MASTER THE GAME: application development outsourcing

Negotiating an IT outsourcing agreement is risky business. The results could be critical to the future success of an organisation and enhance or hamper its ability to move with the market. Like chess, each move must be strategic. The tactical key to success lies in the ability to "accommodate the future" because what is signed today could be perilous tomorrow. How do you predict partnership outcomes?

Sandra Van Dijk examines the pitfalls, positives and prayers associated with outsourcing application development.

Buyers beware. The risks inherent in IT outsourcing agreements are many and the implications long-term. However, managed effectively the opportunities for big rewards are too great to disregard.

General perceptions about outsourcing are somewhat optimistic simply because announcements are made in the early days of an agreement amid much fanfare and high expectations.

Failures rarely reach the public domain but when it comes to outsourcing casualties, Business Catalyst International consulting director Bill Broockmann can name a few.

IT outsourcing deals are not a quick fix to internal incompetence, financial pressures or technological weaknesses, he warns, and organisations should take an approach that is both long-term and aligned with business performance strategies.

"As the long-term effects of IT outsourcing can have far-reaching impact on such things as customer service, expense optimisation, market competitiveness and business initiatives it may be appropriate to use an outsourcing consultant to assist in the process as a form of risk mitigation," Broockmann said.

"The customer may not have sufficient expertise in establishing details such as scope and service-level standards in a contract which will skew terms in favour of the provider."

Negotiating an agreement is just the beginning; the outsourcing arrangements have to be managed along with the growing partnership.

Brookmann said it is the customer's responsibility to be vigilant in its management to ensure service providers perform.

Hidden cost

"Industry research has shown that the cost of managing an outsourced IT arrangement is equivalent to the value of three to seven per cent of the annual contract cost, a fact that many organisations do not appreciate," he said.

"It is better to use this spend proactively to achieve the objectives of outsourcing, rather than have it remain a hidden cost incurred in trouble-shooting, recovery, ineffeciencies and disputation; therefore a partnership relationship is essential."

However, there are competing interests inherent in the agreement because the service provider has to make a profit to remain viable.

This leads to the provider seeking to do less within the scope of the agreement while the customer wants more for its money.

As Brookmann points out: "Would you expect excellent ongoing services from the service provider as a matter of course, without any customer framework in place to manage service delivery and the relationship?"

This is where service-level agreements are important but should not be related only to technical performance of the IT infrastructure as all components of business have to be operating simultaneously.

As an analogy Brookmann explained: "For a car to work you need the engine, transmission, and steering to be operating 1effectively at the same time; it's the same with any organisation.

"Performance needs to be aligned to business operations and benchmarking against industry developments on price, quality, and scope of service," he said.

Lack of clarity as to scope definition and specific detail of services to be provided within the contracted price can lead to many additional charges for services that the customer assumed were covered in the standard pricing.

Future imperfect

Work outside the defined scope will inevitably be priced as new services, which can be expensive if the contract does not allow for competitive quotes.

Brookmann said the outsourcing agreement will inevitably lead to cost blowouts if it doesn't cover all contingencies.

Those who can "accommodate the future" when negotiating an agreement will be successful, particularly in the IT environment which is always changing.

While the pricing of services may be competitive at the outset of a contract, they might not reflect any fall in technology prices which occur during the term of the agreement. The result is that the customer misses out on the competitive edge in pricing.

Inflated prices may also be paid by the provider for the customer's IT assets to make the up-front deal more attractive.

However, in reality the service provider builds the recovery of the cash into the price of services over the life of the contract.

"Even if the contract provides for price renegotiation points and price benchmarking, the service providers are much more experienced at exploiting the ambiguities in benchmarking; again this can result in noncompetitive costs," Brookmann warned.

"Unit prices, based on actual usage rather than total capacity, may have been negotiated related to a certain volume of business; if the customer has large growth these unit prices will be too high if there are no price adjustments for volume increases."

Also lying in wait for the unwary, particularly for companies in rapid-growth mode, are the questions of duration and flexibility It can be dangerous to have fixed provisions for a set number of years because the customer requires flexibility as the organisation grows and marketplace dynamics shift.

If the customer does not retain sufficient skills and expertise in-house to set IT strategy the service provider will set the direction offering advice based on different goals.

Companies might also opt to undertake new business initiatives during a contract term that could require skill-sets the service provider does not have. Brookmann believes this is particularly relevant if the outsourcing decision was based on operational services. "The contract may inadvertently lock in specific technologies which eventually restrict flexibility, rather than focusing on the services to be provided, regardless of the underlying technology," he said.

"The service provider may stay with out-of-date technology to keep costs low, whereas the customer's business may be better served by more modern, flexible technology." A simple illustration, he said, is that desktop technology may need to be refreshed every three years.

The service provider needs to be able to inject and maintain skilled resources, but this may be stretched if the provider wins significant new business.

Put simply, the customer needs to maintain IT management capability to manage the outsourcing application development, otherwise an organisation's future direction and security is solely dependent on a provider whose basic objectives are not the same.

Length matters

The length of the partnership is also a factor with vendors promoting longer agreements to accommodate economies of scale over many years with options to extend agreements.

To achieve a long and prosperous outsourcing partnership is great but beware when renegotiating as the service provider may leverage a company's dependence into greater profit.

Remember, at this stage, the outsourcer may own all the technology assets and be the licensee of all the critical software - a situation, Broockmann says, that less scrupulous suppliers could use to exploit a successful partnership. Successful long-term outsourcing partnerships can foster codependencies making it easy to forget the two parties involved work for different companies - a customer and a supplier both wanting maximum profits.

On a smaller scale there is an increasing trend toward outsourcing specialty one-off projects particularly with the rapid growth of e-commerce development and the need to source Web enabling software and specialist skill sets.

Getronics Australia managing director Robin Dixon said application development is growing at a rate of more than 20 per cent a year locally, largely as a result of e-business.

"Companies should focus on their core business which is what they do best, not develop software; outsourcing is the obvious solution," he said.

Interim Technology Associates managing director Bart Vogel agrees: "The rapid pace of IT means it is virtually impossible to retain the necessary skills required all the time."

As head of one of the largest IT recruiting and contracting companies in Australia, Vogel assists organisations needing to source different IT skills for a single project.

A recent Interim Technology project involved the development of a database for a travel company, which then sought to Web-enable its business.

"The databases were the main business engine. To Web-enable it involved two entirely different skill sets for one project and it was more effective to use an external provider," Vogel said.

"The customer has to understand the scope of the project and what work needs to be done, a good brief is essential and removes future problems."

Software projects with specifications are posted on the exchange and software developers bid for the job.

Even here IT managers need to define specs, estimate time and costs and track the work.

Micro-outsourcing seems more suited to straightforward projects and those on the dull side to test the process.

To avoid infringing on in-house capability there is generally no benefit in micro-outsourcing interesting projects that keep staff developers enthused or which need company-specific knowledge of business processes.

Companies can control critical applications and data, leverage their existing portfolio, and attain a set of applications that respond to specific business requirements when they maintain part of the applications portfolio in-house and integrate it with new outsourced solutions.

However, moving away from a totally outsourced solution creates possible integration problems across different packages, which can be expensive.

The risks of outsourcing IT are many and varied and as Brookmann points out: "If these risks are not appreciated and managed, it is unlikely the anticipated benefits will be realised.

"Always consider risk exposures in both favourable and unfavourable scenarios."

Such scenarios should include risks arising from changes to the business as well as to technology and to the outsourcing arrangement failing to meet expectations.

All these risks impact on customer service, expense optimisation, market competitiveness and business initiatives, the driving factors of any organisation.

Like a game of chess each move is critical and today's decision will determine an organisation's future.

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