In undertaking a large IT outsourcing arrangement an organisation is effectively selling its systems' family silver. Since that is something that you only do once, it is imperative to secure the best deal you can. The secret is to ensure the deal creates maximum shareholder value for the long-term and not be seduced by short-term gains.
For years now, outsourcing experts have emphasised that the desire to save money in the short term is not the right reason for outsourcing. Many companies can confirm from bitter experience that even short-term benefits are difficult to achieve. Despite this often-repeated advice, when it comes to the next deal, organisations forget what they have learned, and revert to doing deals whose only possible benefit is short-term financial payback.
Undoubtedly, companies have progressed beyond looking for simple reductions in IT operating and support costs. Recent research undertaken by PA Consulting Group shows that 85 per cent of respondents view the ability to deliver new services and access to specialist skills and expertise as important. But a primary factor is still cost reduction (84 per cent)*. This is as you would expect and right, except where the cost reduction is looked at narrowly, that is simply in terms of the difference in cost between service today and service tomorrow, and not in the strategic context of the assets being disposed.
A recent IT systems outsourcing deal by a large air transport industry player suggests a new approach. The deal resulted in the transfer of some of the organisation's core operational systems to an outsourcing supplier. One example hardly makes a method, but because of the size of the cost savings created, it merits a little investigation.
With the airline sector already going into recession, next year's profit and loss account was high up on the agenda. However, so too was long-term shareholder value creation.
The company recognised that it was transferring significant assets - hardware, software, people and intellectual property - and that the deal amounted to selling part of its family silver. This is something that it could only do once and it was determined to get the best deal possible.
In this example, cost saving remains a key objective, but the size of the saving and other benefits is determined by some rather innovative additions to the traditional IT outsourcing approach.
Success came from taking a far more market-oriented approach to the deal. The natural impulse with outsourcing is to go through a rigid and limiting procurement process and drive the hardest bargain possible. But, if the aim is to maximise shareholder value, it is essential to turn the picture round and see the proposed deal as a market opportunity. Assets are put into play and the aim must be to find the best way to get value from them.
In the deal under consideration here, there was some very hard bargaining, but the value at the heart of the bargaining was driven by four market-facing factors:
Choosing partners that want the business: This may sound obvious but the key is to choose potential partners that want the business - not just for the extra volume, but because they see an opportunity to gain strategically. Where you have a partner that sees the deal as strategic, they will be looking to create more value than just the margin on your business. If that is the case, they win on the back of the deal and so your deal should look sweeter. For example, if the partner sees the deal as a way of gaining entry to a new market, your business could be worth more to them than to an incumbent player.
Getting the timing right: Good timing can aid value creation, especially if there is a "market moment" where asset value is at a maximum. For example, in a consolidating market, size can matter. A desire to gain position in such a market could drive your partner to offer more today than they would if your deal is further down the pike, and behind others. They could even see the deal as the start of a domino effect - if they win this one, others will follow.
Broadening the scope of the deal: Constraining scope can reduce value; expanding scope for partnership can create value. Where software and intellectual property is being transferred, there may be opportunity to take a stake in future product development. Where your partner is strong, it may make sense to make more use of this - unlocking even more value from your family silver.
Finding the best structure for the deal: While it is easy, and sometimes appropriate, to use a standard IT outsourcing contract, there are alternatives to consider. It sometimes helps to think of the initiative as, for example, a joint venture, for the purposes of defining the value-creation potential, even if the contract is then cast as a customer-supplier outsourcing deal with add-ons.
What is the main success factor for those contemplating such a value-creating approach? The usual IT outsourcing guidelines do not help here, because they are focused on the minimisation of risk rather than the maximisation of reward. Important as it is to define requirements, write SLAs, establish competition and so on, you need to put as much thought into the other side of the equation if you are to move beyond marginal cost savings to substantial increases in shareholder value.
The primary requirement is to inject market knowledge into your approach to the deal. A surprising number of IT suppliers are willing to contemplate an unconventional approach and to respond to value propositions. Frustrated by low margins from traditional outsourcing, many suppliers are now looking for better ways to work.
Willingness is not enough, however. Cutting these deals does require special skills on both sides. In particular, both negotiating teams must fully understand and subscribe to the principle that it is as important to gain reward as it is to limit risk or cut costs. It helps to have facilitators or team members who have been through the process before.
Cost reduction is always going to remain the main consideration in an outsourcing deal. After all, the reason for outsourcing is usually because the supplier can provide service at greater economy of scale. The good news is that a market-facing approach is likely to deliver higher cost savings because the supplier wants the business for reasons other than the additional volume. Sometimes, it seems, you can have your cake and eat it - but only if you make a bigger cake and are willing to share.
