There has always been a certain degree of choice available to organisations that are seeking to outsource IT.

To differentiate themselves in a crowded marketplace, suppliers have been forced to develop new payment models, new service offerings and facilities in new geographical locations. Build-operate-transfer, managed services, out-tasking – these are just a few of the well-established ways in which an organisation can involve a third party in their IT operations.

This variety of engagement models has not always translated into clear customer value, however.

A 2009 survey of the chief financial officers of businesses that outsource IT, conducted by outsourcing consultancy Cognizant, was revealing. The study found that 78% of the CFOs believed that the value for money they received from IT outsourcing was ‘unclear’, while only 38% were confident of the ability of their organisation’s CIO to communicate the benefits of their particular outsourcing engagement to the business.

This finding may say as much about internal accounting and cost-justification practices as it does about the actual value that may or may not be delivered by IT outsourcing. Either way, though, businesses need their outsourcing providers to deliver clearer value. This impetus is only likely to intensify because, as a recent study by analyst company Gartner discovered, CFOs are wielding increasing control over IT spending in the wake of the recession.

Outcome-based pricing

IT services suppliers are happy to oblige, at least on the face of it, and the downturn has accelerated the development of alternative ways of outsourcing IT. “In the past two years, we’ve been constantly looking at changing how we fundamentally engage with our clients,” BG Srinivas, head of Europe at offshore IT services giant Infosys, told Information Age recently, “and we have incubated what we call new engagement models.”

Srinivas says that the recession drove demand for IT services contracts in which charges are linked to a certain business metric, for example by charging for each transaction. “When we saw clients go through the challenges of the past two years, they found it extremely difficult to manage their costs because their business demand fell so radically; so they were under pressure to cut costs, and a significant part of their [Infosys] costs were fixed costs,” he explains. “We decided that if we had to support our clients through business cycles then the best way is to reduce their fixed costs and make sure that their expenses can be varied based on the business need.”

Another such model is often referred to as value- or outcome-based pricing. Under this kind of contract, customers are billed not for time and materials but on the basis of a certain outcome, such as reduced transaction cost, accelerated time to market or improved customer satisfaction. Forrester Research analyst Liz Herbert writes that despite “challenges ranging from internal organisation hurdles to crafting the contract and agreeing on fair payment drivers”, outcome-based pricing models can deliver “significant rewards”.

One advantage of this approach is that the supplier absorbs some of the risk involved in outsourcing – if the desired outcome does not materialise, they don’t get paid.

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Yann Gloaguen, offshore delivery manager at outsourced software testing provider Software Quality Systems, argues that without some “skin in the game”, there is no motivation for a supplier to improve its service.
“Service level agreements should include some element of risk and reward to encourage good performance,” he says. “Without this, any incentive to define and action a process improvement plan, which is core to a true value-add proposition, is compromised.”

Such an engagement also engenders a cooperative, as opposed to adversarial, relationship, says Gloaguen. Issues can therefore be resolved as they arise: “A risk- reward agreement, where both parties have a measure of transparency, is far more likely to succeed than one where some issues are kept behind closed doors.” He warns, however, that subtleties of terminology can impact the effectiveness of any engagement. For example, the word ‘milestone’, typically understood to denote an outcome successfully achieved, can sometimes be used simply to mean some task to be performed. “When tasks are called milestones, the result is to weaken dependencies,” he explains. “It also increases the number of ‘milestones’, which dilutes failures.”

Not everyone advocates an outcome- based approach to outsourcing. Greg Jones, managing consultant at PA Consulting Group, warns that while such an approach means that the supplier shares in the risk, a boon in hard times, they also share in the reward, a disadvantage when business is strong.

“When times improve and the supplier starts to share the profits, the CFO will often try to make the CIO renegotiate the deal,” he explains, “because suddenly they are paying out more than the market rate for those services. The last thing a CIO wants is their CFO saying, ‘We don’t want to share our profits with them this year!’”

Futhermore, offshore providers may not be as committed to outcome-based engagements as their rhetoric might suggest. Speaking at Information Age’s Managing IT Cost Effectively seminar in February 2010, Stephen Bullas, managing director of the European Centre for Offshore Development, explained that offshore providers are indeed “shifting from the normal and well-understood cost and labour arbitrage deals to so-called output-based deals engagement models based on value”. “But,” he added, “the problem is that they are badly promoted and badly understood by the vendors.”

Lower service models

Another significant development in IT service delivery has of course been the advent of cloud computing, in which technical resources are consumed on a utility basis via the web.

In one sense, cloud computing is diametrically opposite to the outcome- based approach to IT outsourcing, in that it allows organisations to procure IT resources with no real relationship with their supplier. Amazon Web Services, for example, lets customers provision hosted servers through a web interface with no human involvement on the supplier side, let alone any shared interest in the success of the project.

But like outcome-based pricing, cloud offerings serve the need for greater value (by scaling up and down according to demand) and greater insight into value (by providing a more granular view of expenditure).

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Not surprisingly, given the buzz that surrounds the topic, many traditional IT service providers have launched cloud solutions in the past year. In March 2010, for example, IBM launched its development cloud, on which customers can test newly built applications. In January, Atos Origin launched a suite of cloud services, although it admitted at the time that much of the functionality was previously available as part of its ‘utility computing’ range.

Do these suppliers run the risk of cannibalising their existing revenues by offering cloud services? Only to a certain degree, as many customers will still demand the ability to dictate terms such as the technical specification and geographical location of the hardware that supports their outsourced systems. Indeed, in the short term at least, the adoption of cloud computing is likely to drive consultancy and systems integration business.

Craig Boundy, the UK CEO of IT services supplier Logica, was unphased by the advent of cloud when he spoke to Information Age in April 2010. “Our point of view is that people are going to move to cloud computing, but not in a huge rush,” he said. “Rather, they are going to find new services that they are going to want to integrate with their existing fixed IT operations, and so our position is to offer the advice and consultancy to do that, and to broker and integrate [cloud services].”

However, according to one analyst, cloud-based platforms may prove more disruptive in the outsourcing industry when combined with business process outsourcing.

Hybrid services

Phil Hersht, an outsourcing industry analyst and founder of Horses for Sources, believes that outsourcing providers offering BPO services such as data entry or insurance claims processing can deliver greater value to customers by basing the applications they use to support those processes on cloud platforms. Equally, he argues, IT services suppliers can differentiate their cloud offerings by embedding BPO services into them.

In a recent round-up of the outsourcing industry, Hersht cited his own research, which found that 18% of organisations are evaluating combined IT outsourcing and BPO services ‘extensively’, and 45% said they had ‘some interest’ in such offerings. Hersht argues that the best way to make these bundled offerings work is through the cloud.

“Cloud computing presents the biggest opportunity for today’s services vendors to deliver blended IT/BPO services,” he wrote. With a combination of cloud and BPO “they can not only drive down costs through labour arbitrage and the removal of IT hardware with its associated energy costs, but also improve business performance through holistic, integrated business solutions”.

This is just one of example of how IT and BPO service models are diversifying exponentially, as emerging models are recombined into hybrid offerings.

Some customers might question whether this proliferation really works in their interest. Indeed, such is the diversity of models on offer that the job of selecting, managing and coordinating outsourcing providers has itself spawned at least one outsourced service offering – Capgemini’s so-called ‘service- management-as-a-service’ (SMaaS).

But this diversification, when subjected to the Darwinian process of natural selection, could give rise to a stronger and more demonstrably valuable form of IT outsourcing. Outsourcing engagements are long, however, and this process may take many years.