Managing the value of outsourcing initiatives
The value of outsourcing to an organization has a tangible and intangible component. The tangible dimension is largely monetary of nature and can be expressed in for example return on investment (ROI), Net Present Value (NPV) or Internal Rate of Return (IRR). Examples of potential intangible benefits from outsourcing are improved quality, access to a larger knowledge pool and flexibility of service mix. But even these intangible benefits should result in an improved financial bottom line even though their Euro value might be difficult to predict.
The value of the outsourced service portfolio is determined on its discounted future cashflows (see this post), and value is created only when the return on the capital invested in the portfolio exceeds the risk-adjusted cost of capital. Implemented properly value based management helps to align the overall outsourcing aspirations, analytical techniques and management processes to help the company maximize its value by focusing management decision making on key drivers of outsource value.
Value based management (VBM) should ideally be implemented company wide as effective VBM shapes company wide decision making and includes managing the balance sheet and income statement from a value perspective. Nevertheless has looking from a VBM perspective at outsourcing many advantages, because it provides an unambiguous and precise performance metric, namely value, upon which to build an outsource portfolio. And steering on results versus activities (e.g. ISO9000, Total Quality Management, e-Sourcing Capability Model (eSCM) is one of the transitions the company outsourcing has to make anyway as it is unlikely the external vendor will agree to be managed on activity level (‘white box’ approach). The typical external vendor wants to be responsible to deliver on certain objectives (‘black box’) and agree on these with the client. It wants to have the freedom to define its internal processes and procedures (this desire may result to conflicts with certain clients and is an example of a risk that is introduced when outsourcing/sharing services).
A successful implementation of VBM as a means of managing the outsourced service portfolio is a deep understanding of what performance variables will actually drive the value of the contracts. These are called the sourcing value drivers. There are two reasons such an understanding is essential. First, the retained organisation cannot act directly on value. It has to act on things it can influence, such as customer satisfaction, cost, capital expenditures, and so on. Second, it is through these drivers of value that the senior management learns to understand the rest of the organization and to establish a dialogue about what it expects to accomplish. The figure provides an simple example how financial benefit, sourcing value drivers and accompanying risks are related to each other.
The example indicates how a requirement from the business (improve productivity) can be translated into sourcing value drivers which are embedded within the relationship and contract with the external vendor. To be useful, however, sourcing value drivers need to be organized so we can identity which have the greatest impact on value and assign responsibilities for their performance to individuals who can help the retained organisation meet its targets.
The value of the outsourced service portfolio is determined on its discounted future cashflows (see this post), and value is created only when the return on the capital invested in the portfolio exceeds the risk-adjusted cost of capital. Implemented properly value based management helps to align the overall outsourcing aspirations, analytical techniques and management processes to help the company maximize its value by focusing management decision making on key drivers of outsource value.
Value based management (VBM) should ideally be implemented company wide as effective VBM shapes company wide decision making and includes managing the balance sheet and income statement from a value perspective. Nevertheless has looking from a VBM perspective at outsourcing many advantages, because it provides an unambiguous and precise performance metric, namely value, upon which to build an outsource portfolio. And steering on results versus activities (e.g. ISO9000, Total Quality Management, e-Sourcing Capability Model (eSCM) is one of the transitions the company outsourcing has to make anyway as it is unlikely the external vendor will agree to be managed on activity level (‘white box’ approach). The typical external vendor wants to be responsible to deliver on certain objectives (‘black box’) and agree on these with the client. It wants to have the freedom to define its internal processes and procedures (this desire may result to conflicts with certain clients and is an example of a risk that is introduced when outsourcing/sharing services).
A successful implementation of VBM as a means of managing the outsourced service portfolio is a deep understanding of what performance variables will actually drive the value of the contracts. These are called the sourcing value drivers. There are two reasons such an understanding is essential. First, the retained organisation cannot act directly on value. It has to act on things it can influence, such as customer satisfaction, cost, capital expenditures, and so on. Second, it is through these drivers of value that the senior management learns to understand the rest of the organization and to establish a dialogue about what it expects to accomplish. The figure provides an simple example how financial benefit, sourcing value drivers and accompanying risks are related to each other.
The example indicates how a requirement from the business (improve productivity) can be translated into sourcing value drivers which are embedded within the relationship and contract with the external vendor. To be useful, however, sourcing value drivers need to be organized so we can identity which have the greatest impact on value and assign responsibilities for their performance to individuals who can help the retained organisation meet its targets.
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