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Guidelines For IT Management: Planning for Offshore Outsourcing

How do you take an existing outsourcing relationship and drive more value from it? That, to paraphrase Hamlet, is the key question for both buyers and suppliers.

Both parties in an outsourcing transaction spend a great deal of time structuring their initial outsourcing deal. Once the relationship develops a rhythm, it typically continues along on automatic pilot until it hits an obstacle. Battle lines start forming. Both sides don't know what to do.

So you ask us for help. At the Outsourcing Center, we receive over 4,000 emails a month from you, our readers. Common themes emerge. We gather a great deal of insight from this communication.

Because the Everest Group is a leading provider of outsourcing advice, buyers and suppliers often ask us to help them get their relationships back on track. After working with these issues for years, we have discovered the key to achieving consistent turnarounds is to get both parties to focus on the creation and delivery of value. After all, this was at the heart of the relationship when it was first conceived. Like a failing love affair, both parties have sadly forgotten what originally brought them together.

Of course, both parties have to agree on the definition of value. That definition often differs widely between the two parties at this stage. The first step is to reach a consensus on what's really important.

An Anatomy of The Problem

Often, the initial vision of value for the supplier is to be able to provide the agreed-upon services at a lower cost and higher quality than the buyer can achieve itself. This is a fair value proposition that both sides can easily understand. However, over time each side's interests fall out of alignment with the other party. The supplier has a natural interest in growing its revenue and profits. Yet, the buyer has a natural interest in finding ways to reduce its costs. This potential conflict of interests presents a need for both parties to work together in aligning their interests to meet both imperatives.

Unless they work together to align their potential conflicts in alignment of interests, seeds are planted for destructive behavior. For example, some buyers may try to expand the scope of services while refusing to pay for the additional tasks. Or, they may try to undermine the supplier's ability to deliver these services by taking away key tasks. While accepting supplier success as a given, they tend to pounce on every hiccup, setting impossibly high standards for the supplier that they would never apply to themselves.

Some suppliers are equally responsible when a relationship breaks down. They relentlessly attempt to reduce the scope of the services while charging the same price in an effort to improve profits. Or, they may add a premium price tag to every service that's added on to the original project. Sometimes suppliers have a bad attitude. If the buyers asks for something, the answer is always "no."

These natural tendencies introduce a fair amount of tension into the relationship. Some critics claim this tension is the normal outcome of outsourcing. I say, "Absolutely not!" At Everest, we believe if you introduce the concept of value creation, that commitment places both parties on the same team. They then have a common framework and can evaluate every idea based on how it helps the relationship (as well as each side) prosper. The goal is to have both sides get their business needs met-but not at the expense of the other. Outsourcing is a win-win, not a zero sum game.

Creating value aligns each side's financial goals. The buyer wants to get more for less. The suppliers want to give less for more. Creating value is the best way to relieve the inherent tension in those seemingly contradictory goals.

For example, when a supplier creates more value for a buyer, the real price of the services typically falls because a more valuable transaction takes place. Creating value satiates the buyer's need for a constantly improving cost structure. At the same time, more valuable transactions create more revenue for the supplier and improve supplier profitability - and not at the expense of the buyer. There's also more money on both sides to expand the scope.

Turning Conflict Into Value Creation

Here's an IT example from our practice. A teaching hospital outsourced its desktop functions. The hospital's major goal was to reduce its IT cost structure. The relationship rocked along. Then, the hospital decided to implement a new technology: a physician's computer order entry system that allowed the doctors to access a database of best practices and expert systems to help them prescribe medication and chose therapies. The database gave the doctors a huge bank of knowledge to rely on when making a decision instead of being forced to rely on their own, limited experience.

The doctors were excited about the new order entry system because it clearly improved the quality of medicine they practiced at the hospital. However, the service level agreements (SLA), which were written before the new system, were now outdated and unacceptable. The agreed-upon eight hour turnaround for fixing a desktop problem, designed for administration users, was now way too slow for an MD facing a life-or-death patient decision.

The physicians were upset and felt they couldn't rely on the new technology. They put pressure on the hospital administration to fix the problem. They requested the supplier to improve the SLAs.

This, in turn, created tension with the supplier. From the supplier's perspective, the buyer changed the rules and was now expecting different services than it originally contracted for. Emotionally, the supplier felt the buyer was being unrealistic and unfair in its new demands, especially since it was meeting its contractual SLAs.

The supplier's unwillingness to comply with the new rules upset the hospital administration. They felt they weren't getting value for their money. In fact, they felt the supplier was taking advantage of them. This sense of betrayal created an emotional problem that made them unreceptive to any price increase to pay for the new services.

To solve this seemingly irreconcilable problem, Everest helped the two parties focus on the value the outsourcing relationship could achieve. First, both parties agreed that the situation had changed. We helped the buyer understand that it was now asking for different services, which helped overcome its emotional resistance to any price increase. We helped them understand the new technology they wanted would produce significant cost savings for the hospital, improve its patient care and allow it to be ever vigilant about patient safety. The potential gains were huge.

Once they reached that mutual understanding, the supplier agreed to change its services to meet the hospital's new requirements. It also committed to making a significant investment in a new technology-a mobile network-to provide the instant service the physicians expected. The new mobile network enlarged the scope of the agreement and allowed the supplier to charge slightly higher prices over the life of the contract. In addition, the supplier had an at-risk component that was tied to the successful implementation of this mobile network. This increased its compensation and upside profit potential.

This created a lot of good will because the hospital had reached the limit of its capital appropriations for that year and could not commit to any new investments. In addition, letting the supplier handle the implementation slashed the ramp-up time.

Once the new mobile system was in place, the doctors were happy with the system and much more willing to use it.

This story had a happy ending. The supplier earned more revenue at a higher profit. The buyer lowered its risk and maintained its cost, thanks to the implementation of the new mobile technology. A sense of partnership replaced the feelings of betrayal and abuse.

Universal Applications

Is this an exceptional case? No! In most cases, there are ways to improve the value in an outsourcing relationship without penalizing either side in the process. Not all outsourcing relationships can produce such a dramatic value improvement as our hospital client. But many do, and far more can than most people realize. Almost every outsourcing relationship I've seen has the opportunity for modest value improvement.

I believe this topic is so important I will devote the next three issues explaining how to create value in an existing outsourcing relationship. Next month I'll discuss how to create value by building a relationship around your supplier's strengths. Buyers who shape their solutions around what their suppliers do best allow the supplier to maximize value. A happy result: the lowest cost environment.

In May I'll discuss how a supplier's services can impact other departments in the buyer's organization as well as the strategic goals of the company. Alliances are the topic for June. I'll explain how outsourcing relationships form the basis for productive partnerships.

Lessons from the Outsourcing Journal:

• There's an inherent tension in outsourcing relationships unless both parties focus on creating value.
• Buyers can achieve low costs and suppliers can enjoy a healthy profitability if both sides focus on creating value.
• It's possible to create additional value in existing outsourcing relationships, no matter how mundane the outsourcing process.
• Creating value transforms outsourcing relationships from a zero sum game to a win-win relationship with everyone benefiting - but not at the expense of the other.

Publish Date: March 2002

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Copyright © 2002 - Everest Partners, L.P.

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