by Sven Geissler, Senior Consultant, ISG
While an outsourcing transaction can be a powerful tool to improve business operations and financial performance, it can prove counterproductive without a sound business case. This is especially true if a company lacks effective governance. The process of preparing and negotiating an RFP is already complex and stressful. Add time pressure, lack of transparency and poor planning, and you may end up making “The Big Mistake”—a business case that looks good on paper but, in reality, leads to higher costs.
Consider the following Top 5 tips to avoid making “The Big Mistake”:
1. Build a solid financial base case. For a solid case, consider multiple sources, evaluate recent trends and assess the accuracy of your budgeting and forecasting. Use next year’s budget to approximate the actual outsourcing contract term. Ensure a broad perspective that includes retained costs and allocations held at group or corporate level. Throughout the process, document key assumptions so you can evaluate and articulate the level of transparency and confidence you have in the numbers. If your organization requires an analysis per business unit, geography or service area, build in those views from the start.
2. Define financial responsibilities. Services are typically based on products, such as a set of assets, applications or facilities. Transferring the operational responsibility for a service does not necessarily change the legal and financial ownership. Allocate all current and future components involved in the delivery of services to either the service provider or your retained organization to avoid additional cost or a change order once the agreement is signed. Know the current inventories of equipment, licenses, leases and third-party contracts, and define the process of transferring them in the context of local laws. Get authorization from involved third parties to share relevant information, including contractual terms and relevant pricing.
3. Improve transparency by documenting resource baselines. When moving to more flexible cost structures and consumption-based pricing models, volume consumption becomes the key. The “Q” of the P x Q pricing mechanism represents a measurable device, unit of consumption, staffing level or other resource associated with the services. To avoid the risk of contract change based on inaccurate volumes, get to know current volume consumption including those resources that are not yet measured. Make sure the measurement is repeatable and that it provides consistent results so you can hand it over to the service provider during transition. A sign-off process, which also involves your demand organization, will help you to avoid issues when charging back cost to your business.
4. Plan the total cost of sourcing. Comparing service provider pricing to the in-scope base case does not provide a sufficient view of the impact of outsourcing. Significant one-time costs, such as the creation of the RFP and support of transition and transformation, can add up to millions, and retained costs, including the governance organization, has significant impact. Consider normalization of proposals during the evaluation process, and build scenarios including risk contingencies – and conduct a sensitivity analysis – to test the validity and integrity of the business case across various permutations. Take time to ensure understanding of the business case and alignment across key stakeholders even if the objectives are driven from the top of the organization.
5. Ensure viability of your business case. Once the agreement has been signed, prioritize the management and tracking of the business case, including assumptions made early in the project. Proactively mitigate risk and other potential cost-drivers such as the consumption of services. Establish key performance indicators to monitor and measure the business case objectives over the course of the contract. Assessing progress toward the original business objectives is a powerful tool to use with owners of the business and a strong platform for governance discussions with the service provider.
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