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ATOMDoes the maths around outsourcing work?
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Survey after survey shows that cost is a key determining factor in outsourcing IT services. But beware of driving too hard a bargain when negotiating a managed services contract -- you might just find that your determined haggling later turns around and bites you on the behind!
"The fact is that the best managed services contracts are the ones where both sides benefit -- both the customer and the supplier," says Ian Hodgson, a managed services specialist at Logicalis.
That's because IT outsourcing spend is not just a mechanism for reducing the cost of IT services, he explains.
It's also about tapping into the expertise of a third-party specialist capable of delivering innovation and improved efficiencies that are beyond the scope of the in-house IT team. In fact, he says, that's where the true value of outsourcing IT services lies.
"If there's no money to be earned in a deal for the provider, then there's no incentive for them to give the client the full benefit of their experience," Hodgson adds.
It's vital, then, to understand the financial equation for outsourcing and the cost challenge it presents to both parties. On one hand, the customer usually wants to see any increases in costs limited to a maximum of the retail price index (RPI), or even a commitment for year-on-year reduction in costs, in the region of 5 per cent to 10 per cent per annum over the contract term. On the other hand, the service provider wants to make an average of 20 per cent to 30 per cent per annum gross margin on the contract.
At its simplest level, for both parties to achieve these objectives, the service provider has to provide the same levels of service for 25 per cent to 35 per cent less cost than the current costs of the client.
For this to be possible, both client and service provider need to be realistic about the maths involved - or risk a major fall-out, potentially damaging to both parties, further down the line.
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Your Comments and Questions
Jon, 6 months ago
I remember when outsourcing was the new "big thing" at IBM back in 2000. They signed a huge 5 year deal ($5bn) with a large American bank which was cancelled after 2 and a half years. That must have led to interesting discussions as my understanding is that the vendor typically loses money in the first two years only to make it back in years 3, 4 and 5?
Gary Edwards, 6 months ago
Amanda is absolutely right. Outsourcing provides access to latest technologies (that often would be outside the financial reach of most organisations), as well as the expertise and best practice that outsourcing providers bring to the table. While there is a growing realisation by some organisations that price comes a little way down the list in terms of weighing up the advantages of outsourcing, there's still a long way to go in terms of educating the majority.
Amanda Smith, 6 months ago
I understand why an outsourcer needs to make money out of any deal - they have shareholders after all. But I do think IT outsourcing is one of those services that has been sold largely on the fact that it will save you money, so it's understandable that companies expect outsourcers to be competitive on price. Perhaps this demonstrates more than anything else how the industry needs to work harder to educate the market about the other benefits of outsourcing - namely, that you can achieve service improvements as well as some cost efficiencies.
George Black, 6 months ago
An interesting article. Do you have any advice on how best to negotiate and calculate the 'maths' for a successful relationship i.e. where does one start? Thanks