Static sourcing methods are going by the wayside, as change management is now the name of the game. But just what is the optimal approach to sourcing when a business is in the midst of transformation?
A brief history
IT outsourcing, an important business tool for some twenty years, has undergone numerous changes since it first arrived on the scene. In the early days, outsourcing was driven by a need to improve cost, speed to market, service levels, access to needed skills, and/or the balance of fixed to variable costs. Corporations outsourced a certain IT function or tower (often the mainframe initially) to one of the few players in the field, and they frequently handed over control, management, and architecture of those functions, too. Never expecting to operate those functions again, they signed long agreements for those operations. Over time, more and more towers became outsourcing candidates, including desktops, servers, network management, and, occasionally, application development and maintenance.
In recent years, agreements have shortened, moving first to seven years, then to five, and even to as few as three years, depending on the tower. Customers preferred shorter terms to mitigate the risk of locking in deals they didnt like or no longer wanted. Vendors, naturally, wanted the annuity stream provided by longer terms. The tradeoff frequently was, and still is, a slightly lower price for a longer deal.
What these early deals had in common, though, is that they were seen as one-offs: A tower was outsourced for cost savings or service level improvement, and that decision was considered independent of evolving changes in other functions, the corporations strategic intentions, or the broader business environment. For all the names given to them (e.g., First Generation sourcing), these initiatives are Simple or Static sourcing. The goal was to make the best outsourcing arrangement based upon the current understanding of the business, and then live with that decision for the duration of the deal.
In recent years, complexity has reshaped the sourcing decision. We now know that early deals did not fare especially well because the management and architecture were often assumed by the vendor, granting them too much power, and deal termination issues had not been thoughtfully considered. Eventually, the industry made governance changes to better handle deal terminations, and customers learned to retain critical decision-making elements.
Applications outsourcing, which had gotten little traction (since the deals were risky and the expected value rarely materialized), took off with the advent of offshoring. Organizations began to build captives (their own overseas delivery facilities) as alternatives to offshoring. Deals terminated, either because they were reaching their natural end, had outlived their usefulness (customers changed their strategy due to market pressures or acquisitions/divestitures, etc.), or because vendor performance forced a change.
The sourcing industry entered a Second Generation phase where old deals were renegotiated and extended, resourced to another vendor, or brought back in-house. Nevertheless, this was only a slightly more complicated version of first-generation Static Sourcing: Every tower was still viewed on its own, where the deal was either good (keep or extend) or less good (re-source it or bring it back home).
These days, almost any business process that can be measured can be outsourced, from IT infrastructure and applications to HR, Finance and Accounting, facilities, and legal services. In fact, almost any business process can be safely outsourced, so long as it can be counted and measured. Towers are outsourced for different reasons (e.g., cost savings or to access specialized skills), for different lengths of time, to multiple vendors in different countries, and by various parts of the organization. While it is difficult to keep track of all the variations, this is still a form of Static Sourcingeach tower is still seen as independent of the others and can therefore be viewed as an individual initiative whose deal value is still based on a snapshot in time.
The old models can not deal with today's complexity
Something dramatically different is now emerging. For some time, market seers have been advocating the notion of an adaptive infrastructure to describe rapidly changing environments driven by changing customer needs. These changes are caused by increasing globalization and electronic business structures, with capital moving rapidly between markets, and new channels emerging and vanishing in one breath.
The upshot is significantly increased complexity along several dimensions:
Time: The speed with which market dynamics can change demands that companies adapt their strategies and operations over much shorter time spansspans that evolve within the time horizon of typical outsourcing deals
Functional interdependence: With so many aspects of the business now serving as outsourcing candidates, the simplifying assumption of functional independence between towers no longer holds; there are too many interfaces within the business and between vendors to treat each decision without consideration of its downstream effects
Geographic reach: Options for outsourcing now span the globe, introducing compounding elements of cultural, political, and regulatory risk that vary over time, and that must be factored into outsourcing decisions.
These factors have cascading effects throughout the organization, and they are forcing the delivery functions to transform on the fly, making flexibility with external players paramount. Sourcing strategies and delivery models must adapt: many of the agreements now in place are lacking industry best practices and need to change to accommodate environmental transformations. In addition, technology innovations contribute to the rising challenges in outsourcing relationships. Customers and employees are located worldwide, and money flows internationally via the Internet or mobile telephone. The speed of interactions within global markets has made the danger of miscalculating the sourcing decision simply too great to ignore.
Improved models for Increasing complexity
Increasing levels of business change and transformation have driven a reassessment of the optimal approach to sourcing strategies everywhere along the life cycle. Consider some of the new issues that cannot be determined using the static sourcing methodologies and tools that are so familiar in the industry:
How does one determine the optimal mix of outsourcing, insourcing, and resourcing by geography, over various deal lengthsall while keeping track of an ever-changing corporate strategy and competitive landscape?
What second order effects will a change in one area of the sourcing strategy have on another, given the functional dependencies that did not previously exist? (For example, if change/ transformation occurs in one area, what demarcation changes are needed from a vendor covering a different function?)
How does one determine when to terminate a current agreement, if it is delivering smaller benefits than one could get elsewhere, while accounting for the decreasing switching costs of moving from one vendor to another, and while considering constantly changing priorities?
How, then, does an organization get a handle on this complexity to optimize its opportunities, and minimize the threat of paralysis in the enterprise?
Addressing complexity without oversimplifying
One approach for evaluating this complexity is a methodology known as system dynamics (SD). System Dynamics explicitly defines the cause-effect relationships, interdependencies, and feedback at play within the business and its broader operating environment. Importantly, it also characterizes the delays between the time a decision is taken and when its full consequences are realized. An SD approach to evaluating and categorizing outsourcing options offers a dynamic view, and the potential to inform decision making and define more effective arrangements.
This capability can enhance sourcing strategies by rigorously evaluating the consequences of different actions or combinations of actions, and how consequences change when implemented under different timing.
The process involves creating a cause-effect model that graphically describes the key interdependencies between the business, its vendors, and the operating environment. These cause-effect relationships drive business performance over time, including the unintended consequences that are hard to infer based on intuition alone.
The next step is to quantitatively define these connections in a series of interlinked mathematical equations that are validated numerically against past performance (e.g., headcount, profits, etc). The product is a simulation model that serves as the analytic engine for assessing the full business impacts of different outsourcing options, from tender to renegotiation or to other hybrid solutions.
An organized summary of key assumptions describing how things will change under outsourcing is compiled. Factors may include:
- Bundles of activities outsourced
- Timing of change (i.e., from insourced to outsourced, or offshore to nearshore)
- The degree of change, and the likely disruption
- Relative capability, capacity, and cost of current and potential providers
This information is fed into the simulation model. The models internal logic calculates the consequencesboth intended and unintendedof these changes on business performance over time. Typical analytical outputs from this process might include:
a) charts showing changes in profit over time;
b) how value changes for different assumed conditions (e.g., how deal termination timings will affect profits); and
c) the drivers of costs and savings for different sourcing options or suites of options (to help find a set of actions that will be consistently robust over a range of uncertain future conditions); or causal diagnoses of unexpected behavior.
Together, the model, scenario assumptions, and simulation outputs form a decision framework for evaluating different outsourcing arrangements, as shown in Figure 3. This approach adds rigor and flexibility to the outsourcing process by more explicitly evaluating:
The optimal time to terminate an existing arrangement while balancing the penalty for termination vs. the value to be gained from switching (net of switching costs)
How the termination sweet spot moves if the current provider increases its value over time by transforming itself and passing along the benefits
Where the point of diminishing returns to further outsourcing will likely occur, given constraints posed by the business, labor, and regulatory environments
The value (e.g., cost avoided or profit gained) of selective sourcing (i.e., using multiple best practice providers) vs. staying with, or moving to, a single provider
The savings of using a phased approach, whereby parts of the current agreement are terminated and moved in one year, other parts are improved under the current provider, and different parts are moved or improved in yet another year.
Conclusion
In the new outsourcing world, where everything is on the tablefrom multiple towers and business processes, to timing, geography, and interdependenciesthe static models of the past are insufficient to optimally evaluate an organizations best approach to gleaning rich benefits. The multiple, varied inputs to these complex decisions require a dynamic methodology to replace the static tools that have been used since the advent of the outsourcing industry.
An SD approach can provide a disciplined path to help businesses make sense of their operating environments and to improve their ability to address these complex and evolving challenges by:
(a) identifying the most important questions to answer as part of strategic sourcing decisions;
(b) rapidly improving the big picture perspective and enhancing the ability to balance near-term actions with a better understanding of long term consequences;
(c) providing a platform to enable rigorous evaluation and productive discussion without simplifying to the point of distortion; and
(d) accounting for all the inputs that constitute the elements of the sourcing decision and how they vary over time.
