Managing the Outsourcing Relationship


ÒLet\’s just say itÉ Users stink at outsourcing, so open your eyes before you get into it.Ó — Stan Lepeak, Managing Director of Research for EquaTerra.


When it comes to the minefield of outsourcing, there\’s virtually no area where companies do a particularly good job, according to Stan Lepeak, Managing Director of Research for EquaTerra. ÒLet\’s just say itÉ Users stink at outsourcing, so open your eyes before you get into it.Ó

From picking out a provider, to structuring the deal, to managing the relationship, to dealing with the distributed process, there are no areas where firms are consistently doing a good job, Mr. Lepeak said.

One big bugaboo he sees among many: failure to manage the outsourcing relationship. In project after project, Mr. Lepeak said, companies make the mistake of thinking that once the contract is signed, the deal is done.

ÒIf you\’re pursuing outsourcing strictly for cost savings,Ó Mr. Lepeak said, Òyou\’re likely to have problems.Ó That\’s because firms generally don\’t save as much as they anticipate on outsourcing. More to the point, a climate of trying to save as much as possible means that firms tend to under-invest in doing outsourcing right.

ÒThey don\’t take the time,Ó Mr. Lepeak said. ÒThey don\’t have adequate talent involved; they don\’t have the right people in place to manage the process [or] the ongoing relationship.Ó

Companies fall into the ÒWhy spend money to save money?Ó trap, Mr. Lepeak said.

Typically, he sees firms rushing to consummate an outsourcing deal and sign the contract — and then consider it done. Actually, he said, Òyou\’re just starting. You have to manage the transition, and you have to manage the ongoing relationship.Ó When cost is the main driver for an outsourcing project, as it usually is, that can be difficult to sell.

And don\’t forget that you\’ll need to determine how the company will function when a given process is no longer done within the company. For example, if someone else is doing customer care, that impacts your sales and marketing efforts, Mr. Lepeak said. If someone else is running your data center, that impacts how you develop new applications.

Ongoing survey work over the years, Mr. Lepeak said, shows that one of the most direct correlations to outsourcing satisfaction is how much money the company has spent on managing the relationship. In general, Mr. LePeak\’s research numbers show, those who spend more than five percent a year are happier than those that have spent less.

That\’s an average; a basic IT operational activity might cost less, but business process outsourcing or offshoring, in the early years, could be closer to 10%, Mr. Lepeak said. ÒBut just generally, the firms that spend a little aren\’t very happy, and the firms that spend a lot are.Ó

If you\’re spending $10 million a year with an outsourcer, Mr. Lepeak said, you probably should be spending five percent — about $500,000 — of that managing the deal.

Where is that money spent? Primarily the governance team, and on other expenses such as third parties you might bring in for benchmarking or re-interpreting contracts.

When firms recognize that signing the deal is just the start, they can then accept that they\’ll be managing the ongoing relationship from many aspects. That means the basics — have we set up a service-level agreement and is it being adhered to, and if not, what do we do?

Firms tend to forget that Òyou\’re outsourcing the work, you\’re not outsourcing the responsibility that the work is performed well,Ó Mr. Lepeak said. ÒIt\’s still the user\’s responsibility to hold the outsourcer accountable.Ó

–> INSIGHT #1: Escape the relationship management trap.

According to Mr. Lepeak, outsourcing isn\’t an excuse to not pay attention. That\’s a common error. Instead, accept that the relationship will need constant management. ÒYou\’re outsourcing the work, you\’re not outsourcing the responsibility that the work is performed well,Ó he said. ÒIt\’s still the user\’s responsibility to hold the outsourcer accountable.Ó

Mr. Lepeak has seen a few clients manage to avoid the relationship management pothole. As an example, he offers up the tale of a large financial institution Òinvolved in some very aggressive outsourcingÓ in which efficiency and a focus on core competencies, rather than cost, was the main driver. The company realized that although the tasks it wanted to outsource could be done well internally, there was no upside in doing so. Rather, they wanted to focus on revenue-producing tasks at which they could excel, such as integrating mergers and creating new financial products.

How did the financial firm do it right? Since cost wasn\’t the main driver, they were able to justify dedicating a significant amount of resources to the process. They also kept the CIO engaged in all aspects of the project. By using third parties for process benchmarking before the outsourcing began, Òthey knew how well they did it to start with and what their true costs were.Ó

The financial firm continues to have a large internal team dedicated to the project, Mr. Lepeak said, including people with skills in relationship management and contract management. The cost of managing the deal: In excess of five percent, although that could drop as the project matures.

The lesson from the large financial firm and plenty of others Mr. Lepeak has seen: Recognize up front that you\’ll be spending significant money on the outsourcing relationship, accept it, and budget for it.

–> INSIGHT #2: Sourcing insight: Move the focus away from cost.

Companies that aren\’t solely focused on saving money as the reason for outsourcing tend to do better, according to Mr. Lepeak. That\’s because they\’re willing to spend what it takes to manage the project correctly.

Rather than focusing on cost as a driver, Mr. Lepeak suggests, companies might look at other reasons for outsourcing, such as getting access to skills and capabilities you don\’t have internally.

ÒMost Indian firms are better developers than US IT operations,Ó he said bluntly. ÒThey\’re more consistent, they\’re more thorough. They may not understand the business as well, but when it comes to coding, they\’re better.Ó Given that, why should your firm struggle to maintain an internal staff and train them on new skills, when an outside service provider can do it as well or better?

The outsourcing driver then becomes, Òto tap into the skills that you don\’t possess internally, and ideally, tap into them at the outsourcer\’s cost.Ó

Another reason beyond cost, Mr. Lepeak said, is reallocation of scarce resources to focus on core competencies. By shifting some work outside the company, you can reallocate skilled internal resources to something that needs to be handled within the company. ÒOr fire those people because they don\’t have the right skills and hire someone else.Ó

For example, you might hire a service provider to handle basic application development work, while using more skilled internal people to plan and design applications. Or, figure out the business sticking point that technology could solve and translate that into a development plan, but then go to a third party to do it. Or have someone else do your transaction work in finance and accounting so you can have the internal people analyze the results.

Summary: Set aside time, money and people with the right skills to manage the relationship. Outsourcing doesn\’t end when the contract is signed. It begins.

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Stan Lepeak, [email protected]