The outsourcing paradox: The way forward

Recently we took part in Outsource World 2008, which turned out to be a remarkably good conference. A part of our job is to take part in a lot of these events, all with the aim of adding to, and absorbing the latest wisdom and best practices for the benefit of you, our client. Some conferences can be time better spent elsewhere, most are mediocre, and a few are special. Outsource World was in the latter: not over-generously attended, but that may have contributed to a remarkably open exchange of views from a well selected group of speakers and attendees including vendors, clients, analysts, advisors and lawyers. And that made it a very interesting conference, well worth our, and we are sure, most other attendees' time.

There were three key topics that weaved through most of the discussions: global sourcing, multi-sourcing and innovation.

Unavoidably, global sourcing played a big part of the conference discussions. It is encouraging to see that the debate is moving to the next level. It is not just about locations other than India, although it was obvious from the marketing efforts from offshorers based in China, Latin America, and places such as Mauritius and Malta, that there is a much broader, vigorous, and a viable market for offshoring destinations. The key issue is how, once the right skills are located, in the right place, at the right price, to integrate it all to work seamlessly with the rest of the global operation AND the client. Right now there is a lot of learning going on exactly on this issue. This is a challenge, even for the Indian vendors who are expanding into offshore locations such as China and Latin America, but one that has to be addressed if clients are to realize the full value and outcomes, rather than just cost advantages of global sourcing. We will be sharing some of our research in this area in a forthcoming report on managing a global workforce.

The second theme was inevitably around multi-sourcing. Listening to second generation outsourcing clients such as the Lloyds Register, it is becoming clear that multi-sourcing is increasingly the norm for large clients who can afford the break up of their technology portfolio into chunks of sufficiently attractive size. Moreover, multi-sourcing is another plank of the demand side's attempt to realize the value, rather than simply cost objectives from outsourcing. What is becoming very clear from the shared client experiences is that multi-sourcing is leading to a step increase in demands on a client organization's retained IT organization when it comes to supplier management, governance and service integration. Those that don't get these elements of their multi-sourcing approach right risk joining the two thirds of outsourcing clients who today feel dissatisfied with the benefits of their outsourcing deal (even though most have realized the planned cost savings). Several colleagues in my team are currently working on a study addressing these issues which will synthesize our learning and advice in this area.

The final theme was innovation in outsourcing, where, having done extensive research on it over the last 18 months, we were invited to take part in what was a vigorous panel and audience debate on the topic. Clients increasingly demand not just cost reductions, but innovation that leads to tangible business outcomes from their vendors. Vendors, in turn, are ever-happy to talk about and present their innovation capabilities, particularly during the courtship stages. Yet, it is clear that neither clients feel they are getting expected innovation (read business outcomes) from their vendors, nor do vendors feel they are incentivized to deliver it, a state of affairs which one participant summarized as 'outsourcing paradox'.

We argued, and continue to do so, that the core of the outsourcing paradox, is a mismatch between incentives in the current vendor-client outsourcing relationships, and their legal manifestations, the contracts. Clients enter outsourcing relationships with the aim of achieving real business outcomes, enabled through lower cost, more efficient, more flexible, and higher performing service, be it their IT or other business process area. The problem is, with little help from the procurement department, and sometimes sloppy third party advisors, by the end of the negotiation process, most clients start a relationship where the contract incentives are skewed towards lower cost services addressing their existing state of affairs, and few or no incentives for the vendor to deliver more flexible and higher performing services that will evolve as their business evolves. Put simply, most outsourcing relationships and contracts today focus on measure and reward inputs, rather than technology or business outcomes. It takes a very enlightened vendor to focus on innovation and business outcomes if the contract is on time and materials (T&M) basis according to rate cards and goes through an annual cost benchmarking process.

We believe that the proportion of clients disappointed with the benefits of their outsourcing initiatives (and level of innovation) will remain in the majority until the industry shifts incentives to measuring outcomes through effective value-based pricing models. We are not advocating that every client should move to deals such as IBM's with Bharti, Idea and Vodafone India where it is paid a percentage of the client's total revenues. For many clients and vendors the risks of such a deal will be a step too far. But there is a full spectrum of options in pricing models between a pure input-focused model at one end (e.g. T&M), and pure business-outcomes focused on the other (e.g. IBM/Bharti). Until the industry starts to take substantial steps to measure and reward outputs, innovation will remain mostly in the realms of the aspirational, as it is today.

Taking these steps requires a paradigm shift in the approaches to outsourcing relationships and incentives, in the measures and rewards/compensation with many clients, but also on the vendor side. But we think it is an absolutely necessary change towards realizing full value (rather than just cost benefits) of outsourcing. As the adage says, if we (as an industry) always do what we've always done, we'll always get what we always got.