See also:
Outsourcing -- Part One
Outsourcing -- Part Two
Outsourcing -- Part Three
Are We Indispensable?
The Best Gift Arrived in a BIG PACKAGE

          Outsourcing is growing at a rapid rate in the United States, Europe and Asia because organizations view outsourcing as a way to achieve strategic goals, reduce costs, improve customer satisfaction and provide other efficiency and effectiveness improvements. Like any organizational decision, outsourcing is not free of risk and requires effective management from the outset of the outsourcing evaluation through the life of the contractual relationship. This article outlines fifteen critical factors for successful outsourcing.

1. Define the Objectives
          Outsourcing must be done carefully, systematically, and with explicit goals. Companies that rush into outsourcing without fully understanding what they hope to gain may find themselves mired in a contractual battle with a chosen vendor or the recipient of services that worsen rather than improve. Sensible reasons to consider outsourcing include both strategic and tactical concerns on both a department and organizational level.

          Outsourcing might be justifiable for a department with high costs that cannot be reduced or a lack of competency in specific areas. Organizational needs that generate consideration of outsourcing include the ability to compete globally with global services or relief from financial pressures achieved through immediate cost savings.

          Outsourcing is not an excuse to wash management's hands of a poorly managed, costly, or misunderstood function. Understand the costs of a function and manage it effectively before evaluating its potential for outsourcing. Otherwise, you are probably deciding to outsource for the wrong reason, you may be giving the outsourcing vendor gains you could have reaped, and you may be starting a relationship that is destined to fail.

          Organizations should consider (or reconsider) the overall merits of selective outsourcing every three to four years. Revisiting outsourcing may be particularly relevant under changing market conditions or when internal, industry, or technology changes have occurred.

2. Outsource for the Right Reasons
          Assess outsourcing's potential tactical and strategic benefits and disadvantages.

          Potential disadvantages include outsourcing for the wrong reasons, losing control of the resource, losing personnel who have been trained in the organization's particular business practices and have become a part of the organizational family, and the risk that the outsourcing vendor may not be able to achieve the desired benefits or may fail in providing critical services. Figure 1 and Figure 2 summarize the main tactical and strategic reasons for outsourcing.

3. Answer Key Questions
          The outsourcing issue should be part of a larger one regarding how the function or functions being evaluated for outsourcing fit into the organization. As part of the outsourcing evaluation, questions like the following should be answered:

• What are our core competencies?
• Which services or corporate support functions are not integral to or close to our core competencies?
• What are the barriers raised by the corporate culture?
• What is the cross-functional impact?
• Can we fix ourselves internally before we consider outsourcing?
• What might be better accomplished by an outside vendor?
• What are the goals we want to achieve from outsourcing?
• What kind of relationship with a vendor is most appropriate?
• How do we deal with the people issues?

4. Use a Methodical Approach
          The process of deciding whether outsourcing is warranted involves numerous steps or phases. These are: identifying requirements; preparing and distributing a request for proposal (RFP); examining proposals; evaluating vendors; negotiating contracts; and implementing outsourcing. Adopt a methodology that describes the various steps to be performed and lays out the project plan necessary for a thorough evaluation. Just as applications development activities should be guided by a written, explicit methodology, the effort to consider and possibly implement outsourcing should be systematically conducted and documented.

          The various phases are as follows:

• Planning Phase. The objectives and scope of the outsourcing idea are defined and the feasibility of outsourcing is determined before a decision to proceed. The effort is 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 information system function(s) to be outsourced and other functions that will remain in-house are also clarified so that contracts with vendors are certain to include proper interfaces with in-house services. The request for proposal 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 is made.
• 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.

5. Consider All Stakeholders
          Managers who have made the decision to outsource should be able to predict the likely impact that outsourcing will have on the organization's stakeholders, who include stockholders, customers, suppliers, and employees. For example, news of a pending outsourcing arrangement may alert the stock market to perceived organizational troubles or send a signal that "something is finally being done at Company X" thus causing the stock to rise. After anticipating the impact of an outsourcing evaluation on stakeholders, managers should include the revealed issues in the outsourcing plan.

6. Get the Right People Involved
          Early in the evaluation, persons must be identified who will take leadership responsibility, perform the analysis, and make the decisions.

          The persons who should be involved depend on what is to be outsourced and the circumstances surrounding the outsourcing decision. An executive sponsor or champion is desirable, and in cases that involve organizational politics such support is absolutely critical. For larger outsourcing initiatives, top management must play a role. For smaller efforts, middle-level managers might do the heavy lifting with the support of higher managers. The team likely needs a mix of managerial and technical talent. The team should also include representatives from user areas that will be directly and heavily impacted by the outsourcing under consideration. User views may be critical for setting scope and for assessing risks.

          The size of the team depends on the scope and size of the project, but smaller teams are generally more effective than larger teams. The team can be quite small in the planning phase and expanded in size 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 big 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. Outside consultants are highly recommended.

          Once the decision is made to outsource, identify persons who will be given responsibility for oversight and management of the outsourcing arrangement and vendor relations after the contract is signed. These people should be part of the team that crafts the contract. Their inclusion is critical 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 deal. Second, relationships with vendors start at the moment discussions begin. Being on the ground floor and having continuity in the relationship with people in the vendor organization contributes to success.

          When outsourcing threatens to upset the status quo in an organization -- as in instances of outsourcing motivated by high costs or poor performance-- it may not be possible to rely on internal sources for accurate estimates of internal costs or internal effectiveness. Under these circumstances, bring in objective outsiders for the assessment work.

7. Understand the Vendors
          Vendors that offer various outsourcing services aggressively market and pursue organizations to adopt outsourcing. Although the information that such vendors provide is often useful for establishing the types and general prices of services that might be outsourced, the actual price an organization will pay is set in actual negotiations related to specific requirements.

          Managers should take care not to be misled by what other organizations are paying or what a vendor might casually offer as a possible pricing scheme. After narrowing potential vendors to a manageable handful, better pricing and service agreements can often be reached by negotiating with the best-fit two or three vendors and then striking a final deal based on the best final offer.

          Because the path toward outsourcing can be a difficult one, managers should seek outside assistance from advisor(s) who can help coach an internal team during the evaluation and negotiation processes. It is important to bear in mind that outsourcing vendors have fine-tuned their approach and are usually armed with seasoned staff. Using unbiased advice to guide an organization through the process from beginning to end helps level the playing field.

8. Realize that Outsourcing is not All or Nothing
          Total outsourcing transfers most equipment, staff and responsibility for delivery services to a vendor, while selective outsourcing is the outsourcing of one or a few selected information systems functions. The sum of what is outsourced is substantially less than total outsourcing.

          Total outsourcing isn't easy because of the scope of the endeavor and because of the consequences if it isn't done well or if it shouldn't have been done at all. The stakes are high. A considerable sum of money is usually involved, not to mention the effectiveness of an information pillar that supports your organization's structure and performance.

          Total outsourcing is a major undertaking and no organization should do it without considerable thought. These deals are often structured to last for long periods -- usually more than five and often ten years. Vendors plan to make their margins on economies of scale and on replacing hardware in the future at costs that are substantially below costs today. Total outsourcing arrangements only yield acceptable margins over longer periods of time. Morever, clients who enter into total outsourcing arrangements must spend considerable time, effort and money analyzing the deal and contracting with a vendor and information systems flexibility may be considerably reduced. Technology will certainly change over a five or ten year period. The business environment will change, yet it is hard to set contracts that allow for large changes in scope. If the arrangement with the vendor does not succeed, it is necessary to either contract with another vendor, which involves substantial costs and disruption, or it's necessary to bring the function back inside the organization with all the attendant costs and problems. This is not to say that total outsourcing should never be considered, but it drives home the point that it should not be undertaken lightly.

9. Choose the Right Relationship
          Contracting relationships can be viewed as a range or continuum. At one extreme are market-like relationships in which your organization has a choice of many vendors capable of performing the work, relatively short contract durations, and the ability to switch to another vendor at the end of a contract for future work of the same type with little or no cost or inconvenience. At the other extreme are long term partnership arrangements in which your organization contracts repeatedly with the same vendor and develops a mutually beneficial relationship that lasts a long time. The middle of the continuum is occupied by relationships that must endure and remain reasonably harmonious until a major piece of work is completed; these are termed "intermediate" relationships. Since it is a continuum, there are relationships that lie closer to market relationships and relationships that lie closer to partnerships, as well as those that are midway between the two extremes.

          Market relationships cost the least to set up and administer and are relevant for work that is fairly simple and straightforward. Intermediate relationships cost more and are relevant for work that is more complex and has substantial benefits. Partnerships cost the most and are only relevant when the benefits of a close relationship with a vendor are substantial. Choosing the wrong relationship could result in excess costs or failures.

10. Negotiate a Sound Contract
          There are several critical components of a good outsourcing agreement. The emphasis from the outset should not be on who wins the best deal, but rather on negotiating a fair and reasonable contract for both parties. Because each aspect of the outsourcing relationship is governed by the contract, both your organization and the outsourcing vendor need to agree on everything. This also means that managers must think of every possible contingency to cover in the contract. The parties also need to agree on how to resolve disputes after the contract is signed. Such an agreement should not take the form of an open-ended assurance of goodwill but rather delineate the who, what, when, and where of conflict resolution.

          The manner in which employees are handled during the outsourcing process and contractual loopholes with a chosen vendor can lead to lawsuits. For these reasons, managers should ensure the involvement of in-house legal staff throughout the process and consider using outside legal advisors with expertise in outsourcing matters. An outsourcing contract may last for a long time, and both the organization and the vendor must understand how the relationship will be managed throughout the life of the effort.

          Some of the important contract considerations are:

• Terms of the agreement. The trend is toward a shorter-term renewal option (e.g., three to eight years). Managers should ensure that the contract stipulates that a renewal of the contract occurs only if a renewal notice is sent.
• Minimum services levels. It is vital that the contract specify as accurately as possible the services to be provided in the contract. This includes establishing minimum service levels and identifying any ancillary services to be provided.
• Ownership and confidentiality of data. The agreement must specify that the customer retains ownership of the data it submits to the vendor and that the data is kept strictly confidential.
• Warranty. Managers must ensure that the vendor warrants that it will provide the services as defined in the agreement and that it will accommodate a specified increase in requirements.
• Exhibits. Exhibits should be carefully read. As complex transactions, first-drafts of outsourcing contracts usually contain exhibits that are incomplete.
• Incentives. Consider providing the vendor with an incentive to perform. Such incentives include guaranteed savings, shared benefits/risks, profitability index, teaming arrangements, and cross-marketing opportunities.
• Disclaimers. Accept the fact that disclaimers will be part of the contract but ensure that a disclaimer does not void the warranty and indemnity sections.
• Bankruptcy. Both parties to the outsourcing contract should consider the possibility that the other may go bankrupt, which changes the outsourcing situation and obligations entirely.
• Force Majeure (Acts of God). These provisions state that the vendor is excused from performance if it experiences certain conditions. Such events should be limited to 30 to 60 days.
• Performance measures. A sound contract must include performance measures, because without them, there are no objective criteria for managing the outsourcing relationship. It helps considerably to develop such measures long before the contract, so that a history of effective measures can be used in the negotiations. Managers whose organizations lack such measures should not ignore them in the contract, however, but instead include a provision stipulating that the two parties agree to establish a baseline and begin using the metric on some specified date.
• Anticipating change. Contracts should provide for both good and bad times and accommodate cycles of demand that require an adjustment in services. If, for example, an organization becomes smaller, it could find itself paying for services that were priced based on conditions that no longer exist. Consider all the reasons why a contract might not work and ensure that the agreement can be terminated if necessary.

11. Use Performance Incentives and Penalties
          Incent the vendor to meet and exceed the contracted performance standards. Pay bonuses when the vendor exceeds expectations and charge penalties when performance falls below expectations. Ensure the incentives of the individual managers on both the customer and vendor sides are also consistent with the overall goals and with each others incentives.

12. Establish a Relationship Management Structure and Processes as Part of the Contract
          Provide in the contract for a formal relationship management structure linking the customer and vendor. This structure typically takes the form of joint management teams which have responsibility for day-to-day, tactical, and strategic aspects of the relationship. Each team has a clearly defined responsibility, agenda, frequency of meetings, and relationship to the other teams.

          Identification, resolution and rapid escalation of issues should be a key responsibility of each team.

13. Use Objective Performance Criteria
          Successful outsourcing relationships focus on results. To be meaningful, these results must be objective, measurable, quantifiable, and comparable against pre-established criteria.

          The specific performance criteria differ depending upon the types of services being provided, the customer requirements, and the level of service. Properly defined performance criteria for an outsourcing engagement are objective, quantifiable, and collectable at a reasonable cost, and should be metrics which can be benchmarked against performance of other organizations and providers.

14. Emphasize the Development of the People Responsible for Relationship Management.
          The individuals responsible for managing the outsourcing relationship for the customer should receive specific training on how to do the job. This includes a complete understanding of the business goals of the contract, the specific performance criteria agreed to, and individual roles, responsibilities, authority, and reporting structure. The same information should be communicated to the larger end-user community. In this way, the entire organization understands what is intended, why, how problems will be identified and resolved, communication channels, what is expected, etc. This training and communications can also help reduce resentment or resistance.

          Encourage training for the vendor personnel on the customer business environment and goals. Although the vendor personnel are experts in their fields, they require specific, ongoing training on the client's business and its goals. In this way, they develop the needed sensitivity to the issues driving the client's needs.

          You are also encouraged to involve both customer's and vendor's personnel in informal meetings and social events; education on company heritage and history; rotation of employees between the companies; participation of employees in "internal" meetings of the other firm; participation in the partner's internal improvement programs, such as quality teams; jointly sponsored recognition events, etc.

15. Manage the People Issues
          Managers who make the decision to evaluate outsourcing need to consider a host of people issues, the foremost of which is communication. Although communication requires more effort than might be anticipated, it is critical to a successful evaluation process.

          One of the first steps managers should take to ensure good communication is the establishment of a hotline to manage the rumor mill. Various forms of communications (e.g., newsletters and organizationwide meetings) help ensure that the right message is traveling as fast and as widely as the rumor mill.

          Keeping people informed every step of the way and working out a deal perceived as fair for them is important because an organization trades more than its physical assets to the vendor in an outsourcing arrangement-it often gives away its people as well. The customer's employees may become the vendor's employees, and individuals who feel they have been mistreated will have the power to bring systems down. Pragmatic reasons aside, treating people as fairly as feasible is the right thing to do.

          Also, consider human factors from the perspective of the user community. Users should be provided with points of contact before implementation, and an issue-resolution process should be immediately instituted.

Wendell O. Jones, Ph.D.
Vice President, Worldwide Outsourcing Delivery

Compaq Computer Corporation
40 Old Bolton Road, OGO1-2/T12
Stow, Massachusetts 01775
Voice: (978) 496-8251 -- Facsimile: (978) 496-8652
Email: wendelljones@erols.com

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