IT outsourcing can bring big benefits to your business, but there are significant risks and challenges when negotiating and managing outsourcing relationships. Here, we break down everything you need to know to ensure your IT outsourcing initiatives succeed.
What Is Outsourcing?
Outsourcing is a business practice in which services or job functions are farmed out to a third party. With a technology provider, information technology activities can be outsourced in a variety of ways, from the full IT function to discrete, clearly defined parts like software development, network services, disaster recovery, or QA testing.
Companies may choose to outsource IT services onshore (within their own country), nearshore (to a neighboring country or one in the same time zone), or offshore (to a more distant country). Nearshore and offshore outsourcing have traditionally been pursued to save costs.
Outsourcing Benefits and Costs
The business case for outsourcing varies by situation, but the benefits of outsourcing often include one or more of the following:
- Lower costs (due to economies of scale or lower labor rates)
- Increased efficiency
- Variable capacity
- Increased focus on strategy/core competencies
- Access to skills or resources
- Increased flexibility to meet changing business and commercial conditions
- Accelerated time to market
- Lower ongoing investment in internal infrastructure
- Access to innovation, intellectual property, and thought leadership
- Possible cash influx resulting from the transfer of assets to the new provider
Some of the risks of outsourcing include:
- Slower turnaround time
- Lack of business or domain knowledge
- Language and cultural barriers
- Time zone differences
- Lack of control
Business process outsourcing (BPO) is an overarching term for the outsourcing of a specific business process task, such as payroll. BPO is frequently separated into two categories: front-office BPO, which includes customer-related activities like marketing, and back-office BPO, which includes internal business functions like purchasing or billing. As a result, business process outsourcing (BPO) includes information technology outsourcing (ITO).
Outsourcing IT Functions
Traditionally, outsourced IT functions have fallen into one of two categories: infrastructure outsourcing and application outsourcing. Infrastructure outsourcing can include service desk capabilities, data center outsourcing, network services, managed security operations, or overall infrastructure management. Application outsourcing may include new application development, legacy system maintenance, testing and QA services, and packaged software implementation and management.
But in today’s cloud-enabled environment, IT outsourcing can also involve working with companies that offer platforms, infrastructure, and software as a service. In reality, cloud services make up to one-third of the outsourced business, and their market share is only going to increase. These services are more frequently provided by industrial firms that provide technology-enabled services as well as by global and specialized software suppliers, in addition to typical outsourcing organizations.
IT Outsourcing Models and Pricing
The appropriate model for an IT service is typically determined by the type of service provided. The most common ways to structure an outsourcing engagement include:
Time and Materials:
As the name implies, the customer pays the service provider according to the time and materials required to perform the task. Historically, long-term application development and maintenance contracts have employed this strategy. This methodology may be helpful in circumstances where it is challenging to estimate the scope and specifications or where needs are changing quickly.
The vendor sets a fixed price for a specific level of service, and the client pays according to how much of that service they actually use. For instance, the customer may pay a predetermined sum based on the number of supported desktop users if you outsource desktop maintenance. Pay-per-use pricing can result in productivity increases right now and makes it simple to analyze and modify component costs.
The purchase price is decided upon upfront. When the requirements, objectives, and scope are steady and distinct, this model can function effectively. Because it makes expenses predictable, paying a fixed sum for outsourced services can be tempting. It may be successful, but a fixed price stays fixed when market pricing declines over time (which it frequently does).
Fixed pricing is difficult for the vendor as well because they must maintain service levels at a set cost regardless of how many resources those services ultimately consume.
This model permits some variation in pricing depending on offering greater levels of services, but the client pays a fixed price at the low end of a supplier’s given service.
The contract is drafted so that the customer pays the supplier’s real expenses plus a predetermined profit margin. Such a pricing strategy offers no motivation for a supplier to deliver high-quality service and does not allow for flexibility if corporate goals or technological advancements change.
The buyer provides financial incentives that encourage the supplier to perform optimally. Conversely, this type of pricing plan requires suppliers to pay a penalty for unsatisfactory service levels. Performance-based pricing is often used in conjunction with a traditional pricing method, such as time-and-materials or fixed price.
Pricing is determined by the value that the vendor adds above and beyond what is typically required of it but results from its experience and contribution. For instance, an automaker might compensate a service provider based on the volume of vehicles it produces. Both the customer and the vendor have stakes in this kind of partnership.
Provider and customer jointly fund the development of new products, solutions, and services with the provider sharing in rewards for a defined period of time. The financial risk is shared between the two parties in this approach, which also motivates the provider to come up with suggestions for how to enhance the company. Communicating some hazards to the vendor also reduces some risks. But for it to succeed, more governance is needed.
Choosing The Right Outsourcing Provider Portfolio
An all-time high multibillion dollar megadeal for one vendor occurred several years ago, and the major global IT service providers couldn’t have been happier. However, many businesses have found it challenging to manage wholesale outsourcing. In order to satisfy IT demands, CIOs of days have adopted the multi-vendor approach, integrating services from various best-of-breed vendors.
The majority of the top providers of IT services have tried their best to follow this trend. In reality, several top CIOs not only collaborate with a group of rival outsourcers but also demand that they achieve shared deliverables.
The rise of digital transformation has initiated a shift not back to megadeals but away from siloed IT services. As companies embrace new development methodologies and infrastructure choices, many standalone IT service areas no longer make sense. Some IT service providers seek to become one-stop shops for clients through brokerage services or partnership agreements, offering clients a full spectrum of services from best-in-class providers.
How To Select A Service Provider
Selecting a service provider is a difficult decision. But start by realizing that no one outsourcer is going to be an exact fit for your needs. Trade-offs will be necessary.
To make an informed decision, articulate what you want from the outsourcing relationship to extract the most important criteria you seek in a service provider. It’s important to figure this out before soliciting any outsourcers, as they will undoubtedly come up with their own ideas of what’s best for your organization, based largely on their own capabilities and strengths.
Some examples of the questions you’ll need to consider include:
- What’s more important to you: the total amount of savings an outsourcer can provide you or how quickly they can cut your costs?
- Do you want broad capabilities or expertise in a specific area?
- Do you want low, fixed costs or more variable price options?
Once you define and prioritize your needs, you’ll be better able to decide what trade-offs are worth making.
Finding the best providers and negotiating an appropriate contract has typically taken IT firms six months to a year or longer to complete. But since contracts for IT services — and, increasingly, as-a-service — have grown shorter, that time-consuming procedure could no longer be necessary. There are various more iterative transaction methods that can shorten the time needed to buy IT services, even though the selection process still requires care.
To assist in determining needs and priorities, many companies hire an independent consultant or adviser. While the advice of a third party can undoubtedly be helpful, it’s crucial to thoroughly vet the consultant. Some consultants can be more interested in pushing you toward outsourcing than in assisting you in determining whether outsourcing is a wise decision for your company.
An inexperienced buyer can benefit from the assistance of a good advisor as they navigate the vendor selection process, helping them with tasks like conducting research, selecting companies to participate in the RFP process, developing a model or scoring system for assessing responses and reaching the decision.
Help can also be found within your organization, from within IT and the business. These people can help figure out your requirements. There is often a reluctance to do this because any hint of an impending outsourcing decision can send shivers throughout IT and the larger organization. But anecdotal evidence suggests that bringing people into the decision-making process earlier rather than later makes for better choices and also creates an openness around the process that goes a long way toward allaying fears.
Outsourcing’s Hidden Costs
The total amount of an outsourcing contract does not accurately represent the amount of money and other resources a company will spend when it sends IT services out to a third party. Depending on what is outsourced and to whom, studies show that an organization will end up spending at least 10 percent above that figure to set up the deal and manage it over the long haul.
Among the most significant additional expenses associated with outsourcing are:
- The cost of benchmarking and analysis to determine whether outsourcing is the right choice
- The expense of investigating and selecting a vendor
- The cost of transitioning work and knowledge to the outsourcer
- Costs resulting from possible layoffs and their associated HR issues
- Ongoing staffing and management of the outsourcing relationship
It’s important to consider these hidden costs when making a business case for outsourcing.
The Outsourcing Transition
It’s the outsourcing transition period — during which the provider’s delivery team gets up to speed on your business, existing capabilities, processes, expectations, and organizational culture — the “valley of despair.” During this period, the new team is trying to integrate any transferred employees and assets, and begin the process of driving out costs and inefficiencies, while still keeping the lights on.
The problem is, this is also the time when executives on the client side look most avidly for the deal’s promised gains; business unit heads and line managers wonder why IT service levels aren’t improving, and IT workers wonder what their place is in this new mixed-source environment.
IT leaders looking to the outsourcing contract for help on how to deal with the awkward transition period will be disappointed. The best advice is to anticipate that the transition period will be trying, attempt to manage the business side’s expectations, and set up management plans and governance tools to get the organization over the hump.
The Bottom Lines
When it comes to negotiating and managing outsourcing relationships, there are a lot of risks and challenges to consider. We hope this breaking down all about IT outsourcing can help you successfully manage your outsourcing relationships.
With the expertise of the software developers at Innotech, you will get the finest outcomes imaginable. In addition, we can assist you in controlling development costs and delivering software that meets or exceeds KPIs in terms of quality.
If you are looking for an IT outsourcing team who can meet all your high expectations, contact us now!