A strategic view of service provider relationships: how to realise value in contemporary outsourcing
Today’s CIOs view IT outsourcing as a strategic tool and no longer only as a means for cost-takeout. 3gamma’s research shows that a majority of IT organisations already have, or are in the process of, entering into second- and third-generation outsourcing deals. However, to leverage the benefits of specialised capabilities, it is crucial to nurture and manage positive and mutually beneficial relationships. To do this, IT organisations need to take a strategic view on the vendor. They need to identify selected strategic vendor relationships and invest in these to ensure operational efficiency and long-term strategic alignment.
A recent ISG survey confirms that in the European market, outsourcers are turning to specialised niche vendors to achieve flexibility and gain access to new technologies. Second- and third-generation IT outsourcers are applying more advanced sourcing models to acquire new solutions, technologies and capabilities while controlling IT costs. Significant efforts are put into evaluating offerings upfront, but less attention is paid to identifying, nurturing and managing fit-for-purpose relationships with each vendor. All too often, relationship and vendor management is based on a traditional template, with little investment from either buyer or seller.
In IT sourcing, there is a seemingly fundamental assumption about buyer-seller relationships that rarely gets challenged. The assumption is that the nature of a relationship should be determined by the size of the deal. For larger deals, both buyers and sellers nearly always strive to form strategic alliances or partnerships because they are viewed as inherently better than arm’s-length transactional relationships. However, when it comes to forming partnerships, there are other drivers which are much more important than deal size. A simple example would be network and telephony services or standard PC/laptop provisioning for a distributed organisation. Both might constitute a considerable portion of the ICT spend but provide limited competitive advantage. Simply put, they are bulk commodity services. On the other end of the spectrum are buyers with small niche providers delivering services that are a direct part of the company’s core business, such as a mobile interface for a retail bank or a critical SaaS platform.
The real driver for a partnership model should be the level of business integration of the service provider’s offering/solution and the unique added value they are providing. The need for a more elaborate approach to supplier management is underlined by the shift towards specialised solutions more tightly integrated into key business processes. If the relationship with a true strategic supplier – a partner – is focused on commercial discussions and contractual arguments, both sides have failed. On the other hand, if a simple transactional outsourcing of commodity services include supplier expectations such as innovation leadership and business process development, then the focus on the value of the commodity delivery is lost.
3gamma’s experiences in these areas show that key advantages can be gained by taking a strategic view of service provider relationships. IT organisations that identify and strategically develop relationships based on business impact rather than deal size and share of IT spend can create significant benefits. They are able to reduce typical outsourcing-related issues and create innovative, business-oriented solutions.
Aligning the buyer-seller relationship with IT strategy objectives
There are different ways to configure a buyer-seller relationship. Within IT, this arrangement needs to be aligned with the business and IT strategies. The preferred setup depends on the capabilities being acquired. On a general level, a relationship can be classified based on resource scope and type of inter-firm contact, ranging from transactional outsourcing to in-house operations.
In the IT industry, and in IT organisations in particular, there is an ongoing debate on build versus buy and the structure and nature of relationships with IT service providers. In short, there are driving forces for vertical integration and transactional procurement. The fact that IT has moved from support function to become an integrated part of business processes, products and services – and now is faced with the demand for fast time to market and differentiation – has created a push for vertical integration. In contrast, the pace of innovation in the market has created a push for companies to acquire new solutions and services from service providers using a more transactional approach (the most prominent example being cloud-based software as a service offerings). In light of this challenge, understanding the level of closeness needed and correctly configuring the buyer-seller relationship is key.
Considerations that lay the foundation for strategic IT outsourcing relationships
The nature of the service will on a strategic level determine the suitable type of relationship. In order to strategically develop or reconfigure existing buyer-seller relationships and align them with business objectives, a set of considerations needs to be understood. These considerations shape the preferred type of relationship for a specific customer-vendor situation.
Business and IT integration
This involves the level of integration in the buyer’s business offerings/processes and/or IT organisation and technology. As the technology component of a company’s offerings increases, so does the reliance on external service providers. Any company that acquires a business-critical capability through sourcing needs to be involved in the service delivery process and act as a competent service integrator – regardless of the characteristics of the services, products and competencies in scope.
The delivery of IT services may be stand-alone and isolated, such as some SaaS solutions. Other services may be delivered through joint efforts across two or more organisations. For example, scrum teams with representation from both different vendors and the buyer require closer collaboration and a higher degree of flexibility.
Variety and volatility
The variety (level of difference of services in scope) and volatility (level and frequency of change) of the goods or services being exchanged between the seller and buyer – including requirements, technology development and variety of offerings – are an indication of the fundamental complexity of the relationship. Variety and volatility should not only be viewed from an IT perspective, it also needs to include the business perspective. High variety and volatility drives complexity and needs to be managed more closely.
Commercial and operational risk
This involves the commercial and operational risk associated with the relationship and available risk mitigation strategies. The commercial risks come from the scale and scope of the relationship, the proximity to the vendor, the criticality of the service and the consequences of a service failure.
Another key consideration includes the ability to manage the risk. High risk is however not synonymous with scale. It is important to view risk exposure from a business impact perspective and not purely from the perspective of the monetary size of the agreement.
Closely related to the contract scope flexibility is the question on volume commitment. In a tight low-risk (for the vendor) contract there is a large contracted minimum fee from the provider. These contracts have typically large exit fees and are often motivated when there is a significant investment for the providers at contract start. Today, more contracts of framework character are emerging, where actual services are called off by the customer in an evolutionary approach. Naturally, the customer will carry the transformational costs when initiating or exiting services.
Outsourcing is not a single transaction – it is a relationship
To realise the value of IT outsourcing and optimise the throughput of scarce IT resources, it is imperative to adopt a strategic approach to vendor relationships. The considerations are not consistent with one another why outsourcers need to make trade-offs.
As companies move to multisourced environments, mixing commodity services with highly specialised niche services, they need to base their sourcing strategy on a portfolio view of the service provider landscape. As outlined in figure 6, the decisions on how to configure the sourcing portfolio will be influenced by buyer side capabilities, supplier capabilities, strategic priorities and current IT architecture.
A company looking to outsource or reshape its IT sourcing strategy should seek to optimise both the ‘what’ and the ‘how’ in an iterative manner considering four perspectives:
Buyer-side capabilities, commercial models and relationship preferences
Buyers need to understand the internal capabilities that exist to manage a portfolio of service providers and if there are any gaps that need to be addressed. This analysis should be based on the business and IT integration, the variety and volatility, and the commercial and operational risk. Notably, both the decision on what and how to insource and the design of the retained organisation are influenced by this analysis. To remain cost-efficient, it is imperative to minimise the number of variations that are managed by the retained organisation. The service provider portfolio should be segmented and the required service integration function should be built up to manage these services.
Supplier-side capabilities, commercial models and relationship preferences
Service providers have elaborate operational models to deliver services. These are typically consistent across their different customers and are not easily customised or changed. Buyer-side requirements for special treatment and custom solutions often end up being wishful thinking. The sourcing strategy can therefore not just be internally focused but must also consider the setup of the service providers’ delivery processes. The design of the target solution needs to include this perspective to realise the value of the outsourcing initiative.
Critical and non-critical IT capabilities
This involves what capabilities are critical to retain and what can be outsourced. Initially, a company often identifies a set of capabilities that are candidates for outsourcing. The analysis is often based on business criticality and cost benchmarks, and/or an effort to acquire a previously non-existing capability. However, the initial target state needs to be revisited in the sourcing process based on what exists in the market and how it can be delivered.
Technical requirements and current IT architecture
Outsourcing never exists in isolation. It is an integrated part of an IT organisation’s overall delivery. There is a path dependency for any new service provider, which mean that they will face the buyer’s legacy environment. Any sourcing or outsourcing decision must be based on a solid understanding of the legacy environment and this analysis should be revisited in the sourcing process.
IT outsourcing is an ongoing management effort
IT sourcing has moved from transaction-oriented deal-making to become an intricate management challenge. In addition to the actual service provider selection, there are critical trade-offs that need to be addressed in the commercial model, the IT architecture and the retained organisation to meet business demands. Facing rising complexity, contemporary outsourcing needs to be iterative and allow for the sourcing solution to be continuously developed during the sourcing process. An outsourcer needs to revisit and adapt the sourcing strategy based on internal capabilities, available external capabilities, outsourcing scope and the IT architecture. It is important to allow for adjustments in all these areas to maximise the value of the solution as a whole.
The outsourcing process needs to be explorative and allow for continuous improvement of the target solution. Within this process, an outsourcer should set up and define the approach to the service provider relationship and shape the commercial model, the IT architecture and the retained organisation to realise the value of their IT sourcing strategy – and ultimately support their business’ objectives.
About the Authors
Peter Wahlgren, PhD is CEO and IT management consultant at 3gamma. Peter is specialised in IT sourcing, IT operation models and retained organisation design and implementation. Over the years Peter has successfully been advising international clients across 3gamma’s geographies.
Jens Ekberg is a Director and senior IT management consultant at 3gamma. He is specialised in IT strategy, IT architecture and IT transformation. Jens works across industries supporting clients in IT-enabled business change working in the intersection between business and technology. Jens holds dual degrees in engineering and business administration.