Today, executives have to cut through a lot of hype around automation. Leaders need a clear-eyed way to think about how these technologies will specifically affect their organizations. The right question isn’t which jobs are going to be replaced, but rather, what work will be redefined, and how? Based on our work with a number of organizations grappling with these issues, we’ve found that the following four-step approach can help.
1. Start with the work, not the “job” or the technology. Much work will continue to exist as traditional “jobs” in organizations, but automation makes traditional jobs more fluid and an increasing amount of work will occur outside the traditional boundaries of a “job.”
Optimally integrating humans and automation requires greater ability to deconstruct work into discrete elements — that is, seeing the tasks of a job as independent and fungible components. Deconstructing and then reconfiguringthe components within jobs reveals human-automation combinations that are more efficient, effective, and impactful. AI and robotics increasingly take on the routine aspects of both blue and white collar jobs, leaving the non-routine to humans. That challenges the very essence of what organizations retain as human work. The reconfiguration of these non-routine activities will yield new and different types of jobs.
2. Understand the different work automation opportunities. AI can support three types of automation: robotic process automation (RPA), cognitive automation, and social robotics.
RPA automates high volume, low complexity, routine administrative “white collar” tasks — the logical successor to outsourcing many administrative processes, further reducing costs and increasing accuracy. Optimizing RPA can only be done when the work is deconstructed. For example, RPA will seldom replace the entire “job” of a call center representative. Certain tasks, such as talking a client through their frustration with a faulty product or mishandled order will, for now, remain a human task. Others, such as requesting customer identification information and tracking the status of a delivery are optimally done with RPA.
Cognitive automation takes on more complex tasks by applying things like pattern recognition or language understanding to various tasks. For example, the Amazon Go retail store in Seattle has no cashiers or checkout lanes. Customers pick up their items and go, as sensors and algorithms automatically charge their Amazon account. Automation has replaced the work elements of scanning purchases and processing payment. Yet other elements of the “job” of store associate are still done by humans, including advising in-store customers about product features.
Social robotics involves robots moving autonomously and interacting or collaborating with humans through the combination of sensors, AI, and mechanical robots. A good example is “driverless” vehicles, where robotics and algorithms interact with other human drivers to navigate through traffic. Deconstructing the “job” reveals that the human still plays an important role. While the human “co-pilot” no longer does the work of routine navigation and piloting, they still do things like observing the driverless operation, and stepping in to assist with unusual or dangerous situations. Indeed, it is often overlooked that the human co-pilot is actually “training” the AI-driven social robotics, because every time the human makes a correction, the situation and the results are “learned” by the AI system.
3. Manage the decoupling of work from the organization. The future global work ecosystem will offer alternative work arrangements including each of the three automation solutions, along with human work sources such as talent platforms, contingent labor, and traditional employment. The human work that is created or remains after automation will not fit easily into traditional jobs, nor will it always be optimally sourced through employment. Work will need to be freed from “jobs within organizations,” and instead be measured and executed as more deconstructed units, engaged through many sources. Today’s supply chainstrack the components of products at both an atomized and aggregate level. Similarly, the new work ecosystem will develop a common language of work, enabling organizations not only to forecast and meet work demands from various sources, but to devise new reconfigurations of work elements that are best sourced in alternative ways.
4. Re-envision the organization. The combination of automation, work deconstruction, and reconfiguration will often redefine the meaning of “organization” and “leadership.” The “organization” must be reconsidered as a hub and capital source for an ecosystem of work providers. Those “providers” include AI and automation, but also include “human” sources such as employees, contractors, freelancers, volunteers, and partners. The optimal combination of these providers seldom appears if you frame the question as, “In which jobs will AI replace humans?” Only when you look within those jobs, as described above, will you discover the human-automation combinations that redefine work and how it should be organized.
AI will significantly disrupt and potentially empower the global workforce. It won’t happen all at once or in every job, but it will happen, and leaders will need an automation strategy that realizes its benefits, avoids needless costs, and rests on a more nuanced understanding of work.
An unsettled global political environment has not shifted CEOs’ focus on profits and growth in 2017. Growth is the No. 1 business priority for 58 percent of CEOs, according to a recent survey* of 388 CEOs by Gartner, Inc. This is up from 42 percent in 2016.
Product improvement and technology are the biggest-rising priorities for CEOs in 2017 (see Figure 1). “IT-related priorities, cited by 31 percent of CEOs, have never been this high in the history of the CEO survey,” said Mark Raskino, vice president and Gartner Fellow. “Almost twice as many CEOs are intent on building up in-house technology and digital capabilities as those plan on outsourcing it (57 percent and 29 percent, respectively). We refer to this trend as the reinternalization of IT — bringing information technology capability back toward the core of the enterprise because of its renewed importance to competitive advantage. This is the building up of new-era technology skills and capabilities.”
Figure 1: CEO Top Business Priorities for 2017 and 2018
Source: Gartner (April 2017)
CEO Understanding of Digital Business Is Improving
While the idea of shifting toward digital business was speculative for most CEOs a few years ago, it has become a reality for many in 2017.
Forty-seven percent of CEOs are being challenged by the board of directors to make progress in digital business, and 56 percent said that their digital improvements have already improved profits. “CEO understanding of the benefits of a digital business strategy is improving,” said Mr. Raskino. “They are able to describe it more specifically. Although a significant number of CEOs still mention e-commerce or digital marketing, more of them align it to advanced business ideas, such as digital product and service innovation, the Internet of Things, or digital platforms and ecosystems.”
CEOs have also progressed in their digital business endeavors. Twenty percent of CEOs are now taking a “digital-first” approach to business change. “This might mean, for example, creating the first version of a new business process or in the form of a mobile app,” said Mr. Raskino. “Twenty-two percent are taking digital to the core of their enterprise models. That’s where the product, service and business model are being changed and the new digital capabilities that support those are becoming core competencies.”
Half of CEOs Have No Digital Success Metric
Although more CEOs have digital ambitions, the survey revealed that nearly half of CEOs have no digital transformation success metric. “For those who are quantifying progress, revenue is a top metric: Thirty-three percent of CEOs define and measure their digital revenue,” said Mr. Raskino.
CIOs to Help CEOs Set Success Criteria for Digital Business
Deeper transformation can only be achieved at scale if it is systematically driven. “CIOs should help CEOs set the success criteria for digital business,” added Mr. Raskino. “It starts by remembering that you cannot scale what you do not quantify, and you cannot quantify what you do not define. You should also ask yourself: What is ‘digital’ for us? What kind of growth do we seek? What’s the No. 1 metric and which KPIs must change?”
Many CEOs have recognized that being open-minded, entrepreneurial, adaptable and collaborative are the most-needed digital leadership mindsets. “It is time for CEOs to scale up their digital business ambition and let CIOs help them set and track incisive success metrics and KPIs, to better direct business transformation. CIOs should also help them toward more-abstract thinking about the nature of digital business change and how to lead it,” concluded Mr. Raskino. “The disruption it brings often cannot be dealt with wholly within existing frames of reference.”
Recently a lot has been said and written about two prominent trends: digital and automation. However little has been discussed about the commonalities between these prominent trends and the outsourcing industry.
Digital and automation are two of the most prominent trends influencing the outsourcing industry.
Below are some ideas and considerations organizations may wish to consider before placing emphasis on one versus the other:
The organization’s strategy sets the direction: Having a clear understanding of the organization’s strategy and goals will directly determine the linkage between digital, automation and outsourcing. As simplistic as it sounds, a balance between these can be hard to achieve. A good way to approach this is to think digital as the environment, automation as an enabler and outsourcing as a way to deliver services. As part of this approach, organizations will also require higher emphasis in other important pillars such as governance, risk and internal staff skills.
Digital is a reality organizations shall not ignore: Service providers are supporting the digital transformation by and large, as it does increase their portfolio of services and revenue. For organizations, the implications of a digital environment to services, if well implemented, tend to be positive. The biggest challenge lies on the organization’s community and clientele. For example, let’s think about the recent trends in retail banking and the opportunities digital will continue to bring with direct positive impact on operational costs. Other industries that may benefit from digital are insurance and telecom, as those have usually higher volume of services and effort associated with their service delivery models. A recent article released by The Economist magazine titled “Tech pundits’ tenuous but intriguing prognostications about 2016 and beyond” provided some mind bogging predictions, including the following: “By 2020, predicts IDC, a third of today’s IT companies will no longer exist in their current form, swallowed up in a wave of mergers and takeovers. And although demand for cloud computing will soar, many smaller contenders will fall by the wayside. Within five years the market will be dominated by perhaps half a dozen global giants, from American ones such as Amazon and Microsoft to Chinese ones like Alibaba.”
Automation is evolving rapidly: There is no doubt automation will continue to grow and evolve over the next few years. As service providers opt to automate vs. labor in, commodity services are already in high demand to be transformed through automation. In my latest CIO article I wrote about BPO being renamed as BPA – more can be found by clicking here. In a nutshell, the benefits associated with automated services can help organizations to realize value in a much faster and effective way – while services providers minimize their existing labor risks. Another important factor to consider is that machines now can “learn to execute” with little guidance and oversight from humans. A very interesting article published by Shivon Zillis provided a very insightful picture of the current state of machine Intelligence across different industries:
Manage the organizational changes associated with these trends: It is common to see the excitement big transformational trends such as digital and automation bring to an organization. For those who live and breathe change, this might be heaven. For others, this can be a very stressful time in which future is somewhat unclear. As such, organizations should not underestimate the level of effort required to manage changes associated with these trends. The key here is to, from internal clients to service providers and the organizations clientele, monitor and manage changes appropriately so that the organization’s strategy can be adjusted accordingly.
The importance of governance and risk management should not be understated: With multi-sourcing becoming more evident and increased regulatory pressures, organizations will continue to need to invest heavily on appropriate governance and risk management practices. Notwithstanding the fact automation and digital are new trends, there is a bit of learning curve for both organizations and services providers taking place. The fact of the matter is that, when determining value for money, organizations should factor in the service providers ability to deliver services while complying with the set organizations’ governance and risk protocols for their relationship. At the same time, organizations shall be able to effectively assess their risk appetite, protocols and reputation so that the desired outcomes can be realized. What organizations should not compromise is their ability to comply with their respective regulatory requirements, as this can have a significant impact to the organizations’ reputation and bottom line.
The importance to invest on the organizations staff skills: While organizations invest to enable digital and automation, they should also invest on their internal staff skills and capabilities required to effectively manage and support their transformation. Many times there is a consent this should be considered a priority, however it usually tends to get lost – as it is hard to execute any type of business transformation. If we take into account the organization’s team as a critical element for success, it is imperative that internal staff have the right skills and knowledge to effectively execute their roles going forward. As much as learning while executing is possible, organizations should not place themselves in situations that could represent a higher than normal level of risks or with significant impacts to their clientele.
The conclusion: This is going to be an exciting year for the outsourcing industry, with great opportunities for buyers and services providers to collaborate and contribute on how to best enable their digital environment, use automation as an enabler to promote services and continue to use outsourcing as a way to obtain and deliver services. Stay put.
India’s position as a labor arbitrage market may continue for another “25-35 years”, said IT consultancy Everest Group. However, it is unlikely that earlier offshored work would be back to its home market, it added.
“There is no doubt that India is still a highly attractive and viable option for low-cost labor, albeit not quite as good as it was 15 years ago, but still very compelling, and it will likely remain so for another three decades,” said Michel Janssen, Chief Researcher at Everest. “We move out our estimate for the end of the India labor arbitrage to beyond the 2040-50 time horizon.” Indian IT firms have put it that they have shifted from a model based purely on labor arbitrage and have been hiring in bulk onshore.
However, changes to the business model have seen slow growth and hurt margins. “The services jobs that moved to offshore locations will not be coming back in any large quantities because labor arbitrage economies will continue to be attractive,” Everest said in its report.
India’s huge talent base will also ensure a buffer to rising labor costs. Around one million engineers enter the job market every year and salaries for fresh engineers with no specilaised skills have remained stagnant for nearly a decade. “Fifteen years ago, we thought that wages in Bangalore would grow to reach those wages in Dallas. But we didn’t take into account the growing talent pool. That really keeps a lid on costs,” Janssen told ET.
He further said that while robotics process automation (RPA) would change some of the ways companies do business, it may not be a drastic change. “RPA is important, but if the costs of labor remain low and you can get access to talent at low prices it might limit the amount of process automation a company might put in place. They may not need to invest as much in RPA.”
While automation will render pressure on headcount, the country’s talent base will be an advantage as the industry moves to more digital technologies.
“The current limited availability of niche/emerging skills in India puts them at a premium; however, as more people learn these skills, they may lose their premium status,” the report said. This will further restrict labour rate hikes.
European companies are looking to outsource operations in the Philippines to capitalize on a young workforce, whose skills need to be upgraded to meet demand, officials said.
The Nordic Chamber of Commerce considers the Philippines as “outsourcing destination” for information technology, accounting and graphic design jobs, said its president, Bo Lundqvist.
“The opportunities are amazing, there are so many opportunities, there’s not just enough talent,” Lundqvist told ABS-CBN News.
As Europe taps Filipino workers, the Philippines can benefit from technology transfers, said EU Ambassador to the Philippines Franz Jessen, who also chairs the EU-Philippines Business Network committee.
“Europe does not have a young workforce so we focus very much on technology,” Jessen said.
European Chamber of Commerce of the the Philippines president Guenter Taus cited Austria as example, wherein the government offers graduates free courses to give them skills that meet job demand.
The European Union is home to some 800,000 Filipino workers and the bloc is the second largest source of remittances. Seafarers alone account for 30,000 of the total, he said.
BM remains an American-based, not an Indian- based company, as a recent New York Timesarticle gave the impression to some readers when it claimed that IBM employs more people in India than in America.
IBM may have outsourced a great deal of its operations around the world as many other large companies have done, but its center of gravity remains in America. IBM was founded in the U.S. 106 years ago, and its headquarters and major research facilities remain to the U.S.
But IBM is an American company in decline, as evidenced by the long string of drops in its sales.
The root cause of IBM’s long decline is the failure to make a timely transition from the traditional mature declining business segments to emerging fast growing segments.
To be fair, IBM’s revenues from “strategic imperatives” (cloud, Watson and analytics, security, social and mobile technologies) have been rising in recent years. But IBM is late in this space, which is already crowded with heavyweights like Amazon, Microsoft and Google.
Apparently, IBM’s leadership has been spending too much time to revive its traditional business rather than to renew its pioneering drive that made it a great technology leader back in the old days.
That raises a simple question: why keeping the old business around, anyway? Because these businesses are outsourced at a lower cost to India and other locations.
But that has been a trap. Outsourcing hasn’t helped IBM improve its operating margins, which continue to slide — see tables.
Besides, outsourcing leaves management with fewer resources to plow into new business initiatives. Hence, the slow speed of transition from traditional business segments to new business segments.
Wall Street has taken notice, sending IBM’s shares south as the rest of the technology shares have been soaring. Over the last five years, IBM’s shares have lost close to 30% of their value, as the Powershares QQQ have gained 121.26% — see table.
Outsourcing provides certain competitive advantages to early-movers – that is, to companies that adopt it first — but it isn’t proprietary. Others can adopt it, and therefore, isn’t a source of sustainable competitive advantage.
Then there’s corporate complacency whereby leadership of these companies fails to renew the pioneering drive that characterizes market leaders.
That’s what eventually happened in the PC industry, to companies like the old HP.
Outsourcing was supposed to cut costs, limit corporate size, and improve operating margins. But instead it ended up giving HP’s advantage away to Asian PC and printer makers, piece-by-piece, failing to re-ignite sales growth.
Meanwhile, HP failed to revive its old pioneer drive that made it a great technology company in the first place.
The rest is history, which IBM will be destined to repeat. Unless it scales back on its outsourcing activities in India and other locations.
IT purchasers and providers can achieve win–win outcomes by altering their sourcing routines. Here’s how they can be more strategic about the principles and practices they follow.
Global companies in all industries typically acquire a significant portion of their IT services from external providers. Annual global spending on external IT services is about $900 billion, with companies procuring IT consulting, systems integration, application development and maintenance, and IT-infrastructure-management services, among others. 1. Forecast alert: IT spending, worldwide, 4Q16 update, Gartner, January 2017, gartner.com.
We can expect spending on IT services to increase as companies explore digital products and business models, and require more and different types of technology support. Indeed, digital transformations typically require higher-order IT capabilities and involve strategic partnerships with providers that supply critical knowledge and expertise along with new technologies and support services.
For a number of reasons, however, IT-sourcing relationships have been difficult to get right. Given the speed at which new technologies and software-development approaches emerge, IT purchasers often struggle to understand how to set realistic objectives and incentives; how to balance multiple priorities relating to cost, efficiency, quality, and innovation; and how to structure governance arrangements to benefit both sides. For their part, IT providers wrestle with similar issues: how best to meet a range of customers’ expectations, how to prioritize objectives and resources to help customers meet their individual needs, and how to create next-generation improvements and innovations for customers rather than just carrying out immediate tasks.
To help executives understand how to answer these questions, we conducted reviews of hundreds of contracts over the past three years. 2. Our observations are drawn from a sample of more than 50 companies and about 200 live contracts. We examined an average of 35 to 40 data points per contract. In performing this research, we employed the strict confidentiality procedures that govern our work with purchaser–provider relationships. The contracts covered IT-sourcing relationships across multiple industries and regions. We analyzed the contracts along three main dimensions: general terms and conditions, commercial terms and conditions, and governance structure (Exhibit 1).
In many of the contracts we reviewed, the sourcing relationship was not meeting its full potential (Exhibit 2). For instance, greater innovation was a desired goal on both sides but often was lacking, according to the executives with whom we spoke. Such performance gaps exist because of shortfalls on both sides of the partnership.
Our research revealed five obvious but often overlooked changes IT purchasers and providers can make to their sourcing routines that could bridge these gaps and create win–win outcomes. Specifically, they must develop a shared understanding of business outcomes, emphasize the long term, actively collaborate on critical IT architecture decisions, pursue transformation with clear planning and relentless “grit,” and devise win–win contract mechanisms (Exhibit 3). Businesses and IT providers should address all five of these areas if they want to achieve a full spectrum of benefits from IT contracts, beyond just cost. Based on our experience, the value gained by both sides could be between two and four times that of pursuing traditional contracting approaches (Exhibit 4). We believe the best way to break from status-quo practices and relationships is to fully recognize the dynamics at play and devise clear plans to alter them.
Develop a shared understanding of business outcomes
For many IT purchasers and providers, it can be hard to achieve a shared understanding of business objectives. In more than 60 percent of the contracts reviewed, teams had not followed a thorough process for internally discussing desired business outcomes.
IT purchasers faced hard internal deadlines for developing and finalizing contracts with providers. They felt they did not have enough time to engage all relevant business stakeholders in defining the full potential value to be gained from investment in external IT services—whether it be cost savings, increased productivity, or more agility and innovation. As a result, they were often unsure of priorities when setting new contracts or resetting existing ones. In 100 percent of the contracts we reviewed where business outcomes were not clearly defined, key indicators of performance were not exhaustive; they tended to be focused on cost. Hence, they were inadequate for measuring desired business outcomes.
Because they had incomplete information about purchasers’ business priorities, providers were unable to determine how best to allocate talent and resources. And because providers were required to follow purchasers’ standard contracting structures and processes, they were less likely to bring new ideas to the table.
To ensure a shared understanding of objectives, purchasers and providers will need to actively break from time and process constraints. Purchasers should involve end users and business-unit leaders in contract discussions with providers early in the process. Desired outcomes should be captured in a minimum viable contract, with the understanding that there will be further collaboration and refinement on terms over time. At one asset-management firm, IT leaders insisted that the CEO, other C-suite executives, and members of the board be involved in the provider-selection process. Senior business executives were asked to attend supplier visits, and the board received periodic updates on the selection process. When properly informed in this way, business executives and other stakeholders can help contract teams set meaningful short-term and long-term objectives and ensure that enforcing mechanisms are embedded in contracts.
IT purchasers and providers will also need to reimagine the request-for-proposal (RFP) process as a “request for solution” process—an opportunity to jointly identify critical problems and define potential solutions. We observed one provider challenge traditional boundaries: in response to an RFP, the provider went beyond a simple outline of services it could provide; it suggested ways that the purchasing company could form a joint venture with the provider and go to market with a joint service offering. This proposal reframed service provision as an opportunity to generate revenue—an approach that turned heads and established the provider’s credentials with the purchaser. The joint-venture idea was not approved, but the provider eventually was rewarded with the services deal.
Emphasize the long term
Almost 80 percent of the contracts we examined included service requirements that were narrow in scope. They were valid for a particular point in time but left little room to incorporate future needs. Contract teams had estimated the volume of work flow required but had built in few or no options to reset contract parameters midstream based on actual usage. Additionally, it was often the case that purchasers had not considered future IT needs in any depth. About the same percentage of contracts we reviewed (80 to 90 percent) did not include adequate mechanisms for encouraging long-term innovation.
The conventional thinking among purchasers is that contracts implicitly compel providers to innovate and adopt a long-term focus. The reality is that the success of the sourcing process will be measured according to savings in the first year rather than value created beyond that. This was evident in our reviews. Ninety percent of the contracts included commercial terms and conditions that were not mutually advantageous, implying that discussions around these terms and conditions had been focused on the here and now rather than on how to activate longer-term innovation and value.
To unlock long-term vision, commitment, and innovation, purchasers should delineate a range of service requirements and expected volumes at the outset, based on real-world business objectives, but then refine and codevelop the service requirements with providers through regular “hackathons”—gatherings aimed at surfacing new ideas and determining the resources required to act on them.
IT purchasers also need to give providers more visibility into the business and its big-picture goals: What capabilities and technologies could providers bring to the table to help the business achieve its objectives? The agreed-upon contract could include a continuously updated backlog of requirements and options for both sides to shift to alternative work-flow requirements and management approaches when delivery models, the volume of work, or the scope of work changes. Both sides might also agree to a series of checkpoints at which they could reassess and redefine terms. Purchasers could also join providers’ customer-council meetings to understand and influence their long-term direction.
A consumer-electronics company negotiated for such flexibility from core IT providers as it determined the best ways to shift to a cloud-based infrastructure. The company did not want to upend existing operations all at once, so it developed a three-year transition plan with providers. The providers would continue to deliver traditional infrastructure services in the first year while gradually shifting the company’s work flow to a cloud platform in the second and third years. Frequent reviews were built into the process, and both sides agreed that pricing mechanisms would be changed accordingly. The transformation is still under way, but as a result of this arrangement, the purchaser has made significant progress in migrating applications to the cloud.
Actively collaborate on critical IT architecture decisions
Most of the contracts we reviewed contained comprehensive governance plans—detailed descriptions of multilevel forums convened by purchasers, designed to gather input from providers or to review and refine day-to-day processes and tasks. But in practice, providers were mostly kept at arm’s length, with no direct input into important technology and innovation forums—for instance, the architecture-review board.
In our observation, this dynamic occurred, in part, because contract-governance mechanisms were generally designed and agreed upon by teams that were not accountable for day-to-day execution and outcomes—for instance, procurement and legal. The teams’ primary focus understandably tended to be on anticipating potential catastrophes and retaining control rather than on creating long-term value from the sourcing relationship.
Win–win relationships cannot exist when IT purchasers do not treat IT-service providers as strategic partners. To facilitate this partnership, companies can activate a provider-success team that includes sourcing experts, technicians, and business leaders from both the purchaser and the provider. This team should create a seat at the table for IT-providers in forums like an architecture-enablement board, where the purchaser discusses ideas on IT architecture and underlying platform innovation jointly with providers.
In our observation, transformations are less likely to succeed—and changes are less likely to be implemented on the ground—when providers do not have input into purchasers’ decisions about the underlying architecture. In about 10 percent of the contracts reviewed, we saw evidence that IT purchasers were beginning to design contracts to actively involve providers in these types of forums and explicitly asking providers to be consulted or informed in architecture-review boards. Companies could improve collaboration by following Toyota’s genchi genbutsu approach—that is, scheduling go-and-see sessions for purchasers and providers. 3. Genchi genbutsu means “actual place, actual thing” and it is a key principle of the Toyota Production System. It suggests that in order to truly understand a situation one needs to go to the “real place” where work is done.
A global telecommunications company works with multiple IT providers that support the company’s infrastructure management and delivery of software applications. The telco’s contracts with these providers explicitly define partnership-based governance principles. There is a built-in expectation that subject-matter experts from the IT providers will actively participate in conversations about architecture and innovation. In turn, IT providers have gained greater visibility and have shown greater commitment to ensuring that the IT purchaser meets program-level measures of success—for instance, improvement in service levels or direct impact on fees. This approach has enabled the overall environment to function smoothly, with an emphasis on collaboration and transparency.
Pursue transformation with clear planning and ‘grit’
About 75 percent of long-term IT-sourcing contracts reviewed had language indicating that purchasers expected the sourcing relationship to result in a significantly altered IT landscape. But in most cases, there was limited evidence of a transformation plan or a strategy to get the required investments for changing the underlying operating model. For example, 75 percent of the contracts focused on cost control as a significant transformation objective but had less focus on how to measure progress against their transformation objectives. Any dialogue about transformation plans was typically led and owned by IT representatives rather than business stakeholders. The latter were informed as needed. For their part, providers often were not privy to plans regarding the architecture road map, so they felt they could have little influence on outcomes from transformation efforts. In most cases, neither side was completely clear about the starting point for change, the target state, and the exact path to get there.
IT transformations cannot succeed without two things: a shared commitment to creating change, including the underlying IT-architecture choices, and something we call transformation “grit”—or rigorous and relentless attention paid to planning and execution. Purchasers and providers must jointly design a transformation road map; it is critical that it be codeveloped and co-owned by the business-unit leaders. Purchasers and providers must support this road map with detailed planning to get to a new target operating model. In this way, they can build a baseline against which to measure outcomes from any sort of IT transformation. Contract teams can monitor costs, but they can also track nonfinancial performance-based metrics (for both business and IT activities) such as asset-refresh rates and service-delivery times. Under this approach, IT purchasers can manage change in the IT landscape more effectively (with input from business stakeholders), and IT providers can be assured that their share of gains will be based on a solid business case rather than an ambiguous definition of success.
The contract team at one investment bank set aggressive transformation goals at the outset of its conversations with sourcing partners. The contract team sought a 40 percent reduction in costs in the first two years and an additional 40 percent reduction over the following six years through the use of the provider’s services. These numbers galvanized the bank and the IT provider. They jointly considered unconventional ideas for transforming the bank’s operations—for instance, moving to cloud-based services and retiring some applications—and implemented each according to a detailed plan they had drawn up early in the process. The bank, its stakeholders, and the IT provider managed to reset existing relationships and worked together to push for significant technology improvements over the long term.
Devise win–win contract mechanisms
The reality of IT-services sourcing is that in most contracting relationships, negotiations are treated like miniature battles, typically with each side focused on achieving the best price rather than mutual value. Indeed, in most of the contracts we reviewed, commercial mechanisms were not designed to be mutually advantageous, particularly during large contract resets. Certainly, cost reductions are an important objective for IT purchasers, but those reductions cannot come solely at the expense of providers’ margins if sourcing relationships are to flourish.
Both sides should instead pursue a balanced set of economic incentives. They could ensure sustainable economics by being transparent about underlying sources of cost and by setting mutual targets. Instead of focusing solely on unit prices, they could adopt a total-cost-of-ownership approach to pricing that, at the outset, incorporates all possible costs, consumption patterns, and other factors, given different scenarios. There could be an open discussion about mutual incentives in a scorecard that tracks implementation of gain-sharing mechanisms in the contract. Both sides should also consider the value of the contract over its duration rather than just at the beginning. Some contracts are structured so that one side can meet its business and financial objectives in the first year while the other party benefits in the ensuing years. We found balanced incentives in only about 10 percent of the contracts reviewed.
An automaker struck a deal with the provider of IT-infrastructure services under which it agreed to a certain minimum in annual spending. It also agreed to provide reliable forecasts of service needs for a small group of business activities that were stable and thus easier to predict. In return, the provider offered the automaker commercial discounts and agreed to a gain-sharing arrangement in which both sides would benefit from aggressive productivity improvements.
Similarly, a European telecommunications company struck a win–win deal with the provider of its infrastructure-management and application-development services. Under the terms of the deal, the purchaser would benefit from an aggressive and predefined schedule of productivity improvements that would push unit prices down, thereby counterweighting the effects of inflation. Instead of offering outright volume discounts, the provider changed unit rates every year based on actual consumption by the telco compared with the previous year’s numbers. This helped sustain the volume of work flowing to the provider and allowed it to correctly gauge and meet the required levels of service each year. As a result of these win–win economics, the provider was always willing to address any pain points for the telco during the contract term. The purchaser received reliable service. In turn, the telco’s IT users gave the provider high customer-satisfaction scores.
IT sourcing is not going away. Companies in all industries lack the bandwidth necessary to maintain all their IT capabilities in-house. They must rely, to one degree or another, on external service providers to get even the most basic tasks done. And as more companies attempt to digitize their products and operations, IT sourcing becomes even more critical.
Companies should continually assess the efficacy of their strategic partnerships—they must evaluate not just technologies provided or service-level agreements forged but also the expertise obtained and innovations achieved. Our research pointed to five ways to strengthen IT-sourcing dynamics. There are likely other areas for improvement as well. What’s clear is that both sides will need to view their interactions differently—as true win–win partnerships, where more value from IT is created together than apart.
The growth of fintech shall deal with stringent banking outsourcing regulations which might put burdensome obligations on providers in Italy.
Given the potential impact of outsourcing services in the banking sector, the Bank of Italy issued very specific rules on the contents of outsourcing agreements and obligations that are both on banks and suppliers. These obligations together other general obligations might create a demanding environment for providers. And this happens at the time when Fintech is rapidly growing.
The regulations apply only to the outsourcing of ‘important company functions‘ which are those that have a relevant impact on the business of a bank and include the outsourcing of for instance the back office and the information system.
Compulsory contents of Fintech outsourcing agreements
The Bank of Italy regulations provide for minimum clauses that need to be addressed in outsourcing agreements relating to information systems and those include
the obligation on the bank to
prove that the supplier is a ‘qualified outsourcer’ which might create issues in case of Fintech start ups;
keep control and responsabiliy on outsourced activities; and
keep internal technical and managerial competences to be able to insource the outsourced activity if necessary;
the obligation on the supplier to
comply with the security policy of the bank and with privacy laws;
ensure that at all times it is able to provide the required service and to notify the bank if it is no longer able to do so; and
be subject to the notification obligations towards banking authoritiies and their potential audits; and
the obligation to regulate within the contract
data, software and technical documentation ownership with the obligation on the supplier to destroy in any case the bank’s customer data in case of termination of the agreement;
management of security breaches;
termination events in case of supplier’s inability to provide the requested service or breach of the service levels;
disaster recovery and back up systems, including continuity plans; and
migration obligations in case of termination of the agreement.
Privacy related obligations
I have already discussed about the impact of the new EU Data Protection Regulation on technology suppliers. But, when it comes to banking outsourcing, the additional tracking and alert obligations that I had addressed in this blog postbecome also relevant.
Sanctions against outsourcers
In addition to the privacy related sanctions that under the new EU Data Protection Regulation will be also against outsourcers, banking regulations introduce sanctions from EUR 30,000 up to 10% of the turnover of the outsourcer. This is a peculiarity as no direct sanctions against outsourcers were provided in the past.
It will be interesting to see the impact of these regulations on Fintech deals.
Recently a customer of ours gave me a copy of the ‘Outsourcing Performance 2016’ guide published by Giarte. It had caught my eye when I was in his office, because the title was ‘Simplicity’. One of my favorite topics, and one that I fail to understand would be at all applicable to the outsourcing industry…
Struggling to survive
For years I have seen outsourcing companies in bad weather, resulting in many layoffs across the board. It seems that a lot of companies are struggling to survive, now that their customers are beginning to see the true nature of many of these companies.
The report summarized this problem very clearly: “For years the buzzword ‘partnership’ has been abused by the IT outsourcing market. Much was promised, but innovation and transformation hardly ever emerged. The result: a huge lack of trust between the partners, managed by using very strict contracts and a tight, direct control structure.”
It is evident that this lack of trust and the absence of promised results leads to many companies taking a different approach to outsourcing. General Motors, for example, has gone from a maximum of 50% of IT being outsourced to a 10% maximum. Similar reductions are seen in many other companies as well.
The future of outsourcing
The lack of trust is also exactly our own experience in the outsourcing market. When we started with our first company, we were in the outsourcing business. Customers would often not trust a deal, and we had to make a huge list of specifics to show that what we offered was realistic. Even if we offered a deal as fixed price.
The Giarte report also concludes that the future of outsourcing lies in making different choices. Letting go of the focus on technical specifics, instead managing on output and business goals. I couldn’t agree more. Outsourcing companies have a broken business model. Can this be fixed, or is it too late?
Broken Business Model
I have been in the IT business for about 15 years now and for as long as I can remember, outsourcing companies have had the billability business model. A junior consultant costs X per hour, a senior costs Y and a principal consultant costs a lot more. If you need a number of hours of consultancy, simply multiply, haggle a bit for a discount and you’re good to go.
The problem of course is, that you need to ask the consultancy firm how many hours something takes. Not a big deal, I hear you say. You just ask for 3 different offers, from different companies. Choose the least expensive one, and you feel you have done a great deal. But now the problem manifests itself….
You want a change in your software, or need to expand your IT because you expect more customers to be using your website for example. Now you are stuck with the outsourcing company you hired, because they have all the knowledge. The Giarte report states this as one of the major downsides of how outsourcing has been done in the past years. This, in effect, puts all the power in the hands of the outsourcing company and leaves companies fully dependent on the outsourcing company. These outsourcing companies will now drive up their price, because switching to a competitor is more expensive.
In my perception, the issue is that your success as a customer, isn’t necessarily the success of the outsourcing company. You’d want the outsourcing company to be successful if you are, and to suffer enough if you aren’t due to their work.
In 2014 I was in a meeting with the board of a big consultancy firm. They claimed to do things differently, they were no stranger to making deals based on the results of the project, they said. So I asked them what percentage of projects was done using a results based model, instead of invoicing the hours spent. They couldn’t really say. So I asked how many projects they had done this way, in absolute numbers. The answer? None.
And I can’t blame them. It is easier to be able to invoice the effort, and not the result. It is easier to not take responsibility when a project doesn’t bring what it was supposed to. And there we are; the problem. How to align the success of the outsourcing company with the success of the customer?
A truly results-based, longterm business model
At Triggre we ran into this exact same issue. As I said, we came from outsourcing originally (granted, a long time ago), and we got fed up with this issue. Old school software companies don’t need to pay attention to the customer, because they care more about their outsourcing partner eco-system. If their partners are happy, they will sell the product for them. To make partners happy, all they need to do is make sure the partner can spend a lot of hours. So there is no need to fix any non-critical defects very quickly, or make a new release completely backwards-compatible. The partners will solve these issues for the customer, by spending additional hours on implementation. Happy partner, happy software company. And if they’re very lucky … a happy customer.
The solution lies in making the (financial) success of the software company and partner dependent on that of the customer. And the model doesn’t need to completely change. For example, a good first step would be to charge cost-price for hours during the project, and charging a percentage of the financial gains the customer makes. If there are no direct financial gains such as extra turnover or saved costs, a similar agreement could be made based on the improvements the customer intends to achieve with the project, e.g. a price per point that customer satisfaction increases. Sadly, there are very few companies that are willing to take this risk. And think about it; is that really testament to how well they will perform for the customer?
I truly hope that outsourcing companies world-wide can change their business model to a fair one, a more value-based pricing model. Because if they don’t, their business will dry up very quickly. Rightfully so, if you ask me.