The High Costs of Outsourcing

By Channel Insider Staff  |  Posted 2005-11-16 Email Print this article Print
 
 
 
 
 
 
 

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A lot of outsourcing contracts end up costing more than they are worth. It's important for providers and customer to set the right expectations in advance.

I recently led a session on IT outsourcing at the Outsourcing Institute's Roadshow in Chicago. The daylong event included an exceptional presentation by Sara Parker Enlow from Vantage Partners about relationship management that I believe would be of great interest to solution providers.

Vantage Partners, of Boston, works with firms on conflict resolution. Enlow's presentation focused on the cost of outsourcing when the relationship is unhealthy and the benefits of outsourcing when both parties go into negotiations with a win-win attitude. Based on Vantage Partners' research, the cost of a sour relationship can hurt both the service provider and the outsourcing company and have an impact the lasts through the contract term.

Look through the annual reports of the largest managed service providers, and it becomes clear there are numerous instances when a long-term contract worth hundreds of millions of dollars is better terminated than continued. There isn't a single global service provider that doesn't have at least three or four examples highlighted in their annual reports of a contract gone south.

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Many of the conference attendees nodded in recognition of the impact of poor relationship management. Sour contracts affect service providers and users of all sizes and across all vertical markets.

Here is how a bum contract impacts the firm, according to Vantage Partner: The dollar cost of outsourcing relationship management is up to 75 percent of the value of the total contract. These costs include both substance and relationship items. Substance items are such things as pricing, reporting methods when and how, defining service levels, and service delivery.

Relationship items would be things like understanding each other's objectives, building trust and respect, and developing open and honest communication. If any one of these items is out of sync, costs creep up, quickly negating any cost savings associated with the initial outsourcing contract. Two, three or four items out of sync, and outsourcing quickly becomes an expensive exercise for both parties involved.

Here are some numbers on the cost of a sour contract:

Initial outsourcing contract:

  • Cost of outsourcing contract: $5 million
  • Base cost of relationship management: $3.75 million
  • Savings produced by outsourcing: $1.25 million

    One failed delivery schedule:

  • Initial savings with outsourcing: $1.25 million
  • Set of internal user meetings to identify failure: $0.05 million
  • Set of meetings with outsourcing vendor to determine cause: $0.10 million
  • Set of meetings to mitigate future failures: $0.10 million
  • Cost of increased monitoring of service provider: $0.02 million
  • New cost savings of outsourcing: $0.98 million

    The meeting numbers are based on an average annual salary of a midlevel manager and three subordinates spending a total of 3 hours in meetings for problem identification, and two times that value for joint meetings between service provider and user. In this example, 22 percent of the cost savings associated with outsourcing has been lost. Assume there is only one problem each year over the course of a five-year contract, and the savings associated with outsourcing has been eliminated. Factor in metrics such as lost opportunity costs, and outsourcing becomes a burden to both the vendor and the user.

    To get around these problems, Vantage Partners suggests the following actions by the user company during the negotiation process:

  • Find a service provider who is expert in the process being outsourced.
  • Ensure the service provider's culture is similar to yours, especially around communication styles.
  • Listen to the providers when they suggest process improvements; after all, they are the experts.
  • Define and develop communication methods as well as problem escalation procedures.

    On the service provider side, Vantage Partners suggests:

  • Recognize some customers are not right for your business.
  • Ensure communication styles are compatible.
  • Ensure the account representative is adequately empowered to quickly resolve minor problems before they become issues.
  • Reduce/eliminate churn within your account representative team.

    In a healthy outsourcing relationship, Vantage suggests the following win-win strategies:

  • Both parties come to the negotiation table with the attitude of "This is about meeting both companies' needs in a sustainable way."
  • When something goes wrong, diagnose joint contribution to the problem and work to avoid repeating it.
  • During contract negotiations, some of the measurable metrics should be jointly developed.
  • Avoid surprises on both sides. Be open and honest, including how outsourcing fits in to the company's strategic business objectives.

    The net of Enlow's discussion is that an outsourcing relationship is very similar to a marriage or core relationship. Share responsibilities for successes and failures, work together to resolve the root cause of a problem to eliminate repeats, avoid ugly surprises, and most importantly, keep the lines of communication open and operational.

    A free, complete copy of Vantage's report on the value of effective relationship management and governance can be obtained from its Web site.

    Nova Amber, a founding partner of Perspective Group, is conducting a Web-based study on storage and storage management as a service. If you have a few minutes and would like to voice your opinion on the subject of storage, as well as have the opportunity to win one of a number of cool prizes, go to www.perspectivereports.com.

    Some of the more interesting results of the study will be discussed here in my January and February columns. Wishing each of you a safe and festive Thanksgiving holiday.

    Martha Young co-authored "The Case for Virtual Business Processes," published by Cisco Press. She has extensive global expertise in the outsourcing and managed services market intelligence arena. Young can be reached at myoung@novaamber.com or (303) 642-0941.

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