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Outsourcing Delivers Value Companies Demand

Compliance: Finance's Bridge to the Enterprise

Is Your Resource Commitment to Outsourcing Governance Sufficient?

An outsourcing evaluation should follow a disciplined, managerial approach from planning through negotiation and implementation, to ongoing management of the relationship. The planning, analysis and design steps followed during an outsourcing assessment are similar to the familiar project management development process (1) feasibility study; (2) detailed analysis of requirements; (3) design of the relationship with a vendor through contract negotiation and contract provisions; (4) building and implementing the relationship; (5) on-going operation of the relationship; and (6) expiration of the relationship with its renewal in a succeeding contract or termination.

This article focuses primarily on the all-important first steps of the planning phase. A major part of the planning phase is the feasibility study. The feasibility of outsourcing is determined by a series of screens that every outsourcing idea should pass before further, detailed evaluation. The first is the core competency screen. If the function or functions to be outsourced contribute in central ways to the organization's competitive success (core competencies) then those core functions probably are not strong candidates for outsourcing. But do not confuse a critical function with a core competence, as the former probably should be outsourced to a best-in-class provider.

The second feasibility screen is the cost of controlling a vendor. Service providers are controlled through governance mechanisms that can be termed a "relationship." The contract is a critical part of control and of the relationship. If complete contracts can't be written that anticipate all future contingencies, other means will be needed to control the vendor and see that the outsourced work is successfully completed.

The third feasibility screen is defining the explicit goals of outsourcing. If you do not know what you are trying to accomplish, any alternative can look good or bad. Companies that rush into outsourcing without fully understanding what they hope to gain soon find themselves mired in a contractual battle or not receiving improved services. Sensible reasons to consider outsourcing are both strategic and tactical.

Outsourcing is not an excuse to wash management's hands of a poorly managed, misunderstood function. Understand the costs, problems and potential of a function before deciding to just get rid of it.

The fourth screen is to define the scope. Outsourcing can be divided into two general categories: total and selective. Total outsourcing involves contracting out 80% or more of the function. Selective outsourcing involves outsourcing a few functions that total less than 80% of the whole. Methods for identifying functions that might be selectively outsourced include opportunistic, problem-focused approaches and more methodical planning approaches.

There is a framework for determining the kind of vendor relationship most appropriate to various circumstances. Possible vendor relationships run a continuum from those in which complete contracts can be written (market relationships) to relationships that can't depend on complete contracts or even a single contract (partnerships). Intermediate contracts have some aspects of market relationships and some aspects of partnership and occupy the middle of the outsourcing relationship spectrum. Outsourcing should not be undertaken when the costs of governance are too high relative to the benefits.

If the outsourcing idea passes the initial screens, planning can proceed to a detailed outsourcing evaluation. Early in the outsourcing evaluation process, the customer must identify who will take leadership responsibility, perform the analysis, and make the decisions. Who should be involved depends on what is to be outsourced and the circumstances surrounding the outsourcing decision.

An executive sponsor or champion is desirable; in cases that involve organizational politics, it is absolutely critical. For larger outsourcing initiatives, top management must play a role. For smaller initiatives, middle-level managers might do the heavy lifting with the support of senior management. The team usually needs a mix of managerial and technical talent and representatives from user areas whose services will be directly impacted by outsourcing. User perspectives and objectives are essential for setting scope and assessing risks.

The size of the customer's team depends on the scope and size of the project, but smaller teams are generally more effective. The team can be quite small in the planning phase and expanded when analysis begins. Teams with full-time members are often more focused and effective than teams composed of people who work part-time, although full-time allocation may only make sense for large outsourcing projects. It helps tremendously to have persons experienced in outsourcing on the team for the insight they bring to the issues and the realism they bring to cost and benefit estimates. In most cases, adding experienced team members means bringing in an outside consultant. In fact, since the service provider has considerable experience with the outsourcing process, it is highly recommended that the customer bring in experienced outsourcing consultants who can advise and assist throughout the entire process.

Once the decision is made to proceed with the next phases of the outsourcing process, identify as early as feasible the people who will be given responsibility for oversight and management of the outsourcing arrangement and vendor relations, if and when the contract is signed. These people should be part of the team that crafts the contract. Their inclusion is important for several reasons. First, there is no better way to understand the issues involved in outsourcing than to be involved in all aspects leading up to the decision. Second, relationships start at the moment discussion begins. Being in on the ground floor and having continuity in the relationship with people in the vendor organization contributes to success.

Here are a few key tips to remember during the planning phase:

• Before serious evaluation of outsourcing can take place, you should know the objectives of outsourcing, know the scope of what is to be considered for outsourcing, and answer as many of the questions listed in Figure 2 (below) as possible before proceeding to the next step.
• The fact that outsourcing is being considered should be made known to all employees, both those whose jobs may be in scope and users whose services are in scope. In the absence of compelling reasons to do so, secrecy is to be avoided for it is hard to maintain, and once broken, management credibility is probably gone forever.
• Never outsource all of management in the outsourced function. Even in total outsourcing, keep a top performing team to manage the on-going outsourcing relationships, oversee and pass on vendor technical decisions, develop experience with outsourcing and help make future outsourcing decisions, negotiate and enforce future outsourcing contracts, and keep the outsourced function in strategic and tactical alignment with overall corporate strategy.
• Determine the most appropriate relationship to establish with a vendor, for it is critical to outsourcing success. Effective control depends on the appropriate relationship. Don't "partner" with a vendor unless the circumstances clearly warrant it.
• An intermediate-type relationship, with a complete outsourcing contract and a sound management structure and process for managing the relationship, is normally the preferred type of relationship for IT outsourcing. Neither a vendor partnership nor a pure market relationship usually fit most IT outsourcing situations.
• Carefully consider the costs of controlling a vendor as part of the total costs of outsourcing. When there is a good chance the costs will outweigh the benefits, don't outsource. But be certain you know all the costs of both an outsourcing and an in-house solution.
• Outsourcing a troubled organization is not recommended. Part of the problem may lie outside the department or in parts of the function that won't be outsourced. It is essential to understand the problem and correct what will remain inside the organization before proceeding with outsourcing.
• Outsourcing a function that has many interrelationships with other functions poses special control problems, so be certain to not fragment business processes between the provider and in-house or among different providers.
• Don't outsource a function that is an integral part of your organization's core competency.
• Recognize that very few processes in a typical business are core competencies, so virtually any support function (HR, IT, accounting, finance, legal, etc.) is a potential candidate for outsourcing, if it passes the above screens.
• Don't confuse a core competency with a critical function. The latter can and probably should be outsourced to a best-in-class provider.

Figure 1. Phases of the Outsourcing Process

• Planning Phase. In this initial phase, the objectives and scope of the outsourcing concept are defined and the feasibility of outsourcing is determined before a decision to proceed. The total effort is also planned in terms of time, budget and resources needed.
• Analysis Phase. Baselines are determined and the service levels required of vendors are specified. Relationships between the function(s) to be outsourced and other functions that will remain in-house are clarified to include proper interfaces. The request for proposal (RFP) is developed, responses are collected from vendors and analyzed, and a vendor is chosen.
• Design Phase. Negotiations proceed with the vendor and a contract is developed and signed.
• Implementation Phase. The transition from in-house provision of services to outsourcing.
• Operations Phase. The outsourcing relationship with the vendor is managed and any maintenance or changes in the outsourcing relationship are negotiated and implemented.
• Termination Phase. At the end of the contracting period the decision is made to negotiate another contract with the vendor or a new vendor, and the cycle begins again. Alternatively, a decision is made to bring the function back inside the organization.

Figure 2. Example Questions to Answer Early in the Process

• What are the company's core competencies?
• What are our critical functions that are not core?
• Which services or other support functions are not integral to or close to the core competencies?
• What are the barriers to change raised by the corporate culture?
• What is the cross-functional impact and interfaces for the functions considered for outsourcing?
• Can we/should we fix the problems internally before considering outsourcing?
• What can be better accomplished by an outside provider?
• What are our outsourcing objectives?
• What type of supplier relationship is most appropriate?
• How will we deal with the people issues?
• Is service delivery onsite, offsite, offshore or some combination possible?
• Which vendors are the best-in-class providers of the services we are considering for outsourcing?

Publish Date: March 2001

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Copyright © 2001 - Everest Partners, L.P.

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