Value creation in IT outsourcing

Value creation in IT

outsourcing From strategic needs to a fitting IT outsourcing

construction

Leon Dohmen and Joop Nabbe

July 2011

Review and translation by Dennis Coll, Francoise Eemsing, Gianfranco Franceschi, William Martin.

This article is translated from the original Dutch article ‘Waardecreatie met IT-outsourcing’ published in Outsource Magazine in July 2011.

For the past 15 years the focus on IT outsourcing has been primarily on standard services

and shopping for the lowest price. Long-term contracts were preferably closed. The external

IT suppliers have responded by setting up large factories on efficiency-oriented delivery. The

changing circumstances on the demand side, has left little space in this construction to design

a different way of value.

http://www.logica.com/

Value creation in IT outsourcing

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Introduction

Creating the expected value of IT outsourcing is not as easy as it seems. This is explained in

the book ‘Kampioen organisatieverandering’1 which talks about how significant improvement

need to take place when it comes to IT outsourcing and governance. The value that was

created (the result achieved) of 9 projects that dealt with IT outsourcing, in one way or

another, measured on average only a 4.8 on a scale from 1 (being very poor) to 10 (being

excellent). This result is 8% lower than the average result of the 46 involved research projects.

Governance2 also offers opportunities for improvement with an average score of 5.7.

Value creation

Technological developments of devices such as the iPhone, iPad, BlackBerry and increasing

applications in the Internet domain, such as social media marketing and the realization of

links between social media and customer relation management systems, for example, are not

so easily captured in standard IT services. Adding these technological developments to those

organisations that take part in active acquisitions and sales policy, and when creating new

business joint ventures are entered, then the internal IT department will have a hard time

following this and translating this into plausible IT services that adds value to the business.

Working with the IT department’s approved or authorized hardware and software lists, and

(rigid) standard services is not sufficient enough (anymore). Some organisations also have the

courage not to apply any longer the principle of forced trade with the internal IT organisation.

The internal IT organisation will therefore have to create value for the demand side (also

known as business) with IT services, otherwise the risk arises that the demand side goes

shopping elsewhere. In order to deliver IT services, many IT organisations seek the help of

external IT suppliers. Welcome to the world of IT outsourcing!3

IT outsourcing

The decision to (partly) outsource IT services has several underlying reasons, cost reduction

being the most dominant. This is confirmed in the article "De toekomst van Outsourcing” in

Outsourcing Performance 2010.4 Cost reduction being the most dominant is not surprising

when you look at the basic structure of many IT outsourcing deals: standard service set up in

long-term contracts with service level agreements, purchased at the lowest price with annually

imposed efficiency improvements during the course of the contract for the involved supplier.

This basic structure leaves little room for other (strategic) reasons of IT outsourcing such as

accelerating innovation, knowledge improvement and improving the quality of IT services.

This does not prove that purchasing IT services at a low cost is wrong. If this is a desired

requirement from the demand side, then there’s nothing wrong with that. IT service then

creates value for the demand side by being inexpensive, in addition to providing basic

required functionality.

Demand side

To be able to create value in IT outsourcing, it is important to understand the complexity and

dynamics of the demand side. This applies as well to the internal IT organisations that have

little or nothing to do with IT outsourcing. Complexity is associated with the product/service

needs of the demand side. If these product/service needs are characterized as being standard,

then the complexity is low. If the product/service needs are (very) specific, then complexity

1 Dohmen, L. (2011). Kampioen organisatieverandering. Unibook. 2 This article use the tern governance or governing whereas the terms control(ling) and direct(ing) are also suitable terms. 3 This article should not be read as a plea for IT-outsourcing. Taking a decision for IT-outsourcing should be done with care

and needs investigation. This article deals about the strategic design for value creation in IT-outsourcing after the decision to do this has been taken. 4 Riet, S. van de, M. Gianotten, J. Huige (2010). Outsourcing Performance. Giarte Media Group.


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is considered to be high. Dynamics can be linked to the predictability of delivery (time

aspect). When the supply of IT services can be planned, then this is interpreted as low

dynamics. When delivery is primarily ad hoc (and speed of delivery is desired), then there is a

high dynamic demand. To create value it’s important to know the (strategic) needs of the

demand side. This is an important starting point to set up a basic construction. Figure 1

divides the strategic needs of demand into four areas.

Figure 1: Complexity and dynamics of demand

Each quadrant offers different requirements for the delivery of IT services from the supply

side.

Supply side

External providers are positioned at the supply side of IT outsourcing. To create value, these

have to match the delivery of their products and services with the strategic needs of the

demand side. The requirements associated with this delivery are different for each quadrant

and they do influence also the relationship of the demand side with external providers. In the

lower-left quadrant - standard and easy to plan service delivery (low complexity and low

dynamics) - a low cost delivery price will indeed add value for the demand side. This can be

well supported by aligning on processes that support the delivery of these products and

services. In the upper-left quadrant, what is delivered is well known but the moment when it

happens is less predictable (low complexity but high dynamics). In the logistics sector, this

situation leads to frequent use of on-call contracts. In IT outsourcing, value for the demand

side can be created through the availability of a pool of employees that can be assigned when

the demand side requires it. This capacity has to show flexibility in its availability. In the

lower-right quadrant, predictable to deliver but (highly) specific products and services (high

complexity, low dynamics), value is created at the demand side through high quality products.

The craftsmanship of the external IT provider will steer the creation of value at the demand

side. The upper-right quadrant is to most challenging to serve. Value is created with highly

specific products or services that have to be delivered at unpredictable moments. Both

(flexible available) capacity and craftsmanship are needed to generate value. Here both the

demand and supply side, to quickly move forward together, have to form a solid and open

Complexity low;

dynamics high

Complexity high;

dynamics high

Complexity low;

dynamics low

Complexity high;

dynamics low

Variation in customer product/service

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Complexity: Diff iculty of the

product/service

Dynamics: Movement, time

related


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partnership bond. Figure 2 illustrates the relationship between the strategic needs of the

demand side and the desirable connection with the external provider at the supply side.

Figure 2: Relation between strategic needs demand and relation type supply

Most delivery models of today’s IT outsourcing or relationship types are located in the

quadrant of standard and easy to plan services. Here the emphasis is placed on process

alignment, for example on the basis of ITIL processes.5 When the strategic needs of the

demand side consist mostly of specific, ad-hoc, and quick to deliver IT services, such a

standard delivery model will not help generating much value for the demand side. A lot of

problems in current IT outsourcing contracts can eventually be traced back to this strategic

mismatch between demand and supply side. Albert Plugge6, in his 2011 graduation research

paper, lays the blame almost exclusively by the external providers. However, the question

arises: What is the role of the internal IT organisation in the alignment mismatch between

strategic needs of the demand side and the delivery of IT services by the external providers?

Governance

The delivery and support of IT services in (large) organisations has evolved into an exciting

and spectacular form of teamwork, where more and more (external) parties are involved

through IT outsourcing. From the original function of specialist and internal supplier, the IT

organisation has transformed into a director who is less and less required to build and deliver

solutions itself. The main task evolved towards governing external providers, which on the

basis of agreed requirements with the demand side, take care of developing, running and

supporting suitable IT solutions. Governance in IT outsourcing is then the linking function

between demand and supply side and contributes a substantial share in the creation of value in

delivering IT services to the demand side. Governance focuses on the management of the

Technology, Organisation and People complex (TOP-mix). In each of the identified strategic

quadrants, the TOP-mix shows different features, thus governance will have to be shaped

differently, in order to generate value. If the strategic requirements of the demand side have to

5 ITIL is the acronym for Information Technology Infrastructure Library. ITIL is a best practices based method for the set up of IT management processes. 6 Plugge, A. (2011). IT-sector snapt weinig van dienstverlening. Automatiserings Gids, 25 maart.

Capacity Partner

Process alignment

Crafts-manship


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be satisfied with specific, ad-hoc services and products, it won’t be possible to effectively

govern only on the basis of ITIL processes. Besides, the balance of powers tends to be

different in each of the four quadrants, and this reflects on either governance or the foundation

of the relationship between the demand and supply side of IT outsourcing.

Technology

In order to set up solid governance, the technology requirements are different in each of the

four quadrants. Effective support tools for operational processes are useful in the lower-left

quadrant, and there is a wide commercial availability of tools that support service delivery

based on standard ITIL processes. However, where the need for ad-hoc products and services

is outstanding, collaborative tools tend to be more useful.

Organisation

The organisation component of the TOP-mix includes the process, structure and location

aspects. When the demand is rather foreseeable, but the product or service is very specific

(lower-right quadrant) then investing in the continual improvement of the (software)

development process should be considered.

People

Attitude, competence and experience play a role in the P-component of the TOP-mix.

Effective teamwork in the upper-right quadrant (high complexity and dynamics) requires

different kind of individual qualities than the teamwork in the lower-left quadrant (low

complexity and dynamics).

Figure 3: TOP-characteristics for governance per strategic quadrant

Each quadrant determines specific requirements for the TOP-mix to satisfy, in order to set up

effective governance. In the last 15 years, IT outsourcing and the associated governance have

set their sights from the IT service management sector mainly upon the lower-left quadrant of

standardized and foreseeable IT service delivery. The (new) outside-in approach from the

viewpoint of value creation helps to remove this limitation. Figure 3 gives a comprehensive

Technology

Pool contract;

quick access to people

with required skills

Flexible; decentra-

lized; communities

Formal processes to

arrange operational eff iciency; centralized

Mature software

development processes

OrganisationInfra-

struc-

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Middle-

ware

Appli-

cationsLoca-

tion

Struc-

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Pro-

cesses

Proactive; long term

commitment; personal

development

Proactive; experts

Reliability; basic

knowledge and skills

Reliability; experts

Atti-

tude

Know-

ledge

Skills

People

Tooling for resource planning

Tooling for support

collaboration and

knowledge sharing

Tooling for support service

management processes

Tooling for support software

developmentPred

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overview of the features of governance for the technology, organisation and people

components, for each quadrant.

IT outsourcing basic constructions

In order to create value for the demand side through IT outsourcing, four different basic

constructions were identified that show different TOP-features. In the first construction, called

Standard, value is generated through low-cost delivery. The organisation and technology

aspect of the TOP-mix define the process alignment for purchasing and operational service

management. The principles of operational excellence, according the value disciplines of

Treacy and Wiersema7 are fairly applicable. In the second construction, named Preferred, the

delivery speed is the main factor of value creation. Agreements concerning the availability of

on-call capacity determine the basic settings. The value creation discipline, customer

intimacy, is well applicable here. The third construction is called Excellent and the value

generation is determined by the quality of the products and/or services. Attitude, competence

and craftsmanship lay the foundation for the IT outsourcing construction. The value creation

discipline, product leadership, is the most applicable in this case. The IT outsourcing

construction Partner is a blend of Preferred and Excellent; specific attitude, competence and

craftsmanship that include high availability and flexibility determine the value generation

through high quality products and quick deliveries. Figure 4 shows a comprehensive overview

of the four identified basic constructions that are identified to generate value in IT

outsourcing.

Figure 4: IT outsourcing basic constructions and TOP-characteristics

7 Treacy, M. en F. Wiersema (1995). Discipline of Market Leaders, Persues Publishing.

IT-Outsourcing types and characteristics:

1. Relation type Standard-> Process is leading -> Organisation and tooling aspects form basis for relationship-> Price of standard service and/or product creates value-> Following principles of operational excellence

2. Relation type Excellent-> Craftsmanship is leading -> Knowledge and skills of people form basis for relationship-> Quality of the customized product and/or service creates value-> Following principles of product leadership

3. Relation type Preferred-> Delivery capacity is leading -> Organising and making agreements for needed capacity (flexible availability) form

basis of the relationship-> Fast delivery creates value-> Following principles of customer intimacy

4. Relation type Partner-> Craftsmanship and delivery capacity are leading-> Knowledge and skills of people and organising and making agreements for needed

capacity (flexible availability) form basis of the relationship-> Fast delivery and quality of the customized product or service creates value-> Following principles of product leadership and customer intimacy

Value creation via:

Cheap delivery

Value creation via: Quality of product /service

Value creation via: Fast delivery

Value creation via: Fast delivery and quality of product /

service


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Case study In 2008, the internal central IT and purchasing department of organisation Z asked an external

IT service provider to take over their network infrastructure, formally managed by another

external IT service provider, for a reduced price and subject to further annual price reductions.

During the term of the contract from 2008 to 2011, the internal central IT department and the

new IT service provider were 'trapped' in dispute regarding service level agreements for an

inflexible service. Both have lost sight of the user, which are mostly local IT departments

and/or other external IT suppliers, their service value and further development.

By realising their centralization and outsourcing strategy within the organisation Z, the local

IT departments disappeared, and the landscape for external IT suppliers changed. Knowledge

shifted or disappeared, and roles and responsibilities changed. The imposed annual cost

reduction causes much ‘pain’ for the external IT service provider and the internal central IT

department does not contribute enough to the much higher saving targets of the demand side.

The model of low costs contracts and standardisation (lower-left quadrant of figure 1) does

not comply (anymore).

The contract expires in 2011. The service requires a new global infrastructure. The internal

central IT and purchasing department of organisation Z, challenge themselves and their

external suppliers, to fulfil the needs of the users, and begin the contract renewal phase. The

chosen approach is agile and copied from 'Spiral', a continuous improvement and prototyping

based software development method. Three potential suppliers, based on an initial set of

requirements, have offered a budget proposal8 and each supplier built a demonstration

environment (prototype 1). A budget proposal means that the supplier’s proposal is

subsequent to change following the requirements of the demand side. Evidently, only the

initial sets of requirements are known. Based on the findings of prototype 1, one supplier is

sent home.

The internal central IT organisation invites the service users. They will be asked to supply

work scenarios and test them through workshops with the central IT organisation, internal and

external suppliers on two demonstration areas (prototype 2). Contract negotiations will start

with the supplier with the best results. Hereafter, the construction of the service will start and

the implementation for a number of local branches (operational prototype) and a global

rollout.

The specification of the service, the basis of the contract, will be modelled on the ‘Critical to

Quality Tree’, part of Lean Six Sigma, which is a process improvement method. ‘Critical to

Quality Tree’ makes the service continuously measurable, during the term of the contract

based on user relevant criteria. The central internal IT department, the owner/IT controller of

the service, takes the lead on the continuous improvement process and ensures the alignment

between demand and supply. It is intended to establish a win-win situation for both customer

and supplier, hence continuously developing the service.

The rationale behind the approach is to evolve from an IT outsourcing basic construction

Standard (old contract situation) to a basic construction Excellent. The change to lower right

must ensure that the right attitude, the right contract and the right service implementation is

8 Parallel to requirements, also the proposal is a developing prototype. Selection is done from high level to low level, the

supplier will not be forced to stick to the first price indication provided.


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chosen for ongoing service and planned development to guarantee the service. The service in

this case is about a ‘standard administration’ which objective is to improve security and

reduce operational risk. Development is required, because the user is changing. The user is

more diverse and has less knowledge (available nearby), because the local IT departments are

reduced. The total cost of the service should also go down. Based on these developments on

the demand side, an external supplier who thinks along and participates as an expert is

required.

Summary

For the past 15 years the focus on IT outsourcing has been primarily on standard services and

shopping for the lowest price. Long-term contracts were preferably closed. The external IT

suppliers have responded by setting up large factories on efficiency-oriented delivery. The

changing circumstances on the demand side, has left little space in this construction to design

a different way of value.

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Leon Dohmen is principal management consultant at Logica and teaches

Management of Technology at the Rotterdam Business School for Master- and

MBA-programmes.

Joop Nabbe is project director at Logica.