The 4 horsemen of outsourcing

The 4 horsemen of outsourcing

Looking back over the last three decades of outsourcing, there are a few trends that emerge. It’s especially obvious to those in the (IT) outsourcing world when you look at the hundreds of agreement that get created or updated each year. Whilst there are many reasons companies look to outsourcing, when looking at it from the client’s perspective, outsourcing benefits derive from one or more of four areas. These four breakdown into 17 specific areas that support growing your business or optimizing it: 

  1. To reach a financial objective 
  2. To acquire capability 
  3. To catalyze change 
  4. To be somewhere or sometime specific

When considering outsourcing, strategic objectives should map to one or more of these four areas. Each area has its consequences for on who the provider should be and the structure, and operation of an outsourcing approach. These four major reasons breakdown into 17 specific objectives that outsourcing can achieve.  

Start your consideration of outsourcing not with the question “What can outsourcing do for me?”. Instead ask “What strategy or business objective can outsourcing enable?”. Failing to ask the question about outsourcing in this way will fail to bring the proper weight of your business context to the question. Once a strategic context is established, the decision to and consequences of outsourcing may be properly assessed. 

The 4 Horsemen of Outsourcing 

For some, the title “4 horsemen of Outsourcing” draws your mind to negative connotations of apocalypse and for others it just sounds a little odd. Outsourcing services, or components of services,  requires your business to change and that change can, at times, be both hard and, for some in the organization and a scary prospect for others. Much of that tension is because outsourcing requires you to relinquish a degree of control. 

Where your service components sit on this continuum will be dictated by a number of factors, your corporate strategy, your IT strategy and your appetite for risk. These factors are supported by business drivers, financial, capability, geo-temporal needs and business change catalysts. As we go through this section we will look at some well publicized examples of the use of these drivers and how they shaped the decision and direction of IT sourcing. 

Most outsourcing contracts reflect more than just 1 of the following motivations. The larger the contract the more likely it reflects several.

Financial Objectives Supported by Outsourcing 

The financial motivations to outsource are more than reducing costs. They can include the conversion of costs, release of assets or even the access to cash or investment capital. Financial drivers include: 

1. A need to reduce expenses. 

Most people think outsourcing’s reason is reduce expenses. But it is only one; in fact, it is only one of 4 possible financial reasons to pursue the benefits of outsourcing. Your motivation in this case is to reduce the cost of some business process or operation. When outsourcing, the basis of cost reduction is the comparison of internal cost to the managed service provider’s price. 

2. A need to convert capital expense (CapEx) to operating expense. 

Your motivation here is to convert the accounting basis for a business operation from something such as an owned data center (fixed asset) to leased space (rent expense) in a service provider’s facility. It can also be the conversion of a set of depreciating assets (e.g. servers) into a rental scheme (e.g. public cloud, infrastructure-as-a-service). Outsourcing can achieve this through mechanisms such as refinancing of existing assets through acquisition by service provider and converting any continuing use to a recurring service charge. Many make this objective a “two-step” exercise with the first step of outsourcing, and the second step that of selling off or eliminating the capital that provided the services now delivered by the service provider.

3. A need to reduce or eliminate capital assets such as real estate. 

Your motivation is to completely eliminate capital expense versus just converting it to operating expense. This is often achieved through consolidation (e.g. physical facility real estate consolidation or virtualization of compute and storage assets) and then disposal of unused assets. Some types of service providers can directly enable the recovery of costs from asset disposal by incorporating the processes and sale of assets into pricing that is realized as operational savings. But this is not just a real estate exercise, it can be the elimination of equipment such as phone systems or vehicles. Any capital asset that is eliminated in the process serves to reduce costs of maintenance and depreciation. The intent however is not to reduce the expenses related to capital assets as much as it is to reduce the asset side of the balance sheet with the consequence that financial measures tied to capital such as return on assets (ROA) rises.

4. A need to access or generate cash. 

Outsourcing can be used to gain access to cash out of the transaction. Unlike capital expense conversion, this always shows as a cash moves to the client from the service provider. Examples of this include the McDonnell-Douglas’ contract with IBM in the early 1990s. IBM purchased McDonnell-Douglas’ primary data center and office campus in St Louis in the course of striking a 10-year $350M service contract with the manufacturer.  

Capability Acquired by Outsourcing 

Capability drivers are present when businesses require a capability that they have no desire or ability to develop or acquire directly. Frequently, this includes access to capital, skills and staff that are highly developed by service providers over the life of many client engagements. Benefits derive from service provider competencies or resources that are not the main focus of your business. Capability drivers include: 

5. Skill and staff competency. 

This motivation surfaces as a gap in skills and related resources (e.g. labs, equipment, methodologies) needed to execute on some business initiative. Business initiatives can use this approach to acquire capabilities, temporarily or for an extended period of time. It manifests as a need for the capability but along with a desire to maintain close control of both while they are employed. An example is deep technical knowledge and skill needed to uncover, or provide insight, to the business that allows the business to operate in its new operating state, 

6. A need to insert capability. 

This motivation often appears with the separation of a single firm into parts. Examples from industry include the split out of Post Holdings from Ralston Purina where Post was “re-“created with no data center or major enterprise applications. This motivation typically includes the need to quickly develop a capability that will be a core to the on-going business without any organic growth path. These are capabilities that are intended to be built and maintained for the planned future and often appear as a service contract struck to seed the contracted capability. 

7. IT environment transformation/update. 

Unlike adding skill or quickly gaining access to resources or facilities, this motivation appears when the IT environment needs to transform. This is related to the change catalyst motivation, but is focused on the operational aspects of IT. Outsourcing can be utilized to for its ability to transform an IT operation or estate to align with or move ahead of existing industry conditions or mitigate weakness in the current environment. It is often related to the change of the enterprise architecture; this benefit derives from a service provider’s ability to bring skill and resources to bear. It can include access to capabilities and resources such as data centers and network. This motivation differs from the first two capability motivations in that it’s focus is on “transformation” and not on on-going operations. Service providers are often unaware of this intent, or if they are, will work to convert such a contract into a continuing provision of capability along the lines of motivation 5 or 6.

8. Innovation. 

The motivation to innovate can be clear or subtle. In any case, it will appear as a shift to your business’ value chain. Examples include the application of disruptive technologies available from a service provider (e.g. ServiceNow is an example of a service provider that had the first ITSM-aaS offering) or the implementation of sustaining innovations that reduce your cost or time to sell your product or service. Outsourcing can give you access to major and minor innovations held by service providers; outsourcing can also give you access to the capability to address disruption and develop innovation (sustaining or disruptive). These innovations may be industry innovations; however, this motivation is often with a view to enabling innovation from the client point-of-view. As a result, the innovation may appear to be common practice to a service provider. The key context is what positive change and improvement do you as the client require.

Change Catalyst 

When you do not have all of the means to initiate, action, or complete a change, service providers can be utilized to provide the necessary catalyst. They can often take the organizational hit that disruptive changes may impose on a company. The benefits support: 

9. Merger/acquisition or separation. 

You would have this motivation if your speed to implement the combination or separation required more than the likely pace of resource and capability acquisition needed to execute the strategy. Service providers can provide the ability to combine separate or dis-integrate combined IT environments. Examples include the ability to transform separate businesses into one with common IT services and structure or to provide the IT environment for a separated unit left without any after a separation.  This is often the primary motivation when you see this paired with #6 in the Capabilities motivations.

10. Enterprise architecture with restatement and reorganization. 

A shift in enterprise architecture including business structure and processes can impose issues for existing operations. Service providers can often provide the bubble of new process, architecture and environment to “slipstream” a new structure into the business while minimizing disruption for existing operations and customers. Examples include ERP replacements and the shifts incurred by strategic product and market entries (or exits).  

11. Process maturation/transformation.  

Adoption of ITILv2 was a popular driver in the 2005-2010 period. As regulatory environments change or develop, you may benefit from the shift to a service provider well-placed to transform the environment. They can effect operational changes that may otherwise be difficult to impose. Examples include the implementation of ITIL operating practices, DevOps application development and management, or implementing a regulatory framework (e.g. CMS for healthcare, FISMA for government agencies and subcontractors). 

12. Forced corporate culture shift.  

Moving IT to a service provider in whole or in part can provide the removal or addition of a cultural environment required by your business. Service providers will have their own culture and it may be what you need in your own. Outsourcing contracts inevitably cross pollinate both organizations. However, outsourcing alters the cultural equation by bringing service provider staff into an environment to replace or augment an existing condition. Management planning (especially communications planning) with this approach is essential to deal with the possible effects of cultural conflict deriving from different groups.   

13. Developing needed capability. 

Often this motivation appears as the transformation of IT to bring it even level with competitors or market requirements. This can include technology acquisition and adoption. Examples include IT automation via contract (e.g. automation, tooling. This motivation focuses on outcome of a completed contract. 

Geo-Temporal 

The geo-temporal driver for outsourcing presumes to extend the client with presence geographically or temporally. The need that gives rise to this driver is for the client to be places or at times that they are otherwise unable or unwilling to be. It is principally a requirement to extend otherwise existing client capability. Corporate growth strategies often give rise to this motivation when a need to expand faster than organic growth can deliver.  

Examine what your strategy requires. Look at needs beyond your geographic presence or time. The need can appear as: 

14. New geographic presence

The requirement for staff presence (or their support) in a new or developing geography.  

15. Address growth

An increase in capacity to address growing or bursting market pipeline or velocity for product/services above planned capacity growth. 

16. Temporary scale

This motivations reflects a corporate strategy requiring capability beyond when an internal capability can provide it. This differs from the first geo-temporal motivation by focusing on organic growth of existing territories/regions. It tends to be a gap that you will ultimately fill internally but need to address for the strategic initiative to be actioned. 

17. Access to restricted geography

If you cannot get somewhere, a service provider may meet the need to access a location or product/service that supports your corporate objectives. One example includes a need to be present in a foreign country where you cannot be. Another example is the need for a product or service within the value or support chains that require a lengthy or undesirable acquisition cycle or process. 

The Inside Story 

Service providers are not in the business of helping you decide whether to outsource or not. They have made that decision already. Instead, they will focus on relative benefits while avoiding the entire context of your strategy and business objectives. You should decide first whether outsourcing can even address any of your needs and gain clear view into what context that benefit can be acquired, before any engagement with a service provider on a strategic level. 

Even many third-party advisors will not help you with your strategic context view. Their motivation is to gain an advisory client pursuing a transaction. Your motivations and the benefits you pursue should be strongly stated before you decide whether a transaction is in your best interest. In fact, you cannot even decide the value of a transaction without first deciding if a transaction will advance your business objectives. An exception to may occur if you have a business strategy consultant engaged. If you do, presumably they are in place to help you state your strategy and decompose it into initiatives and projects that realize it. Their assistance in this decision process would be valuable. Above all, do not expect a consultant from a service provider to be indifferent to your decisions. They gain from follow-on contracts; it is this very situation that prevents public sector customers from hiring their advisors as their service providers. 

In addition, watch for our post on how different types of service providers actually help or hurt you meet these different motivations. Some can even make the real objective more difficult to achieve.

The graphic for this post points to the needed evaluation before you engage vendors or consultants. We have developed it to integrate with the decision models you will find in other posts we have or will provide on what you outsource and what type of vendors you consider. We have also developed a tool that helps with this analysis and accommodates the reality that multiple motivations of different levels of urgency (weight) exist. 

Caution: If these factors don’t apply to your reason for outsourcing, then you should give serious consideration to whether you have a the reason for outsourcing. 

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