Value creation in IT outsourcing
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Value creation in IT outsourcing

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For the past 15 years the focus on IT outsourcing has been primarily on standard services and shopping for the lowest price. Long-term contracts were preferably closed. The external IT suppliers have ...

For the past 15 years the focus on IT outsourcing has been primarily on standard services and shopping for the lowest price. Long-term contracts were preferably closed. The external IT suppliers have responded by setting up large factories on efficiency-oriented delivery. The changing circumstances on the demand side, has left little space in this construction to design a different way of value.

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Value creation in IT outsourcing Value creation in IT outsourcing Document Transcript

  • Value creation in IT outsourcing From strategic needs to a fitting IT outsourcing construction Leon Dohmen and Joop Nabbe July 2011 Review and translation by Dennis Coll, Francoise Eemsing, Gianfranco Franceschi, William Martin.This article is translated from the original Dutch article ‘Waardecreatie met IT-outsourcing’ published in Outsource Magazine in July 2011. For the past 15 years the focus on IT outsourcing has been primarily on standard services and shopping for the lowest price. Long-term contracts were preferably closed. The externalIT suppliers have responded by setting up large factories on efficiency-oriented delivery. Thechanging circumstances on the demand side, has left little space in this construction to design a different way of value.
  • Value creation in IT outsourcingIntroductionCreating the expected value of IT outsourcing is not as easy as it seems. This is explained inthe book ‘Kampioen organisatieverandering’ 1 which talks about how significant improvementneed to take place when it comes to IT outsourcing and governance. The value that wascreated (the result achieved) of 9 projects that dealt with IT outsourcing, in one way oranother, measured on average only a 4.8 on a scale from 1 (being very poor) to 10 (beingexcellent). This result is 8% lower than the average result of the 46 involved research projects.Governance2 also offers opportunities for improvement with an average score of 5.7.Value creationTechnological developments of devices such as the iPhone, iPad, BlackBerry and increasingapplications in the Internet domain, such as social media marketing and the realization oflinks between social media and customer relation management systems, for example, are notso easily captured in standard IT services. Adding these technological developments to thoseorganisations that take part in active acquisitions and sales policy, and when creating newbusiness joint ventures are entered, then the internal IT department will have a hard timefollowing this and translating this into plausible IT services that adds value to the business.Working with the IT department’s approved or authorized hardware and software lists, and(rigid) standard services is not sufficient enough (anymore). Some organisations also have thecourage not to apply any longer the principle of forced trade with the internal IT organisation.The internal IT organisation will therefore have to create value for the demand side (alsoknown as business) with IT services, otherwise the risk arises that the demand side goesshopping elsewhere. In order to deliver IT services, many IT organisations seek the help ofexternal IT suppliers. Welcome to the world of IT outsourcing! 3IT outsourcingThe decision to (partly) outsource IT services has several underlying reasons, cost reductionbeing the most dominant. This is confirmed in the article "De toekomst van Outsourcing” inOutsourcing Performance 2010.4 Cost reduction being the most dominant is not surprisingwhen you look at the basic structure of many IT outsourcing deals: standard service set up inlong-term contracts with service level agreements, purchased at the lowest price with annuallyimposed efficiency improvements during the course of the contract for the involved supplier.This basic structure leaves little room for other (strategic) reasons of IT outsourcing such asaccelerating innovation, knowledge improvement and improving the quality of IT services.This does not prove that purchasing IT services at a low cost is wrong. If this is a desiredrequirement from the demand side, then there’s nothing wrong with that. IT service thencreates value for the demand side by being inexpensive, in addition to providing basicrequired functionality.Demand sideTo be able to create value in IT outsourcing, it is important to understand the complexity anddynamics of the demand side. This applies as well to the internal IT organisations that havelittle or nothing to do with IT outsourcing. Complexity is associated with the product/serviceneeds of the demand side. If these product/service needs are characterized as being standard,then the complexity is low. If the product/service needs are (very) specific, then complexity1 Dohmen, L. (2011). Kampioen organisatieverandering. Unibook.2 This article use the tern governance or governing whereas the terms control(ling) and direct(ing) are also suitable terms.3 This article should not be read as a plea for IT-outsourcing. Taking a decision for IT-outsourcing should be done with careand needs investigation. This article deals about the strategic design for value creation in IT-outsourcing after the decision todo this has been taken.4 Riet, S. van de, M. Gianotten, J. Huige (2010). Outsourcing Performance. Giarte Media Group. 2
  • Value creation in IT outsourcingis considered to be high. Dynamics can be linked to the predictability of delivery (timeaspect). When the supply of IT services can be planned, then this is interpreted as lowdynamics. When delivery is primarily ad hoc (and speed of delivery is desired), then there is ahigh dynamic demand. To create value it’s important to know the (strategic) needs of thedemand side. This is an important starting point to set up a basic construction. Figure 1divides the strategic needs of demand into four areas. Complexity Complexity customer request Ad hoc low; high; Predictability of dynamics dynamics Planned high high Complexity Complexity low; high; dynamics dynamics low low Standard Customized Complexity: Dif f iculty of the product/service Dynamics: Movement, time Variation in customer related product/serviceFigure 1: Complexity and dynamics of demandEach quadrant offers different requirements for the delivery of IT services from the supplyside.Supply sideExternal providers are positioned at the supply side of IT outsourcing. To create value, thesehave to match the delivery of their products and services with the strategic needs of thedemand side. The requirements associated with this delivery are different for each quadrantand they do influence also the relationship of the demand side with external providers. In thelower-left quadrant - standard and easy to plan service delivery (low complexity and lowdynamics) - a low cost delivery price will indeed add value for the demand side. This can bewell supported by aligning on processes that support the delivery of these products andservices. In the upper-left quadrant, what is delivered is well known but the moment when ithappens is less predictable (low complexity but high dynamics). In the logistics sector, thissituation leads to frequent use of on-call contracts. In IT outsourcing, value for the demandside can be created through the availability of a pool of employees that can be assigned whenthe demand side requires it. This capacity has to show flexibility in its availability. In thelower-right quadrant, predictable to deliver but (highly) specific products and services (highcomplexity, low dynamics), value is created at the demand side through high quality products.The craftsmanship of the external IT provider will steer the creation of value at the demandside. The upper-right quadrant is to most challenging to serve. Value is created with highlyspecific products or services that have to be delivered at unpredictable moments. Both(flexible available) capacity and craftsmanship are needed to generate value. Here both thedemand and supply side, to quickly move forward together, have to form a solid and open 3
  • Value creation in IT outsourcingpartnership bond. Figure 2 illustrates the relationship between the strategic needs of thedemand side and the desirable connection with the external provider at the supply side. customer request Ad hoc Predictability of Capacity Partner Planned Process Crafts- alignment manship Standard Customized Variation in customer product/serviceFigure 2: Relation between strategic needs demand and relation type supplyMost delivery models of today’s IT outsourcing or relationship types are located in thequadrant of standard and easy to plan services. Here the emphasis is placed on processalignment, for example on the basis of ITIL processes.5 When the strategic needs of thedemand side consist mostly of specific, ad-hoc, and quick to deliver IT services, such astandard delivery model will not help generating much value for the demand side. A lot ofproblems in current IT outsourcing contracts can eventually be traced back to this strategicmismatch between demand and supply side. Albert Plugge 6, in his 2011 graduation researchpaper, lays the blame almost exclusively by the external providers. However, the questionarises: What is the role of the internal IT organisation in the alignment mismatch betweenstrategic needs of the demand side and the delivery of IT services by the external providers?GovernanceThe delivery and support of IT services in (large) organisations has evolved into an excitingand spectacular form of teamwork, where more and more (external) parties are involvedthrough IT outsourcing. From the original function of specialist and internal supplier, the ITorganisation has transformed into a director who is less and less required to build and deliversolutions itself. The main task evolved towards governing external providers, which on thebasis of agreed requirements with the demand side, take care of developing, running andsupporting suitable IT solutions. Governance in IT outsourcing is then the linking functionbetween demand and supply side and contributes a substantial share in the creation of value indelivering IT services to the demand side. Governance focuses on the management of theTechnology, Organisation and People complex (TOP-mix). In each of the identified strategicquadrants, the TOP-mix shows different features, thus governance will have to be shapeddifferently, in order to generate value. If the strategic requirements of the demand side have to5 ITIL is the acronym for Information Technology Infrastructure Library. ITIL is a best practices based method for the set upof IT management processes.6 Plugge, A. (2011). IT-sector snapt weinig van dienstverlening. Automatiserings Gids, 25 maart. 4
  • Value creation in IT outsourcingbe satisfied with specific, ad-hoc services and products, it won’t be possible to effectivelygovern only on the basis of ITIL processes. Besides, the balance of powers tends to bedifferent in each of the four quadrants, and this reflects on either governance or the foundationof the relationship between the demand and supply side of IT outsourcing.TechnologyIn order to set up solid governance, the technology requirements are different in each of thefour quadrants. Effective support tools for operational processes are useful in the lower-leftquadrant, and there is a wide commercial availability of tools that support service deliverybased on standard ITIL processes. However, where the need for ad-hoc products and servicesis outstanding, collaborative tools tend to be more useful.OrganisationThe organisation component of the TOP-mix includes the process, structure and locationaspects. When the demand is rather foreseeable, but the product or service is very specific(lower-right quadrant) then investing in the continual improvement of the (software)development process should be considered.PeopleAttitude, competence and experience play a role in the P-component of the TOP-mix.Effective teamwork in the upper-right quadrant (high complexity and dynamics) requiresdifferent kind of individual qualities than the teamwork in the lower-left quadrant (lowcomplexity and dynamics). Tooling f or Pool contract; Flexible; Proactive; support Tooling f or long termcustomer request collaboration quick access decentra- Proactive; Ad hoc commitment; Predictability of resource and to people lized; experts planning personal knowledge with required communities development sharing skills Formal Tooling f or processes to Planned Tooling f or Mature Reliability; support support arrange sof tware basic Reliability; service experts sof tware operational development knowledge management ef f iciency; development processes and skills processes centralized Standard Customized Variation in customer product/service Technology Organisation People Infra- Middle- Appli- Loca- Struc- Pro- Atti- Know- Skills struc- ware cations tion ture cesses tude ledge tureFigure 3: TOP-characteristics for governance per strategic quadrantEach quadrant determines specific requirements for the TOP-mix to satisfy, in order to set upeffective governance. In the last 15 years, IT outsourcing and the associated governance haveset their sights from the IT service management sector mainly upon the lower-left quadrant ofstandardized and foreseeable IT service delivery. The (new) outside-in approach from theviewpoint of value creation helps to remove this limitation. Figure 3 gives a comprehensive 5
  • Value creation in IT outsourcingoverview of the features of governance for the technology, organisation and peoplecomponents, for each quadrant.IT outsourcing basic constructionsIn order to create value for the demand side through IT outsourcing, four different basicconstructions were identified that show different TOP-features. In the first construction, calledStandard, value is generated through low-cost delivery. The organisation and technologyaspect of the TOP-mix define the process alignment for purchasing and operational servicemanagement. The principles of operational excellence, according the value disciplines ofTreacy and Wiersema 7 are fairly applicable. In the second construction, named Preferred, thedelivery speed is the main factor of value creation. Agreements concerning the availability ofon-call capacity determine the basic settings. The value creation discipline, customerintimacy, is well applicable here. The third construction is called Excellent and the valuegeneration is determined by the quality of the products and/or services. Attitude, competenceand craftsmanship lay the foundation for the IT outsourcing construction. The value creationdiscipline, product leadership, is the most applicable in this case. The IT outsourcingconstruction Partner is a blend of Preferred and Excellent; specific attitude, competence andcraftsmanship that include high availability and flexibility determine the value generationthrough high quality products and quick deliveries. Figure 4 shows a comprehensive overviewof the four identified basic constructions that are identified to generate value in IToutsourcing. IT-Outsourcing types and characteristics: Value 1. Relation type Standard creation via: -> Process is leading Cheap -> Organisation and tooling aspects form basis for relationship delivery -> Price of standard service and/or product creates value -> Following principles of operational excellence Value 2. Relation type Excellent creation via: -> Craftsmanship is leading Quality of -> Knowledge and skills of people form basis for relationship product -> Quality of the customized product and/or service creates value /service -> Following principles of product leadership 3. Relation type Preferred -> Delivery capacity is leading Value -> Organising and making agreements for needed capacity (flexible availability) form creation via: basis of the relationship Fast delivery -> Fast delivery creates value -> Following principles of customer intimacy 4. Relation type Partner Value creation via: -> Craftsmanship and delivery capacity are leading Fast delivery -> Knowledge and skills of people and organising and making agreements for needed and quality capacity (flexible availability) form basis of the relationship of product / -> Fast delivery and quality of the customized product or service creates value service -> Following principles of product leadership and customer intimacyFigure 4: IT outsourcing basic constructions and TOP-characteristics7 Treacy, M. en F. Wiersema (1995). Discipline of Market Leaders, Persues Publishing. 6
  • Value creation in IT outsourcingCase studyIn 2008, the internal central IT and purchasing department of organisation Z asked an externalIT service provider to take over their network infrastructure, formally managed by anotherexternal IT service provider, for a reduced price and subject to further annual price reductions.During the term of the contract from 2008 to 2011, the internal central IT department and thenew IT service provider were trapped in dispute regarding service level agreements for aninflexible service. Both have lost sight of the user, which are mostly local IT departmentsand/or other external IT suppliers, their service value and further development.By realising their centralization and outsourcing strategy within the organisation Z, the localIT departments disappeared, and the landscape for external IT suppliers changed. Knowledgeshifted or disappeared, and roles and responsibilities changed. The imposed annual costreduction causes much ‘pain’ for the external IT service provider and the internal central ITdepartment does not contribute enough to the much higher saving targets of the demand side.The model of low costs contracts and standardisation (lower-left quadrant of figure 1) doesnot comply (anymore).The contract expires in 2011. The service requires a new global infrastructure. The internalcentral IT and purchasing department of organisation Z, challenge themselves and theirexternal suppliers, to fulfil the needs of the users, and begin the contract renewal phase. Thechosen approach is agile and copied from Spiral, a continuous improvement and prototypingbased software development method. Three potential suppliers, based on an initial set ofrequirements, have offered a budget proposal 8 and each supplier built a demonstrationenvironment (prototype 1). A budget proposal means that the supplier’s proposal issubsequent to change following the requirements of the demand side. Evidently, only theinitial sets of requirements are known. Based on the findings of prototype 1, one supplier issent home.The internal central IT organisation invites the service users. They will be asked to supplywork scenarios and test them through workshops with the central IT organisation, internal andexternal suppliers on two demonstration areas (prototype 2). Contract negotiations will startwith the supplier with the best results. Hereafter, the construction of the service will start andthe implementation for a number of local branches (operational prototype) and a globalrollout.The specification of the service, the basis of the contract, will be modelled on the ‘Critical toQuality Tree’, part of Lean Six Sigma, which is a process improvement method. ‘Critical toQuality Tree’ makes the service continuously measurable, during the term of the contractbased on user relevant criteria. The central internal IT department, the owner/IT controller ofthe service, takes the lead on the continuous improvement process and ensures the alignmentbetween demand and supply. It is intended to establish a win-win situation for both customerand supplier, hence continuously developing the service.The rationale behind the approach is to evolve from an IT outsourcing basic constructionStandard (old contract situation) to a basic construction Excellent. The change to lower rightmust ensure that the right attitude, the right contract and the right service implementation is8 Parallel to requirements, also the proposal is a developing prototype. Selection is done from high level to low level, thesupplier will not be forced to stick to the first price indication provided. 7
  • Value creation in IT outsourcingchosen for ongoing service and planned development to guarantee the service. The service inthis case is about a ‘standard administration’ which objective is to improve security andreduce operational risk. Development is required, because the user is changing. The user ismore diverse and has less knowledge (available nearby), because the local IT departments arereduced. The total cost of the service should also go down. Based on these developments onthe demand side, an external supplier who thinks along and participates as an expert isrequired.SummaryFor the past 15 years the focus on IT outsourcing has been primarily on standard services andshopping for the lowest price. Long-term contracts were preferably closed. The external ITsuppliers have responded by setting up large factories on efficiency-oriented delivery. Thechanging circumstances on the demand side, has left little space in this construction to designa different way of value.----------------------------------------------------------------------------------------------------------------- Leon Dohmen is principal management consultant at Logica and teaches Management of Technology at the Rotterdam Business School for Master- and MBA-programmes. Joop Nabbe is project director at Logica. 8