The reductions in operational risks when a function is removed do not mean that the total risk exposure of the buyer organization has decreased. There are increased legal, financial and strategic risks as a result of the outsourcing exercise. The agreement between the buyer and supplier organization is a source of new risks. The variation in emphasis shifts operational risk to the supplier; this changes the relationship between the buyer and supplier. In addition there are the implications of the relationship between the buyer and supplier organizations to consider.
Buyer/Supplier relationship difference
The relationship between the buyer and supplier changes with the type of contract or commercial arrangement. Assuming the 12
Chap-01.qxd 3/1/05 12:29 PM Page 13
Common Terms and Concepts Used in Outsourcing supplier is able to deliver the same activities as the buyer but at a lower cost, the difference in costs translates to a profit margin for the supplier. In the outsourcing model discussed in the previous sections, the supplier is no longer required to follow the processes previously owned by the buyer. In this way, the supplier is now free to make modifications to the original process, motivated by profitability.
The buyer and supplier relationship forms a key component that will make the outsourcing arrangement either a success or a failure. The questions that are posed remain relevant in a dynamic buyer–supplier relationship. Some key examples include questions like: What prevents the supplier from compromising on quality and delivering lower-quality work to derive higher margins (gains)? How can the buyer manage the activities of the supplier to ensure that the promises of quality services are delivered? What is the buyer going to do in order to manage the supplier, who will be motivated only to reduce its own costs?
Will the supplier’s methodology be acceptable to the buyer? How is the supplier going to manage its risks and where are the risks going to come from?
This raises the need to have ongoing supplier and buyer governance procedures. When considering the relationship, each party (the buyer and supplier) needs to consider managing their individual risk profiles to within acceptable risk tolerance levels.
As the buyer and supplier interact, components of agency theory apply. In the governance of outsourcing, both the buyer and supplier work in an agency environment. There are various models propounded by researchers and practitioners for managing this relationship. The ‘potential contract’ relationship model addresses the organizational needs of control and flexibility. Here, commercial arrangements including multiple supplier contracts, joint ventures, individual and joint-venture spin-offs, consortia and shared service structures re-emphasize the importance of the quality of supplier–buyer relationships.
Changes in process model difference
‘Changes’ in this section refers to the specific process differences between outsourcing and contracting. To examine the alternative sources of risks within the ITO exercise, changes in the process model are reviewed. The need for control over the processes being outsourced stems from a variety of other requirements, like the need to maintain quality in the processes as well as control of the risks. Managers of organizations are anxious when key 13
Chap-01.qxd 3/1/05 12:29 PM Page 14
Managing the Risks of IT Outsourcing
functions are performed outwith the organization. At the same time, these managers require flexibility in moulding the services in order to deliver optimum service. In a situation where maximum control and flexibility is needed, the buyer and supplier relationship is in a state of close partnership (Figure 1.1).
Flexibility
Outsourcing
Short-term contract
partnership
Figure 1.1
Partial ownership, joint
Relationship
development, retainer
Full ownership
between buyer and
and long-term
contracts
supplier in a
contract setting
Control
(Tho, 2004)
In situations where the need for control is low and flexibility is high, short-term contracts are suitable. Conversely, in situations where the need for flexibility is low and the need for control is high, a full ownership contract is the overriding factor in the agreement. In between these extremes lie alternative arrangements involving partial ownership, joint development, retainer and long-term contracts.
As was noted earlier, to the buyer, there is concurrently greater control over the outcomes of processes as the supplier of services is directly accountable to the buyer for the outcomes of the processes. The benefit to the buyer is, then, a smaller organization, reduced attention to extraneous processes and stricter control over the critical outcomes. When engaged in an outsourcing exercise the buyer organization utilizes the external supplier’s investments, innovations, and specialized professional capabilities. The supplier provides multiple organizations with the services and benefits from economies of scale. This would be prohibitively expensive to achieve for any single organization operating independently. These concepts support the view that activities such as the IT capability, for which the organization has no crucial strategic need, could be and should be outsourced.
An external supplier that can provide superior services is used where service quality improvement, the need for strategic flexibility and the focus on core competencies are primary 14
Chap-01.qxd 3/1/05 12:29 PM Page 15
Common Terms and Concepts Used in Outsourcing concerns for sourcing decisions. The need for quality services and improved operational efficiencies is consistent and remains as the core reason to outsource the IT function (on core competency and economies of scale). In addition, the strategic requirement to focus on core competency has been an additional catalyst for outsourcing services. Figure 1.2 is an attempt to summarize some of the views expressed here.
Specificity/
Degree of customization
Partnership/
High
Made to order
Integration
Mass production
Service
Low
(off the shelf)
provider
Figure 1.2
A model for
Business
outsourcing
value
relationships
Low
High
If the ability to provide business value is mapped against the flexibility or degree of customization required, then several other variants of the relationship appear (see Figure 1.2). High business value and high customization (top right quadrant) is delivered only when there is a close partnership or integration; much like an in-house process unit.
There would be very little business value if the services were mass produced (bottom left quadrant). In a service provider model (bottom right quadrant) where the contracts are made based on commoditized services, business value would be high but relatively lower than in an integrated or partnership model. In a made to order situation (top left quadrant), business value is still low but this would be compensated for by a higher degree of fit, or specificity. The customer or buyer would then have a more-tailored business solution. The model that provides the maximum return is the integrated solution where, together with high specificity or an ability to customize, the services to the buyer organization have a high degree of business value. This outsourcing partnership arrangement is characterized by a constant transfer of operations risk between the buyer and supplier.
15
Chap-01.qxd 3/1/05 12:29 PM Page 16
Managing the Risks of IT Outsourcing
Outsourcing is an almost ubiquitous concept, which is used in different scenarios and in different industries to achieve business benefits including an impact not only on direct cost but on the business and strategic drivers. The strategic impact involves value creation through strategic relationships, freeing up investments, increased flexibility and scalability, and the ability to build on strategic capabilities. For some organizations with high specificity, the significant nature of inseparable supplementary services may warrant the need for internal sourcing to ensure tighter quality control.
The quality of the final deliverable or outcome is dependent on the supplier being able to deliver an improved service compared to services that have been performed in-house. To do this efficiently, suppliers have an advantage over the buyer organization. For example, the supplier has more access to competence in new technologies, access to better IT professionals, and better processes for IT integration and development. In all these models, however, there is still scant detail on how the risks are transferred between the buyer and supplier, what the risks are, when they occur and the extent to which each party can tolerate the risks before an existing relationship is irreparably severed (as a result of the outcomes of these risks).
1.7
Process changes
The processes that are enabled by the use of the IT function are changing and complex. Those that are driven by IT, change as a result of this. Figure 1.3 represents an attempt to summarize some of the dynamics of this change.
Drives
Outsourced function
Systems integration
Business objectives
(IT outsource process)
(IT outsource outcome)
Business
IT function
function(s)
Changing &
Variable &
complex
ambiguous
Enables
Supplier provides
Buyer defines
Figure 1.3
Business functions/processes are the drivers for information technology (IT) development.
IT in turn, enables the creation of more-efficient business processes, including ‘outsourcing processes’
(Tho, 2004)
16
Chap-01.qxd 3/1/05 12:29 PM Page 17
Common Terms and Concepts Used in Outsourcing An attempt made to illustrate the coexistence of IT and business processes in a tightly linked relationship demonstrates interdependence between business processes and the IT function. The organization’s business objectives drive the IT function in order to deliver the expected outcomes – where the IT function enables successful outcomes.
Figure 1.3 consists of two halves. On the left, the illustration shows the IT function enabling a group of business functions.