Rethinking IT Outsourcing
December 1 2004 by Chief Executive
Realizing business value from information technology is a top priority for most CEOs, Forrester Research estimates that the average top 500 company in the U.S. spends close to $400 million, or 3.8 percent of revenue, every year on IT; in 2005, the figure is expected to grow by 6 percent.
Unfortunately, many companies are dissatisfied with the results from their IT investment. Recent announcements by JP Morgan Chase, UBS Warburg and Britain’s J. Sainsbury signify major changes in the way large companies plan to approach IT: J. Sainsbury stated that its IT systems “have failed to deliver the anticipated increase in productivity.” At JP Morgan Chase, the company ended a $5 billion outsourcing contract that had failed to produce and brought the work in-house.
At some of the world’s largest organizations, CEOs and their senior management teams are thinking about IT in a very different way. They are bucking the old models of IT outsourcing€¦quot;finding one company to do it all€¦quot;and pioneering a fundamentally different strategy, seeking substantially better results for their businesses. This new sourcing strategy underscores the difference between a monopoly and a competitive market.
Global industry leaders and some of the world’s largest buyers of IT, including JP Morgan Chase and Dow Chemical, are moving away from monopoly agreements with a single IT service provider and introducing the dynamics of competition. An October 2004 statement from Rod Bourgeois of Sanford C. Bernstein supports this point: “Our research shows that IBM has lost signings share in recent periods, and it emphasizes that the Big-3 outsourcers [IBM, EDS and Computer Sciences Corp.] are experiencing increased competition from a growing list of non-Big-3 players.”
We believe these events are indications of a major change to the three traditional approaches to IT sourcing that exist today, and they are:
External monopoly. A company outsources the bulk of its IT to one large external provider. By removing competition, innovation is stifled, control is lost, accountability is limited and inertia sets in.
Internal monopoly. A company relies on internal staff for the vast majority of its IT. Theoretically, there is a benefit to leveraging people who know the business, but, in practice, most internal IT organizations are not well aligned to the business, not subject to competition and not held to the same standards and expectations as external providers. When asked to describe his IT organization, the CIO of a large financial services firm said succinctly, “We’re a monopoly and we act like one. We need to get some competition in here.”
Mix and match. This model, used by most companies today, consists of a combination of internal and external approaches. The greatest inefficiencies in this model are found in the way external providers are selected and managed. Most organizations use a “best bid” approach for each engagement. This approach has the benefit of competition, but loses knowledge as companies change providers for projects. This model also fails to foster an environment where providers and internal employees work together to achieve the clients’ best interests.
One global energy leader (and a Sapient client) is approaching information technology in an entirely different way. This company has decided to outsource virtually all of its IT, but not by using one of the traditional models above. Instead, it reduced its list of IT providers from several thousand to a few hundred and dropped its list of IT service providers to fewer than 20. By keeping this number of providers in the mix, the client has removed the pitfalls of the “external monopoly” model, which could threaten the success of its IT strategy.
Additionally, the client set standards and metrics upfront and established common dashboards to formally review the providers’ performance, which has improved their vendor management approach. As a result, they now have a commitment on all sides for mutual value creation. Each party is willing to make investments to create more value; the client takes the time to ramp up and include the providers in its strategy and the providers are more willing to make investments that may result in innovation and bottom-line improvements. Another benefit: The company receives better service, pricing and ideas as a result of a defined competitive playing field that also allows visibility into provider performance metrics. For example, as a midsize provider of business and technology consulting services to this client, our company acts as a catalyst for higher performance. Every day, we are competing with other providers while helping those same providers succeed, and the client receives the best ideas, lowest pricing and highest quality service.
Taking key aspects of this client’s approach with best practices from other companies we work with, we see another model emerging, which we call the “managed competition” model. This strategy is fundamentally different because it has competition at its core. We expect this model to outperform all models in service, business results and innovation. The basis of our belief is simple: Competition at its core will unlock the problems created by all the other models. The managed competition model is characterized by the following:
A segmented IT portfolio. Segmentation can be by business line, technology, function or other criteria. A small number of preselected providers are matched to the organization’s various segments of work.
A competitive environment. Preselected providers are expected to cooperate and compete in the best interest of the client.
Visibility into performance. A common set of business measurements that evaluate each provider on effectiveness (such as return on investment and client satisfaction) and efficiency (such as timeliness and cost) are established. Providers are evaluated regularly and evaluations are transparent and visible, creating ongoing pressure for high performance.
The right balance of service providers. Traditional global integrators offer scale, while midsize innovators force agility, creativity, better pricing and higher standards.
Moving to a managed competition model requires visible and ongoing commitment from senior executives and the CEO. While challenging, it is not insurmountable and has the potential of unleashing material bottom-line results. To succeed, companies need to overcome a recurring problem other companies have learned the hard way to deal with: selecting the right set of providers.
Companies that are successful in choosing providers have done three things very well: matched the right type of work to the right provider, selected providers that have the strongest track record for execution and focused on outputs versus unit cost inputs. While this may seem obvious, companies do not follow these basic steps. Many are far more fascinated with lowering unit costs than achieving return on investment. As simple as it sounds, executives who never forget that the end game is about achieving business results will be the most successful.
For example, take execution track record€¦quot;a major point of distinction between providers. A 2003 Standish Group survey found that 66 percent of projects are either canceled or materially off target (in terms of timeliness, functionality or on-budget performance). The cost of lost or late functionality quickly outstrips unit cost savings and reduces return on investment.
Most organizations are not capturing the financial, operational and business innovation benefits they expected. Traditional IT sourcing models are simply not effective. However, the good news is that a new model is emerging that holds tremendous promise, and it is based on a proven idea€¦quot; competition. CEOs need to examine this new model to see if it holds value for their organization. After all, with top companies spending in the neighborhood of $400 million per year on IT, it is not only the CIO, but the CEO, who is on notice.
Jerry A. Greenberg is co-chairman and co-CEO of Sapient, based in Cambridge, Mass.