IT options for their business. For example, these C-level executives may have been sold on the idea by a good service provider, but where the motivation of the service provider’s sales goals and rewards did not match with the longer term needs of the client. When such decisions are reached without real input and business advice from the IT group, the natural reaction is for them to scan their operations for ‘candidates’. At the same time they wil also tend to over-segment the operational services in a kind of means to ensure that some part of the operation survives. They can also readily make the systems architecture and relationships and technology seem complicated enough, and the risk of failure sufficiently high, that the higher level executives back away from bigger plans and accept partial tactical outsourcing.The irony of such segmentation and of tactical outsourcing is that it involves many relationships with and between many service providers in order to coordinate the total service. For example segmentation into desktop support, and server support, and enterprise systems support, and network support requires complex and costly management which al stems form a organisational view of the IT department and not a business-value delivery view of IT services. The point of the irony is that if a client has not learnt to manage one relationship successful y then how they can expect to manage many successful y from day one?Because this tactical approach requires many contracts and multiple negotiations and difficult interfaces it is also a boon for advisors and consultants. This work is tactical, it is work that can be reused across many clients, and there is a large portion of ‘grunt’ work that does not require business value add or strategic thinking from the consultants and advisors. That said, there are many advisors who know better, but yield to their clients and make accept the revenue stream generated by tactical outsourcing.Final y, in reviewing tactical outsourcing as a potential cause of missed expectations, the cost of managing such programs is often hidden within the accounts and departments of the client organisation. It is not at al inconceivable that such costs would exceed 20% of the contract value if they were correctly identified. The costs on the service provider’s side are also higher than for one larger strategic relationship. Consider the Pharmaceutical industry where outsourcing has long been practiced: in 2003 survey 64% of firms said that their outsourcing management costs were now below 10% of the total contract values. Five percent said that their costs exceeded 20% of the contract values. IT outsourcing client’s, in my observation, claim that their management costs are a smal fraction of those from the pharmaceutical companies, but there is substantial y more reason to believe the pharma companies’ figures because of their outsourcing history and 5experience.A common cause for current 1.4disappointmentsThe single most common mistake is that organisations did not identify, and then build and retain, the strategic, management and complementary operational skills needed to create and capture the potential benefits of outsourcing.Walter AdamsonEnhancing alignment and value for IT investments©2003 Walter AdamsonWhether an outsourcing project has been driven strategical y or tactical y, not identifying and recruiting and retaining the right combination of in-house skills is the biggest mistake made by clients, sometimes aided and abetted by short-term thinking on the part of service providers. The service providers think that wil retain more power and control by encouraging their clients to reduce the number of staff retained inhouse by the client. But in the longer-term this always backfires. This is because the service provider later finds themselves on the wrong side of changing expectations from the key business users without having a internal buffer or group to assist in managing those expectations.Clients, starting from tactical cost-cutting motivations, natural y see the retention of extra in-house staff as extra and unnecessary cost going ‘against the point of the whole outsourcing exercise’. It is often poorly explained to clients that the “retention of staff” exercise is not about preserving the IT department as it was. It is about building a strategic IT capacity, along with a sourcing management capability which combines a broad range of cross-disciplinary skil s. The vast majority of current IT staff wil not be suitable, and new people wil need to be recruited and placed in the new unit to build a strong cooperative relationship with the service provider.The single biggest risk in outsourcing, to shareholders, is that a client does not understand and does not build a strong internal new management capability to work with the service provider. This group, plus the re-formed IT group, have to take prime responsibility to identify and oversee the delivery of IT value – through the service provider.6Future strategic sourcing will 1.5be more complexStrategic sourcing is a growth industry:US$68.5b business growing to $100b in 2007More knowledgeable buyersNew pressure for growth and innovationBPO a new global growth marketOffshore in more complex forms→ More complex, cross-functional relationshipsEnhancing alignment and value for IT investments©2003 Walter AdamsonAlthough outsourcing, and offshore outsourcing, are the subject of debate and argument about their effectiveness, there is absolutely no doubt that the trend is growth and the industry is a growth industry. In that case, the arguments would seem to be more within the IT industry itself, since CEOs and Boards, from al reports, are committed more than ever to more outsourcing.The future, towards strategic sourcing, wil be built not only on the back of some missed expectations from past performance but also on the back of those lessons learnt. Buyers are now more knowledgeable and there is some shift in power from the service providers to the buyers.However something new, and for which there is little prior experience, is that sourcing from the CEO level is being pushed to go far beyond cost-cutting and to now be used as a vehicle to enable build growth in top-line revenue and in business innovation. This latter is particularly tricky and troublesome under the style of tactical contracts that have been used in the past. It is not clear how to build innovation into outsourcing contracts without severely disadvantaging the service provider, and not clear how to reward cost-saving initiatives from the service provider. One solution is through a jointly funded innovation review group, which I wil not cover today but which is the topic of a paper on my website entitled “How Innovation can be Built Into Outsourcing”.Growth in the BPO demand, and the increase in cross-functional and value-chain oriented outsourcing, and the move to more innovative offshore outsourcing, are al trends which support a clear case for the future of outsourcing being bigger and more complex than the past. To cope, requires equal y comprehensive and thorough thinking, in response. 7Factors influencing decision-2.1makingThree key dimensions:Business-level decision-makingNew organisational models – outtaskingExtended options – going globalEnhancing alignment and value for IT investments©2003 Walter AdamsonIn this Section 2 we discuss some of the major factors which influence the decision to outsource and in particular the trend towards strategic IT outsourcing.Firstly, more future decisions about outsourcing wil be made and executed at a business-level, not a departmental or IT-only level.Secondly, new organisational models, such as the networked organisation, wil be enabled by effective outsourcing.Thirdly, decisions wil be influenced by the wider choices in going global for outsourcing solutions.82.2Business-level decisionBenefits from the tactical approach exhausted:Cost , competencies , assets Focusing on contract yields no benefitsFuture requires holistic strategy:Improve business risk, value chain, EVAMore cross functional and “extended enterprise”Deliver value as a strategic management toolEnhancing alignment and value for IT investments©2003 Walter AdamsonThe business benefits of tactical outsourcing are beginning to fade. The costs have been reduced, access to competencies in some core technologies improved, and assets moved off the books.From here on in, focusing on the details of the contracts, and the excessive number of contracts, wil not yield business benefits that are aligned with the future business direction. The savings from tactical outsourcing have been made, and the costs of running tactical outsourcing are coming to light.The direction towards strategic sourcing needs to get back to basics which are know but have not been implemented. These principles have remained consistent and relevant and need to be bought to the table again: (1) IT sourcing polices need to be set strategical y, (2) Sourcing trade-offs need to be analysed holistical y across the enterprise, and (3) Service provider management needs to be cross-functional and expert in their field.(See my 2-page IT Executive Insight “When Wil Outsourcing Grow UP” on my website.)By adopting these principles clients wil improve their management of business risk, and improve service across the value chain, and also be able to focus their investments in areas which yield a substantial increase in, say EVA, as against investing in support or content functions of the organisation. The value delivered through strategic IT sourcing wil then contribute to an intrinsic organisational strength, which wil in turn (as a secondary effect) enable the organisation to more effectively compete and serve its customers. This is al very high-sounding but the point is that these words have some meaning in a business context and they bring focus onto the fact that many of the past approaches to outsourcing cannot bring benefits at this level.92.3New organisational modelsMost advanced thinking is Cisco’s ‘outtasking’:Extending the organisation ‘deeply’Cisco holds the keys to the overal data architecture and systems interfacesClear thinking about the customer value chainClear thinking about core and non-coreSophisticated al iance relationshipsClear performance metricsEnhancing alignment and value for IT investments©2003 Walter AdamsonJohn Chambers, CEO of Cisco, has spoken out about ‘out-tasking’, framing a new word to escape the stigma of outsourcing. A new word is useful to create fresh thinking. The essence of the difference between outsourcing and out-tasking is that out-tasking means that clients “maintain control over the strategy and implementation, and their out-tasking partner executes on it”.Crucial y, because Chambers is so passionate about his supply chain, the out-tasking client remains completely in control of the overal strategic systems architecture and the data architecture.The out-tasking partner has to operate to the common data architecture – this is one critical key to being able to achieve productivity and profit business goals in multi-source out-tasking relationships.Chambers explains: “The company of the future is the networked virtual organization that retains work associated with its core competencies and out-tasks contextual work to trusted partners. But out-tasking is not outsourcing—it requires that the company retain strategy and control implementation. And it requires standardization of data and network systems, and the partners have to be ready to embrace it.”10