Outsourcing research paper


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Outsourcing research paper

  1. 1. Critical Aspects of Governance in Outsourcing: Insights from Industry* Markus Biehl1, Kaustuv Halder2, Michael Hart3 Toronto, Ontario September 2011ABSTRACT. In the past decade, with an increased focus on core competencies support functions havebeen increasingly outsourced. To this day, however, success is illusive to many outsourcers. This paperdraws on the experience of outsourcing executives on the buyers and vendors side by drawing lessonsfrom both successful and unsuccessful outsourcing initiatives. We find that communication, theengagement of the appropriate resources, a mutual understanding of service delivery objective, and acooperative, trust-building relationship can improve the chance of completing outsourcing initiativessuccessfully. We put these findings into an outsourcing governance and relationship managementframework for use by outsourcing practitioners on the buyer and vendor side.* This report is partially based on interviews carried out by MBA students at the Schulich School of Business, York University, taking the course on Global Operations and Information Management in Winter 2011. The projects were co-supervised by Markus Biehl and Michael Hart. We thank the students for conducting the interviews and the outsourcing managers for taking the time to speak to the students.1 Dr. Markus Biehl is an Associate Professor of Operations Management at York University’s Schulich School of Business in Toronto and the school’s Associate Dean – Academic; mbiehl@schulich.yorku.ca2 Kaustuv Halder is an MBA Student at Schulich School of Business and was a Summer Intern at Merit Outsourcing Advisors; khalder@schulich.yorku.ca3 Michael Hart, MBA, is the Managing Partner of Merit Outsourcing Advisors, Toronto; michael.hart@meritoutsourcing.com
  2. 2. The importance of governance in outsourcing initiativesOutsourcing has grown from a mere cost reduction tool in the 1990s to a powerful business strategy thatcan act as a competitive differentiator, allowing companies to increase productivity and the quality oftheir offerings by focusing on their core operations. By enabling third party service providers to manageIT or business process operations, organizations have not only been able to access an experiencedexternal talent pool, but also turn fixed cost structures into variable costs. Information Systemsoutsourcing in particular has become increasingly popular following Kodak’s decision to outsource its IToperations in 1989. The pervasive adoption of outsourcing of Application Development andMaintenance (ADM) and IT Infrastructure (collectively referred to as IT in this paper) makes theoutsourced delivery model the most dominant form of acquiring IT services. Organizations havesuccessfully used outsourcing to reduce costs, acquire capabilities or achieve a global reach.All too often, however, the buyer’s satisfaction in an outsourcing arrangement is evasive. Recentresearch by the Centre of Outsourcing Research and Education (CORE4) reveals that only 75% of buyersare satisfied in the case of IT deals. While there are many factors that explain this dissatisfaction, thereis a strong correlation between governance capabilities and buyer satisfaction in outsourcingarrangements. A study conducted over 1600 IT outsourcing deals confirms that buyers with bettergovernance and relationship management capabilities, achieve much higher satisfaction levels thanbuyers who do not possess the same (Lepeak, 2010).Outsourcing initiatives contain numerous complexities and interdependencies at the technical andrelationship level and often require a major restructuring at the organizational level. This posesnumerous operational and organizational challenges towards achieving the intended business objectivesthrough such arrangements. An enterprise-wide governance perspective is crucial to deal with thiscomplexity (Lacity & Willcocks, 2003). We have seen increased prominence of governance models in outsourcing relationships. Despite thatoutsourcing engagements have been plagued with issues that lead to buyer dissatisfaction. Even thoughwe know that better governance leads to better outcomes, we wonder what the drivers and conditionsare that lead to unsuccessful outcomes. To address this question, this paper looks at the first handexperience of twelve executives involved in both successful and unsuccessful outsourcing arrangementson both the client and vendor side. The following section shares some of the hard-earned wisdom thosemanagers shared with us based on the outsourcing initiatives they managed. We then propose anoutsourcing governance framework that, if taken into account when managing an outsourcing initiative,should lead to substantially better outcomes.4 The Centre for Outsourcing Research and Education (CORE) is the leading Canadian outsourcing association, comprised of buyers of outsourcing services, service providers, lawyers and advisors; www.core-outsourcing.org 1
  3. 3. What were the challenges for outsourcing relationship managers?The understanding of the service level objectives by both clients and vendors is important forrelationship management.Cases that had a clear understanding of service level objectives and goals led to greater satisfaction tothe buyers and better performance of the relationship. In many failed outsourcing arrangements therelationship worsened over time due to inadequate description of service delivery requirements. As onemanager of a failed initiative put it: “As the relationship progressed, the discussions deteriorated around what was a defect versus what was a change request. Things got adverse. Lack of understanding of the original scope, and the alignment of goals was not there.”Even in successful outsourcing arrangements management realizes the importance of a clear descriptionof objectives and processes. When asked what they would do differently next time, managersmentioned that they would specify more clearly the requirements and scope of the project at the start,and have a roadmap of goals for each delivery phase. This was true for clients and vendors alike, asvendors risk not only satisfaction with the failed project but also their reputation. As a vendor put it: “[The] lesson we have learned is, don’t engage with the client that does not have clear objectives and goals defined as this will hamper our performance and brand.”Recommendation: Determine what you really need (and at what level), based on past performance,your competitors’ service levels and your customers’ demands. Then properly define service levels incollaboration with your outsourcing service providers to ensure that they understand them and arecapable of fulfilling them. Frequently, experienced outsourcing vendors can help in defining servicelevels.Have the right and steady resources on the job over the course of the relationship.Our findings show that a structured governance model with the right resources can be instrumental tothe success of outsourcing engagements. In cases where such engagements were unsatisfactory,managers revealed both internal resource allocation problems and a lack of executive focus as factorsthat caused dissatisfaction: “The roles were not clearly documented upfront in the transaction. The relationship manager who was responsible for the transaction was not clear how the internal resources were going to operate with respect to external resources. The progress of the project was not as fast as required.” 2
  4. 4. Clients in particular realized the importance of retaining human resources throughout the relationship sorelational governance can be executed in addition to contractual governance. Reflecting on the issues inhis project, a senior manager advised: “Try to have a steady team on your side. When people go, with them go relationship, trust and everything else which has been developed over time.”Another important consideration for the buyers was the loss of skills due to attrition in vendororganizations. Some of the clients expressed their discomfort with the time needed for their vendors totrain new employees, often resulting in project delays. These findings are in line with those related tothe implementation of large internal IS projects. Biehl (2007) found that particularly middle managersthat were managing the projects at a more detailed level tended to burn out and leave theirorganizations.Recommendation: Proper, detailed planning will aid the appropriate deployment of human andfinancial resources (Biehl, 2007). More proactive human resources management on both sides and solidtop management support are necessary to keep employees engaged and support them. In contracts,introduce specific clauses that offer a reasonable safeguard against attrition.Use good contractual governance to build up trust, and performance will follow.Interviews with buyers and vendors alike reveal that the quality of service delivery helped build trust ineach other. For clients, trust was generated through the performance of their vendors, including timelydelivery and proper communication. As one vendor put it: “Trust built up over time through proven delivery.” Another client felt that communication in the form of “structured lower level meetings” also facilitatedthe development of trust. Cases where buyers trusted their vendors resulted in a more collaborativeatmosphere between the partners and in faster issue, escalation and dispute management, thusincreasing the chance of completing the initiative successfully.In contrast, trust can be broken through unexpected behavior. In one particular case we saw ill effectsgenerated by the perception that the vendor attempted to skimp on the delivery aspect: “Some people on our side don’t trust the prices of the vendors. They nickeled and dimed the project.”As a result, the client was saddled with additional costs that were not part of the upfront agreement.While likely also the result of poor planning from the client’s side, this directly affected the satisfactionlevel of the client, regardless of whose fault it was. In general, we noticed that the lack of trust lead todissatisfaction amongst partners and low morale amongst vendors, thus negatively impactingperformance and the likelihood of success. According to a large global vendor, 3
  5. 5. “There was lot of criticism and finger pointing, comments of low productivity, poor delivery standards, poor communications, low efficiency, etc. directed towards the off-shore team.”Recommendation: Three components seem to impact trust: well-planned processes, goodcommunication and satisfactory performance, with the former two impacting the latter. Trust, in turn,helps overcome difficulties by generating a collaborative atmosphere (Sabherwal, 1999) which, in turn,increases the chance of completing the outsourcing initiative successfully (Goo, Kishore, Rao, & Nam,2009).Implement an effective communications process.Effective communication mechanisms between multiple stakeholders in outsourcing are critical forunderstanding and conveying issues as well as assessing performance and the health of the relationship.We found that while satisfied clients had placed importance on what one manager called “high rigor andstructure around communications,” clients with unplanned or ineffective communication mechanismssuffered issues and missed deadlines. Those issues could lead to significant delays, or worse. Managersmade clear that communicating the right issues to the right person (i.e., through the right channel) at theright time was critical. The statement of a manager of a successful initiative on the vendor sideunderscores this finding: “The perceived risks were communicated to the client at all the levels and on several occasions. Since clients were made aware of the potential issues they actively worked to ensure that the issues did not materialize.”Similarly, keeping senior management informed was useful for avoiding surprises. When asked aboutthe lessons learnt from his outsourcing initiative one manager mentioned: “Timely communication at all levels is important. This ensures that there are very few surprises at any instance. Senior managers should always be updated with what`s gone well, what’s gone wrong, impact and the steps taken/planned.”Some vendors also pointed out that structured communications and reporting mechanisms increasedtheir productivity and helped enhance their performance.Recommendation: Good intentions are not good enough. Ensure that communication is scheduledhorizontally (i.e., among outsourcing partners at the same organizational level), with more frequentinteraction at the operational level as compared to the executive level. In addition, ensure thatcommunication is scheduled vertically, i.e., across organizational levels. Senior management will not beable to effectively help trouble-shoot problems if they are not kept in the loop (Biehl, 2007). As pointedout above, communication also supports the development of trust. 4
  6. 6. How do these findings relate to best practice?In this section we relate the above findings to outsourcing best practice and develop a governanceframework that should be useful to outsourcing managers on the buyer and vendor side.Drawing the above findings together, it is important to first determine what is needed, then encodethese requirements in a service level agreement. Like in new product development, it is advisable thatboth outsourcing partners be involved in this process. Vendors are often more experienced than clientsand can advise on the sensibility, feasibility and financial impacts of the buyer’s choices, or buyers canobtain input from third party sourcing advisors. Proper planning also extends to the determination ofthe human and financial resources needed on both sides to implement the contract. Finally, the contractshould contain a communication schedule that outlines who will communicate with whom and howfrequently or under what conditions, typically included in the governance schedule, attached to themaster services agreement. All of these contractual components determine the parameters that definehow, at what time and by whom parts of the contract will be executed.Drawing on CORE’s standard three tiered governance structure (which was validated by the executivesinterviewed for this paper and appears to become widely used), we propose the following governanceframework (Figure 1). In the remainder of this section we will relate this framework to best practices forthe outsourcing sector.Engaging the right people in an accountable manner. According to CORE, the de facto standardgovernance model is based on joint Operational, Management and Executive committees. These levelsare not distinct, but share both resources and data to be effective. The operational level is responsiblefor managing the day-to-day outsourcing activity. The management level is concerned with more of anadministrative role relating to the administration of the initiative, including the context of the broaderbusiness terms and high-level performance measurement. Finally, the executive level will likely have theManagement level lead attend in a support role and monitor the progress at a very high level. Note thatthe coordination between these levels constitutes what we call “vertical communication.” This type ofcommunication must take place on both the buyer and vendor side.The business processes, implemented to execute the outsourcing arrangement, must be carefullyconstructed with a clear identification of roles that own the processes and act as points of contacts forthe coordination and maintenance of vendor’s performance. Identifying important resources,establishing points of contacts and clear lines of responsibility between the key personnel on both theparties alleviates the typical resource allocation problems that buyers and vendors typically face. Themost common business processes include: issue, escalation and dispute management, financialmanagement, demand & scope management, change & release management, contract management andcontract compliance management (Hart, 2011). 5
  7. 7. Customer’s Vendor’s Governance Structure Governance Structure Execu ve Commi ee Execu ve Commi ee Management Commi ee Management Commi ee Opera onal Commi ee Opera onal Commi ee Planned Ver cal Planned Horizontal Planned Ver cal Communica on Communica on Communica on Communica on over the project life cycle: Life Cycle Stage Contrac ng Transi on Steady state Frequency High High Medium Topics Contracts, including Progress reports on performance, resource requirements, customer sa sfac on management, risks service level agreements and rela onship health (SLAs), communica on plan Processes needed for effec ve rela onship management: • Issue, Escala on and Dispute Management, Financial Management, Contract Management, Contract Compliance Management, etc. Trust, Cooperation, Success Figure 1: Outsourcing Governance FrameworkAs discussed earlier, the impact of attrition can also be handled by placing a limitation of turnover ratesin SLA, where timelines can be specified on how often vendors can turnover, along with a requirednotice period and approval by the client on the replacement person(s).Understanding service delivery objectives and mechanisms. The above framework ensures that theexpectations for the outsourcing initiative, as formalized in the service level agreements (SLAs), arewithin the scope of services and that the service delivery clauses are mutually agreed upon andunderstood. This avoids any confusion on what is a defect versus a change request.Communication and Performance Management. A documented and published governance manualenables effective horizontal and vertical communication. Best practices for a governance manual includeall the key activities for each of the governance communication and business/operational processes,with responsibilities assigned to the various roles (Hart, 2011). It should be the task of mostly theoperational governance team to formally and consistently manage the vendor, but also report the healthof the relationship to higher management levels.Reporting mechanisms should be put in place to not only acquire and assess all stakeholders’requirements, but to also construct a set of activities and metrics for assessing customer satisfactionwith the service quality and capabilities provided by the vendor. This ensures that all stakeholders are 6
  8. 8. continuously aware of the actual (versus expected) performance levels, risks and health of therelationship and can hence take appropriate corrective measures as required. It also negates thechances of ‘finger-pointing’. When issues arise, they should be handled through structured frameworkslaid out in the governance schedule to make sure that issues can be resolved fairly and within theagreed-upon timeframe.Periodic assessments of the health of the relationship. In addition to the above, a separate processdedicated towards governance & relationship maturity assessment needs to be executed periodically.During the early part of the transaction it is important to define a cycle to review performance ofdocumented agreements and metrics to assess relationship maturity. As the relationship materializes,financial and operational health checks on the relationship conducted on an annual basis arerecommended. Key stakeholders are interviewed to assess relationship maturity across a broadspectrum of governance components. This ensures that management is not only aware of the health ofthe relationship but also recognize the strength areas and develop a joint action plan necessary toimprove the areas of lower maturity. Again, this process involves both horizontal and verticalcommunication on both sides of the arrangement.Trust and Success. We see that a smooth and efficient delivery process impacts the satisfaction levelsand helps build trust. The governance framework proposes a standard approach to address, resolve orescalate client or vendor issues to ensure a minimal impact on service delivery. Apart from this,reporting mechanisms including performance scorecards can be used to notify all stakeholders of theperformance of the service provider. The scorecards are then distributed to all levels of management fortrend analysis and obtaining feedbacks. As the relationship matures, the above mechanisms will ensurethat the outsourcing parties achieve mutually agreed upon objectives and, thus, build a cooperativeworking environment that instills trust in each other. Trust, in turn, allows the parties to overcomeissues more quickly and easily and thus ensure that the outsourcing initiative can be completedsuccessfully.ConclusionIn this paper we reported on interviews we conducted with outsourcing managers of successful andunsuccessful initiatives on both the buyer and vendor side. We focused on the governance process, asthe same has a dramatic impact on the chances of successfully completing the outsourcing initiative.Feedback from the managers indicated that service expectations need to be clearly laid out, requiredhuman and financial resources need to be well-planned and available throughout the outsourcinginitiative, and planned horizontal and vertical information are vital to build up trust and be successful.Based on these insights, and drawing on the standard three-tier outsourcing governance modeldeveloped by CORE, we proposed and discussed a framework that facilitates a well structuredoutsourcing governance. Applying this framework should lead to a more responsive, cooperative andtrusting environment which, in turn, increases the chance of completing the outsourcing initiativesuccessfully. 7
  9. 9. BibliographyBiehl, M. (2007). Implementing Global Information Systems: Success Factors and Failure Points.Communications of the ACM , 50 (1), 52-58.Goo, J., Kishore, R., Rao, H. R., & Nam, K. (2009). The role of service level agreements in relationalmanagement of information technology outsourcing: An empirical study. MIS Quarterly , 33 (1), 119-145.Hart, M. (2011) Outsourcing Relationship Management. Retrieved Aug 19, 2011 from http://www.core-outsourcing.org/core-research/index.php.Lacity, M., & Willcocks, L. (2003). IT sourcing reflections - Lessons for customers and suppliers.Wirtschaftsinformatik ISSN 0937-6429 , 45 (2), pp. 115-125.Lepeak, S. (2010). Sourcing management: the secret to outsourcing success? Retrieved Aug 19, 2011 fromhttp://www.outsourcemagazine.co.uk/articles/item/3611-sourcing-management-the-secret-to-outsourcing-success.Sabherwal, R. (1999). The Role of Trust in Outsourced IS Development Projects. Communications of theACM , 42 (2). 8