Critical aspects of governance in outsourcing: insights from industry
This article was written in conjunction with Kaustuv Halder and Markus Biehl.
Kaustuv Halder is a graduating student at Schulich School of Business, York University, Canada. He is specializing in Operations and Information Systems and has developed a keen interest towards Outsourcing. Prior to his MBA, Kaustuv spend five years with Tata Consultancy Services (TCS).
Markus Biehl is an Associate Professor in Schulich’s Department of Operations Management and Information Systems. He teaches Global Supply Chain and Information Management, Operations Management and Management Practices for Sustainable Business in the MBA program and Operations Analysis in the Executive program.
In the past decade, with an increased focus on core competencies support functions have been increasingly outsourced. To this day, however, success is illusive to many outsourcers. This article draws on the experience of outsourcing executives on the buyers and vendors side by drawing lessons from both successful and unsuccessful outsourcing initiatives. We find that communication, the engagement of the appropriate resources, a mutual understanding of service delivery objective, and a cooperative, trust-building relationship can improve the chance of completing outsourcing initiatives successfully. We put these findings into an outsourcing governance and relationship management framework for use by outsourcing practitioners on the buyer and vendor side.
The importance of governance in outsourcing initiatives
Outsourcing has grown from a mere cost reduction tool in the 1990s to a powerful business strategy that can act as a competitive differentiator, allowing companies to increase productivity and the quality of their offerings by focusing on their core operations. By enabling third-party service providers to manage IT or business process operations, organisations have not only been able to access an experienced external talent pool, but also turn fixed cost structures into variable costs. Information Systems outsourcing in particular has become increasingly popular following Kodak’s decision to outsource its IT operations in 1989. The pervasive adoption of outsourcing of Application Development and Maintenance (ADM) and IT Infrastructure (collectively referred to as IT in this paper) makes the outsourced delivery model the most dominant form of acquiring IT services. Organisations have successfully used outsourcing to reduce costs, acquire capabilities or achieve a global reach.
All too often, however, the buyer’s satisfaction in an outsourcing arrangement is evasive. Recent research by the Centre of Outsourcing Research and Education (CORE4) reveals that only 75 per cent of buyers are satisfied in the case of IT deals. While there are many factors that explain this dissatisfaction, there is a strong correlation between governance capabilities and buyer satisfaction in outsourcing arrangements. A study conducted over 1,600 IT outsourcing deals confirms that buyers with better governance and relationship management capabilities, achieve much higher satisfaction levels than buyers who do not possess the same (Lepeak, 2010).
Outsourcing initiatives contain numerous complexities and interdependencies at the technical and relationship level and often require a major restructuring at the organisational level. This poses numerous operational and organisational challenges towards achieving the intended business objectives through such arrangements. An enterprise-wide governance perspective is crucial to deal with this complexity (Lacity & Willcocks, 2003).
We have seen increased prominence of governance models in outsourcing relationships. Despite that outsourcing engagements have been plagued with issues that lead to buyer dissatisfaction. Even though we know that better governance leads to better outcomes, we wonder what the drivers and conditions are that lead to unsuccessful outcomes. To address this question, this paper looks at the first-hand experience of twelve executives involved in both successful and unsuccessful outsourcing arrangements on both the client and vendor side. The following section shares some of the hard-earned wisdom those managers shared with us based on the outsourcing initiatives they managed. We then propose an outsourcing governance framework that, if taken into account when managing an outsourcing initiative, should lead to substantially better outcomes.
What were the challenges for outsourcing relationship managers?
The understanding of the service level objectives by both clients and vendors is important for relationship management.
Cases that had a clear understanding of service level objectives and goals led to greater satisfaction to the buyers and better performance of the relationship. In many failed outsourcing arrangements the relationship worsened over time due to inadequate description of service delivery requirements. As one manager of a failed initiative put it:
“As the relationship progressed, the discussions deteriorated around what was a defect versus what was a change request. Things got adverse. Lack of understanding of the original scope, and the alignment of goals was not there.”
Even in successful outsourcing arrangements management realizes the importance of a clear description of objectives and processes. When asked what they would do differently next time, managers mentioned that they would specify more clearly the requirements and scope of the project at the start, and have a roadmap of goals for each delivery phase. This was true for clients and vendors alike, as vendors risk not only satisfaction with the failed project but also their reputation. As a vendor put it:
“[The] lesson we have learned is, don’t engage with the client that does not have clear objectives and goals defined as this will hamper our performance and brand.”
Recommendation: Determine what you really need (and at what level), based on past performance, your competitors’ service levels and your customers’ demands. Then properly define service levels in collaboration with your outsourcing service providers to ensure that they understand them and are capable of fulfilling them. Frequently, experienced outsourcing vendors can help in defining service levels.
Have the right and steady resources on the job over the course of the relationship.
Our findings show that a structured governance model with the right resources can be instrumental to the success of outsourcing engagements. In cases where such engagements were unsatisfactory, managers revealed both internal resource allocation problems and a lack of executive focus as factors that caused dissatisfaction:
“The roles were not clearly documented upfront in the transaction. The relationship manager who was responsible for the transaction was not clear how the internal resources were going to operate with respect to external resources. The progress of the project was not as fast as required.”
Clients in particular realised the importance of retaining human resources throughout the relationship so relational governance can be executed in addition to contractual governance. Reflecting on the issues in his project, a senior manager advised:
“Try to have a steady team on your side. When people go, with them go relationship, trust and everything else which has been developed over time.”
Another important consideration for the buyers was the loss of skills due to attrition in vendor organisations. Some of the clients expressed their discomfort with the time needed for their vendors to train new employees, often resulting in project delays. These findings are in line with those related to the implementation of large internal IS projects. Biehl (2007) found that particularly middle managers that were managing the projects at a more detailed level tended to burn out and leave their organizations.
Recommendation: Proper, detailed planning will aid the appropriate deployment of human and financial resources (Biehl, 2007). More proactive human resources management on both sides and solid top management support are necessary to keep employees engaged and support them. In contracts, introduce specific clauses that offer a reasonable safeguard against attrition.
Use good contractual governance to build up trust, and performance will follow.
Interviews with buyers and vendors alike reveal that the quality of service delivery helped build trust in each other. For clients, trust was generated through the performance of their vendors, including timely delivery and proper communication. As one vendor put it:
“Trust built up over time through proven delivery.”
Another client felt that communication in the form of ‘structured lower level meetings’ also facilitated the development of trust. Cases where buyers trusted their vendors resulted in a more collaborative atmosphere between the partners and in faster issue, escalation and dispute management, thus increasing the chance of completing the initiative successfully.
In contrast, trust can be broken through unexpected behaviour. In one particular case we saw ill effects generated by the perception that the vendor attempted to skimp on the delivery aspect:
“Some people on our side don’t trust the prices of the vendors. They nickeled and dimed the project.”
As a result, the client was saddled with additional costs that were not part of the upfront agreement. While likely also the result of poor planning from the client’s side, this directly affected the satisfaction level of the client, regardless of whose fault it was. In general, we noticed that the lack of trust lead to dissatisfaction amongst partners and low morale amongst vendors, thus negatively impacting performance and the likelihood of success. According to a large global vendor,
“There was lot of criticism and finger pointing, comments of low productivity, poor delivery standards, poor communications, low efficiency, etc. directed towards the off-shore team.”
Recommendation: Three components seem to impact trust: well-planned processes, good communication and satisfactory performance, with the former two impacting the latter. Trust, in turn, helps overcome difficulties by generating a collaborative atmosphere (Sabherwal, 1999) which, in turn, increases the chance of completing the outsourcing initiative successfully (Goo, Kishore, Rao, & Nam, 2009).
Implement an effective communications process.
Effective communication mechanisms between multiple stakeholders in outsourcing are critical for understanding and conveying issues as well as assessing performance and the health of the relationship. We found that while satisfied clients had placed importance on what one manager called ‘high rigour and structure around communications’ clients with unplanned or ineffective communication mechanisms suffered issues and missed deadlines. Those issues could lead to significant delays, or worse. Managers made clear that communicating the right issues to the right person (i.e., through the right channel) at the right time was critical. The statement of a manager of a successful initiative on the vendor side underscores this finding:
“The perceived risks were communicated to the client at all the levels and on several occasions. Since clients were made aware of the potential issues they actively worked to ensure that the issues did not materialise.”
Similarly, keeping senior management informed was useful for avoiding surprises. When asked about the lessons learnt from his outsourcing initiative one manager mentioned:
“Timely communication at all levels is important. This ensures that there are very few surprises at any instance. Senior managers should always be updated with what’s gone well, what’s gone wrong, impact and the steps taken/planned.”
Some vendors also pointed out that structured communications and reporting mechanisms increased their productivity and helped enhance their performance.
Recommendation: Good intentions are not good enough. Ensure that communication is scheduled horizontally (i.e., among outsourcing partners at the same organisational level), with more frequent interaction at the operational level as compared to the executive level. In addition, ensure that communication is scheduled vertically, i.e., across organisational levels. Senior management will not be able to effectively help trouble-shoot problems if they are not kept in the loop (Biehl, 2007). As pointed out above, communication also supports the development of trust.
How do these findings relate to best practice?
In this section we relate the above findings to outsourcing best practice and develop a governance framework that should be useful to outsourcing managers on the buyer and vendor side.
Drawing the above findings together, it is important to first determine what is needed, then encode these requirements in a service level agreement. Like in new product development, it is advisable that both outsourcing partners be involved in this process. Vendors are often more experienced than clients and can advise on the sensibility, feasibility and financial impacts of the buyer’s choices, or buyers can obtain input from third-party sourcing advisors. Proper planning also extends to the determination of the human and financial resources needed on both sides to implement the contract. Finally, the contract should contain a communication schedule that outlines who will communicate with whom and how frequently or under what conditions, typically included in the governance schedule, attached to the master services agreement. All of these contractual components determine the parameters that define how, at what time and by whom parts of the contract will be executed.
Drawing on CORE’s standard three-tiered governance structure (which was validated by the executives interviewed for this paper and appears to become widely used), we propose the following governance framework (Figure 1). In the remainder of this section we will relate this framework to best practices for the outsourcing sector.
Engaging the right people in an accountable manner. According to CORE, the de facto standard governance model is based on joint Operational, Management and Executive committees. These levels are not distinct, but share both resources and data to be effective. The operational level is responsible for managing the day-to-day outsourcing activity. The management level is concerned with more of an administrative role relating to the administration of the initiative, including the context of the broader business terms and high-level performance measurement. Finally, the executive level will likely have the management level lead attend in a support role and monitor the progress at a very high level. Note that the coordination between these levels constitutes what we call “vertical communication.” This type of communication must take place on both the buyer and vendor side.
The business processes, implemented to execute the outsourcing arrangement, must be carefully constructed with a clear identification of roles that own the processes and act as points of contacts for the coordination and maintenance of vendor’s performance. Identifying important resources, establishing points of contacts and clear lines of responsibility between the key personnel on both the parties alleviates the typical resource allocation problems that buyers and vendors typically face. The most common business processes include: issue, escalation and dispute management, financial management, demand & scope management, change & release management, contract management and contract compliance management (Hart, 2011).
Figure 1: Outsourcing Governance Framework
As discussed earlier, the impact of attrition can also be handled by placing a limitation of turnover rates in SLA, where timelines can be specified on how often vendors can turnover, along with a required notice period and approval by the client on the replacement person(s).
Understanding service delivery objectives and mechanisms. The above framework ensures that the expectations for the outsourcing initiative, as formalised in the service level agreements (SLAs), are within the scope of services and that the service delivery clauses are mutually agreed upon and understood. This avoids any confusion on what is a defect versus a change request.
Communication and Performance Management. A documented and published governance manual enables effective horizontal and vertical communication. Best practices for a governance manual include all the key activities for each of the governance communication and business/operational processes, with responsibilities assigned to the various roles (Hart, 2011). It should be the task of mostly the operational governance team to formally and consistently manage the vendor, but also report the health of the relationship to higher management levels.
Reporting mechanisms should be put in place to not only acquire and assess all stakeholders’ requirements, but to also construct a set of activities and metrics for assessing customer satisfaction with the service quality and capabilities provided by the vendor. This ensures that all stakeholders are continuously aware of the actual (versus expected) performance levels, risks and health of the relationship and can hence take appropriate corrective measures as required. It also negates the chances of ‘finger-pointing’. When issues arise, they should be handled through structured frameworks laid out in the governance schedule to make sure that issues can be resolved fairly and within the agreed-upon timeframe.
Periodic assessments of the health of the relationship. In addition to the above, a separate process dedicated towards governance and relationship maturity assessment needs to be executed periodically. During the early part of the transaction it is important to define a cycle to review performance of documented agreements and metrics to assess relationship maturity. As the relationship materialises, financial and operational health checks on the relationship conducted on an annual basis are recommended. Key stakeholders are interviewed to assess relationship maturity across a broad spectrum of governance components. This ensures that management is not only aware of the health of the relationship but also recognize the strength areas and develop a joint action plan necessary to improve the areas of lower maturity. Again, this process involves both horizontal and vertical communication on both sides of the arrangement.
Trust and Success. We see that a smooth and efficient delivery process impacts the satisfaction levels and helps build trust. The governance framework proposes a standard approach to address, resolve or escalate client or vendor issues to ensure a minimal impact on service delivery. Apart from this, reporting mechanisms including performance scorecards can be used to notify all stakeholders of the performance of the service provider. The scorecards are then distributed to all levels of management for trend analysis and obtaining feedbacks. As the relationship matures, the above mechanisms will ensure that the outsourcing parties achieve mutually agreed-upon objectives and, thus, build a cooperative working environment that instills trust in each other. Trust, in turn, allows the parties to overcome issues more quickly and easily and thus ensure that the outsourcing initiative can be completed successfully.
In this paper we reported on interviews we conducted with outsourcing managers of successful and unsuccessful initiatives on both the buyer and vendor side. We focused on the governance process, as the same has a dramatic impact on the chances of successfully completing the outsourcing initiative. Feedback from the managers indicated that service expectations need to be clearly laid out, required human and financial resources need to be well-planned and available throughout the outsourcing initiative, and planned horizontal and vertical information are vital to build up trust and be successful. Based on these insights, and drawing on the standard three-tier outsourcing governance model developed by CORE, we proposed and discussed a framework that facilitates a well structured outsourcing governance. Applying this framework should lead to a more responsive, cooperative and trusting environment which, in turn, increases the chance of completing the outsourcing initiative successfully.
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