What Every CIO Should Know About Outsourcing Cost Savings

Many clients pose costs and savings questions to me when they have decided to embark on a large-scale outsourcing agreement:

Can we outsource our IT services this year and ensure we achieve our savings targets for the last quarter?


Lets' talk a little about the realities of outsourcing.

A full-scope sourcing transaction, with its technical complexities and decision-making is challenging and time-consuming to negotiate. It is unlikely you’ll be able to complete a contract negotiations, a full transition and achieve cost savings in the same year -- especially if you are just now starting to think about it. You might be able to source some components in a short time frame, such as Help Desk and Desktop, or your ERP system. But even if you complete a sourcing agreement in a single calendar year, the savings are unlikely to show up until the second year, and then, only if you manage the arrangement properly.

Have some companies done it? Yes. But typically it means that you must “financially engineer” the deal, meaning that you actually take savings in the first year and pay the service provider to spread the costs out over the term of the agreement. This may or may not make good business sense for your company.


What about the Transition Costs? Can't the Service Provider make these go away?


No matter how you slice it, you will have transition charges in the first year to pay the service provider for getting started: for moving resources, buying new equipment, and so forth. You can choose to pay these up front or upon completion of key milestones. Or you can finance up-front costs over the term of the deal. But the costs will still be there and will impact your overall business case. Financing over the term of the deal has drawbacks, and deserves a closer look – we’ll save that for another time.


When will we know how much savings is possible?


First of all, the best way to determine potential savings is to establish a current baseline. You can start by setting up a pro-forma business case before you get the service providers involved. To do that, you will need a very good financial base case, which includes all your costs to deliver the service – not an optimistic, feel-good model, but a realistic model that accounts for things such as overhead costs, shadow organizations, and both internal and external resources. It is advisable to get someone outside the organization to help with this model. A professional sourcing advisor can bring a third-party perspective to the development of a solid baseline that is comparable to the deal you are about to undertake.

Next, work with an advisor who can provide you with market data around the costs of the services you are about to source. The resulting model will provide an idea of where you are headed, and the savings potential before you start the bidding process.

You will have a second look at the business case after the bids are in and the team has completed its analysis and normalizations. Don’t ask for this on the first day the bids show up on your doorstep. Let the team do its analysis – Give it a couple of weeks if you have multiple service providers involved. You will have a good feel for the business case then. Remember, this could be 2 to 3 months after your team starts working on the deal. Numbers given any sooner are not really valid or solid enough to use in decision-making. As you go through the negotiations, changing elements of the deal, customizing the arrangement for your company or adding or deleting services, the business case will change. Final numbers and savings projections will be available only when the negotiations are over and the deal is inked.

We’ve heard that the cost savings promised don’t materialize. Are the service providers misrepresenting the numbers to get the deal?

The reason most savings never materialize often has less to do with the service provider or the original business case – and more to do with how well you manage the agreement, control demand from your business entities, and collaborate with the service provider. The business case is as good as the paper it is written on for that moment in time. The business case helps support your decision to do the deal and with whom, but it cannot promise actual savings — that part is up to you and your service provider.

It is critical to remember that your environment will change over time, technologies will come and go, and your demand will increase and perhaps decrease. Through all of this, it is imperative that you keep watch over the arrangement -- manage the change and demand inherent in the environment to ensure you are receiving the benefits you agreed to (in other words, not what you expect, but what you signed up for).

We’ll talk more about managing the agreement later, for now, get a solid base from which to measure the value of the agreement, and plan on managing the arrangement to ensure that the value of the agreement is realized.