Sourcing Insights with a Dutch Twist

Case study: awakening of an IT department

2011-10-24T11:06:00.001+02:00

Most organizations are facing a multitude of challenges these days, including pressure on pricing and shorter lifecycles of new products. This requires organizations to become more flexible, focused on their core activities and enhance the capability to use new technologies to create or sustain a competitive advantage.

When the IT department is too sheltered

One of the companies busy transforming itself from a traditional, low IT density business model, to a highly digitalized business model is the company ‘Merchant’. It is a specialist in auctioning consumer products in high volumes (millions of items per day). To do so it has invested in an impressive amount of buildings which handle the inbound logistics, auction, outbound logistics and financial transaction.

In the last decade both producers and buyers of the products are increasingly looking for ways to improve efficiency, including the role of Merchant to align demand and supply. As a result are producers and buyers looking at Merchant for an improved service offering.

Traditionally, reliability and thus very thorough development, testing and operating procedures were the cornerstone of the IT department. A typical IT project would take at least a year from start to finish. And as the traditional business model required the physical buildings to perform the auction, it was Merchant (and subsequently their IT) which was calling the shots. Merchant had grown over the years into the largest company of its kind and the required investments in new physical infrastructure ensured a high entry barrier.

The introduction of the internet changed all that, even though Merchant was able to ignore it until quite recently. One of the ‘problems’ of the internet for Merchant is that it considerably lowers the barrier of entry. It allows the information flow required to auction a product to be disconnected from the physical flow. In the traditional business model, both flows were combined with documents travelling with the physical product. The internet also makes it easier for producer and buyer to find each other without the Merchant as a broker.

While the business very clearly saw these threats and scrambled to action, the IT department initially failed to appreciate the sense of urgency. During summer it was not uncommon that a project was on hold for three weeks because the developers were on a three week holiday. The difference in culture and economic model are depicted in the table.

	Traditional auction	Internet auction
Economic model	High fixed cost require high volumes to recover them. Economies of scale are crucial.	Increasing the number of users of the online system is crucial. The more producers and buyers the system use, the more attractive it becomes (‘positive feedback loop’).
Culture	Risk averse, efficiency focused.	Fight for talent to ensure own system is improved faster than competition’s offering.
Competition	Focus on costs and high level of standardization among business partners	Focus on attracting and retaining most talented employees.

Due to the lack of action from the internal IT department the business manager of Merchant responsible for the e-commerce domain engaged a third party supplier to build a pilot system. A pilot which was rolled out within three months. Since the introduction the transaction volume has grown exponentially and the system has become of strategic importance to Merchant. Subsequently the business has requested IT to insource the solution and incorporate it into the internal IT ecosystem. However, the ecosystem of Merchant was standardized on Microsoft and the external vendor used a non-compatible system from IBM. As a result will the system now be rebuild in dot-net.

Structural solution

The sense of urgency has in the meantime taken hold at management level within the IT department and several steps are undertaken to create a more agile and responsive department. Central in this approach is the need to differentiate based on the demand profile of the business (speed-to-market & innovation versus efficiency & reliability). More on this topic can be found in previous blogs, including here. The essence of the required change is however a cultural one. From a mindset of thinking in roadblocks to a mindset of thinking in possibilities.

Political unrest and economic trouble versus offshore outsourcing

2011-07-14T18:20:00.001+02:00

The recent bomb attack on Mumbai, killing at least ten people and wounding more than fifty, is one in a series. According to Wikipedia are “as of 2006, at least 232 of the country’s 608 districts afflicted, at differing intensities, by various insurgent and terrorist movements. In August 2008, National Security Advisor M K Narayanan has said that there are as many as 800 terrorist cells operating in the country”. While India is not the only outsourcing destination which suffers from ‘political’ unrest, are this bomb attack and the 10 coordinated shooting and bombing attacks of 2008 of a completely different order than what is going on in most other countries (except for maybe Pakistan).

Also Egypt had its period of unrest when toppling over president Mubarak, and Malaysia recently caught the headlines with people demanding democratic reforms. And the Ministry of foreign affairs of Australia “advise you to exercise a high degree of caution in the Philippines because of the high threat of terrorist attack and the high level of serious crime”. While these last examples are magnitudes different from the situation in India, is it an indication that several popular offshore destinations end up in news papers in a less than favorable way.

While the impact on the short run is likely to be very limited, may long term unrest in combination with continuing economic struggles in the United States and Europe have an negative impact on offshore volumes. In the United states some 8 million jobs were lost with financial services accounting for 800.000 of them. In Europe unemployment is not much better with especially Southern European countries suffering from rates up to 21,3% in Spain.

With the supply of skilled people surpassing demand in both the U.S. and Europe, wages tend to stabilize or even decline. Of the people who lost their job in the U.S. between 2007 and 2009, had 36 percent to accept a job which pay was at least 20 percent less than their previous job. At the same time are wages in India, Sri Lanka and Bangladesh expected to show a double digit increase in 2011.

In manufacturing this has already resulted in many American companies insourcing their production again. But “homeshoring” is also picking up in the service industry. Arise employs more than 7000 call center American agents who work from their living rooms and connect via telephone systems to national service lines. At the same time provides the U.S. government tax incentives to keep jobs at home and some states (e.g. Ohio) even ban offshoring. In Europe, the social security system prevents large wage fluctuation, but also over here are people accepting jobs with at lower pay grades.

Subsequently do I wonder whether we will see lower (growth) figures in new offshore contracts for the coming two or three years. Because a) the labor surplus in the U.S. and Europe will not be absorbed anytime soon even with economic growth slowly picking up, b) the battle for talent in India and other destinations will continue to push wages further, and c) the unrest in India, Pakistan, Philippines and other countries does not show any signs of subduing.

Simply stated: the financial benefit of offshore is getting smaller, while the risk profile is growing. Two trends which might result in corporate decision makers steering for (a larger share of) local outsourcing.

The need for a differentiated sourcing strategy

2011-06-27T14:21:00.001+02:00

Technology is everywhere and is becoming of increasing importance to attract and retain consumers and engage with upstream and downstream business partners. It is changing industries, impact the roles of CEO, COO and CIO. Insurance companies are transforming their business model from selling though big, impressive marble decorated buildings and well paid sales men in Porsche cars, to a lean no fuss companies using internet as the primary sales channel. Physical newspapers are increasingly replaced by digital versions and we shop on the internet when it rains or just for our convenience. The part of the IT portfolio where time-to-market, intense business-IT interaction and innovation are the key success factors (Enabling IT).

While IT plays a key role in transforming business models, consists a large part of IT portfolio still of value propositions which core attributes include reliability, availability and efficiency (Factory IT). As this category still represents the majority of the budget within most companies, has it subsequently shaped the structure, culture, and capabilities of the average IT department. And subsequently its sourcing strategy.

With IT required to deliver both IT enabling the business to capture more market share or open new ones and provide more traditional IT services, the standard approach of centralization and outsourcing may have to be reviewed. Before providing some of my thoughts, first the basic organizational structures an organization can pick from:

Centralized/shared. People and assets are concentrated within one department or unit, reporting hierarchically to the board. This ‘silo’ provides economies of scale regarding deployment of both labor and assets. The subsequent standardization and rationalization makes it also more prone of being more internally orientated with the business being dealt with through formal procedures, forms and reports. Its main benefits are efficiency and reliability.
Decentralized. People and assets are allocated to the business units needing their capabilities. The distance between business and IT is here much narrower as IT and business staff daily bump into each other. Drawbacks are the inability to use economies of scale when providing services like a standard workstation environment and telecom facilities. Its main benefits are business specific differentiation and flexibility.
Hybrid. By choosing this form it is possible to use the advantages of a centralized IT department (leverage on standard services) and decentralization (business specific differentiation). The drawbacks are additional cost due to coordination between the units, as all pieces of the puzzle will have to act as a whole. An increasing number of organizations are embracing this model to cope with the differentiated demand from the business.

When looking from a sourcing perspective at these three structures is it obvious that the traditional stronghold of outsourcing has been boosting the efficiency by increasing the economies of scale further than a company can by itself (supplemented by labor arbitrage). This kind of services are known as Transactional IT or Factory IT, and are depicted at the right side of the table.

The table shows some typical aspects of the highly centralized (and outsourced) Factory IT part of the portfolio. As mentioned before is the Business IT cooperation here highly formalized with many documents and procedures flowing back and forth. Subsequently is the relationship with the external service provider also highly formalized with thick documents, aimed at mutual risk mitigation. Actually, one of the key aspects of the whole right sight of the table is its risk-averseness. Risk in the form of budget overruns, disruptions, and security breaches.

	Enabling IT	Factory IT
Business-IT cooperation	Intense daily interaction, joint team	Client-supplier relationship
Importance speed-to-market	High	Medium to low
Importance reliability	Low to medium	High
Innovation orientation	Joint product innovation	Business and IT process optimalizations
IT management orientation	Strong leader, creative stars	Manager plus administrators
Sourcing orientation	Enhance innovation and speed-to-market, volume flexibility, minimize investment risk.	Sourcing decisions based on drive for efficiency and reliability.

The left side of the table is very different. Here the business wants to deploy IT as a means to increase its market share and IT needs therefore to be much closed to the business. Here IT is decentralized (if hardly any shared services, rare) and/or part of hybrid model (most common model). For this part, risk taking is part of the game, with the business expecting IT to come up with innovative ideas and high speed-to-market. External service providers are deployed here to enhance the innovative profile of the internal IT function, resource flexibility and reduced investment risk (e.g. through PaaS or IaaS). It requires a different contract and engagement model between client organization and external service provider to work. Here resources from the external service provider are part of the joint Business IT team translating the business vision into an actual product or service. Here not the procurement department has the last say (like with Factory IT contracts), but the content specialists and creative stars. In these cases are attitude, drive and energy the attributes the client is looking for.

One of the issues is however that in many cases the fundamental difference between Factory IT and Enabling IT is not made when looking for external service providers. It is still the procurement department which ensures the lowest bidder gets selected. Only when the business and IT join forces, a too narrow minded (and elaborate) contract can be avoided. When product cycles are measured in months instead of years, bickering two months about the cost is a recipe for loosing losing the continuous battle for market share. For enabling IT, it is about value, not about cost.

CobiT, ITIL v3, ISO 27002: Benefits and risks

2011-05-18T12:38:00.001+02:00

By the beginning of the 1990’s an increasing number of IT departments started using process oriented models like ITIL, ISO/IEC 9000 and CMM(i). Later on substituted by CobiT, ISO/IEC 27002, ASL, BiSL, ISO/IEC 20000 and many more. That these models helped professionalize IT and transform themselves from a technology playground to a more business and service oriented procession is without a doubt. A survey among 503 companies on the benefits of ITIL shows that with the increased maturity of the IT function, also the realized benefits increased, while the perception of implementation challenges decreases (2010 [FZ1]). From a strategic standpoint is the added value however limited as ITIL implementations can be easily imitated by competitors, leveling the playing field again. Furthermore is there a considerable risk implementations will end up in a swamp due to over-engineered procedures, templates, PPI and KPI reports and lack of fundamental understanding of the concept behind ITIL. A risk especially prone to materialize with the introduction of version 3 which is even more complex and extensive than the previous version. As a result companies got disappointed with the outcomes of implementations.

Investigating two American and two Australian companies which implemented ITIL (version 2) provide some pointers however to the increase the chance of a positive return (2009 [FZ2] ): executive management support, interdepartmental communication and collaboration, use of consultants, training and careful software selection. Besides these more generic critical success factors, they also found three specific ones: creating an ITIL-friendly culture, process as a priority, and customer-focused metrics. In my experience is especially the ITIL-friendly culture an important one as the implementation of a service and process-orientation in an organization that is used to think in functional silo’s has a considerable impact on both staff and managers. And changing a culture is a time consuming process and may thus collide with ambitious targets like ‘we are going to implement ITIL within the next six months’. Hence, the disappointment in some cases.

Some of the same risks and challenges may arise when implementing (parts of) CobiT and ISO/IEC 27002, as these are also extensive frameworks. CobiT covers both strategic governance (e.g. IT value management) and more operational IT management (e.g. managing service calls). ITIL’s original focus was more on the operational aspects of IT (the ‘service support’ and ‘service delivery’ processes), but with version 3 the framework also added more strategic topics, resulting in even more overlap with CobiT. While both CobiT and ITIL cover security management, provides ISO/IEC 27002 much more detail and is therefore widely adopted by any IT function where security is considered to be a risk factor which has to be mitigated. More information on the overlap and alignment of CobiT, ITIL v3 and ISO/IEC 27002 can be found here. It is a management briefing of 130 pages which gives an indication of the extensive scope and complexity of these models.

Embedded in the broad scope and complexity is one major strategic risk: compliance to the model itself tends in time to overshadow the original purpose of the implementation. So much effort and time is invested in the implementation that IT becomes inward looking while the core of most frameworks is making IT more externally focused. The risk of internal focus is given momentum by two other factors: the CFO tightening the resource tap and the increased dynamics and complexity of the business demand. Less resources means paying a lot of attention to initiatives to enhance internal efficiency, while the natural defense against contracting forces is building a (paper) shield. In the words of Minzberg (1991 [FZ3] ): ‘Organisations that have to reconcile contradictory forces, especially in dealing with change, often turn to the co-operative force of ideology or the competitive force of politics’. And this is not without pitfalls as Mintzberg continues that an ideology encourages the members of an organisation ‘to look inward – to take their lead from the organizations own vision’.

What does not help is the focus on most frameworks on activities and accompanying forms, reports and other pieces of paper. While the business is mostly interested in results. Result from a business perspective (99,9% of transaction processed flawlessly), not IT perspective (e.g. we closed 20 incidents today). Also Schaffer and Thomson (1992 [FZ4] ), and Mastenbroek (1997 [FZ5] ) are convinced that improvement programs that focus solely on structures and systems (= frameworks and tools) don’t necessarily lead to increasing performance. In the words of Mastenbroek: ‘the more the organisational change is linked to improvements in the output, the better’. Schaffer and Thomson distinguish within this context between ‘activity centered’ and ‘result driven’ transformation. Some of the typical characteristics of both approaches are summarized in the table.

‘Activity centred transformation’	‘Result driven transformation’
Often too ambitious, large-scaled and diffused. Not oriented towards archiving specific outputs, resulting in misleading performance measurements.	Forces management to prioritise its targets and the necessary means to archive them.
Preference for orthodox approach instead of empirical.	Empirical tests show what works and what doesn’t .
Focus on long term, not on results.	Frequent reinforcement by the management provides the transformation with new energy
Controlled by staff departments and consultants.	Management creates an ongoing learning process by leveraging on lessons learned in previous phases and use new insight when designing and implementing the next phase.

As a result have many IT departments entrenched themselves with formal procedures and templates to structure the communication with the business. A business which is the ‘client’ and IT being referred to as the ‘supplier’. Good and well in a static environment, but a recipe for an out-of-business-signboard in a highly competitive one as the Entrepreneurial IT requires a fundamentally different approach.

[Note: this is another small piece of the book I’m writing]

Literature:

[FZ1]ITIL and the creation of benefits: an empirical study on benefits, challenges and processes, 18th European Conference on Information Systems, Marrone, Mauricio, Kolbe, Lutz M.

[FZ2]Justifications, Strategies, and Critical Success Factors in Successful ITIL Implementations in U.S. and Australian Companies: An Exploratory Study, Carol Pollarda; Aileen Cater-Steelb, Information Systems Management, Volume 26, Issue 2, 2009, Pages 164 – 175.

[FZ3]The effective Organization: Forces and Forms, Henry Mintzberg, Sloan Management Review, Winter 1991, Volume 32, number 2

[FZ4]Successful Change Programs Begin with Results,
Schaffer R. H., Thomson H. A, Harvard Business Review, January-February 1992.

[FZ5]Mastenbroek, W. Verandermanagement. Holland Business Publications, 1997.

Benchmarking becoming obsolete?

2011-03-28T22:19:00.001+02:00

Today I was asked to give my opinion on the proposition “when outsourcing is benchmarking required to prevent a failure” by an editor of an IT magazine. My first thought was: of course it is, as including a benchmark clause in a contract was standard practice when I drafted a contract. But then I thought again and come to a less back-and-white conclusion.

Benchmarking before or during the contract period is common good and big business for companies like Gartner, Alsbridge and Compass, but given the increased complexity and tailoring of the solutions provided I wonder whether their usage is not restricted to a limited set of services. Services which soon get so common that many just buy them out of the cloud. Let me explain.

Many organizations outsourcing for the first time did not know what to expect from a supplier and often also have no clue about the cost of a workspace or server. They just knew the total IT budget and had a target to reduce it by 5% before next year. The benchmark company helped these companies in two way: allocate the aggregated budget to individual services and provide the average cost in the market for that same service. That way the organization knew whether there would be a positive business case.

Since than many things have changed. For starters have most organizations learned that selecting the cheapest suppliers is not always the best decision. The damage caused by crappy services and the invoices send for additional work ensure many business cases end up in the archive, together with the responsible IT manager. Both not to be seen again. As a result know companies that outsource for a second or third time what to expect and go for a more balanced contract. And as they have the price sheet of their existing supplier, it is easy to calculate any benefit by choosing a competing supplier.

At the same time are many standard IT services commoditizing to an extent that it is as easy as going to a grocery store. Server capacity, storage and a continuously increasing list of applications can be bought out of the cloud on a pay per use basis. How much price transparency do you want?

That leaves the company specific solutions and technology. Solutions which key business value are for example improving flexibility or speed-to-market of the business. How are you going to benchmark those qualities? How do you ensure you use the same definitions per company? Everybody can easily agree on a definition of ‘availability’ or ‘response time’, but defining ‘flexibility’ is already more complex (e.g. volume, service mix, time). The same applies to the cost. How do you create a peer group if there are maybe one or two companies which have similar services? In other words, the validity of the outcome of a benchmark deteriorates fast when complexity and tailoring increase.

As a result I believe that the relevance of benchmarking will decrease over time with a) companies leveraging experience from past deals, b) standard services becoming so commoditized that benchmarking does not add any value, c) IT services retained by companies become to specialized to benchmark as the peer group is too thin.

No shares in benchmark companies for me I guess ;-)

Run your datacenter on paprika’s

2011-03-20T18:47:00.001+01:00

The Netherlands has traditionally a leading position in agricultural (Tulip anyone?), but due to the climate many crops are grown in greenhouses that have to be heated during winter. The engines used run on gas and the resulting heat and carbon dioxide are used to create the optimum growing conditions. These ‘micro combined heat and power engines (Micro-CHP) produce also electricity however, and much more than needed to provide artificial lighting during the night hours. One options to feed the access power back to the grid or to feed it directly to nearby houses and company buildings. One such initiative includes using the power of 35 engines used to heat 220 hectares of greenhouses to power a new datacenter. The access heat produced by the datacenter is in turn fed back to the greenhouses. This initiative is an example of the increased emphasis on sustainability within many industries and at the role of technology as an enabler (e.g. smart grid).

Reducing the environmental footprint of information technology has its origin in the Energy Star initiative launched by the U.S. Environmental Protection Agency in 1992. Through this program manufacturers of energy-efficient monitors and other equipment could distinct themselves from less environment-focused competitors. Since then, ‘Green’ has seen a steady rise on the priority list of governments and companies all over the, including the implementation of legislation. In the United States the American Recovery and Reinvestment Act (ARRA) legislation allocated $90 billion to be invested in projects aimed at improving the energy efficiency of IT itself (‘green for IT’) and the use of information technology to increase the level of sustainability within other industries and the society as a whole (‘IT for green’). In France and Australia the adaptation of more efficient technologies is pushed by the government by the introduction of a carbon tax. In France companies with more than 500 employees have to report on their emissions and take action to reduce them and in Australia a ‘cap and trade’ system will be implemented by 2012. For the European Union as a whole both new legislation is underway and funds are freed for initiatives like Green Active Management of Energy in IT Service centers (GAMES). It is a research project aimed at developing best practices, methodologies and supporting tools to improve the energy efficiency of future data centers. Other organizations focus on creating standards and guidelines. Some more generic standards are:

ISO 26000 (social responsibility), ISO 14000 (environmental systems) and ISO 19011 (auditing of environmental management systems) from the International Standards Organization (ISO).
BS EN 16001 (Energy Management Certification) from the British Standards Institute (BSI).
Global Reporting Initiative (GRI),which publishes a widely adopted set of reporting standards on topics like human rights, environmental, anti-corruption and other sustainability related subjects.

Besides these generic standards there are also many aimed specifically at technology. Some are directly related with the manufacturing of the components while others focus on the deployment of them.

Manufacturing. The IEEE P1888 Working Group is developing UGCCNet (Ubiquitous Green Community Control Network) standard which allows various building components to interact with each other to improve energy efficiency. The IEEE P1801 is a standard for the design of low-powered integrated circuits, and IEEE 1680 specifies how to quantify the green properties of electronic devices like computers, printers and scanners.
Deployment. The Green Grid is a group of international companies which aim is to improve energy efficiency of data centers by introducing metrics and indices, allowing mutual comparison on both operational efficiency and maturity level. The CompTIA Strata Green IT and Information Systems Examination Board’s (ISEB) Foundation Certificate in Green IT are certifications aimed at IT managers and professionals who want to advance their knowledge on ‘green computing’.

Even though initiatives to increase the power efficiency of data centers and IT systems in general can have a substantial impact on both the environment and the electricity bill, are the largest (future) gains in be expected in the area of IT for Green initiatives. By implementing smart meters in houses, local CHP systems, supply chain optimalization or teleworking, scarce resources are used more efficiently. These technologies are often combined with initiatives to better inform consumers on their usage patterns, enabling them to change their behavior and thus benefits of the technology. Trackulous allows consumers to track their own impact on the environment, while GreenScanner provides information on the environmental impact of products . Information which will get increasingly detailed and complex with the introduction of Life Cycle Assessments. These kind of assessments allows companies to determine per phase in the value chain both the current impact on the environment, and the potential benefits that can be achieved.

The adaptation rate of green technology will in the end however be determined by the price and the value of the efficiency gain it enables. The illustration shows the relationship between the price of the more environmental friendly product and the number production volume required to become a competitive substitute for existing technologies. It shows that new technologies (e.g. ‘green’ data centers) can initially be substantially more expensive than established ones, but that initial support (e.g. ARRA funding), legislation and carbon tax can even the odds quickly for newcomers. This combined with the rising prices for fuel , raw materials and almost any other commodity, the value of the efficiency gains offered by new technologies will push the economic breakeven point increasingly to smaller production volumes.

The consumer as a micro-supplier

2011-02-17T09:55:00.002+01:00

The interconnections between companies and their external stakeholders become more intens by the day. The world's leading provider of lithography systems for the semiconductor industry, ASML, is a company where several hundred external business partners are very closely integrated in the design, development, integration and servicing of the systems used to make CPU’s, GPU’s, memory modules and other advanced microchips. Up to 90% of the total system costs are supplied externally and business partners several tiers deep in the supply chain have access to relevant technology and product development information from ASML. It allows ASML fast access to new innovations created throughout its value chain, without the need to invest themselves in all these areas. ASML focuses on the high value-added integration role, including product competence and manufacturing cycle times while the business partners design and manufacture specialized subsystems.

But not only suppliers become part of the companies’ eco-systems. With the internet entering homes and mobile phones, the companies’ communication, distribution and sales channels end literally before the eyes of the consumer. The opportunity to tap the knowledge and creativity that becomes available this way is capitalized on my an increasing number of companies.

Companies that integrate consumers into their value chain are among others LEGO, shirt retailer Threadless and Unilever’s Ponds Institute. At LEGO consumers are invited to submit their idea’s for new products and are even financially rewarded if their idea proves to be a commercial success. At Threadless consumers are invited to interact very closely with the design department to shape the new collection while the Ponds Institute seeks your views about your look and feel in order to personalize the skin care they provide to you. Being it capturing new design idea’s, sourcing subassemblies from external business partners or test prototypes with consumers, an increasing number of companies embrace an ‘open’ innovation and cooperation model, contrary to the closed, vertically integrated approach companies like IBM, Bell Labs and Xerox are famous for.

In the future, everybody will have the opportunity to become part of a companies value chain. And not just because the company wants to have a share of your wallet, but because you as a consumer can have a tangible effect on the companies long term success. We can all become micro-suppliers.

Make way for new suppliers on the block! Part II

2011-01-06T09:10:00.001+01:00

Imtech is an example of a (Dutch) Tier 3 supplier which has been successful in closing several considerable IT deals (e.g. deal of 124 million euro). One of their success factors in my opinion is their diversification strategy. They are not only strong in IT, but also in engineering disciplines like Mechanical and Electronics. This has three benefits:

Delivering engineering services to for example companies active in the automotive industry ensures Imtech has solid knowledge of that vertical, which can be leveraged on by the IT discipline.
The disciplines Mechanical Engineering, Electronics and IT are fusing increasingly together within many types of industry, requiring cross functional knowledge to deliver maximum added value as a company (or partner with other suppliers).
Having a contract with a company to provide electronic systems to control the chemical processes of a company, ensures there is an existing relationship the account managers of the other disciples can build on. Increasing the work scope with an existing client requires in general much less effort compared to establishing a relationship with a new client.

Does this mean that all suppliers should follow this strategy? No, of course not, but it is certainly one of the strategies smaller supplier can use to compete with the big IT suppliers as IBM, Accenture, Atos Origin, CSC, TCS, Wipro and so on.

As stated in the previous post is an important USP of smaller suppliers their agility and capability to deliver new innovations to the market faster. With companies looking increasingly for solutions which allow them to become more competitive in the market place instead of solely looking for solutions op optimize the efficiency of back office processes (e.g. ERP), many opportunities are out there which the Tier 1 and 2 players find difficult to provision. This is why many (even larger) companies these days make two adjustments in their sourcing strategy:

Mix large, efficiency focused contracts and single vendor contracts, with smaller contracts allocated to multiple suppliers (‘multi vendor’)
Engage with niche players which can provide in the companies need to improve its flexibility, agility and speed to market

The main differences between the traditional ‘old school’ supplier and the ‘new kids on the block’ suppliers in my opinion:

Economics for old school suppliers is based on high fixed cost make large volumes essential to achieve low unit cost; economies of scale are key. Culture shaped by the continuing battle for scale; rapid consolidation, a few big players dominate. Competition is cost focused; stressed standardization, predictability and efficiency.
Economics for new entry suppliers is based on focusing on early market entry with new solutions enables charging premium prices and acquiring large market share, speed and innovation are key. Culture shaped by the battle for talent, low entry barriers, many small players can thrive. The competition is employee centered, coddling the creative stars which create the new solutions.

The trick for the company which wants to outsource is to create a sourcing strategy which can leverage on the strong points of both types and the capability to integrate the offerings within the internal organization.

Make way for new suppliers on the block! Part I

2010-11-02T09:37:00.002+01:00

A side effect of globalization and informed customers is a shorter lifecycle of products and services. The competitive pressures introduced by globalization and buying behavior of customers in combination with the fast past of technological advances, shorten the payback time of investments in R&D and new production facilities. This requires organizations to become increasingly flexible and agile in order to quickly adjust production volumes and product mix.

The increasing complexity of services and products in combination with the ever higher investments required to improve quality, lower cost and renew the product and service portfolio, increase the entry barrier for new players.

Within the banking and insurance industry several new players have gained considerable market share over the last couple of years by leveraging technological advances and the desire of customers for a bigger bang for a buck. Think of web-based brokers which allow consumers to trade stock, derivatives and other financial instruments without expensive dealing rooms as intermediates. Or start-ups which offer pension products at considerably lower prices than traditional financial institutions. In both situations plays IT a crucial role. The new kids on the block use it as a key enabler to capitalize on business opportunities while the legacy IT of established banks and insurers limits the ability to adjust the business model to the changes in the market place.

One of the effects of the previously mentioned trends is the need as a company to specialize. Where General Motors used to own the whole value chain required to build a car, are many individual chains now allocated to sub-contractors. The benefits are lower cost through economies of scale and freeing up funds that can be invested in strengthening existing capabilities or innovation. Specialization however also means making choices. Choices about retaining which activities, assets and employees. And that brings me to the subject of the external supplier

‘Old school’ suppliers
‘Agile’ is a term which gained in popularity when the software development community introduced the Agile (SCRUM) concept. But not only in software development is often more agility required, the whole IT function has to become more agile to cope with the trend described in the previous paragraph. And that is an area most ‘traditional’ IT service providers don’t excel in. They are the masters of operational excellence: lowering cost through economies of scale.

As a result the big players find it difficult to response on developments like cloud computing, and ‘as-a-service’ solutions with truly agile solutions. Yes of course they advertise that they also can deliver it, but when looking beyond the marketing fluff one sees in most cases that the underlying technology and organization is still largely the same as used to deliver the traditional services.

Everything is ‘virtualized’, but short speed to market is only available if you stick to the standard solution of the supplier. There is typically no room for flexilibility in these concept other than in volume. You have to upgrade when they upgrade, you have to stick with their support and maintenance windows, you have to follow their patch policies, you have to…

	New school suppliers	Old-school suppliers
Economics	Early market entry enables charging premium prices and acquiring large market share, speed and innovation is key.	High fixed cost make large volumes essential to achieve low unit cost; economies of scale are key
Culture	Battle for talent, low entry barriers, many small players trive	Battle for scale; rapid consolidation, a few big players dominate
Competition	Employee centered, coddling the creative stars	Cost focused; stressed standardization, predictability and efficiency

And worse of all, it is in most cases the same service organization that supports it. An organization that is organized in functional silo’s with their concrete processes and procedures. The organizations that take ages to comes back to you when you have an issue and excel in ping ponging tickets between departments.

New school suppliers
As described in the previous post, are the traditional service offerings excellent for a large part of the typical service portfolio of an organization (e.g. Key Operational services), but especially for the services related to the quadrant High Potential, the offering has to be truly agile, quick and innovative. And that is why especially in cloud and as-a-service solutions new players can be successful. They fulfill a business need both the internal IT organization struggles to fulfill and which traditional service providers are also not capable to deliver.

The newcomers allow the internal IT organization to ‘rent’ their innovations and new capabilities and incorporate them into their own service portfolio. This in term allows the internal IT organization to finally transform itself from delivering business process automation services and other low added value solutions. More on these new kids on the block in the second part.

Outsourcing and innovation: a contradiction or not?

2010-10-01T21:07:00.001+02:00

Outsourcing IT to improve the capabilities of the IT to innovate and improve speed-to-market looks at first a contradiction. Typically outsourcing is used to reduce IT cost, with standardization and less responsiveness regarding new business demand as a side effect.

However, outsourcing can actually help an IT organization to improve their speed-to-market and ability to deliver new services that add value to the business. A business that wants to grow again after a period of economic downturn and expects IT to act accordingly. There are two basic keys to achieving this goal.

First key

The first part is understanding that the dynamics to manage on speed-to-market and innovation is fundamentally different from delivering reliable (standard) solutions at high availability levels. The first type of service requires agility, flexibility and a general focus on benefits. The second type focuses on reducing the change of an operational risk materializing. In other words: solid build, test, acceptance and operation procedures, checklist, manuals etc. Not an approach that facilities innovation…

Realizing the required differentiation starts with a better understanding of the dynamics of the services provided by the IT organization. Classification based on the portfolio model of Ward et al (1996) can help this. This model maps services to four quadrants accordingly to their contribution to the primary business objectives and the extent to which business processes are dependent on them for their day-to-day operation (illustration).

Strategic. These services are critical to maintain the existing competitive advantages and to develop them further. IT investments in this quadrant are used for innovation that contributes to the maintaining and developing the current competitive advantage.
High Potential. In this quadrant are services that have in most cases no yet yielded a positive contribution to the financial result, but show a lot of potential. The services in this quadrant have a high level of investment risk and should be managed as such. In this quadrant focus is on innovation and speed to market.
Key Operational. In this quadrant are the services that are crucial for running the current operations of the business. The underlying IT systems enable the organization to execute its business processes in an effective and efficient manner. The focus in this quadrant is on reliability and availability.
Support. The added value in this quadrant is limited to the automation of business processes in order to execute them more efficiently.

The dynamics between the quadrant High Potential on one side and the quadrants Key Operational and Support on the other side differs fundamentally. Within the High Potential quadrant, the speed-to-market of new features and innovations the primary focus. Within the quadrants Key Operational and Support, the emphasis is on high reliability and availability figures.

Second key

From business perspective, the services in the Support quadrant add the least value, so the trick is to minimize the budget of this quadrant and transfer the achieved reduction to the quadrant High Potential (= the innovation quadrant). In short, source standard solutions for the Support quadrant, which are build and operated by external vendors.

Additional financial room can be created by applying specific sourcing strategies to the other quadrants. The outline of these sourcing strategies could be as follows.

Financial room (both CAPEX and OPEX) can be unlocked by deploying cloud-based solutions for the services in the High Potential quadrant. An additional advantage of using cloud services in this quadrant is it reduces the investment risk. Not every service in this quadrant will reach ‘adulthood’ and move to another quadrant. For many another exit strategy will be necessary. Another reason to work more with external parties for services in this quadrant is the disruption caused by the dynamic of innovation on building and managing systems in the Key Operational quadrant.

In the Key Operational quadrant there are possibilities to outsource parts of the infrastructure layer, provided they are not too intertwined with the application layer. Suppliers will have the least work in the Strategic quadrant, given the importance to the organization. Here is would be best to work only with hiring of capacity where necessary.

The approach outlined here gives only part of the puzzle. The difference in dynamics among the different quadrants impacts also aspects like HR management, processes, architecture and the like. Only from a holistic approach, the IT organization will be able to actually roll out new innovations faster.

Why government run shared services often fail, part 2

2010-09-10T09:58:00.001+02:00

This blog is a follow up on this piece in which I wrote on some of my experiences with IT shared services in the government sector. Here I want to write about two solutions which would improve the success rate of a shared service center.

Practical example

The organization is a grouping of local government agencies which have a long history of semi independence. Policy is partially dictated from a ministry and national politics, but there is also room for local decision making. To align, the governors of the local agencies gather on a yearly basis to agree on long term policy and cooperation.

One of the decision was starting an IT-shared service center some ten years ago, because the processes of the agencies showed considerable similarities. However, these similarities turned out to be far fewer than expected and every local agency had a list with arguments why its deviations had to stay. The result was IT systems which had more custom code than common code.

The SCC was in the meantime held accountable for the accompanying budget and time-overruns. Efforts to not make the same mistake for the next IT system, resulted in months of discussion with the local agencies about which functionalities to incorporate and which not. And if there was agreement on the functionalities they were at such a high detail level that designers and programmers could only guess the underlying requirement…. and thus build something that was rejected during functional testing.

The combination of semi-independence, high budgets and local processes which were developed over several hundreds of years, resulted in a failure of transforming the intention to cooperate into a success. This combined with the ‘client-supplier’ relationship which came with the establishment of the SSC, resulted in local agencies putting all the blame with the SSC. The SSC got paid after all to build and operate IT services, and the client is always right….. (illustration 1)

The employees of the SSC had by now the feeling to be stuck between hammer and anvil.

Getting the Principal and SSC closer together

The cooperation between the local agencies and the SSC is depicted in illustration 2. Together, the yearly long term targets are defined, which the SSC is then expected to execute, with the help of the local agencies.

The first solution direction is depicted as option 1 in illustration 3. In other words, the various activities related to governance, information management and functional management are centralized in a ‘director-function’ between local agencies (the principles) and the SSC (the ‘supplier’). This ensures that the fights among the local agencies regarding their differentiations in demand are not fought in the front garden of the SSC.

The SSC is able to focus on building and operating IT services. Building functionalities which have been streamlined and made uniform before communicating them to the SSC. The ‘director function’ was made responsible for alignment of demand-supply and reported directly to the overall government board of the local agencies. Escalations were thus dealt with within the business domain and did not reach the SSC.

Illustration 3, option 2 provides another solution to reduce the tension between SSC and the principles. The second option focuses on a (temporarily) cut of the ambition level by cutting the IT portfolio in two parts. One part is build and operated by the SSC while the remaining services are decentralized again. For this second part a local agency can source independently from the SSC and other local agencies. To apply this second approach for the area’s with the highest level of differentiation, the overall tension level would be reduced.

By focusing the energy to IT services where it is more likely to be successful, a positive feedback spiral would in time lead to a situation where also more difficult challenges could be addressed. In time the end result would be the same, it would just take more time. And time is not a short supply in most government agencies.

The additional cost which accompanying these two options will in practice disappear against the budget overruns on ongoing projects which are executed in the ‘old’ fashion. The impact will therefore be mostly on the organizational side. With option 1, the SCC will have to split off its capabilities regarding information management and functional management as it would become part of the new director function in the business domain. With option 2, the shared service center would lose (temporarily) part of its portfolio and this resources and budget.

In the third part I will write about the application of both approaches and provide some general guidelines based on my experience.

The CIO agenda of tomorrow, part II

2010-09-03T09:08:00.001+02:00

To execute innovation for low cost and ‘lean customization’ more successful than next doors competitor, one shared ingredient is necessary: information dominance. Where achieving air dominance is crucial to decide a military conflict in your favor, will gaining information dominance be central in doing business in the years to come. It can be simple like soccer team AC Milan using a mathematical model to predict the chance players will get struck by an injury. Google uses self-learning algorithms to improve search results and present advertisements while the success of retailers Wal-Mart and Ahold is derived from knowing more of consumers and suppliers than their competitors.

These organization have been able to get a grip on the massive data amounts and can predict to a high degree what an individual customer will buy next. Smart technology alone is however not enough as all relevant information was available on the terrorist who boarded the flight between Amsterdam and Detroit in December 2009. In this case the human factor prevented the proper conclusion to be draw. In that sense is terrorist hunting like doing business, IT can do a lot, but the chain is as strong as the weakest chain.

What else on tomorrows agenda? Expect more patent lawsuits related to business models. Companies increasingly approach new business models or methods as intellectual property and try to protect it with a patent. With several e-commerce related patents being awarded, is it also for IT important to be vigilant when the business requests mimicking somebody else’s e-business concept. Patenting a new business concepts is however at the same time also a mechanism for startup companies to defend themselves against the might of established companies.

Established companies which have capital to spend, but lack the flexibility, creativity and drive of small companies. Many large corporations have insulated themselves over time from their customers, with the financial services industry as an obvious recent example. Transforming large corporations into more nimble organizations is therefore one of the main challenges for tomorrows graduating MBA student. Corporations are increasingly being challenged by SME’s which rely heavily utilizing the latest technological advances to provide higher quality products and services at lower cost levels.

The CIO agenda of tomorrow, part I

2010-08-24T14:02:00.001+02:00

One of the effects of the recent economic meltdown is American and Western European consumers looking for cheaper products. Many are shaken and struggle to pay off existing loans, let alone feel comfortable to engage new ones. At the same time are billions of consumers in Asia, South America and in a lesser extent Africa, entering the middle class. But a middle class which can only afford cheap products. Companies react to these developments by producing cheaper products and services, like the one Lac (2,000 dollar) car from Tata.

In the Harvard Business Review article ‘Innovation’s Holy Grail’, C.K. Prahalad and R.A. Mashelkar argue that this change in demand requires companies to think differently about innovation. Where traditional innovation is built on the assumption of abundance in capital, knowledge and other resources, will future innovation be driven by the need to build more products with fewer resources. According to the authors, companies should focus on ‘affordability and sustainability, not premium pricing and abundance’. The subsequent global search for lower cost, affordable talent pools will lead to even more dispersed value chains, requiring sophisticated IT solutions to manage the accompanying complexity.

Other business models are based on free, as free is better than cheap. This business model is based on providing free services to most consumers in combination with adjacent revenue sources that cover the cost. The concept of free services was made popular by author and Wired editor Chris Anderson in his book Free: The Future of a Radical Price . In reality is the product or service is indeed free for most consumers, with advertisers or ‘premium users’ generating the necessary revenue. Will this the future? Not very likely as the available revenue pool generated by advertisement or user-upgrades is limited. Even Facebook with 500 million users still requires cash donations from its owners.

While being price conscious are consumers at the same time looking for products which reflect their desire for individualism. Companies like Netflix and Amazon.com have already mastered the skill of selling a large number of unique items in relatively small quantities, while still making a profit. Chris Anderson described this concept in this book The Long Tail: Why the Future of Business Is Selling Less of More and this retail concept is gaining in popularity with the consumers’ desire to reflect their personality in the products and services they buy. The ‘Long Tail’ in the book title refers to the statistical property that a larger share of consumers rests within the tail of a probability distribution than observed under a 'normal' or Gaussian distribution. More simply stated, consumers used to be happy with a black Ford, but not anymore. They expect all available colors of the rainbow, paying only a minimum premium for that added value. This requires companies to combine two, on first sight conflicting, requirements in their production process: efficiency and differentiation.

Offering a wide variety of customizations without adversely impacting cost is a skill which Western European car manufacturers learned to master. There the customization process starts with feeding information left behind by visitors of their websites regarding preferred models, colors and options into the production process. A production process which is based on the capability of putting a wide variety of modules together as a jigsaw puzzle. The flexibility these modules bring into in the design process and supply chain is the cornerstone of the car industries’ ability to combine product flexibility and efficiency. It drives the adding and removing of functionalities, integration with suppliers, and allocation of R&D efforts among all companies involved.

This post is from the 2nd chapter in the book I’m writing on orchestrating the Business IT value chain.

Outsourcing with Solvency II in your back pocket

2010-07-29T19:54:00.001+02:00

Getting outsourcing contracts to comply with Solvency II is not rocket science, but requires a certain amount of attention. Here are some practical guidelines.

Where within banks the Basel II implementation projects come to an end, are insurers burning the midnight oil to get Solvency II implemented before the end of 2012. The Solvency II legislation is aimed at improving risk management practices within insurance companies and providing better protection for policyholders. For this purpose, the legislation demands:

the insurer to hold enough capital to survive a period of economic hardship (pillar 1),
adequate quality of internal controls and governance (Pillar 2) and
greater transparency in communication with the regulator and market (Pillar 3).

These three topics have been translated into clauses that must be complied with. If the insurer has not outsourced any IT or business processes, it is sufficient for the insurer to translate the legislation into internal controls. If the insurer has however outsourced activities then two activities are added to the project:

Compliance with specific outsourcing requirements (in particular Article 49)
Translating internal controls into a framework the supplier has to adhere to.

Specific requirements for outsourcing
Before going into more deatil, is it important to note that currently only the top-level requirements have been published (known as level 1). These requirements are now being developed further into more detailed demands (level 2 to level 4). Ensure therefore to incorporate sufficient flexibility in new outsourcing contracts to cater for additional future requirements. Otherwise you might have to break open the contract and renegotiate parts of it.

At the highest detail level the specific requirements the insurer has to comply with related to outsourcing are:

the insurer remains fully responsible for compliance with Solvency II. In short, the insurer does not get away with pointing its finger at the vendor if it does not comply with the legislation.
The insurer must have written policies regarding outsourcing and adhere to them.
Outsourcing should not adversely impact on the quality of the governance system. In short: good control over the vendor is key.
Outsourcing should not adversely affect operational risk. In short: define the operational risk profile before outsourcing and ensure that sufficient mechanisms are in place to manage the operational risk profile after outsorucing.
Outsourcing should not adversely affect the ability of the regulator to check whether the insurer meets its obligations. This includes the requirement of the regulator to have access to the location of the supplier. In short, it is possible that a regulator wants to take a plane to India to audit a vendor.
Outsourcing may not adversely affect the continuity and adequacy of services.
The insurer will inform the supervisor prior to the outsourcing of critical or important functions or activities. In addition, the supervisor has to be informed in case of substantial changes to the contract.

It seems on first sight a relatively simple list, but demonstrating compliance to the regulator requires still some thought. In addition, not all (foreign) suppliers are eager to get a foreign regulator on its premises.

Translating internal controls

When a (part of) a business process or IT systems is outsourced, it must continue to meet the requirements set by Solvency II. The easiest way is to impose the existing internal control framework on the vendor. This is also the most expensive solution, because the vendor would not be able to use its own processes and best practices regarding risk management. Using standard SAS70 / ISAE 3402 as a compliance-cure will not do, because its scope does not match the specific demands posed by Solvency II.

Without going into too much detail, the following recommendations will guide you in the right direction:

Define for the outsourced activities a "Solvency II risk profile”. Some activities and IT systems will hardly be affected by Solvency II, while other parts will be heavily impacted by Solvency II.
Differentiate the design of the risk control framework based on the risk profile. Think of a 'bronze' approach for activities with a low risk and a silver and gold framework for critical processes.
Translate the bronze, silver and gold profiles in specific control measurements and requirements the vendor has to comply with. Put relatively mild measures for bronze (e.g. reporting, due diligence on policies, relying on monitoring framework of vendor) and put heavier measures when outsourcing more risky activities (e.g. prescribing controls, third party audits, strict monitoring of vendor compliance ).

This approach allows for an optimal allocation of scarce time and resources to existing and planned outsourcing contracts in order to make them comply with Solvency II. It's not rocket science, but especially translating an internal control framework into an adequate framework for the vendor requires some thought and attention.

Why government run shared services often fail

2010-07-27T17:50:00.002+02:00

In this blog and the next blog I want to share some of my thoughts on government agencies using shared services. More specifically: why do they often function so cumbersome that they make it into the newspapers.

What makes shared services within government different
Centralization of IT or processes like finance, HR administration offers the ability to rationalize and standardize processes, allowing for lower cost, more consistent quality level and faster decision making. As voters expect their ministries and other government agencies to eat as little as their tax money as possible (especially in these times of economic hardship in the US and Europe), is sharing resources and processes a useful vehicle to achieve that goal.

As a result many ambitious objectives have been defined by high ranking government officials. These government officials did however not always realize that ‘sharing resources and processes’ also effects their power base. Where they use to rule their little kingdom, they now have to talk to other little kings about a common approach. Sharing that hard earned throne is however not something that is part of the standard government culture.

A culture which is shaped by the political context they operate in and often hundreds of years of semi-independency. The political context is influenced by objectives and tasks from various stakeholders. Stakeholders like voters, politicians and government workers higher up in the food chain. To make things even more complex, the needs of these stakeholders are not static, they change. This results in a very complex and dynamic environment. And complexity and especially dynamics are not friends of a shared services. Shared service centers (SSC) have their optimal working area in a relatively static environment as this allows for standardization and functional pooling of resources.

When a SSC is created this ‘tension’ between demand (the ‘business’) and supply (‘supply’) remains under water as creating an organizational structure and filling it with people does not actually change anything yet. All the little kingdoms are still as they were before. The actual change starts when the first processes have to be transferred or the first shared project is initiated. Then all of a sudden all the differences surface. Differences which are often considered insignificant by somebody working in a commercial company, but can result in years of trench wars within government agencies.

Splits between demand and supply
The SSC finds itself now in an impossible position. The Principles that initiated the shared service center and gave it the objective to cut cost, are the same people that prevent it achieving that objective. The result is a nice negative feedback loop. In order to keep the Principles ‘on board’ the SSC creates a lot of exceptions and customizations. This increases however the cost level (and thus financial charge for the Principle), increasing the frustration and need for the SSC to be even more willing to allow for customizations next time round.

In other words: the difference in optimum working area of the SSC and the dynamics of its Principles often leads to considerable tension between supply and demand. The result are budget overruns and missed timelines. In most cases both parties acknowledge that there is an issue/mismatch, but the next projects ends the same way is the culture turns out to be stronger than the rational dictation change. At the end of the day, the king wants to remain king.

In a follow up blog I will share two approaches to ease the tension and bring demand and supply closer together.

Flying through the cloud

2010-06-24T12:04:00.006+02:00

The concept behind cloud computing started off as ‘utility-based computing’, allowing a company to buy CPU cycles, storage and other IT resources. Advances in the area of virtualization and remote access (e.g. Server Based Computing ,HTML5) since then paved the road for more complex services to be delivered by using internet protocols.

Not only technicians have embraced the cloud concept. Marketeers have burned the midnight oil to translate the whole technology stack into ‘as a service’ solution (illustration 1). An overview of the cloud solutions offered.

RaaS: Rackspace as a Service
HaaS: Hardware as a Service
PaaS: Platform as a Service
IaaS: Infrastructure as a Service
DaaS: Desktop as a Service
DPaaS: Data Protection as a Service
MaaS: Mobility as a Service
STaaS: STorage as a Service
SaaS: Software as a Service
BPaaS: Business Process as a Service
AaaS or XaaS: Anything as a Service

For many of the mentioned solutions the marketing fluff still outweighs the underlying technology and value proposition. More mature are STaaS, PaaS and SaaS as a considerable vendor market and client base exist for those solutions. For other cloud services time and the market will tell whether they will enter the premier league or fade away.

Despite using different names, is the business model behind all cloud services the same. By standardization and boosting the utilization of its severs and floor space, a vendor of cloud services can offer lower prices. Where the average utilization of a standard datacenter is around 30%, push cloud vendors these percentages to 80% and higher.

The attractiveness of the offering is reflected by expected growth figures. Research from International Data Corporation (IDC) indicates cloud computing for public use (e.g. GoogleApps) will grow from $582 million in 2009 to $718 million in 2014. Cloud services targeted for commercial use is expected to grow from $7.3 billion to $11.8 billion in the same time period.

The benefits of cloud computing for companies are improved flexibility and cost levels. Flexibility can be expressed in pricing structure, volume variations and service mix, but always within the boundaries inherent to the design of the cloud solution.

This means that also cloud computing does not offer a free lunch. Cloud services require companies to adhere to a strict mold and resembles in that sense the black Ford. This means that when deploying a hybrid model of cloud and company specific services, the cloud is leading. In other words, when hosting a company specific ERP solution on a Platform as a Service (PaaS) model, the application releases and support model have to be adjusted to the underlying platform. A concept considered the world up-side-down to most application professionals. The freedom to customize, cloud model and potential efficiency gains are depicted in illustration 2.

The benefits of cloud computing thus come at the cost of standardization and consequent inability of using those IT services as a strategic differentiator. As typically only a small part of the IT service portfolio can be considered of strategic importance, a considerable part of the portfolio may be suitable for a as-a-service treatment. Being able to look beyond the flashy marketing presentations is however a key requirement in order to pluck the benefits or run the risk of becoming a test bunny for your vendor.

Also this posting is part of the book I'm writing on orchestrating the IT value chain.

The Indian economic development in a nutshell

2010-06-04T12:04:00.002+02:00

I recently started to write a book and I will publish parts in the coming months on this blog. The working title of the book will be: Orchestrating the IT value chain and provides my experience and vision on improving the performance of IT and alignment with the business. This blog is about the effects globalisation had on the country I lived in for an year: India.

After the fall of the Berlin Wall, countries such as India, China and Russia began to open up their economies to the world. This enhanced collaboration across the globe and kick started an unprecedented economic growth within India.

Until the 1980s, Indian policy makers enforced a strict industry policy which resembled in many ways the ‘plan economies’ of communistic countries. By nationalizing companies and regulating the amount of output a company or industry could produce, the government tried to develop the country from a society of farmers to an industrialized country. In line with this policy imposed the government very restrictive rules on foreign investment and international companies desiring to enter the Indian market. With a few exceptions like electronics manufacturer Philips, were international companies effectively banned from doing business in India for several decades.

It took however the payment crisis of 1991 to really kick start the current wave of liberalization and deregulation. To solve the financial imbalances created by its economic policies, India was forced to take loans from international organizations. These organizations then put pressure on policy makers to remove industrial licensing and reform policies on foreign trade and investments.

Since 1991, India has been pursuing economic liberalization and strengthening its infrastructure, legal system and solve financial problems like low foreign exchange reserves and high inflation. Removing the barriers has resulted in an increase in foreign direct investments (FDI) from $233 million to $3.300 million during the 1990s. Two of the industries which reflect the tremendous benefits the changed economic policy has are automotive and, of course, IT.

The domestic automotive industry was until the early 1980s protected with high import tariffs and a ban on foreign investment. This left consumers with the choice between two obsolete cars. In 1983 the Indian government permitted Japanese automaker Suzuki to partner with Maruti Udyog. As a result the car production grew by 13% per year from 1983 - 1993, compared to 1% per year in the decade before. In 1992 the Indian government implemented further liberations resulting in more than twenty major international car manufacturers operating in India today.

Domestic manufacturers are also gaining momentum with Tata and its one Lac (100.000 rupees) Nano being one of the most well known. The number of people employed today keeps par with the IT industry and is estimated to be more than ten million of direct and indirect jobs.

The IT sector provides today some 2,3 million Indians with a job and accordingly to NASCOM another 8 million indirect jobs. The importance of the IT industry is also reflected in the Indian GDP. It has grown from 1,2% of GDP only two decades ago to 6% today. Where Indian IT companies were initially seen by Western companies as providers of low wage employees (value proposition: labour arbitrage) are Indian IT vendors transforming themselves into providers of advanced technological solutions (value proposition: lower cost and innovation).

Think of the domestically developed Tsunami Early Warning System (TWES) which is installed in India’s national emergency response center and detects, processes and monitors seismic activities in real time allowing it to issue tsunami warnings for coastal areas. Another example is the relationship between sports car manufacturer Ferrari and Tata Consulting Services (TCS). TCS has created a dedicated development centre for Ferrari in Madras and supports it in the areas of software development, production techniques and quality assurance. Many other companies have in the meantime discovered that Indian workers can do more than repetitive tasks and setup Research and Development centres or outsourced complex, added value activities to Indian service providers.

To become a truly global player, India still has to overcome some challenges however. A considerable part of the students which graduate from universities have a very strong accent, which makes it difficult for them to operate within an international context. Furthermore is there the notorious culture of corruption and bureaucracy within the government and investments in infrastructure which considerably lag the required levels.

Sourcing managers better shape up for the future

2010-04-23T11:46:00.000+02:00

Many outsourcing contracts are still driven by the aim to cut cost. Cutting cost can be achieved by economies of scale and standardization of similar activities and assets. This means that the scope of typically outsource contracts is defined in terms functional area’s or processes (e.g. IT infrastructure support, payroll, logistics).

Many of the functional area’s or business processes being outsourced can often indeed be split off without large consequences for the retained functions and business processes. There is however at least one area where these standard outsourcing practices start doing more harm than good. One of these area’s is IT.

The rate IT is absorbed by business processes has never been so high and soon almost every items we use in daily live including clothes and food, will have some kind of IT component. At the same time is there the relentless pressure to cut cost and innovate, increasing the complexity and dynamics for the organization as a whole.

The role of IT (for many companies) shifts thus from a facility to an integral part of the value business chain. The IT department is in the meantime however still managed as it was 20 years ago. The CIO has its budget and targets. Targets which often focus on cutting cost and what remains is used to build and run functional requirements from the business.

The result is that the governance of IT (and thus sourcing strategy) gets more and more misaligned with the actual demand from the business. IT is not just a provider of automated business activities, but becomes an integral part of the business value chains.

The typical IT outsourcing deals are however still based on outsourcing a functional silo (e.g. network support, infrastructure support, application support, development). An silo which delivers services to business value chains with differentiated demands. These differentiated demands get however lost when the external vendor starts the transition/transformation as the primary focus of most outsourcing contracts is on cutting cost and thus standardization.

The result is business managers running their own IT when it really matters. Especially companies that have to make the transition from ‘old economy’ to ‘new economy’ are prone to have more than one IT department. One official IT department which is treated by the business managers are a facility provider plus the decentralized IT departments which are closest to the business processes.

What does this means for those involved in outsourcing? It means two things. First of all: understand the business model of your company before outsourcing (e.g. dynamics, strategic positioning, important trends). Understand the key value chains of the business and its dependencies on supporting processes and functions. This understanding allows you to define a scope which is not simply based on functions or departments, but a scope which is aligned with the essence of the company.

Secondly, move away from the typical purchasing approach on outsourcing to an approach which is more aligned with today’s business dynamics (strategic sourcing). The difference between both.

Purchasing is primarily based on the systems theory (input, process, output and objective). (Strategic) sourcing adds to the system theory:

conflict management,
principles of game theory and,
decision making theories.

It focuses more on the inherent conflicts of interests between buyer and seller and their dilemma’s compare to purchasing. (Strategic) sourcing includes decision making on:

entry and exit from supplier markets,
capacity development,
selection and management of sources of supply,
innovation and,
cost development over a long term.

This way the chance of an outsourcing engagement delivering long term value instead of only a short term cost reduction is greatly improved.

Reputation risk outsourcing is underestimated

2010-03-11T11:59:00.002+01:00

The outsourcing of activities is a trend which started in the seventies with car manufacturers and has since then progressed into almost every aspect of our economy. Think of Indians analyzing x-ray pictures for European/American hospitals, South Africans administering mortgage requests and Philippine’s doing the salary administration. The main drivers behind this wave of outsourcing are technological advances and the breaking down of national trade barriers.

The same technology enabling outsourcing also allows for an increasingly intimate relation between company and customer. Books, pizza’s, insurances, movies; almost everything can be ordered these days by TV, laptop or PDA. The technology behind these advances are however so complex that most companies have to rely on external technology partners/service providers to design and manage the technology. The pressure to work with external partners is increased further by the relentless pressure to lower cost, increase quality and innovate.

If this goes all well, the advantages for the company interacting with the consumer are overwhelming. It allows the company to gather valuable information of the consumer behavior, allowing for more tailor made offerings. More precise consumer data allows furthermore for optimized production volumes and better prioritization of future innovations.

The increasing complexity of the value chain due to the ever growing number of external parties a company is relying on also poses a serious risk. So are the troubles with the Toyota Prius ‘insourced’ from an external partner as Toyota does not make the affected components themselves. Other examples are consumers investing in the Madoff scheme without them nor the bank knowing this because the bank did not exercise adequate control over its asset management value chain. In Germany financial and personal data of some 21 million went on sale on the internet after some dodgy service desk providers got hold of it. In this case the prime service provider had subcontracted the service desk activities to smaller service providers to further reduce cost.

This leads to a situation where the consumer thinks it does business with one party, but actually has to deal with a dozen. This should not be a problem for the consumer, but it turns out that the consumer often has to absorb more than a fair share of the risk when it goes wrong. The consumer is the one driving the faulty car against the tree, is the one seeing its pension evaporate due to mismanagement by the bank or sees its credit card information for sale on the internet.

This results in reputation risk resulting from outsourcing becoming increasingly important for companies. The potential damage to the brand due to external partners messing up. External partners which are often chosen for one reason alone: lowest cost. And lowest cost is directly related to what you get at the end of the day.

The resulting effect is consumers and media making a lot of noise, damaging the reputation and brand of the company (typically the external partner creating the issue in the first place stays out of the lime light). That reputation risk is becoming more of a general topic can be derived from a recent statement by Goldman Sachs, addressing it as one of their key strategic risks. On the other hand is outsourcing also a topic which gets more attention from for example regulators. The Dutch regulator DNB has appointed outsourcing as one of its key attention points for 2010.

I’m not saying that outsourcing is a bad things, on the contrary. It drives innovation and productivity gains and a more even distribution of wealth accros the world. What I am saying is that companies introduce a strategic risk when cutting up their value chain in many pieces without being able to execute adequate control over it. Governing and integrating end-to-end value chains (from consumer all the way down to the subcontractors) is thus a topic I expect to grow further in importance. And that starts with transparency. Transparency and trust. Transparency, trust, and not just going for the lowest bid.

Which Shared Service Centers are sustainable?

2010-03-01T15:44:00.002+01:00

Centralisation, either in a shared service center or another form, promises lower cost, a more consistent quality level and faster decision making by consolidation of responsibilities. Putting theory to practice is however not always that simple.

Cultural difference, disagreement over the new process standard and lack of governance by the internal ‘clients’ towards the SSC are well known issues which may limit the realization of benefits. As these issues have been discussed already in-depth by various writers will I not cover them again.

An issue which is less frequently mentioned is the more strategic question whether the shared service center fits within the business model. In other words, was the creation the shared service center based on a ‘me too’ decision of was it part of well thought about strategy. Take for example UPS and FedEx.

UPS en FedEx deliver both packages, but have a totally different business model. UPS has one standard process and does not allow for many exceptions. This standardization allows them to provide a relatively cheap service. The disadvantage for the customer is less choice. FedEx allows for more differentiation within its processes, providing a wider choice to its customers. It uses flexibility to compete. In other words, the SSC concept fits better within the business model of UPS than FedEx.

This does however not mean that there is no room for centralisation and shared services within FedEx. IT services like email and F&A services like invoicing and bookkeeping can be shared without causing tension with the operating model. The extent of the centralization and standardization differs however as it has to be aligned with the core of the business model. And this is where things tend to go wrong within quite a few organizations. In an effort not stay behind, the creation of a SSC becomes an aim by itself. The damage this may create differs.

Lets take a shared service center for information technology as an example. Was maybe 5 percent of the business activities automated twenty years ago, the percentage today may be up to 80 percent. Especially organizations in this last category should be wary not to see IT as the non-value utility is used to be twenty years ago. Business and IT processes have merged together to a level where both cannot be seen independently anymore. The IT-intensity of the business processes is therefore an important driver related to the success of an IT SSC: any mismatch (and resulting financial damage) between the business model and the design of the SSC will be enhanced due to the high IT dependence of the business processes)

Besides the level of IT intensity is also the level of complexity and business dynamics of great importance. Dynamics in terms increasing competition, shorter time-to-market of innovations and increased complexity of products, processes and regulations. Recent research by Colemen Parks indicated that 90 percent of the senior managers surveyed expect the business environment to remain very volatile and 80 percent thinks the flexibility of both business and IT should therefore increase further. The impact of the increasing complexity and business dynamics is organization specific, but expect both profit and non-profit organizations to be affected by it.

The IT intensity of the business process and the dynamics and complexity are closely related to the business model, as the business model describes how the organization creates, delivers and captures value. At UPS and FedEx the business model has been translated properly into their shared service strategy, but there are many organizations out there lacking this crucial alignment. These are the organizations which see the creation of decentralized IT-departments two or three years after the establishment of the shared service center. Standard services are still delivered by the SSC, but when technology is really important for the business, the business managers choose to take care of it themselves.

The result is (hidden) IT cost and a bad image within the business of the shared service center. In more extreme situations, the difference between business demand and supply is such that the business unit builds its own IT department again (this can typically only be pulled off by the business units with the large margin/revenue).

In other words, shared services can definitely add value, but it is no standard solution. Not today, but even less tomorrow.

Outsourcing 2010: repairing of crisis contracts, part 2

2010-02-23T08:36:00.005+01:00

This post is a follow up on this one and it described my thoughts on some of the outsourcing contracts which have been signed in the last 1,5 years. These contracts had to be signed as fast as possible and this meant cutting corners. Cutting by standardizing services which should not be standardized, transferring valuable knowledge, and a contacts structure which fits a shrinking economy, but not a growing one.

As a result will many outsourcing contacts signed in 2008-1009 increase the gap between demand and supply instead of closing it. Contracts solely aimed at reducing price/cost are typically very rigid and do not leave a lot of room for flexibility. Flexibility is however something the business needs now the economy is picking up again. The market dynamics are slowly moving back into the fast paste from before the crisis. This means the business will want to move quickly on new opportunities for growth and does not want to be confronted with outsource contracts which limit its maneuverability.

Add to this that the cost/investments in the contracts signed in 2008-2009 (e.g. transition & transformation cost) still outweigh the benefits (at least for the vendor, maybe the client gets lower prices from day one and pays the transition/ transformation investment as a markup on the price). With the first benefits starting to show only this year plus a potentially increasingly unhappy business the pressure on renegotiation will increase. Renegotiation in order to create a contract more fit for a economy which is expanding again and requires a contract that is flexible (e.g. service and volume mix) and allows for a short time-to-market of new services.

As a result there will be quiet some advisors busy helping clients to revamp their contracts this and next year. Renegotiations which are this time not aimed at lowering prices, but removing the straightjacket which came with the sole focus on cost.

Preventing this kind of situation is not that difficult. It takes basically three things to keep in the back of your mind:

Regardless of the toughness you are facing, do not forget the business perspective. Meaning, if you are outsourcing IT, the might be tempted to look only at the effect the outsourcing has on the IT-function, forgetting the (indirect) effect it has on the business.
Look at the total cost of ownership of the contract for the organization as a whole and not just the effect on the department outsourcing the activities.
Do not believe advisors and vendors which tell you that outsourcing is a pies of cake without corners and hiccups. Outsourcing, even of standard activities, is rarely as simple as originally envisioned.

Added on May 5th 2010 (source:http://www.bpovoice.com/profiles/blogs/it-outsourcing-industry)

Unlike the hype in media reports, the recovery in the IT sector is gradual. A number of factors contributed to mid-contract reorganizations. Clients sought more pricing and contractual flexibility in the wake of the recession. Yet other firms were undergoing mergers and acquisitions, while some companies felt they needed to revisit their IT services contracts to meet current business requirements.

This is because IT outsourcing contract renewals are cyclical and predictable toward the end of the deal term, comments president of TPI Global Operations in an online report by businessweek: "Several of the larger examples took place well in advance of the scheduled contract end dates.”

Outsourcing 2010: repairing of crisis contracts, part 1

2010-01-25T15:49:00.001+01:00

Because of the economic crisis have many companies deployed aggressive scenario’s to cut cost. This resulted among others in stretching the definition of ‘non-core’ activities in order to outsource them to an external party (including selling off offshore captives to cash rich vendors).

Balancing the benefits (cash for asset transfer, lower prices) with the risk, most companies opted not to engage in high profile, high value deals. To further reduce the risk, many companies outsourcing focused on contracts which used labor arbitrage and increased economies-of-scale to reduce cost. Complex transformations of business and IT which would increase the risk (and potentially reduce flexibility/agility when the economy picked up again) were often left out. This to the dismay of vendors as the hours related to these programs are an important area of margin for the vendor (and potential value for the client if done well).

The pressure to cut cost thus resulted in a substantial volume of small to medium sized deals which were closed in record time. Cost were further reduced by shorting the budget and time lines for the outsourcing project itself. Deals were therefore executed with the speed of an formula 1 (or indy 500) car. Advisory firms put oil on the fire by pitching ‘speed sourcing’ solutions, implying that IT or other financial processes are standardized to a level that a Rfx of contract template used in one company will fit the bill within any other situation. I recently spoke to a member of a large financial institution which wants to outsource their IT infrastructure and they take two weeks for their Rfx (their advisor told them: no problemo, can do).

Yes I agree that IT infrastructure services have a large common component, but the devil is in the details. And having some nasty details popping up after signing the contract is ok for a bakery, but for companies which business processes rely fully on the correct functioning of their IT, is speed sourcing tricky. The processes and accompanying assets have grown over decades into a landscape which is not easy to unravel. In other words, I expect some serious discussion related to ‘hidden services’ and the ‘sweep clause’ within six months after signing the deal related to the financial institution mentioned before.

Besides advisors basing their sales pitch more on their own short term revenue instead of what was best for the client (it is also made easy for advisors as they leave after signing and have rarely a financial incentive tied to the success of the deal), are also vendors hitting the accelerator. The sales people from the vendor received only one message from their senior management the last 1½ year: sell sell sell. With both advisors and vendors hitting the accelerator there was nobody to apply some breaking.

The advantage of a formula 1/ indy 500 driver over an outsourcing race is the race driver seeing the corners and chicanes in the road, and thus knows when to break. The company desiring to outsource does not and trusts the advise it gets from advisors and vendors. Their incentive is however closing a large deal as that means revenue and thus prefer to focus on the straight parts of the circuit instead of the corners.

These corners may catch up with the company that outsourced after the contract has been signed and may appear in the form of the previously mentioned hidden services, value knowledge and experience disappearing and additional activities assumed by the client to be part of the standard contract (but assumed by the vendor to be non-standard). Last but not least is the impact of the short term financial gain by standardizing the services to the model of the vendor on the agility and flexibility of the business. This topic is covered in the second part of this post.

Too many process captains and too few indians

2009-12-14T19:08:00.007+01:00

The post will be less valid to American readers and I guess also readers from the U.K. and several Asian countries as it will be a little rant against all the IT process models which are smothering the average Dutch IT organization. Readers from counties which also have a ‘consensus’ culture might however find some common ground in the text below.

My country (The Netherlands) is both blessed and cursed with a culture where everybody wants to talk about every decision. This is totally unlike for example the American style where the department head decides and the rest executes. This approach has as a site effect that potential lower in the organization remains untapped, but it also enhances focus and speed.We have a large (IT) service industry and this combined with our consensus culture created an ideal feeding ground for process models like ITIL (infra support), ASL (application support), and BiSL (information management).

For process models to be effective they require part of the responsibilities and mandate of the functional heads to be distributed lower into the organization. The (theoretical) advantages of a process oriented way of working are evident and I am not going to repeat them here. The disadvantages have been discussed less however (to my knowledge) and it basically boils to the ‘law of diminishing returns’ and the focus on activities instead of result.

The process models all aim to improve the quality of service provisioning towards the client and that is good, excellent even. It then goes wrong in two places:

The drive of the creators of process models to build and build piece after piece on their model, making it ever more elaborate, bureaucratic and expensive. Most well known is the ITIL V3 version which spun totally out of its orbit and spoiled a excellent concept and model. More and more control leads to unhappy clients as control means ‘to exercise restraint or direction over’ (Dictionary.com) and is thus by nature focussed more on the downside of the business instead of the upside. Control is good, but by implementing ITIL, ASL, BiSL and a process model to manage the external suppliers, the IT-organisation is too busy with itself to have any time left for a client. So to the writers of all those beautiful process models: ‘less is more’.
Implementing processes is typically done by creating a new department. And a department needs a chief and that chief want to see its department grow. Grow because the process managers and coordinators all want to do a good job: exercise control on as many things as possible. The result is processes with fifteen decision steps and meters of paper describing the procedures, forms and work instructions. The second reason for the growth of process departments is of course the drive of any middle manager to increase its budget and thus power.

The result (very black and white) is process managers bugging the people doing the real work with procedures which could be half the length and half the time to execute.The result of all the process implementations is SLA’s and reports showing only green colors while at the same time have business managers getting red faces when thinking about their IT-department. And the reflex of the typical IT-manager seeing a red faced business manager: more procedures in an effort to control the control of the control.

And in the meantime nothing really changes, except for an ever increasing number of escalations in order to get at least something done.Ok, this picture given here is very black and does not do justice to the actual situation, but I talked already to several IT managers which are seriously thinking about killing their process departments and absorbing a minimum of process managers into their operations departments.

Like with standardization are also processes a means to an end and not a means in itself. As discussed in previous posts do I think that standardization is starting to hurt the business as driving for IT efficiency only damage business value when pushed too far.

Processes and their managers have their value, no doubt about it, but IT organizations have to learn when enough is enough. When does the addition of one more process manager start to cost more than it adds to the bottom line of the company.

So no post about outsourcing this time, but some process ranting...

Sustainable outsourcing

2009-12-07T10:44:00.003+01:00

Usually sustainability is thought of as cutting down CO2 emissions and planting more trees. But sustainability is more than just acquiring a green image. It is another way to look at your own company, the external environment and thus also your sourcing strategy. Organizations can actually profit from better financial results by a smart application of the modern aspects of this theme.

A large oil and gas company outsourced a part of its BPO activities to Asian supplier. This supplier had contracted another co-supplier for data-entry activities who used illegal under aged employees. A non-governmental organization found this out by accident which resulted in a lot of negative press for the oil and gas company. In order to outperform the competition they outsourced several activities, but this backfired due to severe image damage.

Several clients which outsourced part of their IT activities to a Tier 3 vendor indicated that they needed more insight in their carbon footprint as part of their corporate governance policies . The IT firm was taken by surprise by this request, as their sole focus was on the realization of a new data center concept based on Platform-as-a-Service (PaaS).

In the first example the oil and gas company miscalculated the risks related to sustainability, which caused damage to their image as well as to their financial advantages of the outsourcing deal. The IT vendor in the second example were managed by two directors whose main focus was on internal affairs and the latest technologies. They were taken by surprise by the effects of environmental developments on their business process. In both cases there was too much internal focus and too little understanding of the external developments.

A better approach

Wal-mart is an example of an organization that is able to combine sustainability and high performance. They defined thirteen networks related to a number of sustainability related themes. The Wall-Mart networks are built upon different external and internal stakeholders and have a primary target on reducing the ecological pressure.

For the supply chain network this means not only a reduction of package material but also an estimated reduction of $3.4 billion in the period from 2008 to 2013.

More and more senior businesses managers will demand similar action from parts of the organization that are not under their direct control (like IT, facility management, F&A). A senior manager will for example be able to explain to his clients that also the IT organization defines and meets sustainability targets for its IT Services. So also staff functions will have to make an effort on topics like social responsibility, human rights, ethics and environment.

Sustainability is thus typically a theme where Business and staff functions like IT, facility management, F&A and others have to work closely together. The main difference between “normal” and sustainable value chain optimalization is that value is not only measured by a higher profit. However, the process is quite similar.

Applying the approach

In the first example, the oil and gas company encountered problems because there was not sufficient control on the outsourcing contract. The happiness of the managers who made the deal in the first place, backfired on them, when newspapers reported the violation of human rights by the suppliers.

More and more organization are implied by governmental and consumer organizations on their social responsibilities. The fear of reputation damage is often the starting point for sustainability projects. Therefore more than often regarded as a risk and cost factor.

The illustration uses portfolio techniques to show in which way for example IT initiatives contribute to sustainability, business value and/or lower costs. The green line draws a borderline between attractive and less attractive investments.

In the second example, the IT firm was caught by surprise by the request of its clients to provide more insight in the power usage of the IT systems. Insight in the total power usage is however only a minor aspect of the Total Cost of Sustainability (TCS). For many organizations insight in and allocation of power costs are already a challenge.

Expect that in the near future more and more senior business managers will require that also departments which are not part of the primary business value chain have to contribute to the desire of companies to get a more social and green image. Incorporating this into the sourcing strategy and selection criteria is still a relatively immature practice. Most IT contracts for example do not include much more than some clauses referring to reducing CO2 production.

Expect more selective IT outsourcing, part 1

2009-11-20T16:22:00.002+01:00

A recent survey by Colemen Parks shows that 90% of senior decision makers believe that the business cycles remain very volatile in the coming years and 80% believe that their organizations should become more flexible in their approach of business and technology.

Business agility and common sourcing practices in IT are two words which are drifting apart. And the gap between both worlds increases only with the current pressures on cost (see also this post). The CIO is now still able to sell its traditional sourcing decisions to the business as having no other choice due to the economic situation. But signing a five year outsourcing contract for the whole infrastructure or application portfolio puts both IT and business in a straight jacket with limited ability to maneuver.

The economy will be picking up soon and that means that business are looking forward again and beyond short term cost cutting. The organization as a whole will have to shape up and make sure it has adequate long term strategic advantages available to deal with:

Competition (ever fiercer competitors and demanding customers; decreasing pricing power; and profit margin and continuing pressure to increase productivity)
Rapid pace of innovation and changes (more product variety and shorter product life; faster response to changing market; expensive R&D; and increasing risk for obsolescence)
Globalization (lower trade barriers; faster deployment of resources and technology for worldwide facilities; easier access to low-cost economies; and more options for sourcing at lower risks)
Increasing complexity of product and process technology (expensive investment for new product development and/or production facilities; and wide array of knowledge or expertise for management)

And IT has to be able to stand side by side with the business to capture opportunities and deal with threats. Depending on whether the CIO acts like a Chief Infrastructure Officer or Chief Integration Officer will IT and sourcing be able to add to the success of the business or limit it. To me a Chief Infrastructure Officer is somebody who focuses on:

short term objectives, (obeying to any demand to cut costs)
technology and
the IT department.

A Chief Integration Officer on the other hand focuses on:

balancing short and long term objectives, (includes pushing back if objectives damage long term growth)
adding measurable business value (more on that here and here)
the organization as a whole

The difference in CIO is also reflected in the sourcing strategy. The old-school CIO is more likely to opt for outsourcing technical silo’s as it allows for maximum short term gain (maximum volume, technology driven), the newby-CIO will look define its sourcing strategy based on the characteristics and needs of both business and IT (selective, business sensitive).

I am convinced that in the medium term organization choosing selecting sourcing arrangements will be the winners, because:

Achieving 15% less cost (traditional sourcing) versus 10% (selective sourcing) is not going to make such a huge difference. Example: if the IT budget is 5% of the companies’ overall budget than 15% less counts for a 0.75% reduction of overall budget. So sourcing is not going to save the company if it is standing at the abyss.
The standardization enforced by traditional sourcing (otherwise the vendor cannot achieve the economies of scale required to reduce costs) introduces a lack of flexibility (except maybe for volume flexibility), agility and choice, which forces the business to set up their own IT departments or buy IT services as soon as the economy picks up again. This will introduce hidden IT costs which will have an impact on the bottom line performance.
Selective sourcing arrangements have a lower risk profile and thus a lower value at risk (VaR) than traditional sourcing contracts which typically make it into the newspapers if they fail because of the $$$ at stake. If the scope of the selective sourcing contract is derived from the characteristics and needs of one or more specific business unit/process is it also easier to get active buy-in from the business owners. This in contrast to generic infrastructure or application contracts for which it is much harder to find an active sponsor in the business domain.

In a future posting on this subject I will elaborate a bit more on why I believe selective sourcing has the future and how one can scope these sourcing arrangements.

Better sourcing decisions by using Real Options

2009-11-09T12:09:00.003+01:00

The use of financial business cases to guide sourcing decisions is common practice. And with the current pressure on lowering cost, needs even the smallest investment to be accompanied with a business case showing a solid financial return. The effectiveness of the typical financial business case can be further improved in two key area’s. These are:

Monitoring whether the expected return and investment envisioned in the business case materialize and,
The limitations of the standard Discounted Cash Flow (DCF) methods as it ignores the required flexibility required to define, execute and manage investments.

In this post I explore how Real Options can help to overcome these drawbacks.

The typical DCF calculation assumes a static scenario, ignoring the financial value represented by the flexibility to change course during an (outsource) project. In real life people learn during a project, and want to adjust their decisions accordingly, effecting the business case. Think of a manager who wants to change the speed or scope of an outsourcing after the first part of the transition turned out to be more cumbersome than expected. Real Options enable an organization to incorporate this kind of dynamics into their business case, creating more insight into the true value of the decision to outsource.

The DCF calculation assumes that the original course of action will be executed in full. In practice, companies like to have the option to adjust their planning by postponing, speed up or cancelling an decision to outsource/invest. This flexibility represents a financial value, which is not captured in standard DCF calculations.

For those outsourcing or shared service projects which represent a lot of value to the company is it however important to adjust the speed and direction of the project. Project managers have already their tools to manage the dynamics and complexities of day-to-day life by applying funnel management, stage gates and working with phases. Including them into the business case without having to resort to very complex financial models, is however less common.

By applying the Real-Option methodology, different outcomes and scenario’s get a financial value. This is done by adding options to the business case, but without the original complexity embedded in the methodology created by Black & Scholes (1973). The approach allows to value ‘flexibility’, something which is required of anybody participating within a sourcing project.

Risk and return are firmly interlinked with each other and as the expected return of outsourcing if higher than internal production, has the risk profile also higher (assuming no free lunches exist). This means the required discount rate will be higher, (WACC) resulting in a lower DCF keeping the return constant.

The value of an option increases on the other hand if the risk increases. The option to exit from a shared service or outsource initiative becomes higher if the risk profile increases. Higher risk also leads to a larger spread between the best and worse case scenario’s in the business case. This means that the value of the options at disposal to the management can represent a substantial value, increasing the insight in the true financial potential of a business case. The value of the options can be demonstrated, quiet easily, by using option price models (these can be far less complex than the original models by Black & Scholes (1973)).

Using options to structure investment decisions enables the management to analyze the financial impact of decisions made during the whole life cycle of an outsourcing or shared service initiative (cradle to grave). Applied in its simplest form is outsourcing an call option, the right but not the obligation to outsource certain activities. The value of the option can change during the engagement as for example economic developments impact projected growth figures. Is the value in the new situation equal of higher, than the management executes the option. Is the value of the option lower, the option becomes void.

Other types of options related to outsourcing are increasing the scope (e.g. processes, countries) or the decision to invest in a transformation. The right to sell (put option) can be translated among others in terminating the contract, decreasing the scope or a transition to another vendor (this last one combines a put option with a call option). The third type of option is an investment to learn. Think for example of the cost involved with a due diligence or benchmark. A learning option influences the value of a call or put option, by reducing its risk/uncertainty.

Applying real options to business cases enables an organization to capture better the true dynamics of an outsourcing deal because the business case can be adjusted to reflect the changes in economic and organizational reality. This at the same time increase the value and importance of monitoring the investments and return envisioned in the business case. In a future post I will provide a concrete example on how it looks in an excel sheet. The focus of this post was to provide some theoretical background.

Sources:
T. Blommaert, S. van den Broek, E. Curfs, Methodiek voor betere besluitvorming van (strategische) IT investeringen, Informatie, 2009.
T. Copeland, P. Keeman, Making Real Options Real, McKinsey Quarterly 1998 no 3.
T. Luehrman, Strategy as a portfolio of real options, Harvard Business Review, september-october 1993.

Value chain-based sourcing of IT, part 2

2009-10-22T10:05:00.001+02:00

In the first part of this post I stated that the continuous drive to reduce IT cost by standardization will come to a point where the reduced IT cost are outstripped by the ‘damage’ it causes to the business. The drive for standardisation is further increased by the commonly used method to scope outsourcing contracts. In this post I provide an scoping approach which I believe will gain substantially in the coming years: selective sourcing contracts with a scope derived from differentiated business demands.

The importance of accountability towards the Business regarding the quantitative and qualitative added value of IT will only increase more and more. The Business demands to know how IT supports the opportunities and risks the Business faces due to increasing complexity, competition, globalization and other trends. It is up to the Business to provide insight in the opportunities and risks it faces, while the IT organization is responsible to translate them into IT value and risk drivers. These drivers guide the IT organizational change, investment decisions and sourcing strategy.

One should look more from a business perspective towards the IT value chain and subsequently provides concrete adjustments which allow for sustainable improvement (including definition of the sourcing strategy). This is the first step leading to a fully transparent business IT alignment (see illustration).

The transparency of Business IT alignment is the foundation to connect the performance of the IT organization with the actual demand of the business processes. The results of this approach: more added value for the Business and a more cost-effective IT organization, which invests in innovations which really count. Tomorrow’s IT organization is able to demonstrate accountability over its performance as an integral contribution to the overall performance of the company. An example:

The IT department of a high tech company thought it could reduce cost by applying the same service levels for both R&D and Manufacturing. By doing this they overlooked the elemental differences in demands of both functions. The R&D departments got higher availability service levels than required, but were not able to get access to the latest state-of-the-art hardware to design and test their new products.

In this example the R&D departments were supplied with higher than required service levels at the cost of the capability to innovate, outsourcing was the catalyst. By the introduction of generic IT services it would be easier to find a suitable vendor, allowing the IT organization to meet its cost saving target. The negative impact on the business however, was estimated as being zilch until it was too late.

Outsourcing without making an adequate assessment of its impact on the organization as a whole, opens the door to a disappointment. For this reason one should look from the initial start beyond a superficial business case. It necessary to benefit as an organization as a whole in terms of more value and a lower or equal risk profile. Only then an outsourcing contract can be truly successful. A concrete example is the usage of Real Options for assessing sourcing scenario’s. Real Options allow the dynamics of both Business and IT to be quantified, providing a more realistic estimation of the potential value of the business case. Balancing IT value and Business value is depicted schematically in the illustration below.

Value chain-based sourcing of IT, part 1

2009-10-19T12:34:00.002+02:00

As pointed out in the post below this one is the scope of IT outsourcing contracts typically driven by the IT internal focus to cut cost. Cutting cost can be achieved by economies of scale and standardization of similar activities and assets. This means that the scope of typically outsource contracts is defined in terms of infrastructure support, network support, datacenter facility management, application development or application support.

This ‘horizontal’ orientation his however not aligned with the requirements of the business processes (see illustration). Their needs cut through the horizontal IT service and process stacks. Business managers which see themselves confronted with a supply that does not match their needs triggers unhappy faces towards the IT department and the start of a creative process to get the IT services they want. The result is that business managers will work their way around the standard service catalogue by hiring their own IT staff or getting (additional) services from other vendors. I have seen it happening with a Business Unit of a large Dutch bank/insurer where the central IT department got so sluggish and unresponsive to any request that was not in the standard catalogue that the BU built its own datacenter. So far for IT efficiency by centralisation/outsourcing…

Standardisation is good, but I believe that it has gone too far in many situations. Being tied to a long term contract with an external service provider which allows only for flexibility when the client pays serious $$ is not the way to go. The market requires companies to act faster and more agile as ever before and I think that we are at the top of the ‘standard’ outsource and shared service cycle. Large companies with experience in IT outsourcing will move more towards selective sourcing arrangements. These companies can generate economies of scale by themselves and don’t need an external service provider anymore. AEGON is an example of a company which decided to insource their infrastructure services again after having EDS/HP taking care of it for more than a decade. I guess that EDS/HP has optimized as best as they could and now AEGON wants to be fully in control again by itself.

This company can achieve enough economies of scale by itself and has learned from EDS/HP everything there is to learn about managing infrastructure for operational excellence. Insourcing after outsourcing allows AEGON to combine the low cost experience and setup of their infrastructure with the advantages of being in full control again.

Full outsourcing of infrastructure, application development and the like will however continue (at least for a while). There are enough companies which have a smaller IT department or are new to IT outsourcing. They are the customers of tomorrow, but as said before do I expect a shift from large scale ‘horizontal’ scope outsourcing to selective scope contracts which balance better the needs/objectives of both the IT department and business units/processes.

To define the scope of selective sourcing contracts and services which can be standardised without hurting the business, principles of value-based management and risk management can be used. The approach allows the IT organisation improve its accountability towards the business by aligning its IT services with the opportunities and risks the business managers face every day. I will describe this approach in the second part of this post.

IT sourcing practises damage business IT alignment

2009-10-07T12:02:00.002+02:00

IT-organisations are more than ever before under pressure to cut their cost. Many business managers see IT as a cost centre which adds limited value. And activities with a limited perceived value are the ones which get the highest cost reduction targets.

In reality does IT add a lot of value, but the typical IT organisation is not able to sell that message. It starts with the subjects IT talks about with the business. In 9 out of 10 cases is IT uses to automate manual activities resulting in a cheaper and faster business process. So using IT using to reduce cost.

The IT organisation increases this perception by organising itself into functional silo’s in an attempt to increase internal efficiency. So all network engineers in one department and all application developers in another. To improve standardisation and efficiency even further best practises and models like Cobit (IT governance), BiSL (information management), ASL (development), CMMi (development), ITIL (operations) and ISO20000 (operations) are implemented to standardise processes and control.

This ‘horizontal’ design allows for maximum efficiency from an internal IT perspective. It is therefor not more than logical that this approacg is also reflected within the sourcing strategy: the network infrastructure or application development is being outsourced, again to optimize the IT budget (typically forgetting the trade off between positive effect on IT value versus negative effect on business value).

The IT value created from a business perspective cuts vertically through the horizontal IT ‘ stacks’ and process models (from information mgt to development to operations). One can however seriously doubt whether the actual business demand will survive a collision with all the standard process models and best practises. I have seen change management procedures which have 15 control and decision making steps. Nothing moves anymore within such organisations and IT people are keeping each other and the business busy with procedures and templates. In the mean while is the business getting more and more frustrated with the IT.

By the continuing increase of standardisation, among other driven by outsourcing, get the real demands of the business forgotten, damaging the perception of IT as a value centre. In many cases do the business managers trying to sell the product in the front office (KPIs: flexibility, time-to-market) the same IT service as the business manager running the back office (KPIs: low cost, high volume). The result is a vicious cycle of business managers getting unhappier with the IT services delivered, leading to even more pressure to cut cost (the balance shifts too far to the right in the illustration below).

I expect myself that the whole trend of standardisation might be at the top of its cycle and that business units will soon start demanding more tailor made IT services again. Either the centralised/shared IT organisation starts to break down some of its walls are the decentralised business units will start building their own IT organisation again to compensate the mismatch between demand and supply.

This also means that IT organisations have to rethink their current sourcing practises as outsourcing per horizontal stack limits the ability to align its value chain to the business value chain.

From procurement function to sourcing function

2009-09-24T15:47:00.000+02:00

Procurement as a business discipline has matured over the past few decades. The times are over of procurement as an intermediary functions that records agreements with suppliers and supervises their fulfilment. That is too limited a view in today’s business environment, where management is confronted with a multitude of issues impacting on the role and responsibilities of procurement.

It has been recognised that an effective and efficient procurement function can significantly contribute to business’ bottom line: competitive financial result. What’s more, many organisations feel the need to improve their relationships with suppliers in order to be better able to reduce costs, improve quality, increase flexibility and boost innovation in order to survive.

Especially in these challenging economic times where outsourcing is used as a means to cut cost quickly is it necessary to move away from the traditional role of procurement as an intermediary functions that records agreements with suppliers and supervises their fulfilment. That is too limited a view in today’s business environment, where management is confronted with a multitude of issues impacting on the role and responsibilities of procurement.

Procurement looks traditionally at sourcing as buying services and products from a ratter limited perspective by defining a objective (e.g. less 20% cost), input (e.g. an existing supply contract), process (e.g. renegotiation) and output (e.g. a new supply contract). This is called the system theory and pays little or no attention to the effects of (irrational) human behaviour from those who are involved in the process.

A strategic sourcing function adds various elements to the system theory by incorporating various ‘soft’ elements including conflict management, principles of game theory and decision making theories. As a result is the focus of sourcing in contrast to purchasing more on the inherent conflicts of interests between buyer and seller and their dilemma’s.

Furthermore does (strategic) sourcing include the following elements into the decision making process:

entry and exit from supplier markets,
capacity development,
selection and management of sources of supply,
innovation and,
cost development over a long term.

To evolve from a procurement officer into a sourcing officer it is thus required to develop both interpersonal skills as the engagements are typically more complex and have a higher Value at Risk (VaR) than typical procurement engagements. And also here may adjustments to the bonus structure may ensure that the strategic and long term nature of sourcing engagements is reflected in the decision making process. The lowest bid does not necessarily mean the lowest TCO, while typical procurement officers get their bonus on negotiating the lowest price for the initial contract.

Will offshoring harm Western service economies?

2009-09-14T11:43:00.002+02:00

"Restoring American Competitiveness" is an article from Gary Pisano and Willy Shih in the juli/august issue of Harvard Business Review. The article points out that, against the general consensus, American companies will be unable to develop the next generation high tech products due to underestimating the impact of sending their manufacturing offshore. If this is true, can similar effects be expected for the service industry? In other words: will Western countries not only have to fight an uphill battle in manufacturing, but soon also in services?

The article in HBR uses the value chain of personal computers and laptops as an example. Where American companies like HP, Dell and Compaq outsourced initially only their manufacturing to low cost offshore destinations, is now almost the whole industry based in Asia. Every laptop sold by an American brand, with the exception of Apple, is today designed, developed and manufactured outside the U.S.. The same applies to most phones and other mobile devices.

With manufacturing leaving its shores, developed countries tend to focus on creating economic growth through designing and producing services. I wonder however whether the following quote from the article is also applicable to the service industry (p119): One [myth] is the popular belief that an advanced economy like the United States no longer needs to manufacture and can thrive exclusively as a hub for high-value-added design and innovation. In reality, there are relatively few high-tech industries where the manufacturing process is not a factor in developing new - especially, radically new - products."

In other words, are we in Europe and United States still able to develop new high added value IT services if the graduates leaving the universities today start working in an environment where the developers and support engineers can only be reach by telephone and video conferencing?

Today there are still plenty of employees available in American and European companies who were used to sit behind ‘produce’ the service themselves (e.g. develop software, process mortgages). They will however retire in the coming decades leaves employees which have to manage and instruct offshore suppliers based on theoretical experience only. It is already difficult as an experienced hands-on manager to get the services delivered from an offshore vendor, let alone a situation where all the hard core knowledge of creating and delivering services is overseas.

The argument of the authors that an intact value chain is important for future innovation conflicts thus with the message within Thomas Friedman’s in “The World is Flat”. Friedman believes that geographies lost their importance due to the ability to communicate anytime, anywhere to anybody in the world. Also Amar Bhide’s book "The Venturesome Economy" (2008) argues that innovations will find their way to the customer, regardless of the country it was invented.

Personally I believe that this last argument is flawed. An economy can grow only if it produces products and services which customers want to buy. As soon as all the innovations have to be imported the trade balance will become uneven (in the case of the US: collapse completely as there is already a considerable deficit) which in the end will result in a society which gets poorer instead of richer. I think that, regardless of which author is right, we have to be careful that Europe and America don’t end up being locations where everybody is a ‘managers’ and nobody doing any actual value added work anymore.

CMMi for aquisitions versus eSCM, ISPL and other standards, part 2

2009-09-08T18:54:00.004+02:00

In the previous post related to this topic I wrote some of my thoughts on CMMi for acquisitions and ISO/IEC 12207.These two plus ISPL are models which can be used to structure an outsourcing process. The aim of these models in a nutshell is providing the client organisation with:

the right service/product,
for the best price,
at the desired quality levels,
from the best vendor,
at or within the risk appetite of the company.

The three models mentioned in these posts scratch only the surface of (proprietary) models which can be used to structure an outsource process.

For those situations where these models are too complex, ISO 9001:2008 could be of help as purchasing is one of the processes addressed. The purchase process described consists of three sub-processes: supplier evaluation (section 7.4.1), purchase orders (section 7.4.2) and goods receipts checks (7.4.3).

CMMi for acquisitions and ISO/IEC 12207 were addressed in the previous post, but not ISPL. ISPL stands for Information Services Procurement Library (ISPL) and is a best practice library for the management of Information Technology related sourcing (only ISO9001 is generic, all other models discussed in these two posts have an IT peregrine). The creation of the model was sponsored by the European Community and it aims to help both the customer and supplier organization to structure the sourcing/acquisition process. It provides guidelines and examples to structure a RfX, construct the contract and delivery plan. It can be used regardless of sourcing application development services or application/infrastructure support.

Like with CMMi for acquisitions and ISO/IEC 12207 provides ISPL a very thorough approach and supports the establishment of a structured and risk conscious sourcing process. I found especially the elements regarding risk management useful to deploy during my own engagements. Applying the best practice as a whole is however not something I would do easily as it would require a whole forest of trees to be cut down for paper. It can, as with CMMi for acquisitions and ISO/IEC 12207 be quiet bureaucratic and should thus be used only for very complex and risky engagements. I would typically expect for example the military to fully deploy it when they request some innovative and complex software solution.

Managing demand and supply
The models discussed until now focused on managing the process from sourcing strategy (make-buy decision) up to the signing of the contract. They also spend some attention to the delivery and monitoring of the contract, but it is not their primary focus.

Aligning demand and supply is however an important, if not determining, factor in the success of outsourcing relationships. An organization must be equipped for the task of managing its relationships with external suppliers as effectively as possible. As expressed by Earl (Earl 1996): “If the decision is to outsource, good management remains a necessity, so that the organization can function as an informed buyer and a demanding client”. Studies from research bureau’s including Gartner reveal that after outsourcing the client company must possess a "high number of very skilled and qualified people who understand the business, as well as relationship and vendor management” (Terdiman, 1999).

Various sourcing advisory firms and universities have in the meantime jumped into this gap and created best practices/standards/models to guide the retained organization. Some are proprietary (ISLite from Gartner) and some are open (eSCM, Carnegie Mellon University).

eSCM (e-Sourcing Capability Model) shares many similarities with CMMi for acquisitions as it also incorporates a maturity model. The client version of eSCM consists of 95 practices which are distributed along three dimensions: sourcing life-cycle, capability area and capability level. There are not one or two capability areas, but 17. The sourcing lifecycle consists of four stages and there are five maturity levels.

I expect the information provided on eSCM allows for stating that, yes this is also a very well constructed and elaborate standard/model, but like with all the other models does the user have to cherry pick the useful items. Deploying the full suite is likely to create a retained organization which will consume all projected outsourcing benefits.

Regardless of which model or standard you wish to use to manage demand-supply, just make sure you make sure it is able to:

Consolidate demands to ensure lower supply cost;
Purchase from few suppliers to increase in volume and thus lower cost;
Active quality monitoring of the services, taking into consideration the intentions expressed in the contract;
Continuous improve the professionalization of the retained organization resulting in lower overhead cost for managing demand and supply.

Which Chinese Service Providers are out there?

2009-09-02T14:28:00.003+02:00

In this post I wrote on the rise of the Chinese IT service providers which could be the new kids on the block and give established Indian service providers a run for their money. Here I want to provide some insights on the Chinese supplier market of IT services. Feel free to add any comments if you feel that I missed out some vital information.

One way established service providers deal with the Chinese ‘treat’ is partnering with them, like Yucheng Technologies and Convergys. Yucheng is a China-based IT solution provider and Convergys a U.S. based provider of customer and employee relationship management solutions. As per the agreement, Yucheng Technologies will sell Convergys' Intervoice Edify Voice Interaction Platform (EVIP) and Convergys Dynamic Decisioning Solutions in the Chinese market.

I wonder however whether this is a smart move in the long term. Like with the car industry did Chinese companies learn how to make cars by partnering with Western car manufacturers. Especially American car manufacturers outsourced part of their manufacturing to countries like China to leverage on its lower cost levels. This however allowed local players to learn the art of car building, resulting in American car manufacturers now having to compete with Chinese car manufacturers they used to partner with. This is no problem if it was a deliberate strategy, but I doubt very much whether those American senior managers looked beyond the short term cost saving. That outsourcing of production activities to low cost countries may harm is confirmed by Gary Pisano en Willy Shih from Harvard Business School (more here).

I do not try to state here that Western and Indian service providers should not partner with Chinese competitors, but that one should look beyond the short term benefits. A partnership should be beneficial for all parties involved, both in short and long term

Infosys, a tier 1 Indian service provider, sees China both as a delivery and client location. Where Infosys focussed for the last six years on delivering services from China to oversees clients, does the company see China now also as a potential client market. It generates now some one third of its Chinese revenue from local clients, but is seeking to expand that. Beside Infosys did companies like IBM and Hewlett-Packard also built a strong presence in China. That China is becoming a serious destination for IT outsourcing show the following figures:

Value of IT outsourcing market in 2003 was just US$0.4 billion
Value of IT outsourcing market in 2008 was around US$2.5 billion (based on Gartner Research annual growth figures of 44%)

To support local and oversees vendors, Chinese government has been providing stanch support for the industry by accelerating infrastructure programs and promoting the country to global business community. Some more figures indicating that China is not to be underestimated as a (future) destination for offshoring ITO and BPO services:

In China some 600,000 engineers graduate annually
In India some 400,000 engineers graduate annually
In the US some 70,000 engineers graduate annually
In Europe some 100,000 engineers graduate annually

The sheer numbers of university graduates provides a furtile ground for local and oversees service providers. An overview with Chinese ITO and BPO service providers can be found here. It demonstrates that there are not just one or two Chinese ITO and BPO service providers out there, but a whole list with potential competitors for European, American and Indian suppliers.

Tata Consultancy Services (TCS) is like Infosys also seeing China as more than a delivery destination. Its global accounts are still growing faster than regional and domestic business, but the gap is closing slowly. Indian service providers see China however still as a location for low-end coding and service work and let more sophisticated work be executed by Indian workers. I hope however that Western and Indian service providers are aware that Chinese are fast learners and will give Indian workers a run for their money pretty soon.

Reducing the cost of regulatory compliance for outsource contracts, part 3

2009-08-27T17:47:00.003+02:00

This post is the third in a row in which I write on a methodology I created to improve the effectiveness and efficiency of managing regulatory risk when outsourcing. The first two posts are here and here. Below I write on translating the risk/value ratio’s of the outsource contracts into the optimum control strategy.

The starting point is the contract portfolio in which the value and compliance risk of the outsource contracts are plotted. The position drives among others the resources spend by the compliance function on monitoring a contract. The control and monitor activities are typically described in a so called Compliance Program which is the overarching framework that encompasses the different activities and responsibilities performed by the compliance function.

Compliance cost can be reduced further by applying only a ´golden´ control and monitoring approach when it is really necessary (for example at high risk and value) and select a ´silver´ or ´bronze´ approach elsewhere (see figure).

By strengthening the collaboration of the so called ‘three lines of defence’ and other risk disciplines (for example, operational and information risk departments) even more efficiency gains may be achieved. For example, the department Operational Risk Management (ORM) is usually responsible for controlling the risk related to business and IT continuity. Within the Dutch banking regulation Wft, requirements are stated regarding IT continuity. To comply with this regulation the compliance department may choose to come up with new controls or look into existing assurance measures and add where necessary.

The desired end result is a cooperation in which the lines of defence and risk disciplines make use of a shared set of procedures, risk-control matrices, control measures, reports etc. However, this requires the willingness to put the needs of the group above ones own.

In the figure, the translation is made from the position a regulated object has within a portfolio (see figure in second post) to the corresponding control and monitor strategy. The strategy can be defined in terms of the lines of defence that are involved in the monitoring. This way, the choice can be made only to have the first and second line monitoring in case of a ´bronze´ control and to only give the third line a prominent role in case of a ´silver´ and ´gold´ control.

Removing the discrepancy between the current and desired control maturity can be done by means of an improvement plan or by including actions in the monitoring plan. Optimize the expenses by first of all implementing those improvement actions that have the highest risk reducing effect at the lowest (in)direct costs.

What are the results that can be achieved?
At the compliance department which implemented this methodology a minimum base set has been defined consisting of requirements to which external suppliers have to comply and future suppliers will tested against during the due diligence process. Besides that, together with the retained organization (which acts on behalf of the business as the first line of defence) and existing suppliers, there are talks on creating control frameworks in which a balance is sought between the best practises of the supplier and the requirements and wishes of the bank. Among others, this is a way to try to limit the check related to compliance the supplier submits each month.

In principle all objects (for example products, markets and activities) that are regulated and over which the financial institution runs a reputation risk, can profit from the described approach. The compliance program can be designed both more effective and more efficient than is currently often the case and besides that, by means of continues documenting the steps, a risk-based ´compliance dossier´ for regulated objects is being constructed.

This dossier can be used to indicate to internal and external stakeholders that the organization is ´in control´ and that the organization is acting not only within the law but also in the spirit of the law. Eventually (also in the law) it is about adequately controlling the risk underlying the requirements demanded by the legislator.

The most added value however, is the insight that is gained between the financial value of, for example, a pension product, the compliance risk an organization has and the money that is spent on compliance. This insight will enable management to make a well-informed decision based on possible scenarios that can further optimize the relation between risk and value. No one is waiting for the situation ABN Amro found itself in during 2005 when it had to pay $80 million to the US government because of involvement in money transactions to Iranian and Libyan entities.

Outsourcing risk and Madoff

2009-08-24T09:33:00.002+02:00

One of the key issues of the financial crisis was banks not knowing the value of their assets. This lack of insight has numerous reasons, but to me the main ones are: too much focus on short term profit, not being able to understand your own financial products anymore and inadequate control over your back-end business partners. In this post I want to put some of my thoughts on this last topic: the importance of monitoring the ‘health’ of the other financial institutions the bank does business with. Banks got hit by Madoff and Leman Brothers because they did not appreciate the risk they ‘imported’ by extending their value chain beyond their own borders.

This issue was broad to my attention again in n a recent interview of Z24 (Dutch internet news channel) with the Chief Risk Officer of Fortis Bank Netherlands (3 billion revenue 2008, 184 billion in assets. In this interview the risk management practises of the bank were discussed and the CRO stated that the board is closely involved with all new product introductions, and determines how new products fit into the risk profile of the bank.

If so much attention goes into risk analysis, even at board level, how can it be that Madoff and Lehman Brothers were not detected earlier? As said in the beginning of this post play a lack of insight in de risk profile of the whole value chain and an underestimation of the ‘risk dynamics’ an important role. And looking at the value chain also means outsourcing as the times are long gone that banks ‘produced’ all their financial products and services themselves.

The term ‘outsourcing’ is however typically used for situations were internal employees and assets are transferred/sold to an external party. This means that outsourcing is not the perfect term in this situation, but looking from a risk management perspective is it not that relevant whether your relationship with the business partner is based on acquiring, purchasing or outsourcing. In all cases does the bank ‘import’ risk by dealing with an external vendor.

The point I want to make is that banks pay a fair amount of attention to new product introductions and selecting a new business partner to outsource internal activities to or buy services & products from. This means that most banks will have done some kind of due diligence before signing contracts with Madoff and Lehman Brothers. What many banks failed to do is to monitor these partners adequately and adjust their risk profile and control strategy accordingly (and in case of Madoff do a proper due diligence at all as it was a Ponzi scheme from the start). Financial institutions have been outsourcing various back office activities and buying complex products and services from others and lost in many cases the overview of the risks within their value chain.

Even though some financial institutions have business relationships with hundreds of partners is the control strategy of most banks still very much oriented towards the internal activities. This despite that in some cases more risk is ‘imported’ than produced by the financial institution itself. This immaturity is reflected in the control strategy for external partners. Most organisations do not get much further than a ‘right to audit’ and (miss-)using SAS70 statements to get some insight in the control maturity of its partners (more on SAS70 here and here). To make matters worse are the education curriculum’s for risk managers and auditors also paying inadequate attention to the ‘financial supply chain’. Risk and audit managers learn how to control the internal organisation and learning how to exercise control over external partners is dealt with in maybe 10-15% of the course time.

I expect this to change soon however as financial institutions and their clients are not waiting for a Madoff 2.0.

Reducing the cost of regulatory compliance for outsource contracts, part 2

2009-08-14T10:12:00.005+02:00

In the previous post on this topic I wrote that the control framework created by compliance functions within financial institutions for outsource contracts are often inadequate and too expensive.

The main reasons for these observations are that compliance officers often do not understand enough the scope and dynamics of the contract in order to create a lean but adequate compliance chart. By requiring all regulations to be in-scope they hope not to miss out on anything. Furthermore are compliance officers not trained well enough in translating an internal control framework into an external one. This often results in either requiring the vendor to copy the internal control framework of the bank (very expensive option as the bank does not leverage on the best practises of the vendor) or they just resort to letting the vendor sign a yearly ‘in contol’ statement (too simple as the vendor mostly does not know what it signs for). My third reason for the initial statement was that compliance officers are not used to look at their professional from a financial perspective (other than cost). They are too often not capable of having a discussion on this topic with the business managers on the risk versus return.

Now picking up the story again where I left it last time.

Sub objective one: look beyond risk and regulation; look at the value
The risk profile is one of the two dimensions that should determine how much money is spent on controlling regulatory compliance risk. The second, and currently mostly absent, dimension is the (financial) value the regulated object represents. Determining whether a product, activity, market or outsourcing contract represents a percent of the sales or margin or ten percent is necessary to be able to make a more nuanced consideration between costs and return. In some cases, the costs related to compliance can be so high that they will make a business case unfeasible.

An example is an organization active in the field of payment traffic which wanted to outsource part of its IT because the initial business case predicted lower costs. However, the requirements the supplier had to comply with regarding, amongst others, security were so costly that the entire outsourcing was cancelled two weeks before the planned sign date. In this case too, the compliance department was involved very late in the project, causing the expensive bunny to come out of the hat only just before the planned signing date.

On the one hand, this example is an argument to involve the compliance function in outsourcing, product development (and in other complex projects) at an early stage, while at the same time it also underlines the necessity for compliance officers to become better informed in the financial implications of compliance. Understanding it to such an extent that that compliance officer is able to:

Determine the financial value the regulated object (e.g. outsource contract) represents to the organisation;
Communicate with the responsible business managers on risk versus return

To enable the compliance office to get a more sophisticated view on its area of work portfolio management is introduced. For some regulated objects, like an investment product or an outsourcing contract, it is relatively easy to determine the financial value it represents, while for others it is more difficult. Important conditions for effectively using the found answers are applying a uniform valuation basis and taking into account the future value development.

An outsource contract can have a high compliance risk and a low financial value but the situation can be completely difference in two years time. This is illustrated in the figure in which object 1 currently has an unacceptable risk-value distribution (the object is above the red line). For example by increasing the volume of the contract and/or lowering the compliance risk, the ratio between risk and value can shift to an acceptable level.
The green line in the figure represents the optimal distribution the financial institution has defined for compliance risk versus the related value/return. Based on the position in the portfolio the best improvement strategy for a outsource contract can be determined: lowering the risk profile (object 2), raising the value of cancelling the contract (object 3).

Looking at outsource contracts in this way originates from the portfolio management theory. This is a structured method for categorizing, evaluating and prioritizing objects based on an acceptable balance between risk and value. The objects in the portfolio (for example all outsource contracts) are scored by comparing them to each other and the location within the portfolio directs the amount of resources to be spent on compliance activities.

In the customer example that was discussed earlier, the existing portfolio of outsourcing contracts was analyzed and the contracts with the maximum score (high risk and value) were the first to be assigned to compliance officers. The goal was determining if the existing control and monitoring strategy was in balance with the contract. Amongst others, this entailed determining if the (gross/inherent) risk already had been reduced to an acceptable level (´residual risk´ lower or equal to the risk appetite). If not, which additional control and monitoring activities could accomplish this in the most efficient manner.

How one can translate the risk/value ratio of an outsource contract into the optimum control strategy will be discussed in the third and last post on this topic.

CMMi for acquisitions versus eSCM, ISPL and other standards, part 1

2009-08-10T21:31:00.005+02:00

There are several best practises, standards and other types of models & methodologies around aiming to structure complex acquisition and outsourcing engagements. Others are useful when thinking of designing the contract management/ sourcing governance framework. A couple of the models which are out there in the field:

CMMi for acquisitions (Carnegie Mellon University)
ISO/IEC 12207 (International Standards Organisation)
Information Services Procurement Library (European Community)
e-Sourcing Capability Model (Carnegie Mellon University)
ISlite (Gartner)

CMMi for acquisitions, ISO/IEC 12207 and ISPL were created to provide a structured approach to get:

the right service/product,
for the best price,
at the desired quality levels,
from the best vendor,
at or within the risk appetite of the company

In other words, these standards/methodologies provide companies insight in procuring/acquiring/sourcing products and/or services from an external vendor. The two other models are related to contract management/ sourcing governance, so basically the activities which have to be performed after the contract has been signed.

CMMi for acquisition consists of 22 process area’s: 16 core processes and 6 process area’s which are specific for acquisition. It originates from CMMI for Development v1.2 (2006) and Software Acquisition CMM v1.03 (2002) and has thus its roots in the software development area. The 22 process area’s of CMMI® for Acquisition, version 1.2 are described in 441 pages of text and to me this means it should be deployed in its full scope only for the largest and most complex/dynamic of software acquisition projects.

The standard goes (understandably) very in-dept into all kinds of (software) specific stuff and most processes will thus have only limited use for other types of acquisitions. The most generic process described is ‘solicitation and supplier agreement development’ and it provides an overview of typical steps undertaken to come from the wish to acquire to a signed contract. Other also more generic processes go into the project and risk management side of acquisitions and might thus also be applicable to other types of acquisitions/outsourcing. CMMi 4 Acq is furthermore focussed primarily on discrete software projects and it is thus not directly aimed at facilitating the outsourcing of the software development department of lets say company X.

ISO12207 is an ISO standard for software lifecycle processes and has quiet some similarities with CMMi for acquisitions as it also describes the processes and activities applied during the acquisition phase. It aims to be 'the' standard related to managing the lifecycle of software (developing and maintaining software). There are 23 processes, 95 activities, 325 tasks and 224 outcomes. Like with CMMi is the aim of this standard to create a common ground so that the client, suppliers, developers and other stakeholders can use a common language. In many other ISO standards is acquisition also a subject which is being dealt with (e.g. ISO 3977 for the design and procurement of gas turbine systems).

Both standards provide definitely elements which can be useful when acquiring other types of IT services (e.g. outsourcing network support) and even for BPO/KTO. But in that case one needs a large cup of coffee and do some cherry picking. I actually wonder whether there is still a positive business case if an organisation wants to a) perform all prescribed CMMi processes/activities at b) the highest maturity level. Like with the traditional CMM(i) used to manage internal software development projects I believe the optimum maturity level is around 3. Above level 3 the additional cost of the paper work adds less value than it costs.

Where it comes to the ISO, I agree with those which embrace it as a means to improve quality and not something to get certified against as soon as possible. I see too many companies which just ‘implement’ it in order to pass the certification and only look into their hand books three weeks before the auditors come again for a re-certification. Like with CMMi 4 Acq. pick the elements which help you to improve quality further, ignoring the rest.

More on other acquisition and sourcing models in another post.

Short term gain versus long term loss, part 2

2009-08-06T11:52:00.003+02:00

This post continues my views on the long term damage which might result from sourcing decisions which are based on emotions than rational decisions (‘Behavioural Sourcing’). In the previous post I looked at the subject from the client perspective while I use this one to provide my thoughts on the supplier perspective).

Supplier perspective
As mentioned in this post do I expect that some service providers will not make it through this economic winter as their shrinking revenue and margin are not matched by the amount and speed they can loose redundant employees and get fresh capital.

That service providers are signing contracts in order to get some new revenue in (the gain), which most likely cannot be made profitable during the contract term (the loss) is reflected by the Dutch IT entrepreneur (owner of SME service provider Centric) Gerard Sanderink. In an interview with the Financial Dagblad (Dutch financial newspaper, article here), he states that some large scale layoffs can be expected within the Dutch IT industry. According to him were service providers forced to give large discounts on deals signed in Q1 2009, resulting in contracts with a negative NPV. Especially large clients were able to get discounts up to 20% which makes it almost impossible to make a positive margin in at least the first couple of years of the term. This means that there is a serious over capacity within the IT market which will not be absorbed easily. Even the Indian suppliers feel the slump in demand as they also are cutting their rates. According to the Times of India, large outsourcing firms are trimming their invoices by 35 to 40 per cent. One can now hire an IT specialist in India for about $16 per hour, which is low even for Indian standards.

In this post from last week I already mentioned that I suspect some service providers to go bust somewhere in the next two years are their cash reserves deplete faster than their ability to cut operational cost.

Another source of vulnerability is a higher likelihood of suppliers trying to close a contract by deploying unethical behaviour. Because the enormous pressure on sales executives to sign new contracts, some might resort to bribing the client. It will depend on the culture of the country and companies involved whether this practise is used. But both senior managers within clients and suppliers have to be vigilant of the long term fallout which can result of fraudulent practises getting public (e.g. Wipro and the World Bank).

Another type of fraud is inflating the value of the company by creative bookkeeping with Satyam being a prime example of the effect it can have on the company as a whole. Companies which are cash strapped and want to get additional financing by either selling stock or a loan from a bank might be tempted to stretch or break some accounting rules. Like with recent probing of the English regulator FSA into hedge funds which use very small auditing firms, it might also be wise to be a bit worried of SME suppliers using similar practises.

A risk which may work out positive in the short term, but bite back in the long term are currency fluctuations. In 2008, the Indian rupee fell more than 23 percent against the U.S. dollar, which meant that the supplier could land an additional profit margin of 20% by doing nothing extra (if it would be stock-listed in India and thus reporting its financial figures in Rs.). The situation can however also turn around as the U.S. economy will be struggling to pay of its debt the next couple of decades. A heavily indebted country normally has a weak currency while the continuing growth of the Indian economy would increase the appreciation of the rupee. This is an effect both client and supplier have to be aware of and include related rules of engagement in the contract.

Two more generic pieces on the challenges the suppliers are facing here can be found here and here. I guess the message of this post for suppliers to keep their heads cool and resist making decisions they will regret in two years time.

Short term gain versus long term loss, part 1

2009-08-04T15:42:00.003+02:00

This post provides some of my thoughts on the effects the economic situation has on the (ir)rationality behind sourcing decisions, also known as ‘Behavioural Sourcing’. In other words, one expects that (like with Behavioural Finance) sourcing decisions are made by rational people which have complete information about alternatives, unlimited capabilities to process information, been driven by individualism and are without emotions in their decision making.

The Behavioural Finance theory teaches however that in reality people are inconsistent, subject to cognitive illusions, and often biased in their judgements (example: if the competitor outsources process XYZ, it must also work for the own company).

In my experience, and especially when under pressure like now, are people not always rational in their decisions to outsource. As the aim of this post is not to provide a lot of detail regarding the background of Behavioural Sourcing, just some key points. Behavioural Sourcing aims to:

understand where sourcing decision anomalies come from;
avoid in your own sourcing decision making the traps or errors that other people frequently make;
assess better the advice, recommendations or commentary which others make.

In this post I want to focus more on the effects of (in my eyes) sometimes irrational sourcing decisions being made these days. I do this from two perspectives, client and supplier.

Client perspective
One could say (and many do) that it is the nature of these times that outsourcing deals are rushed to its closing and that any mess will have to be cleaned up later. I believe that this rational is valid only for those companies which have an acute liquidity crisis and are desperate to get some money in through an asset transfer (I guess some of the Indian captives sold last year by large financial institutions fall in this category, more on that here).

That even Chief Financial Officers (typically not the biggest risk takers in the organisation) focus on (overvaluing?) the expected return of outsourcing over the accompanying risk is demonstrated by recent research by Basware and the academic institution Loudhouse. Their ‘The Cost of Control’ research shows that CFO’s underestimate the risk they introduce in their value chain by outsourcing as cost reduction is by 64% seen as the top priority and only 39% believes that risk management should be on the top of the list. I am however not arguing that risk management should be on top of the risk, but I think that a healthy balance between risk and return is the way to go.

Many reasons exist for the failure of outsourcing arrangements from a client perspective. Some of the key risks which have a higher probability during these days of financial stress are:

Outsourcing with the rationale that the competitor is also doing it. The decision to outsource key IT systems and business processes should be part of an integral vision on the companies value chain and how the return and risk profile of the supply chain as a whole can be optimized. Outsourcing of process ABC might work for the competitor but not necessary for you.
Outsourcing of a broken or unmanageable function. Some companies which do not have the management capabilities to straighten out certain activities themselves outsource them with the idea that the supplier has some magic stick to improve things. Especially in these days when the agenda’s of the CxO’s are extra full it might be tempting to throw some activities over the wall, with the expectation of freeing up management attention. Those decision makers could not be more wrong and are likely to be bogged down for the next two years with participating in escalation meetings with the supplier.
Outsourcing and looking only at reduced production cost. The basic rationale behind lowering cost through outsourcing is a supplier being able to create better economies of scale. This is however only one side of the medal. The Total Cost of Sourcing (TCS) during the term of the engagement includes however many more costs. Some costs which have a negative effect on the business case are: project and legal cost to select and contract a vendor, exit cost at the end of the term, sourcing governance/contract management cost (‘transaction cost’), VAT and currency differences (if offshoring) and benchmarking cost. Including these and other outsourcing related cost into the equation and the business case may start to look differently all together.
Outsourcing based on insufficient service/product descriptions. The need for speed within some sourcing projects results in both client and supplier not having a clear understanding of the services and/or products which have to be delivered after the contract has been signed. This is not necessarily a problem is the contract is capacity based, but if the aim is to supply the client with a ‘service’ or ‘product’ it is necessary that both parties have a clear understanding of each others expectations. Failing to address this point triggers among others: frustrations, renegotiations, potential loss of revenue due to inadequate services/products, higher invoices due to extra work by the supplier (‘it is not in the contract, so we don’t do it unless we get paid’) and higher cost to manage the supplier.

These risks are not that difficult to manage and mitigate, but I’m afraid that these days the emotions are sometimes stronger than the ratio. The impact of overspeeding outsourcing projects will primarily rain down on the guys and gals who do the operational day-to-day work and are suddenly confronted with a delivery model which looks like a Swiss cheese.

One might think that the supplier is happy with a chaotic situation as it may result in some extra invoices, but the opposite is true. Suppliers also loose out in these situations as they will be unable to provide a good service/product and have to spend more time and money on managing the client. The only good news is for advisory firms which support clients mitigating the issues resulting from their quick and dirty outsourcing initiatives (after first getting them in trouble in the first place).

In my next post I will look at the same topic, but than from the suppliers’ perspective.

Will more service providers go into bankruptcy?

2009-07-31T11:10:00.006+02:00

In this post I mentioned that vendors are in a tight spot as both revenue and margins are hit by the current economic situation (like almost any other company with the exception those who can capitalise on the Mexican flu). In this post I provide my thoughts on the health of the vendor market and how clients can protect them agains a vendor which goes into a Chapter 11 situation. To start of first some recent figures related to the financial results of some BPO en ITO vendors:

Getronics, provider of IT services, announced Q2 2009 revenues were down 1.3% to €531 million;
Manpower, provider of human resource BPO services, announced Q2 2009 revenues down 35.7% to $3,796.6 million;
Tech Mahindra, provider of IT services, announced fiscal Q1 2010 revenues down 16.3% to $228 million;
Altran, an R&D and IT service provider announced Q2 2009 revenues were down 17.2% to €349.7 million;
Transcom, provider of customer management services, announced Q2 revenues down 14.6% to 135.7 million;
TCS, top ITO provider, announced fiscal Q1 2010 revenues down 2.9% to $1.48 billion;
IBM Global Services, top ITO and BPO provider, announced Q2 2009 revenues down 11.6% to $13,446 million;
Mastek, provider of IP-based solutions , announced fiscal Q4 2009 revenues down 14% to Rs. 214.1 Indian Crore;
Wipro, top ITO provider, announces fiscal Q1 2010 revenues down 3% to $1,033 million.

There were however also some white ravens:

Capita, provider of life and pensions BPO services, announced 1st half 2009 revenues up 10.8% to 1,310.7 million;
Intrum, a credit management service provider, announced Q2 2009 revenues up 18% to $140 million;
Polaris, software development provider, announced fiscal Q1 2010 revenues up 3% to $86 million.

With margins between 3% and 10% in normal years do American and European vendors typically not have a lot of room to build a healthy cash reserve to wither the storm and sustain negative growth scenario’s for a long time. The big well established vendors like Accenture, IBM, HP/EDS and Atos Origin will have enough fat on their bones to ride out the storm, but those companies that started their operations like five years ago and did not carve out a specific niche for themselves will be most likely to be or get into serious trouble soon. My arguments to support this statements are:

In order to keep their order books filled will large vendors go after the smaller deals, increasing the competition for the SME vendor;
It will be less easy for an SME vendor to get funding from banks as the ITO and BPO industry is considered to be a higher risk industry;
It easier for a bank to say goodbye to a small-medium player than to a large player. Refusing to refinance 1 million of debt of an SME vendor creates a problem for the vendor, refusing to refinancing 1 billion in debt for a large vendor puts both the vendor and bank at risk;
Companies outsourcing will look for ways to mitigate their risk by among others going for established, well known brands. This will increase the entry barrier for vendors which want to pitch for a request for proposal.
Companies will try to reduce the number of redundant employees by laying them off, but especially in Europe is this not cheap. Giving employees an exit fee based on 1/2 to 1 1/2 month salary for every year they worked for the company may empty the cash reserves even faster than keeping them on the pay roll.

The impact for clients having contracts with the SME-vendors which will not make it through this winter will however be limited as there will always be larger players which will take over the client portfolio.

Weaker SME-vendors active in area’s which are complementary to the service or client portfolio of stronger players are likely to be either taken over by larger brothers or being bought by private equity parties. There are various interesting deals to be made for both larger players or PE firms as valuations are very low.

In the meantime I wonder who will follow companies like Nortel Networks (filed for chapter 11 bankruptcy) in January 2009), VoIP Service Provider Primus and internet/cable provider Broadstripe. In 2008 and in the United States alone, the companies filing for Chapter 11, and thus potentially your vendors rose at a rate 34% (compared to 2007). Three basic things you can do as a client:

Do not put all your eggs into one basket and use a multi vendor strategy for those products or services which are critical for your operation;
Keep an eye on your vendor and ask them to provide you information on their liquidity and solvency like every six months;
Think about scenario’s related to a forced exit due to a bankruptcy of a vendor. Do not get caught by surprise, but be prepared.

Added August 12, 2009: Just some bankruptcies of the last week here in The Netherlands of small IT service providers: Snelcom IT Dienstverlening and PC Repair Man. Astragy went during this period into Chapter 11.

Reducing the cost of regulatory compliance for outsource contracts, part 1

2009-07-27T12:45:00.004+02:00

This post is a follow up on this post in which I describe the rough outlines of an approach to reduce the expenses one has to include in the business case related to ensuring regulatory compliance. This post is not meant for the average company which has to worry about SOX and standard privacy laws. This post is based on my experiences of working for a large international bank which did a lot of outsourcing, but did not know well how to translate the large amount of national and international laws and regulations into a manageable and cost effective control and monitor framework.

What does regulatory compliance cost?
A study of the Work Bank in 2005 shows that in the Netherlands, the United Kingdom, Belgium, Sweden and Norway on average 8 to 11% van the total expenditures by the government goes towards regulation of the business. Figures from the United States over 2004 indicate that there a total of 14.9% of the Gross National Income is spent on laws and regulation (11.2% on national regulation and 3.7% on regional and local regulation). In 1947 this was 4%.

The figures do not show what percentage was covered by financial institutions but research from Australia does give an indication. In this country, banks spent A$1.02 billion (€630 million) on complying to new anti-laundry and terrorism laws and regulations in 2007. This was A$50 (€31) calculated per capita. These figures combined with the increase attention by regulators and government for the financial sector means that the cost related to compliance is likely to increase even further.

Overall objective: look at compliance more from a financial perspective
The most important prerequisite to structurally reduce the compliance cost is to teach the (senior) compliance officers to approach regulation from a more business economic perspective. The typical compliance officer is used to shouting 'Federal Deposit Insurance Corporation' (FDIC) or ‘Federal Reserve Board' (FDB) in the United States or 'Autoriteit Financiële Markten' (AFM) or ´De Nederlandsche Bank' (DNB) in the Netherlands as being enough to get a new control measure implemented. Hardly ever are direct and indirect costs taken into consideration. Although it is up to a business manager responsible for a product, market or activity to implement a measure or not, the advice of the compliance officer is important in such a case.

Learning as a compliance officer to look more from a financial perspective to its work and being able to make cost-benefit analysis and subsequently talk to the responsible business manager in both risk and finance terminology is to me a key driver to a) optimize the resource usage for compliance (outsourcing or not) and b) improve the alignment between the compliance risk discipline and the business managers. The rest of the post will look more into how this overall aim can be achieved.

Sub objective one: look beyond the regulation; look at the risk
Being able to create a lean and mean regulatory compliance framework for an outsource contract starts with understanding the scope and nature of the outsource contract. Understanding it to such an extent that that compliance officer is able to:

Define the ‘compliance risk drivers, and
Define a lean and mean scope for the compliance chart

1. Compliance risk drivers
The so-called ‘compliance risk drivers’ are parameters which have a negative or positive influence on the compliance risk the organization runs related to the contract. A simple example is the maturity of a financial product. A recently introduced ´green´ investment product scores higher on this point than a standard product that has been invested on the stock exchange for twenty years. So if part of the product selling and/or administration has been outsourced is it important to know that more partner/supplier oversight is required related to this risk driver. Three other examples are the amount of personal data in scope of the contract, the maturity of the vendors’ processes and attention of regulators regarding the outsourced activities or outsourcing in general.

Weighting and then subsequently scoring the risk drivers for the portfolio of outsource contracts provides insight in how outsource contracts relate to each other regarding their compliance ‘heat maps’. The compliance officer should at the end of this activity thus have a risk profile for every individual contract plus insight in how contracts score compared to each other. This insight will later on be an important driver for resource allocation and control/monitor effort

Two attention points here: a) ensure the risk drivers are defined in an adequate level of detail to prevent the outcome of a risk assessment to be too subjective and b) the score of a risk driver changes over time (e.g. the risk appetite changes) and has thus to be updated regularly.

2. Compliance Chart
The risk profile drives the scope of the Compliance Chart which has to be created for the outsource contract. The compliance risk profile regulates the selection of relevant regulations and the underlying themes and requirements (also called ´obligations´). For example, an object can score high on a compliance risk driver called ´presence of personal data records´. In that case several themes from the Dutch Wet bescherming persoonsgegevens (Wbp) will have a prominent place in the Compliance Chart. The design of the Compliance Chart will thus consist of a minimal base set of regulatory requirements completed with specific add-ons derived from the characteristics of the risk profile.

The cost advantage is in leaving out the non-relevant regulation and in prioritizing themes and requirements that do belong in the Compliance Chart. Additional efficiency gains are captured later on when defining the control and monitoring strategy based on the lean-and-mean compliance chart.

The regulator on risk-based compliance management
Research by the Basel committee from 2008 shows that the compliance function is given an important role when managing risks. The responsibilities mentioned in Basel II have been implemented in the Netherlands within the Wet financieel toezicht (Wft) in articles 3:17 en 21 Bpr. These articles have a direct link with articles 13 of the Markets in Financial Instruments Directive (Mifid) and article 6 in which the implementation and measures are discussed: ‘Member States shall ensure that investment firms establish, implement and maintain adequate policies and procedures designed to detect any risk of failure by the firm to comply with its obligations under Directive 2004/39/EC, as well as the associated risks, and put in place adequate measures and procedures designed to minimise such risk.’

The above given quote indicates that the regulator not only expects the financial institution to implement the regulation but also that it has to comply to the regulation’s exceeding goal that undesirable activities and behaviours have to be prevented. In short, the management of the underlying risk.

The approach applied it to practise
At the compliance department of the financial institution I worked with, applying this methodology meant first of all more prominent involvement by compliance officers in new projects. This turned out to be a difficult task as outsourcing was regarded as a subject that was initiated by the business and compliance was not seen as a relevant stakeholder. The situation improved however when compliance described clearly how and when they wanted to be involved and by formally incorporating the compliance function within the project governance

At the financial institution one of the discussions was about the reputation risk that the organisation would take when an Indian supplier did comply with local Indian laws (for example concerning taxes or child labour). In other words: was the organization wide control maturity of the supplier a compliance risk driver? And if so, when would the compliance risk appetite be exceeded?

More on this subject in a follow up post.

Follow up on impact on outsourcing of Obama's tax plans

2009-07-20T10:10:00.003+02:00

I started a discussion on LinkedIn on the potential impact of new legislation by the Obama Administration on the offshore outsource industry and I got some interesting feedback I also wanted to share here. You can read my original post on this topic here. This comment is from Guy Kirkwood and he mentioed among others the following:

"Protectionism is defended by two major arguments. The first is that protectionist policies save jobs in domestic industries. This argument reasons that if a domestic industry is forced to compete against a foreign country that provides services more cheaply, such as India, then that domestic industry will have to lay off hundreds or thousands of workers in order to stay competitive. Entire communities whose livelihoods depend on the service or industry will be decimated by poverty.

The second argument, a corollary to this one, is that eventually, left to compete for too long against an offshore location, a domestic industry might collapse completely, leaving the protectionist-prone country dependant on foreign operations. This, the argument goes, could be devastating as it would find itself unable to provide a badly needed resource. So the question, when times are is not, “Should we save these jobs?” It is, “Should we save these jobs at the expense of other jobs, or should we let economic efficiency decide where people and resources are best employed?”

Domestic protectionism always has a domestic cost. Most of the time, however, the costs of protectionism go unnoticed, because protected jobs in one industry are concentrated and easy to see, while the costs throughout the economy are widely dispersed, over a hundreds of industries and millions of consumers. If offshoring becomes “the” industry that the US seeks to repress, it’s my opinion that this protectionism will cost the US domestic economy much and achieve little."

There have been many scolars trying to quantify the effect of protectionism on a domestic economy and I do not want to go through all of them. There are however (at least) two interesting pieces of research which try to quantify the effects of offshoring on the economy.

One approach is described in an article from McKinsey (2003) in which they argued that the net benefit of offshoring for the ecomomy would be positive due to a combination of lower import prices and redundant worker taking another (lower paid) job. In this article they argue that of one dollar spend by a domestic company offshoring a value of $1.45 - $1.47 is created for the global economy as a whole. The U.S. would capture $1.12 - $1.14 while the receiving country captures on average 33 cents. In other words, the U.S. captures 78 percent of the total value.

The US Bureau of Ecomomic Analysis (BEA), part of the department of commerce came however with some different results. They argue that foreign providers of outsourcing services actually buy U.S. firms, hollow them out, and outsource production their home or other countries. These firms purchase the firms for the domestic market shares, extensive distribution systems, and widespread brand recognition. Result is increase in net imports by that firm and by the United States as a whole. This resulted accodingly to the BEA in a job loss of 4 million in the peiod of 1991 to 2005. As there were not 4 million new jobs created in other area's/companies to absorb the redundant employees is the nett benefit less beneficial for the US economy than predicted by the article of McKinsey.

Explanation of the data in the added picture (Source: Economic Policy Institute, Issue brief #236 August 23, 2007):

Between 1991 and 2005, foreign multinational corporations (FMNCs) acquired 4.94 million workers plus 303k workers in foreign-owned startups. Thus, FMNCs added in theory 5.25 million workers.
If not for layoffs total employment should have been 9.09 million jobs (3.84 million workers plus the 5.25 million hired or acquired by FMNCs)
However, in 2005, FMNCs actually employed just 5.09 million workers, so 4 million jobs short.

What outsourcing can learn from M&A

2009-07-14T10:01:00.004+02:00

There are various elements outsourcing can learn from the way mergers and acquisitions are handled. Especially the attention Private Equity (PE) firms pay to the exit when considering the acquisition of a company is something companies outsourcing can learn from. The last couple of years the situation has improved a lot (at least in the Netherlands) and much more attention is being paid to this topic. For those who are less familiar with the subject here the minimum exit to-do list:

define the exit requirements the vendor has to comply with,
include exit fees in the business case and contract and
make sure the vendor delivers an exit plan based on the requirements within 6 months or so.

But applying M&A to outsourcing has more to offer, even though quiet some elements are already common practise. The synergies and learning points I found are:

Approach of engagement
The activities undertaken during both types of engagement show substantial similarities as both incorporate elements like finding a suitable ‘target’ to either acquire or outsource too and include a (legal) transition of one party to another of assets. Comparing the phases of both types of projects:
One of the main differences between outsourcing and M&A is in my opinion the stronger focus on the non-financial part. Within M&A about 70% of the attention is put into the financial workstream while (in more complex) outsourcing engagements much more emphasis is put on the services/products that have to be delivered and setting up a governance structure. For the outsourcing deals I have been in it was typically 40% finance and the rest divided over requirements definition (e.g. describing the processes), HR, legal and governance.

Financial deal value
Within M&A they use slightly different terms for the value captured within the deal. Value is created by both the client outsourcing and the vendor taking over the activities and assets. The value of an outsource deal described in M&A terms:

Option value for vendor: By taking over the assets and people of the client the vendor might be able to get into new markets and/or clients (e.g. get more clients in the media vertical after signing a contract with a newspaper publisher). The second part of the option value is embedded with increased economies of scale by adding this new client to its portfolio.
Option value for client: The money the client receives from the vendor for the asset transfer can be used to enter new markets, innovation or to other means. The vendor can potentially help the client with forward or backward integration of its value chain and or the creation of new products/services. The vendor allows also for easier absorption of volume fluctuations due to changes in demand.

Embedded value for vendor: the vendor gets access to new assets, people and knowledge which it can use to generate additional revenue in other areas. It furthermore obtains a revenue stream for the term of the contract (and likely even longer; this part could be seen as option value).
Embedded value for client: the vendor can improve the quality of services by applying its best practises and reduce cost by economies of scale and may (if done well) reduce the level of delivery risk for the client organisation.

Exit costs for vendor: the exit cost is related to the risk (option of the client) to switch to another supply source at the end of the contract term. Additional negative value contribution can result from spending more money on the exit-transition than it can recover from the client organisation.
Exit costs for client: the client has to cover the cost of retransition the activities back inhouse or transfer the activities to another vendor.

Other sources of negative value creation are related to various sources of sourcing risk. These might be strategic of nature (e.g. costs due to opportunistic behaviour of vendor), operational (e.g. vendor failing to deliver according to contractual requirements) or compliance (e.g. legal penalties due to vendor not protecting personal data). The last topic of the post discusses some ways the deal value is protected within M&A transactions.

Safeguarding the deal value
The terms used by M&A are slightly different compared to outsourcing, but the basic aim is the same.

Earn-out. As said at the beginning of this post are PE firms very focussed on the exit of a deal. The money they expect at the end of the ‘contract term’ and how this influences the price of the deal is one of the key attention points. Translating this approach to outsourcing means for example linking the earnings of the vendor to the business volume of the client (e.g. client selling 20% more products, means for IT vendor 20% more application transactions x price $$$). Another often used mechanism is linking business performance to penalties/bonuses (e.g. client company failing to invoice due to BPO vendor screwing up means the vendor is penalises for the damage incurred by the client company)
3rd party arbitration: also within M&A situation both parties may agree on for example a fair transfer price. In those cases an independent party (e.g. audit firm) may be asked to provide an independent advise on the matter at hand. 3rd party arbitrage may also be used if there are other types of contract disputes or in case of personal of cultural clashes between parties.
Representation warranty. This mitigating mechanism links the acquisition price to the original assumptions regarding the scope, assets and service levels. Even a due diligence cannot prevent situations where the vendor is confronted with cost drivers which were not in the original scope of the contract. To mitigate this risk parties agree to predetermined price reviews which might include benchmarking by an independent 3rd party.
Change of control: during the term of the contract ownership of either the client or vendor may change and also within M&A engagements is it common to link the termination clauses to this type of event. Related to this topic are the clauses describing the procedures related to ‘key personnel’. In outsourcing contracts there is often a provision regarding the client and vendor changing employees on key (governance) positions.

Not too many people think that M&A and outsourcing are so closely related to each other, but looking especially from a financial perspectives at both types of engagements shows that the similarities are more prominent than the differences. Another post on managing the value of outsourcing can be found here.

Managing the risks within the supplier domain: black-box versus white-box

2009-07-10T09:14:00.002+02:00

Not all risks related to outsourcing can be mitigated in the same manner. Some risks and its mitigation are fully retained within the client company while others can only be mitigated with the cooperation of the external vendor. SAS70, due diligence and audit rights are the most commonly used assurance mechanisms, but are:

limited in their use (e.g. SAS70 focuses on controls for IT systems which function can have a material effect on financial statements and is thus of limited use to mitigate other types of risks).
expensive (e.g. both auditing by the companies own auditors or SAS70 statements requires the vendor (and third party auditor) to invest a lot of hours in collecting and presenting evidence. The bill for an SAS70 type II can easily end up in the area of $100-200k.
showing a snapshot of the situation (e.g. due diligence is typically a one-off exercise which is performed typically as part of the selection or contracting phase, same applies for a SAS70 type I report).

In order to have a more efficient and effective control framework the company should use a combination of expensive assurance mechanisms like third party statements like SAS70, ISA 402 and ISAE 3402 for the area’s of high risk and cheaper alternatives for areas of medium and low risk. See also this post in which I describe at a high level how to the costs related to managing regulatory risk in outsource engagements can be reduced. Part of creating a holistic control framework to manage risk it is important to constantly balance cost and effectiveness.
Describing in contract schedules exactly how the vendor has to execute certain activities prevents the vendor to use its own best practises and is thus expensive. Describing how the output (‘evidence’) for a certain control objective should look like and letting the vendor decide how to come to the result is consequently cheaper than the first option. In other words:

Telling how long and in which pan the cook has to boil the egg versus ordering a half boiled egg
Mitigation of some risks can be done using a ‘black box’ while others cannot. Looking at risks from a ‘black box’ perspective means the client organisation defines requirements or controls that the vendor must adhere to and report on, but with no need to know the internal means of operation.

However, not all risks can however be managed this way. Certain risks require in-depth knowledge of the inside structure and workings of the vendor (medium/high risk) to ensure an acceptable risk level for the client organisation. This is known as a ‘white box’ or ‘glass box’ approach. The two examples below make it more tangible:

A technology risk is the quality of data that is sent from the vendor to the client organisation. The client organisation cannot handle the quality of data purely as the vendors’ problem as that would lead to a ‘garbage-in/garbage-out’ scenario. The client organisation, however, should look at the quality of data in functional terms (e.g. accuracy, integrity, availability, completeness, and timeliness) and define thresholds or service levels for them. It should be left up to the vendor to operationalise the requirements. In this case, manage this risk as a black box.
A vendor-related risk is the turnover of its key employees. Key employees possess skills, knowledge or expertise that are so valuable to the client organisation that the client should be able to influence the decision making process of the vendor when it comes to replacing them. Influencing the internal decision-making process of the vendor on this point means managing the risk as a white box.

Managing a risk as a black or white box needs to be reflected in a) the way it is translated into contract clauses and b) the way the vendor is controlled by the retained organisation of the client organisation. Benefits of this differentiation are more focused management attention, less 'control waste' and thus ultimately lower cost—lower cost due to a smaller retained organisation and lower charges from the vendor for risk management related services.

Sourcing advisory firms: short and medium term outlook

2009-07-07T11:08:00.006+02:00

In two previous posts (here and here) I wrote that the outsource market in Q4 2008 and Q1 2009 was severely impacted by the effects of the economic meltdown. Especially the volume of big, complex deals was hit badly and the attention shifted to smaller deals to reflect the lower risk appetite of most companies.
I see quiet a lot of activity going on within smaller Dutch outsourcing advisory boutique firms and some of these firms are actually actively hiring sourcing consultants again. So despite the fact that outsourcing introduces additional risk can many companies not resist the temptation.

Outsourcing with as a main driver to cut operational cost in the shortest time possible also means that sourcing advisory firms will be asked to a) spend the bare minimum on advisory and b) get a signed contract as soon as possible. I expect that this will result in cutting corners and thus an increase of advisory work in the area of renegotiation and mitigation within one or two years. See this post for the baseline ingredients of a good sourcing relationship.

Expectation for the short term
My believe that cutting corners by speeding up outsourcing projects may just result in postponing certain expenses as a sloppy contract may require some extensive rework later. See also this post on The Outsourcing Weblog in which the author comments on the ‘speed sourcing’ proposition of Equaterra.

So this is my personal outlook for the different types of sourcing advisory firms in the short term (see also the previous posts on this subject here and here):

Independent one-stop-shop
In theory has the one-stop-shop the advantage of being able to provide a wide array of services related to sourcing (e.g. legal, tax, selection), but I do not think they are able to capitalize on it. Why? Because companies outsourcing want it done fast and at the lowest risk possible. That means going for the guys/gals with the solid track record: the independent niche players (e.g. TPI, Equaterra, Gartner, Quint). For the Big 4 is outsourcing an advisory service they provide as a side dish, it is not their bread and butter.

Independent niche players
These independent niche players can be split in three main groups with some sourcing advisory firms combining the first two (e.g. Gartner, Everest Group).

Advisory Firms. These guys are very busy targeting those companies which believe outsourcing can them to free up cash quickly. The ‘Time-to-Signature’ of the outsource contract is the key performance indicator which the client is managing the advisors on. Cutting corners and applying standard templates to capture the engagement as fast as possible is however likely to result in a lot of mitigation and renegotiation in one or two years I expect. Outsourcing complex services is not something to be taken lightly without running a serious risk of getting burned. So expect the same guys rushing deals to the market to be involved with cleaning up their mess in twelve to eighteen months from now (and quiet some insourcing again as senior managers start back tracking on previous sourcing decisions).
Research Firms. The second type of sourcing services is related to providing research information on for example vendor ratings. This type of information has its uses, but be aware that a substantial part of the marketing budget spend by vendors of BPO, ITO and KPO services goes to these research companies. Paying to be included in research I guess also means vendors want to see something back in return: a decent ranking within the (independent) research publication (isn’t what clients have to say of these vendors more important than what the vendors themselves have to say? But that is a whole different discussion).
Anyway, besides the constant challenge of ensuring your independence as a research analyst is there now the economic crisis with the marketing budget being one of the first casualties. And vendors cutting their marketing budget means substantially less income for research firms. Same applies for the conferences these firms organise: not many executives will be allowed to go to Geneva or Miami to attend a conference on outsourcing. So I expect that those research firms that have a hard time if they cannot leverage on income out of advisory services.
Benchmark Firms. The third type of niche players focus on providing benchmark services. These benchmarks can be quiet expensive in my experience and have thus typically only a positive business case in case of larger deals. And let most of the current deals now be smaller in size due to the reduced risk appetite of most companies wanting to outsource. So I expect also these companies to tighten their belt considerably and offering their services at a considerable discount to whether the current storm.

Supplier-dependent niche players
These advisory departments within the ITO/BPO/KPO vendors suffer the same symptoms as the one-stop-stop shop firms: they are not core business for the vendors and find it thus very hard to compete for business in a shrinking market. Besides a lack of dept in their propositions compared to the focussed boutique players have they to overcome the disadvantage of not being vendor independent. I expect these advisors will however be busy soon with ‘repairing’ governance and other issues coming out of some of the ‘speed sourcing’ deals which are signed these days.

The generic outlook for outsourcing related advisory services is gloomy for the short term, but there are exceptions. I know that some boutiques are very busy, especially those which can help companies to outsource quickly using proven best practises. The slumped demand for advisory services and resulting pressure of fees might also result in M&A activities as companies are relatively cheap now. An example is the recent take over by Datamonitor of Black Book research (after taking over niche sourcing advisory player Orbys). Like within every industry is the valuation of advisory firms searching for low points

Those who want to get some idea’s on lowering the risk profile of outsourcing deals which have to be signed in a pressure cooker can read this post.

Outlook for 2010 and 2011
This is where the crystal ball comes into play again, but here are some of my thoughts:

I expect quiet some rework to be done on deals which have been rushed to the market and delivery been thrown over the wall to the vendor to get some free cash fast. So advisory companies which did not get stained by deals gone wrong should be able to capture some substantial revenue from mediation and renegotiation work. Same applies for advisory services related to insourcing/re-transition and supporting the migration from vendor A to vendor B.
The sentiment of people active within the industry shows signs of improvement. For example the latest Black Book 'State of the Industry Report' points to restoring budgets, strategic outsourcing spending and a recovery in 2010 for suppliers that stayed customer-centric through the recession. With an improved confidence the risk appetite of companies is also likely to increase again, increasing the likelihood of companies engaging in complex or large outsourcing deals.
I expect an increased level of commoditisation of sourcing advisory services, forcing boutique firms to come up with new, high added value services allowing them to continue charging their high fees. In the bottom range new (small) companies will enter the market which will compete for the smaller deals on price. As more people and companies gain experience with outsourcing, the total volume of sourcing advisory services will start to decline however. In that sense I expect fierce competition among these advisory forms to continue, even after the market has picket up momentum again.

All in all interesting times for advisory firms active within the sourcing industry and I would not be surprised if some smaller players will not make it to the end. For those firms investing in innovation and adjusting their business model to the needs of the market will be enough action to sustain a healthy business model.

The basic ingredients of a successful outsource relationship

2009-07-02T09:15:00.003+02:00

I have been writing several posts on the impact the current economic situation has on the outsource market, but besides these specific challenges both clients and vendors have to face is there also a generic base with success factors. In my experience these are:

the right services/products and quality are delivered. The client company has two basic ways to obtain a service from a vendor: a) hiring somebody with a certain skill set or b) receiving a pre-described functionality (e.g. orders are processed within 1 day after receiving for 99, 5% of the total volume). In both cases is it very important to have a clear understanding what both parties can expect from each other, both in terms of quality and quantity.
In many cases are the expectations of the client not translated properly in a contract schedule (e.g. service catalogue, job profiles) resulting in tension between both parties.
the right, market conform, fee is charged. The question on what a ’right’ fee is starts with defining in adequate detail the current situation (Current Mode of Operation/ Present Mode of Operation) and expected situation (Future Mode of Operation).
Based on a throughout description of the demand (e.g. volume, service description, quality requirements) for both CMO/PMO and FMO the vendors invited for the RfX selection phase can calculate a realistic price for the contract. The more detail the client can provide regarding its demand (e.g. expected volume 3 years from now), the sharper the vendor can caluculate.
To ensure a market conform price is charged for the whole duration of the contract benchmarking can be used as a means to compare the price charged by the vendor with peers. Here it also helps to have a decent description of the services/products helps to prevent comparing ‘apples with pears’.
any secondary objectives are met (e.g. flexibility, innovation). Lower cost is one of the basic requirements which can be executed by outsourcing as a vendor can achieve better economies of scale. Every company has howver also a unique strategy, service/product portfolio and approach of the market. These parameters should also (where required) be translated in performance indicators the vendor has to adhere too.
the risk is at or below the risk appetite. In several of my previous posts I have discussed some of the risks which are related to outsourcing and shared services and how these can be mitigated. Underestimating the (financial) impact of the sourcing risk may well result in an expensive retransition project (=insourcing) if the expected benefits fail to materialise.
Discussing upfront the risk appetite (e.g. cash flow at risk, clients satisfaction at risk, reputation at risk) of outsourcing activities allows for the definition of a baseline to setup the risk management framework.

To ensure the previous success factors remain up to date the engagement also has to capture:

the strategic objectives including risk reward tradeoffs (e.g. political; currency exchange, logistic lead times);
allowance for long term evolvement of multiple complex objectives to be met;
attention for importance of relationship, reputation and network of supplier.

One of the challenges of a successful outsource relationship is thus capturing and continuous aligning both short and long term requirements. This requires finding a balance between contractual clauses and mutual trust. To implement the requirements mentioned above the client desiring to outsource activities has to:

Make the right sourcing decision. Outsourcing is an option, like there are others. Outsourcing has the potential of a higher return than internal supply, but it also comes with a higher risk profile (there is no such thing as a free lunch…). So do not jump by default on the outsourcing bandwagon, but also consider other options like internal rationalisation or sharing services/captives to capture additional benefits.
Right third party vendor. Sounds simple, but selecting a partner which you might have to rely on for the next five to seven years is not a decision to be underestimated (due to the high costs of an exit the actual duration of the relationship is likely to be even longer). Investing in a thorough selection and due diligence is money well spend for those engagements which represent a considerable value-at-risk for the client.
Right contract. The contracts and its schedules act as a description of the interface which is created between the client and the vendor. Putting all your trust in the blue eyes of the vendors’ account manager is in my experience not the right way to go. Trying to describe any little event and occasion which may or may not happen during the lifetime of the contract is also not feasible not desirable. Finding the balance depends among others on risk profile of the engagement and the value-at-risk.
Right relationship and governance. Selecting the right vendor is one thing, investing in the relationship and governance another. The negotiations can result in a great contract, but if there is nobody to govern the relationship in a professional manner will the engagement be doomed to fail. Creating a culture of mutual trust and a client and vendor which are willing to both give and take are important pre-conditions for a mutual beneficial outcome.
Right competencies and leadership of buyer. In many cases will line manager which previously managed an outsourced department be appointed as a contract manager. In other cases are activities and/or knowledge outsourced which (in hindsight) are required to align demand with supply. Defining upfront which knowledge, capabilities and skills are required to manage the engagement at strategic, tactical/functional and operational levels is thus key. Do also not assume by default that a line manager has the knowledge and skills to successfully manage a complex sourcing relationship.

Can China and India sustain its position as an attractive destination, part 2

2009-06-25T18:16:00.006+02:00

In this post I discussed how tolerance of a people influences the overall development of a country and thus also its attractiveness as an outsource/ captive destination.

This article explores a bit the history behind the exclamations that this is the ‘Century of Asia’ and what this again means for Asia as a destination to offshore activities to. First remark regarding the exclamation is that there is no homogenous Asia. Asia is a continent and countries within it develop at different speeds. Vietnam is not China and The Philippines not Cambodia.

Second remark to this is that the ‘Century of Asia’ was for the first time exclaimed in 1905 by the Japanese when they defeated the Russians in a famous naval battle. The second time the term was used was in 1911 when nationalists overthrew the Chinese Empire. After Mao kicked the nationalists out in 1956 there was another opportunity for Asia to become more prominent, but mess ups by the communist government (e.g. Great Leap Forward, cultural revolution) ensured that only in the 70s and 80s Asian tigers like Taiwan, Hong Kong, Singapore and Korea would set Asia on the economic world map.

So I guess it is fair to say Asia is in its second century as a rising star as 1905 is already more then 100 years ago.

In the previous post I mentioned that innovation and a dynamic economy are required to remain at the head of the pack. If you come from very far it is not that difficult to double for example the productivity every decade. It gets hard when trying to get from 90 to 95 percent and at that point you have to rely on the capabilities of an economy to innovate. China had in 1980 a productivity of 5 when putting the productivity of the U.S. at 100. In 2008 it had grown to 20, a big increase (time 4), but still lagging 80 percent on the U.S.
Two of the challenges of China will thus have to address in order to retain its attractiveness are a) bridging the productivity gap b) gets its productivity to grow at least as fast as its wages do. The core challenge is however how to change from a country that copies into a country that innovates.

Japan for example was capable to increase its productivity between 1950 and 1990 to 90%. It did this by absorbing a lot of technology from Western countries, but at the same time forgot to develop enough capabilities to innovate instead of copying. This is reflected in Japan not being able to get to the 100% in the last 20 years, the number to beat. With wages on the rise in both China and India is transforming the economy from a population that executes pre-described activities into one that starts inventing new products and services by themselves one of the key long term challenges to address.
India has in this aspect also some advantages over China (e.g English language skills) but also some disadvantages (in China 90% can read/write, in India 45%). The typical worker in China is also less likely to demonstrate if he/she does not like something, while in India I was warned not go to some area’s a couple of times as a big demonstration/ strike was expected. And in India a demonstration typically means that not a single window in the street used for the march survives.

But if the government facilitates entrepreneurs and researchers, both China and India can become at par with Western countries in say the next 20-25 years and overtake some in another one or two decades. Chinese, Indians and most other Asians are eager enough for it (when did we loose the same drive in Europe?). So my expectation is that both China and India will remain attractive outsource destinations for the next 10-15 years due to their still untapped potential of young eager workers and rise of a new generation of entrepreneurs.
As both develop further it remains however to be seen especially for China whether they fall into the trap Japan went before them: not being able to transform from a copy machine into an innovation engine.

Can China and India sustain its position as an attractive destination, part 1

2009-06-23T14:58:00.003+02:00

There were two publications in the Dutch newspaper NRC which caught my attention as they are relevant from a sourcing perspective. One of the articles was about why the United States is a ‘hyper power’ and why China is unlikely to become that anytime soon and the other one about the rise of Asia in general. I will briefly discuss the core of both articles and discuss their relevance to Asia as a destination for outsourcing and setting up shared service centres/captives.

Amy Chua (professor at Yale University) investigated how countries become so called ‘hyper powers’ and than fall. She investigated the rise and fall of the Roman empire, Persian empire, Tang empire in China, Mongolian empire, Dutch empire and the English empire. The main finding of her is that tolerance towards people with other believes and culture is one of the main preconditions to become a hyperpower. One of the reasons the United States was/is a hyperpower is their tolerance towards its inhabitants and importing well educated foreigners to boost its capabilities to innovate.

She points out that the lack of tolerance within China for non-Chinese will be a reason why China cannot become a hyperpower like the U.S. The Chinese are too nationalistic to exceed the U.S. in terms of innovation, dynamics, creativity and technology. And these characteristics are required to dominate from an economic or military perspective.

After staying in India for a year I can say that Indians are a very proud people, but that I never felt left out or being looked down on. On the contrary, the typical Indian is open minded and wants to learn as much as possible from Western countries. The ‘disadvantage’ India has over China is its very complex and slow democratic system which limits the speed the infrastructure, government and education system is changed.

So what does this mean for offshore outsourcing and setting up a captive? In the near term there are no effects as the main reasons to outsource to China is the low cost of labour. But low cost is not a sustainable competitive advantage as other countries are or will be cheaper as China develops itself further. Retaining the position of an attractive outsource and captive destination requires them thus to innovate and that requires a dynamic and open economy. The question is thus whether the strong national sentiments will be replaced for a more open and tolerant society enabling them to become at par at Western societies.

From the perspective described above am I a bit more positive on the outlook for India even though it still uses the cast system to suppress large numbers of fellow Indians and its nationalism. It is however much more tolerant towards other religions (Buddhism, Jainism, Sikhism, Christianity, Zoroastrianism, Judaism and Islam) than China. I believe that this tolerance is one of the pro’s India has over China. Question is how important this factor turns out to be in their race to become a dominant global player.

Part 2 of this post will follow later on this week and will give another angle on the ‘age of Asia’ and whether and when China and India can be expected to surpass Europe and the U.S.

Subject which should be on the agenda of vendors, part 2

2009-06-22T11:06:00.004+02:00

This post continues the my thoughts on the subjects top management of BPO and ITO providers are busy with these days (except for getting (profitable) new clients in and getting existing contracts extended) The first part can be found here and discussed the most pressing agenda points. These were margin pressure, reputation (e.g. Satyam scandal) and legislation (e.g. making offshoring more expensive for U.S. companies). The two last pressing short term topics in my mind are access to capital and adaptation to new business models. The two last topics are also important, but not critical.

Access to capital
There was a lot of M&A and other activities the last couple of years which required access to non-equity capital and a good deal of the demand for bonds or other forms of debt came from ITO and BPO/KTO service providers. Some indications that there is serious need in the market for capital in the near future:

More than €2 trillion ($2.53 trillion) worth of public sector, corporate and financial institution investment grade-rated debt will mature in the next two years, forcing companies and banks to come back to market and refinance the bulk at costs higher than ever before (Financial News Online, 27 October 2008)
Businesses in the UK will have to repay £110 billion in debt during the year ahead, figures show (Chartered Institute of Management Accountants, 5 January 2009)
According to the EU's Eurostat statistics agency, non-financial sector liabilities excluding shares and other equity stood at 128 percent of gross domestic product in the euro area just before the credit crisis reached its worst point last fall (ABS CBN News, 18 January 2009).

These bonds and loans have typically an expiry date, but are not always paid in full by the end of the term. This means (part of) it has to be refinanced. But access to capital is now a total different ball game compared to lets say 2007. The type of business outsource service providers are in is characterised by a high level of competition and low margins. Many service providers are struggling to write black figures and the outlook for the industry as a whole is still gloomy. With banks now shier to lend money to a risky business than ever will demand high interest rates, if they provide capital at all. And paying 7% interest to the bank with a margin of 4% is not a sustainable situation.

That M&A activity has not dried up yet completely within the outsource market is indicated by the take over of EDS by HP in July last year and more recently statements by Capgemini that it is ready to make acquisitions in its Outsourcing Services (OS) unit.

Adaptation to new business models
To win clients on more than price alone is it important to develop new business models and new products/services through innovation. Quiet a lot of these ‘innovations’ are marketing fluff or re-branding of existing technologies. Topics that are currently ‘hot’ within ITO and thus have to be adopted by all players are SaaS, HaaS and Cloud Computing. See for my thoughts on these developments also this post. Developments within BPO and KTO are more business function specific, but generally do these ‘transformations’ include the introduction of a higher level of standardisation and automated workflows (so reduce cost through: lower wages by offshoring, automating manual tasks and replacing paper in/output by digital in/output).

Keeping the service catalogue up-to-date as a service providers means investing time and money and that is difficult for players that do not have a well-filled bank account like for example the Tier 1 Indian companies. These smaller companies with less cash can pursue the following strategies:

Focus their resources on marketing, in other words: sell first and worry about delivery later. This is a very risky situation of you are the launching customer and make thus sure to visit at least one reference client during the due diligence/contracting.
Team up with a service provider who has the delivery capabilities already in place and pitch together for clients which require service components you cannot deliver yourself (e.g. one party delivers connectivity, the other party hosting)
Focus limited innovation and marketing budgets by selecting one or two hypes/developments and choose to either not deliver other services or partner with other suppliers for those.

For client companies who read how great SaaS, HaaS, business process transformation and other services are on websites and in marketing flyers:

Cloud computing, SaaS and HaaS are still relatively immature services and lower cost (=higher return) is typically balanced by a higher risk. Be aware of this and be sure to initiate adequate mitigating actions.
Ask for references and make sure the service provider has a proven delivery capability.
Pay adequate attention to ‘what if’ scenario’s: what happens if the service provider cannot deliver as promised? When can you invoke an exit? Who pays what? You might also want to include option pricing techniques when building the business case as it allows for the inclusion of the value represented by postponing investment decisions.

Diversification of clients
The United States remain the largest market for suppliers, measured in total contract value, but it is also the country hardest hit by the crisis. The huge drop in demand combined with a devaluating US$$ against emerging economies, causes major concerns in boardrooms of suppliers that operate from India, the Philippines, China, South-Africa and other developing Currency fluctuations can be covered in a contract, but the dependency of the United States forces offishore suppliers to double their efforts to penetrate the continental European market.

I myself am approached by several Indian service providers who want to get a foothold in Europe and ask for my help. I see on the internet also other initiatives from companies which aim to link Tier 3 offshore suppliers with either potential clients or local Tier 3 service providers. See also this post.

Access to skilled resources
This topic is less prominent these days, but very relevant from a long term perspective. The population with may Asian countries is still young compared to Europe and the United States, but the amount of young people which have an adequate education level and can speak English and other languages at a proficient level is far from limitless. In India do some regions have a very strong accent and when I stayed there I found it difficult to understand some of them. But with the collapse of demand due to the current crisis is there in the short term an abundance of supply, so I expect this topic to be at the bottom of their to-do list.

More in how business and economic trends influence the decision making related to outsourcing and shared services can be found here and here. How business trends drive shared services and outsourcing, part 1?

Subject which should be on the agenda of vendors, part 1

2009-06-17T15:33:00.006+02:00

In this post I want to provide an overview of typical subjects I expect management teams of global operating vendors are looking into these days. I discuss the topic in two different posts as there are several items that the typical senior manager is busy with these days.

Low margins
A combination of the economic situation, new entrants in the market and over capacity results in a permanent pressure on vendors’ margins, especially in the area of ‘standard’ services and products. I expect this to result in a consolidation wave among Tier 2 and 3 players as soon as capital becomes less expensive to come by (so in 1-2 years). This should enable these smaller players to achieve economies of scale similar to the Tier 1 players. A combination of consolidation and a broad service portfolio is how these players earn their living.

Above average margins may be achieved only by innovation, customisation of services or serving niche markets. An in-dept understanding of the client's business and its market will be a key success factor in succeeding in these relative small market segments. These niche markets are typically serviced by small players which, when necessary, bundle their service with those from other niche players within their network to provide a broader portfolio. Their challenge is to get access to clients, innovate faster than the biggies and access to skilled resources.

Specific legislation aimed at outsourcing
In the United States negative national sentiment on offshoring jobs has led in the past already to proposals for legislation on both national and state level (See also: Benvenuto N., Brand D., Managing the Risks of Outsourcing in a Post-Sarbanes World, Information Systems Control Journal, Volume 5, 2004.). More recently is a proposal to increase the tax burden for American companies offshoring jobs (see this post).In Europe similar discussion about the pros and cons of protectionism and market capitalism are also regularly taking place, but did not result in any legislation (yet).

For the European suppliers is there however a set of new rules governing public procurement which could make the life of private sector suppliers more difficult. Under the new legislation, which is based on EU's Remedies Directive (2007), courts will have the power to cancel contracts that breach procurement rules and order a new tender process. The directive has currently still in the phase of ‘consultation’, but is expected to become a law to be implemented by the individual member states in the near future.

Reputation damage
Reputation damage can come in several different flavours and should not be underestimated (just look at what happened to Satyam). Some examples of risks that can result in damage to the reputation and thus future earnings and margin are:

Fraudulent activities. One of the effects of an economic downturn is that fraudulent activities sooner come to the surface. While the whole world is under the spell of the $50 billion pyramid game of Madoff, the Indian market is under the spell of the fraud at Satyam and a bribe scandal at Wipro. Although the fraud by Satyams CEO of $1 billion is nothing compared to Madoff, the effects in India are not any less. As with banks, trust is very important for suppliers and the Indian government already has responded with proposals for additional regulation to limit the reputation damage.
Theft or leaking of customer data. There are various examples of employees from vendors mistreating data of clients. To prevent this vendors go to great lengths to protect the availability, confidentiality and integrity of data as any breach is something any news reporter is more than happy to write about (especially those who see in it an argument not to outsource, like employees of the client organisation are all saints…). Besides a damaged reputation it can also result in legal penalties due to, for example, non-compliance to privacy laws like the Gramm-Leach-Bliley Act (GLBA) or Notification of Risk to Personal Data Act (NORPDA).
Political and other types of instability. Although terrorism is not a recent development, recent attack in India (more than 600 deaths in the last 6 years), the Philippines (10 deaths in six attacks in just the month of July in 2008) and China (several attacks in 2008 with more than 25 deaths as a consequence) have lead to, among other, risk surcharges by suppliers because of higher insurance premiums. I do not expect that countries like Vietnam will now suddenly become much more popular than India as companies that dare to outsource in these uncertain times will opt for the familiar names, both in terms of countries and suppliers.
Negative sentiments among politicians and voters. This item is related to the paragraph which discussed outsourcing and legislation.

More on this subject in part 2 of this post.

Added 21 june 2009: In this post I put margin pressures at the top of the 'worry list' for executives of IT Outsourcing (ITO) and Business Process Outsourcing (BPO) service providers and a couple of days after I red this piece in which Gartner warns for bankruptcies among service providers due to price discounting. I think especially European and American service providers which do not have enough low cost delivery capabilities will be the ones to put on the ‘watch list’ as they are likely to have the largest deficit between earnings and operating cost. See also this post.

Outsourcing within the healthcare sector; comparing Belgium and The Netherlands

2009-06-15T18:48:00.007+02:00

I recently red an article in a Belgium newspaper (‘De Morgen’) in which labour unions successfully blocked the proposed outsourcing of sterilisation services of hospital AZ Groeninge. After several weeks of protests by employees and labour unions the management of AZ Groeninge decided that outsourcing was off the agenda, now and in the future. Even though only 30 people were in scope of the outsource engagement did the management have no other choice but to kowtow to the workers and walk away from the idea.

In this post I want to write about two little countries within continental Europe, which share almost half their borders, but are different in many ways. One the differences is the way elements of market capitalism are adapted and outsourcing/shared services is used to improve effectiveness and efficiency. For those non-European suppliers who want to get a foothold here in Europe, it provides an idea of the complexity and cultural differences of the 20+ countries that make up the European Union (I could make it even more complex by including that there is no homogenous Belgium in terms of language and culture, but three different sub-area’s all using their own language and having their own culture, but I won’t do that as only Belgians themselves can really understand and appreciate their political and cultural complexity).

Anyway, outsourcing and shared services within Belgium is not a very popular subject within any sector that is (semi) government related. Outsourcing in the profit sector can however enjoy good adaptation levels with 76 % of respondents in an E&Y research (2008) outsourcing maintenance activities, 73% logistics and 68 % IT.
Where it comes to outsourcing and government Belgium however follows more the sentiments in France where politicians also find it hard to sell and implement the idea that the social welfare system created in the last 40 years becomes way too expensive to maintain and has to be amended. This also explains the higher penetration/support of labour unions among workers in Belgium compare to The Netherlands (plus Belgium has more blue collar workers than us, we have a more service oriented economy).

The role of politicians
The difference in views on outsourcing starts with the politicians. Where in the Netherlands the majority of the politicians see outsourcing and shared services as a useful means to improve productivity and is widely deployed, see many Belgium politicians it as a threat. There its is part of a trend leading to a more ‘commercialised’ healthcare and this is something many politicians with a socialistic background are against. This means that key figures of several political parties where marching among the workers of AZ Groeninge when they were demonstrating against the proposed outsourcing.
The result is that only a couple of Belgian government related organisations were able to outsource activities, including Belgacom (telecom) and the Vlaamse overheid (Flemish government). To pull this off the management teams had to spend a LOT of time with labour unions and workers counsels.

In the Netherlands is outsourcing and shared services a much more widely embraced phenomena at all government levels (from the Ministry of Defence to small local governments) and is it very rare that government workers organise strikes and marches to prevent them being outsourced. Some outsource examples from the Dutch heath care sector: hospital Viecuri in Venlo outsourcing the preparation of warm meals; Hospital Emmen outsourcing its logistics, AMC in Amsterdam outsourcing its logistics and sterilisation and Accounting Plaza providing financial services to Mediq, Leids Universitair Medisch Centrum and Rode Kruis Hospital.

What helped within the Netherlands was new legislation which allowed for profit and government organisations like hospitals to work together. These changes have been implemented only quiet recently so I expect more outsourcing and shared service related activities within the near future. Within Belgium the politicians are for the time being too busy discussing over the future of Belgium itself to have any time for serious reforms of their (healthcare) system.

My advise to foreign suppliers
For those foreign ITO and BPO suppliers aiming to penetrate the European health care market and wondering whether to start in The Netherlands or Belgium/France: the safest bet for now is The Netherlands, but do not forget that everything has to be in Dutch. No English allowed. Not a single word (I'm not kidding on this one). So teaming up with a local player or investing in setting up a local front office is the only way to penetrate this (lucrative and growing) market.
Still want to go for the Belgium market, please do but do not forget that every document there has to be in Dutch and French (and in the eastern parts of the country also in German). So make sure to include a reservation in your business plan for language lessons...

Is the mighty Chinese dragon threatening the Indian outsource suppliers?

2009-06-12T12:26:00.003+02:00

I get positive signs from clients and research firms (even though I am a bit sceptical on their reports, see here) on the performance of various Indian suppliers. They continue to mature and this also helps them to penetrate the continental European market further. Why? One of the differences I see between American outsourcing engagements and European/Dutch projects is that in America it is not uncommon to have a contract stating the scope as “50 IT employees performing network management”. The company basically hires resources and maybe somewhere in the future the contract changes into a more sophisticated model where the client demands certain functionalities and quality levels (e.g. providing 100Mb network bandwidth to desktops with a response time of X and an availability of Y for price $$ per connection).

In The Netherlands at least (and I think the same applies for Germany and France) we typically start with the second type of ‘service description’. We focus here less on resources, but more on deliverables, processes and performance indicators. But what has this to do with China versus India? Well, quiet a bit as I expect that Chinese vendors which are now starting to penetrate the outsource market in the U.S. will come and visit us Europeans in a couple of years (after practising and learning from their engagements in the U.S. like the Indians did before).

My main interest I want to explore in this post is however what the effect will be of China differentiating it offshore production capabilities into the service industry. There are still very strong ties between the Chinese government and the corporations and if the central governments decrees: we want to become a serious destination for IT or BPO services, I believe that India has something to be seriously worried about.
Here China can also play out one of its ‘advantages’ over India: it is not a democracy and if China puts its might behind something (and a couple of billions of its reserves) things could get ugly fast for the traditional ITO and BPO destinations. Of course does India (and many other countries) have a huge advantage in terms of language skills and experience, but China always plays for the long run. They do not think in one or two years, but in ten or twenty years.

That China is also starting to probe into the service market is demonstrated by China's Neusoft which entered the group overperformers of Black Book’s 2009 survey. So China is already getting slowly into the market traditionally dominated by India and a few others, but I wonder what will happen when China starts to align its education, infrastructure etc with the aim to become a service industry. I believe the board members of TCS and Wipro have then really something to worry about (instead of the tax ideas from Obama, see previous post).

Are Obama’s offshore tax plans good for Indian suppliers and Mexico?

2009-06-12T11:14:00.002+02:00

India is still the main offshore destination for those companies that want to deploy labour arbitrage to reduce their cost. This approach to reduce cost by replacing jobs in the U.S. and European countries with jobs in Asia and Africa is not something American and European politicians like to see (now even less then before). This political sentiment is demonstrated by among others president Obama who is thinking about ending tax breaks for companies that "ship jobs overseas. What the effect could be on offshore suppliers is however not clear yet. Most likely he wants to eliminate U.S. multinationals' ability to deduct business expenses associated with overseas operations while deferring tax payments on profits earned abroad (companies don't pay taxes to the U.S. government on income earned abroad until they bring the money back ('deferral').

In that case companies with their headquarters in the U.S. and delivery centres (shared service centres/ captives) outside the U.S. would be affected. These companies can be divided in two categories:

American companies which own captives in other countries (e.g. GE, American Express, Proctor & Gamble) and,
American companies which provide outsource services from the offshore locations to among others U.S. clients (e.g. IBM, Accenture)

Indian, Chinese, Vietnamese and other suppliers, not having their HQ in the U.S. are not or much less affected (unless Obama wants to include ‘outsourcing’ as a whole within the scope of its new tax rule). In this last case it would be very difficult to implement as ‘outsourcing’ is a very broad term and can include also manufacturing of clothes, car parts, washing machines etc. I mean, where would the legislation it start and where end? And which large new administrative government organisation is going to exercise control? (it would create a lot of jobs however…)

So what can the companies owning captives in other countries do to evade the new ruling? Well, one of the things that pops to my mind is selling of the captive to a local supplier and shift to a ‘classic’ outsource model. This would only work of course of ‘offshore outsourcing’ is out of scope.

If offshore outsourcing gets into scope, I guess that Mexico will become an even more popular destination as it is nearshore and within the NAFTA (North American Free Trade Agreement). Within the NAFTA there should be free trade of goods and services and I expect Mexico therefore to be unaffected. Expect TCS, Wipro and many other offshore suppliers in that case to start invest heavily in Mexico and Canada soon (and an increasing desire of Middle American countries to get into the NAFTA).

But as I think that including ‘outsourcing’ within the scope of the new tax ruling would make things far to complex do I have to agree for now with the statement of the CEO of Infosys on this matter: "Right now, I do not see any impact on our business" and he further mentioned that he would continue to monitor the situation. I will do the same from my end.

Sourcing advisory, which services are out there, part 2?

2009-06-10T13:23:00.010+02:00

This post is a follow up on this post in which I started with an overview of the different types of sourcing advisory services out there. This post continues with an overview of the different services. In a future post I will look into the (dis)advantages of the delivery models deployed by sourcing advisory firms and where I think sourcing advisory services are heading too in the future.

Tax Advisory: when outsourcing activities in many countries or setting up a captive in another country it might be wise to ask a tax specialist for help. Tax specialists can help with some financial reengineering allowing for a reduced slice of money going to the government and with ensuring the company does not run the risk of breaking any country specific tax laws. These services are provided by Big 4 firms and boutique firms.
Pro’s: optimizing the tax structure can potentially reduce the total cost of ownership of the engagement and make sure the company stays compliant with country specific tax regulations.
Con’s: This kind of services is only relevant for large, multi country sourcing engagements or when setting up a captive in another country. Large multinational companies might also have this type of knowledge in-house.

Sourcing governance advisory: Setting up an adequate retained organisation is one of the key success factors for any sourcing engagement (SSC or outsourcing). There are several types of advisory and other services in this area:

Designing and implementation support of governance framework. This kind of work is typically executed parallel to the actual outsourcing or establishment of a SSC.
Designing and (temporally) running the retained organisation (e.g. TCS for IT InBev, Accenture for IT of ING Netherlands). In most cases there is a multi vendor strategy and a third party is asked to provide the role of integrator. This service is also sometimes refered to as Managed Service Provider (MSP)
Providing reporting services over the SLA’s by collecting data from the vendor(s) and integrating it into a comprehensive report.

Pro’s: As said is adequate attention to managing the relationship one of the key ingredients for a successful and lasting outsourcing and shared service centre. There are various best practises and proprietary models out there that can help you (e.g. eSCM, ISLite, SGF)
Con’s: There is a tendency (within some Dutch companies at least) to opt for a more ‘light’ retained organisation where in the past whole departments where established with elaborate processes and new role/function descriptions. An overkill of processes and procedures may reduce the return on the engagement (more is not always better).

Sourcing Research Advisory: there are various companies out there which provide data and information which can be useful to guide sourcing decisions (e.g. Forrester, Gartner). Some of the data available is:

Overview of vendors and a their ranking,
Overview of near/offshore country destinations and their ranking,
Overview of outsoureable activities and where they are in their lifecycle.

Pro’s: If done well the information provided can support the decision making on whether or not to outsource certain activities, or select a vendor or country.
Con’s: Many service providers spend part of their marketing budget on research companies and one can thus question the independence and thoroughness of the results (an interesting piece in this topic can be found here). If the research companies would include experiences from client companies dealing with certain 3rd party suppliers and countries, those rankings would become much more valuable than they are today.

Auditing Services: this type of services includes also various sub-services which might be useful during various stages of the life cycle of an outsourcing engagement. Some of these relevant audit services are:

SAS 70 type I and II assurance reports, including ISA 402 and ISAE 3402. In this case will third party auditors (in general from the Big 4) perform an audit for the 3rd party and assess the control maturity of (a part of) the delivery organisation. More on that topic here

and here.

Assess the control maturity of a 3rd party using a specific set of controls and control objectives. The scope and thoroughness is typically less compared to a SAS 70 and the project is normally not executed by a certified auditor. It is more an assessment than an audit and is thus in most cases cheaper, but also less detailed in its findings.

Audit/assessment during the due diligence. Some clients send their own auditors to get an idea of the control maturity of a 3rd party they want to do business with, while others hire a advisory firm to do an audit/assessment.

Pro’s: Auditors can provide a very thorough insight into the control maturity of an company. Assessments can provide basically the same insight, but at lower cost (and lower level of assurance). Use auditing services thus only in area’s of high risk and use other control mechanisms to gain assurance over area’s of lower risk.
Con’s: Auditing is expensive and auditors approach the matter often from a very theoretical perspective, disregarding the needs of the day-to-day business. I see guys/gals in their twenties with check lists in their hands looking very black & white at evidence and without one hour of real business experience on their resume. To me is the cost-benefit ratio of these audits therefore often negative. The concept behind auditing is however very valuable, but the potential is often not realised.

Mediation Advisory: Like with any relationship can things go wrong and where couples can go to a therapist can client and vendor opt to get a mediator to repair the relationship. In my experience is this a valuable service and I expect I high demand for these services in the coming two years as there is quiet some outsourcing activity in at least the Dutch market and these deals are quiet often of the type ‘speed sourcing’. And fast does not always provide enough room for quality.
Pro’s: Already mentioned before.
Con’s: None that I know of.

Nearshoring by Dutch (and other European) companies: attention points

2009-06-08T14:53:00.007+02:00

This post is based on the answers I gave on questions from the Dutch IT website Computable on nearshoring. They have a couple of expert groups and one of them is on outsourcing and I provide comments so now and than on topics related to outsourcing. You can find the expert site here (Dutch) and my profile here. As nearshoring is a relevant topic for many continental European companies hereby the questions and answers in English.

Question 1: What are the most important considerations and attention points for Dutch (client)organisations to decide for nearshoring?
Answer 1: Nearshoring of activities introduces a number of extra risks on top of the generic/inherent risks associated with outsourcing. These additional attention points are among others:

the difference in language and culture,
other laws and regulations (e.g. tax and privacy laws),
political stability (e.g. North Africa/Jordan, Ukraine, Balkan countries),
redundant employees (when nearshoring they are not always transferred to the 3rd party),
and the increased difficulty to control a 3rd party when increasing the distance.

Question 2: Nearshoring is, like any other type of outsourcing, not always going as originally envisioned. What are the typical pitfalls of a nearshore project?
Answer 2: Nearshoring can fail to deliver the expected benefits due to the same reasons that affect ‘traditional’ local/onsite outsourcing engagements:

too high expectations of the client,
too many promises from the supplier,
lack of detail of the requirements, and
unexpected costs due to insufficient mutual due diligence.

For nearshoring are a couple of additional elements applicable, including:

higher cost for transferring knowledge and work processes to people who are used to another culture/language/work ethics,
lost of in-dept expertise because local employees are made redundant,
more expensive governance and audit costs due to distance/culture/language/work ethics,
faster than expected rising of labour cost due to faster economic development/ shortage of skilled resources.

Question 3: Are there certain advantages of nearshoring in contrast to outsourcing within The Netherlands or to offshore locations?
Answer 3: The advantages of nearshoring over delivery by a pure local 3rd party are mainly lower labour costs, reducing the human cost factor of the service/product. Secondairy advantages can be access to language or other skills/knowledge which are not widely available in the local market, plus in some cases tax benefits if nearshoring results in opening a new delivery centre.

Compared to offshoring are the benefits of nearshoring more cultural fit and less timezones to cross (even though both are that relevant anymore these days, but just something to be aware off), and nearshore destinations within the European Union provide a more uniform tax and regulatory framework (but there is still a lot to wish for in this area). This is especially important if handling/storing/accessing privacy sensitive information (e.g. personal) is in scope of the service provisioning. The last point is more expensive communication lines (network bandwidth) and higher probability of a network incident (examples here and here)

Question 4: Which Central- or East European or North African country would you recommend and why?
Answer 4: There is no easy answer to this question as it depends largely on the type of service. For some services (e.g. managing databases with client information) is it better to choose a nearshore location in Europe (offshore is also possible, but requires a more expensive solution to ensure confidentiality of the data) as there is European privacy legislation which allows for transportation of personal data within the EU, but puts a lot of restrictions on access by other countries (with the exception of access by the U.S. it seems). In that case is Poland a valid option.
For software development is Egypt a country which can be seriously considered as it is developing itself into a serious alternative for IT related services. This view is supported by Wipro and TCS, two mature Indian suppliers, which have chosen Egypt as a delivery destination (Wipro already having some 100 seats there, while TCS is planning for some 400 seats).

Sourcing advisory, which services are out there, part 1?

2009-06-08T11:27:00.010+02:00

Sourcing advisory has come a long way and there are several well established (boutique) players which providing a broad scale of services. There are basically three types of advisory firms:

Independent one-stop-shop. Firms like KPMG, PWC and Deloitte have a broad spectrum of skills and knowledge, including people which focus on sourcing advisory, tax and SAS 70 assurance.
Independent niche players. Firms like Equaterra, TPI, Quint Wellington Redwood, Everest Group, Gartner and many more focus on helping clients with the design & implementation of a shared service centre or finding a suitable vendor to outsource certain activities to. Other nice players focus on helping clients to draft an adequate legal contract, deal with specific HR topics, benchmarking or optiming the tax structure of the deal.
Supplier-dependent niche players. Suppliers themselves have sometimes (small) departments which also provide advisory services in the area of outsourcing (e.g. setting up a sourcing governance framework, making a business case)

I already summed up the majority of the services that are provided by these firms when writing on the types of advisory services I identify, but hereby a repeat and with some additional info:

Strategic sourcing advisory: optimizing the value chain from a strategic and holistic perspective. Outsourcing is seen as one of many ways to create more value.
Pro’s: The core business of these firms is not making as many deals as possible and may thus offer a more balanced view on the scenario’s available to optimize the value chain.
Con’s: If the best scenario’s turns out to be outsourcing, the client might have to engage another advisory firm to support the outsourcing itself.

‘Traditional’ outsourcing advisory: the bulk of the advisory revenue is in this area: drafting a business case, supporting with the selection of a suitable vendor, creating the exhibits/schedules of the contract, supporting the negotiation and facilitating the client during the transition/transformation.
Pro’s: These companies have typically a lot of experience with driving outsourcing projects and know how to mitigate risks related to pricing and quality.
Con’s: Outsourcing is for these guys their bread and butter and thus the solution, they rarely question a decision to outsource. This might result in painful situations after the advisors have left. They also typically focus 90% of their time on $$$, and the requirements (activities/quality) and might thus miss other important area’s (e.g. how to ensure regulatory compliance in an efficient and effective manner).

Benchmarking advisory: comparing the current cost and/or quality levels of a company with peers can provide valuable information to build an initial business case or to check during the contract term whether the rates of the supplier reflect prices paid by the market.
Pro’s: Benchmarking allows for a ‘health’ check of the organisation and can be used for many more purposes than just outsourcing. As the terms of outsourcing contract are typically between 3 and 10 years are benchmark clauses useful to enable midterm adjustments.
Con’s: Some smaller benchmarking companies draw conclusions based on a too small group of peer companies, significantly reducing the value of the outcomes. Another disadvantage is the limited ability of taking non-standard services and quality levels into account. This also can reduce the usability of the outcome substantially.

Legal advisory: many lawyer firms have also discovered that outsourcing is a lucrative market and have created practises which specialise in drafting (Master) Service Agreements (MSA), which capture the essence of the deal in legal clauses. These services are typically used by clients as the 3rd parties have specialised lawyers which do this kind of deals on a day-to-day basis.
Pro’s: Most legal departments of client companies do not have the knowledge to draft an outsource contract or know what the pitfalls are if the client decides to work with a contract provided by the 3rd party. I recommend that clients should only consider using a contract from the 3rd party (and make amendments to it) in case of simple standard services or products. In situations where the client is outsourcing services/products with a high risk/high $ value, I advise to hire a specialised lawyer and let him draft the contract (specialised firms have a standard template to start working from).
Con’s: These guys/gals are expensive and they do in most cases not really know what an IT or Accounts Payable process is about. This means that the lawyer has to work closely together with other (advisory) specialist to create the necessary exhibits/schedules and to align these with the MSA. Another risk is that all kinds of operational items end up in the MSA because the lawyer does not want to miss anything.

HR advisory: especially within Europe can the labour laws be quiet complex and strict. In those cases where a lot of employees are in scope of the planned outsourcing do both the HR department and the labour counsel hire advisors specialised in HR & outsourcing.
Pro’s: Like with legal is HR also a subject that has some specific attention points related to outsourcing and most companies do not retain specialised knowledge in this area. Hiring this kind of services reduces the chance of missing important attention points and also allows the workers counsel to provide a well balanced advise on the matter.
Con’s: None that I know of.

More on additional sourcing advisory services in a future post and also on the advantages and disadvantages of the different types of advisory firms.

Centralising versus sharing, and why the difference matters

2009-06-03T21:37:00.003+02:00

The term ‘shared service’ is very popular as companies see it as a means to reduce cost through economies of scale. The same principle is at work when opting for centralisation, but there are distinct differences. This post describes how shared service centre differ from centralisation and why it matters to make this distinction.

What do sharing and centralising have in common?
Common ground 1: I found among others the following definitions they are an indication that both terms are closely related:

Centralisation: is the process by which the activities of an organization, particularly those regarding decision-making, become concentrated within a particular location and/or group.
Shared Service Centre: A shared service centre (SSC) is a centralised business unit that undertakes internal business functions for divisions or subsidiaries of a particular company, rather than having those functions conducted separately

Common ground 2: shared objective is striving for improved productivity of generic (often non-strategic/core) services or products which are used by multiple business units (e.g. accounting, HR, IT).
Common ground 3: execution of objective by standardisation of working processes and underlying IT systems.
Common ground 4: in both cases does the company want to retain the assets on its balance sheet and control over the resources and IP used (contrary to outsourcing).

What are the differences between centralising and sharing?
Different ground 1: Standardisation and sharing requires the stakeholders to agree on a common process and interface description. The decision maker has however typically a different function. When centralising the design is often a directive from a senior corporate/group level manager (accountability is also at group/corporate level) and the decentralised business units have a limited influence on the design.
In a shared service centre is it more a joint effort by business unit managers (and CxO as a sponsor) and drives a manager appointed by the heads of the business units the design and implementation of the centre.
Different ground 2: centralised activities are more difficult to spin off or outsource than a shared service centre as the latter one has clearer governance, legal structure (separate entity) and financial configuration (own balance sheet, P&L). So activities that are considered to be value add and potentially interesting to spin off, sell or outsource are typically put into a shared service centre.
Different ground 3: centralised activities are typically performed at the same location as head quarters or other staff/corporate functions, while for shared service centres often near- or offshore locations are considered to further reduce cost through labour arbitrage.
Different ground 4: the business units receiving services and products from a centralised department typically don’t have to pay for it (apart from a yearly charge for ‘corporate overhead’ using standard keys) and the department is typically managed as a cost centre. Shared service centres can start as a cost centre, but typically evolve into a revenue centre and even an investment centre. Business units typically pay for actual use and may have the option to buy the service/product from an external vendor if the shared service centre does not charge market conform prices.
Different ground 5: to achieve further optimisation of quality and price can a shared service centre opt to outsource part of its activities while is this not very common when centralising.
Different ground 6: a shared service centre has always more than one business unit/process as a ‘client’ while this is not always the case with centralised activities.

The Do’s and Don’ts of sharing and centralising
Tip 1: Centralising or sharing a function does not mean that all related activities should be concentrated. Those activities that are very close to the essence of the business process/unit are best kept decentralised (e.g. financial reporting for decision making). Discuss the scope of the activities that can be shared/centralised with the relevant stakeholders.
Tip 2: Start with transactional activities (e.g. accounts payable). These are typically the least business process/unit specific and allow for relative low risk, limited scope initiative which, if successful, paves the way for increasing the scope to include more complex services/ products.
Tip 3: Don’t try to build a moon rocket the first time around. So do not try to transfer multiple country, design and implement a new process model and build a new high-tech IT system all in one go. Use a phased approach, one step at a time.
Tip 4: Do not set up a shared service centre in an offshore location (‘captive’) all by yourself if you don’t have extensive international experience as a company. Consider in that case to have a local service provider to setup the captive under a Build Operate Transfer model (BOT).
Tip 5: Involve those managers that are directly affected by the reorganisation from the earliest moment possible. This means the CxO defines the high level roadmap/direction and involves from that moment on all his direct reports to define the scope and (high level) design principles.
Tip 6: consider whether ‘broken’ processes should be fixed first before being moved or the other way around (move, then fix). Both have their (dis)advantages that have to be taken into account.

The question why it matters to make the distinction is already captured in the text above. There are several fundamental differences between centralisation and sharing (e.g. accountability, financial structure, location).
When to centralise and when to share? I think that depends mostly on a) the management culture (centralising is more conservative) and b) whether there are any future plans for a spin off/Joint Venture/outsourcing.

Overview of posts April/May 2009

2009-06-02T19:11:00.007+02:00

I have been blogging for a little bit more then a month now and wrote some 30+ posts in that period. I don't think I can keep up this high frequency but will try. However, I plan to provide monthly overview of the postings of the previous month, divided in a couple of categories. This should prevent readers looking for certain information to work their way through the whole list... The categories I want to start off with are:

Sourcing, its risks and opportunities. This post describes the outlines of a framework aligning value creation (e.g. increase productivity) and outsourcing. I argue that an outsourcing engagement should primarily be steered on output performance (e.g. value drivers) and less on activities. Measuring value also means discounting expected future cash flows, but many companies still use one Weighted Average Cost of Capital (WACC) to calculate the NPV of outsourcing initiatives and other (des)investment decisions. This despite the higher average inherent/gross risk level of outsourcing decisions. This post provides guidelines to for a more sophisticated approach.

A couple of other posts are on different types of risk and how they relate to outsourcing. One of them is about legal and compliance risk. This post also looks into compliance risk, but provides guidelines to implement a control framework to monitor regulatory compliance by a third party more efficiently. A widely used and misused control/assurance tool within the outsourcing world is the SAS 70 report and its successors ISA 402 and ISAE 3402. You can read more on these types of assurance reports here and here. Besides legal and compliance risk are project and financial risk also important risk categories that have to be considered when outsourcing (not to forget operational and strategic risk, more on those in future postings).

Sourcing, an economic crisis perspective. Many third parties are also feeling the effects of the economic crisis and it doesn’t matter whether you are part of the first outsource wave (products) or second wave (services). There are only a few service providers which will show record figures in 2009 and most of them are in the area of Legal Process Outsourcing. More on this subject here. In another post I give a couple of examples where U.S. companies lay off people more easily than over here in Holland, and I wonder whether a fundamental different view on managing 'human resources' is also holding back offshore outsourcing in continental Europe.

For those companies which seriously consider outsourcing as one of the tools to whither this storm I summed up a couple of do's and don'ts here. Many companies have already existing outsourcing contracts and early renegotiation or the an exit and transition to another vendor could potentially be very beneficial as third parties are fighting over any contract out there in the market. Could it be an option for your company too and can European companies get a better deal than Americans? Some companies are even hit so badly by the economic crisis that they are forced to sell off any assets they can, including shared service centres. When is this a good idea and when not?

Sourcing, looking in the crystal ball. The third wave of outsourcing is about countries and companies securing access to food and other basic resources. Does this mean that whole countries should now be considered to be a 'supplier'? In another posting I give my thoughts on the the ability of Africa to become the next big continent for offshore outsourcing. Although there are countries that are positioning themselves as serious alternatives for upcoming Asian destinations, do I have little hope for the majority of the African continent.
In this post I sum up some of the financial results of some Tier 1-2 players and try to make some projections for the rest of 2009. Insourcing as opposite to outsourcing is another movement in the market which might, or might not gain momentum in the near future. I mean what do you think: the economic crisis drives companies a) to lower thier risk profile thus less outsourcing, or b) lower their cost thus more outsourcing. Who wins? What about the role of strategy?

Sourcing, background info and theories. The total newby to outsourcing can read a bit on its incubation here. How today's global trends influence decision making related to the sourcing of products and services is discussed here and here. These posts describe how shared services and outsourcing can help companies act more effectively and efficiently in today's economic rat race.
The terms 'purchasing', 'procurement', 'sourcing' and 'outsourcing' are not always easy to distinct from each other, but I gave a try here. In this posting I wrote on how a procurement function may add more value to the organisation. Organising procurement as a process instead of a department and increasing the capabilities of the procurement officers lead and facilitate complex sourcing engagements are two of the main recommendations.

Hhhmm, I think the material posted here should provide the average student enough material to write at least two papers and half a thesis. Anyway, more will follow soon.

Outsourcing of farming: is this the next big thing?

2009-05-29T18:30:00.005+02:00

What has farming to do with outsourcing? That was also my initial reaction when I stumbled over this article in the economist. The article however points out that certain governments and companies buy the right to plant and harvest wheat, rice or other plants in countries like Cambodia, China and Ethiopia. The harvest will in this case not become available for the internal market, but is exported to the country/company ‘leasing’ the ground. The author calls it the ‘outsourcing’s third wave’ and the main question discussed in the article is whether this is beneficial for the country which provides the crops, or just another form of neo-colonialism. This is not the issue I want to write about, but more about the signs that ‘sourcing’ becomes more and more a (geo) strategic topic, with governments taking the role of ‘customer’ and ‘supplier’.

Outsourcing was started of with in the seventies (see also this post) by Western companies trying to cope with influx of low cost/high quality products from Asian countries and followed by the outsourcing of services (2nd wave, enabled primarily by developments in technology/communications). The players in these first two waves were companies, with governments either facilitating it (e.g. opening India again two decades ago) or limiting it (e.g. President Barack Obama announcing new proposals to end tax breaks for American companies that outsource jobs offshore). The role of the government within this third wave is however completely different. Both companies and governments act this time as ‘client’ and ‘supplier’ and the stakes are very different. This third wave involves access to strategic resources which fulfil basic human needs like food, (bio)fuel and water. With water being even more precious than food, are tensions between governments in dry countries sharing a river a logical result.

That the importance of food is on the rise is also reflected in new investment products being introduced by financial institutions. A recent example is the Swiss asset manager Pictet & Cie which introduced the agriculture fund PF (LUX)-Agriculture fund. They expect that the role of companies involved in food and agriculture will increase over the coming years (you don’t have to be super bright to make that prediction with a global population which shows no sign of stabilizing).

The same population growth and the desire of developing countries to increase their living standard are driving the trend of governments defining sourcing strategies allowing their population and companies to gain access to resources. But what happens if the two countries disagree?
One of the advisory services I provide is mediating between a company and its external vendor if they are throwing mud at each other. But who can mediate when two countries are disagreeing over the contract? I guess the people at the WTO will not get bored anytime soon…

More on this subject can be found here and here.

Is the next stop for outsourcing Cambodia or Rwanda?

2009-05-26T15:41:00.006+02:00

The Middle East seems to be the next hot destiny for companies to near/offshore too. In a report from AT Kearny indicates that Bulgaria is still relatively ok (from ninth down to 13th place) as a destination to near/offshore too, but that other Eastern European countries lost quiet a bit of ground. The Czech Republic, for example, has fallen to 32nd place from 16th, Hungary to 37th place from 24th and Slovakia to 40th from 12th. According to the report are Asia, the Middle East and North Africa yielding ground, while China, India and Malaysia are the countries to beat.

Within North Africa is Egypt one of the front runners when it comes to attracting companies to establish a centre/captive with TCS being one of the more recent companies investing in that North African country. The main reasons giving by TCS is that Egypt allows for 10-15 % lower costs than India and access to a large pool with skilled professionals. Also nearby Jordan is doing well and another of the upcoming countries is Vietnam.

But which area will be the next ‘place to be’ after the potential in North Africa and the classic Asian outsource destinations has been tapped? Middle and Southern Africa (with the exception of South Africa), is still largely unexplored outsource destinations. This is however already slowly changing as I heard that some Indian (and Chinese?) companies are starting to offshore work related to textile/clothes fabrication to Africa is labour prices in India are on the rise. So one of my personal questions is whether certain African countries will become the new hotspots in a few years or that Asian countries like Burma/Myanmar and Cambodia will be the future winners.

When I was in Cambodia half a year ago I encountered a country which was very busy to put its gruesome history behind and busy with rebuilding. The English of the people I talked with was good enough to have a normal conversation and I expect the average level to increase further during the coming years. This is due to families sending their young children to English lessons after formal school hours (the government does not include English in the standard curriculum). This development and more children getting access to education fuels hope that more foreign investments will come into the country. One of the factors holding back the further economic development however is a corrupt one-party government system which channels most of the economic benefits to a very small group of people. But despite this I see the signs of a middle class which can help stabilising the system and maybe work as a catalyst for more democracy.

I wish I could say the same for most African countries, but somehow I am much more sober about that continent developing compared to late-comers from Asia. The drive and passion the average Asian demonstrates in developing its own economic situation keeps amazing me, even after spending more than a year in Malaysia, Singapore and India.

Political system/stability, safety/corruption, work ethics and the (language) skills of the people are to me the most important enablers for a country to be attractive as an outsource destination. Of course is a decent infrastructure (e.g. transportation, legal/government) also required, but building roads is easier to implement than educating a generation of children. You can find a more elaborate list of criteria to evaluate a country on here and more on individual countries here.

Some other questions I have are more ethical in nature. Will companies from India and China look at the countries with questionable regimes the same way as Westerners do, and how do these views reflect on their subcontracting strategies? And if for example Chinese companies invest in Burma/Myanmar or Zimbabwe, will European companies still want to do business with those vendors? And how can national government ensure that its national companies have no (in)direct relationship with a blacklisted country when sourcing and supply chains become so complex due to all the sub-contracting?
I do not have an answer yet to all the questions above, but the tension between ethics and commercial interest is sure to become more prominent with a growing Chinese economy that utilises different concepts of ‘good’ and ‘bad’ than the typical Western government/companies use.

Why the title on top of this post? Both Cambodia and Rwanda have written a terrible chapter in their recent history books, and had to start building their country almost from scratch after loosing or traumatising a substantial part of their population. I wonder however which of the two will be showing the double digit growth figures on their GDP the coming decade. If I would have to make a bet, it would be Cambodia.

Managing the value of outsourcing initiatives

2009-05-25T15:19:00.008+02:00

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.

Legal and compliance risk: what is the difference and who should manage which?

2009-05-20T22:49:00.008+02:00

One of the key deliverables of the project aiming to get into a relationship with a 3rd party is the contract. A contract typically consists of a Master Agreement and exhibits/schedules. Together they are the legal ‘translation’ of all intentions, obligations and requirements of the relationship. Many of the requirements are related to price, quality, governance, intellectual property, exit and a dozen of other topics.

The topics I would like to explore in this post is the difference between compliance and legal risk. The reason I think this is relevant is the different departments that typically deal with both types of risk. Not having a clear distinction might thus result in two departments managing and mitigating the same risk or not managing certain risks are all as both assume the other department takes care of it.

In more general terms are the following risk categories the most relevant to an outsource relationship (I leave out financial risk, as that is to me the result of any of the risks categories materialising):

Strategic Risk: loss due losing the capability to direct and control the services or due to deliberate, opportunistic behaviour by service providers or their employees (e.g. reusing the companies intellectual property, understaffing, overpricing or other symptoms of “asymmetry of dependence”). Some terms used in this context are ‘concentration’ or ‘composite’ risk.
Operational Risk: failed internal processes, people and systems or from external events. Some are specific for the ‘demand’ side and some for ‘supply’ side.
Compliance Risk: impairment of the companies integrity resulting in damage to the companies’ reputation, legal or regulatory sanctions, or financial loss. Sanctions can be the result of for example non-compliance to privacy laws like the Gramm-Leach-Bliley Act (GLBA) or Notification of Risk to Personal Data Act (NORPDA)Also known as ‘reputation’ risk.
Legal Risk: as the risk of loss to a company that is primarily caused by: (1) a defective transaction; (2) a claim (including a defense to a claim or a counterclaim) being made or some other event occurring which results in liability for the company or other loss; (3) a failure to adequately protect assets owned by the company; or (4) change in the law.

The following one from the Federal Reserve mixes however legal and compliance risk: The risk to earnings or capital arising from unenforceable contracts, lawsuits, adverse judgments, or nonconformance with laws, rules, and regulations. This is one of six risks defined by the Federal Reserve.
This definition I found on the web is also not making a clear distinction: The possible financial loss resulting from an action by a court or by a regulatory or legislative body that could invalidate a financial contract.
Even the Webster’s dictionary mixes regulatory and legal elements: The risk that a legal contract or financial transaction won’t be fulfilled because it breaks the law or there is a regulatory conflict. Other legal risks include documentation or contractual problems.

Or maybe am I wrong and:

are legal and compliance risk the same (and can thus be handled by one department) or
compliance risk should be called reputation risk

But looking at the first hit Google produced, I wonder whether Option 2 is a viable one. The definition given here is: reputation risk is the current and prospective impact on earnings and capital arising from negative public opinion. This affects the institution’s ability to establish new relationships or services or continue servicing existing relationships. This risk may expose the institution to litigation, financial loss, or a decline in its customer base. Reputation risk exposure is present throughout the organization and includes the responsibility to exercise an abundance of caution in dealing with its customers and the community.

I am still confused so I guess the only option is to start some discussions here and there to get some more clarity. To be continued.