Is outsourcing really economical?

The regular checking of market prices and arranging of escalator clauses has become standard practice where newlynegotiated outsourcing contracts are concerned. Nowadays the mistakes are made elsewhere and the potential for conflict between companies and service providers remains high.

The question customers typically ask of their benchmarker is: Is the price for the service suitable?

Outsourcing of IT remains a trend. Scale effects and the providers’ technical know-how are powerful arguments. However, uncertainty is increasing. Many companies which have outsourced their IT are worried that they are paying too much. Or they doubt that the quality of the service is really good enough. After all, the fact that market prices are subject to constant change has got about. Nowadays hardly any contracts are being negotiated which do not contain corresponding escalator clauses.

IAs a rule, companies and outsourcing service providers agree on a benchmarking provider as a neutral mediator, which at regular intervals and using comparison groups from its database ascertains the current market prices for all services, be they related to operating the server, mainframe services, the network, SAP hosting, the desktop, WEB hosting, etc. If the price is outside a specific corridor, the service provider has to adjust the price – down, or, as the case may be, up. Both sides should share the costs of benchmarking. This guarantees that no one feels cheated.

So far, so good. However, that is not all. The question customers typical ask of their benchmarker is: Is the price for the service suitable? Is the daily rate appropriate? In this respect, the real mistakes are being elsewhere today, e.g. in the quality agreements.

Lack of quality where SLAs are concerned

Maturity has ascertained that a good half of all agreements on levels of service contain striking weaknesses. Both sides concentrate on the technical aspects and not on what are really the relevant services. In this respect, there are intensive discussions with regard to the availability of computers, though not with regard to the availability of the application. This can sometimes have spectacular consequences, for example the CAD application used in the automobile industry. If this application cannot be loaded quickly, it is almost unusable. However, if the service level is not clearly formulated, the service provider can always say that technical availability did indeed exist

Transition costs underestimated

Conflicts between companies and outsourcing providers are thus inevitable if not enough value was placed on the costs of actually handing over the IT – i.e. people and computers – when the agreement was being negotiated. Unfortunately, this is alarmingly often the case. Both sides are usually guilty in this respect. The situation begins with unclear due diligence. To begin with, the company does not provide accurate details and, for example, sometimes does not know itself how many computers it is actually handing over. And the service provider does not always want to know the number. If the service provider assumes that the number of computers is low, it can offer services at a low price. Here the increasing competitive pressure between providers makes itself felt, which means that everything is put into retaining the order. The fact that additional, substantial transition costs are incurred is only mentioned as a side issue. After all, the customer has not made sufficient enquiries and, in case of doubt, there is not a lot of information on this matter in the competitor’s quotation.

As a result of this – conscious or unconscious – carelessness, both sides put each under stress. After all, the transition costs can make up 10-15 of the overall costs! If both sides have made erroneous calculations in this respect, they will find themselves with their backs against the wall within a short period of time. This is the case even if the costs of normal operations were calculated correctly.

Ancillary services – a grey area

As a rule, the pressure of competition among IT service providers is in no way advantageous for the customer. The supposedly good price turns out be a double-edged gift because, in the long run, no service provider can afford to lose money during ongoing IT operations. It gets this money back in another way, i.e. by means of what are known as “ancillary services”, be these software upgrades, the migration of newer technologies or other types of changes that have to be made in the business environment. These tasks are inevitable at some point, even if they are not discussed much at the beginning. As a rule, the pressure of competition among IT service providers is in no way advantageous for the customer. The supposedly good price turns out be a double-edged gift because, in the long run, no service provider can afford to lose money during ongoing IT operations. It gets this money back in another way, i.e. by means of what are known as “ancillary services”, be these software upgrades, the migration of newer technologies or other types of changes that have to be made in the business environment. These tasks are inevitable at some point, even if they are not discussed much at the beginning.

Issuing tenders in a professional manner

So, what is to be done? Without a doubt the pressure must come from the customer! The mistakes already described can only be avoided by issuing specific tenders, which cover all aspects, including transition costs and the costs of each ancillary service. And which force each provider to take all of the items into consideration. The more detailed the manner in which the tender goes into the services and how they should be provided (quality and volume), the better and more specific are the offers to be expected. In this respect, realistic assumptions that one will not have to pay more later help. In the end, the process is not different to the one involving the leasing of a company car. Here details related to the annual mileage have to be provided. If one begins with values that are too low, after a term of two or three years the company may have to pay significant subsequent costs. Similarly, when tenders are being sent out for IT services, realistic scenarios should be included, for example concerning a large number of calls to the user help desk.

When a human element is involved

However, even when the tender is perfect another aspect is regularly underestimated – the human factor. When outsourcing is taking place many employees are given new tasks and positions. Competences are frequently withdrawn and people are “parked” anywhere handy. As a rule, there are few winners, but many losers. The change makes the employees uncertain and the fact that the legal aspects are clear does not help at all. Companies underestimate the multiplicator function of unhappy employees. The phrase “Everything was better in the past” is often the beginning of a long chain of reactions. In the end there is a loss of image, in the worst cases the outsourcing solution created acquires such a bad image that the work is redone. This is the worst possible case for all of those involved.

Nevertheless, there are no easy answers where the human factor is concerned. However, when management is aware of the problem, it can take a range of precautionary measures. This begins with an open and explanatory form of communication – one can hardly believe how many wrong things are done in this area. And it can end with psychological counselling being provided.

Even if additional costs are incurred, the worst case scenario would be many times more expensive.

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