Strategic Sourcing 101: Business-focused outsourcing

Over the past two decades, corporations have engaged in major IT outsourcing initiatives to improve service while reducing costs, sometimes handing over the entire IT operation to a single service provider in comprehensive outsourcing arrangements. Twenty years later, these organizations have learned significant lessons that are driving the adoption of strategic sourcing, an outsourcing approach that focuses on long-term business needs and strengthens competitive advantage by selectively outsourcing specific IT functions. These lessons provide a valuable guide to strategic sourcing and the five key considerations that must be taken into account when building a successful sourcing strategy.

Lessons from comprehensive outsourcing
In their initial outsourcing programs, many CIOs found that the cost savings that justify comprehensive outsourcing can quickly vanish if the business evolves and the service becomes ineffective. Sometimes, you even pay more to retrofit. As a result, these companies learned a valuable business principle:

Alignment with the organization's business goals should be the top priority for IT operations—and IT outsourcing.

They also recognized three supporting lessons for applying the principle to their organizations.

1. Most outsourced IT services are not commodity services
As many of the pioneers learned, cutting costs should not always be the primary consideration. Very few IT services meet the definition of a real commodity, since technology components become "de-commoditized" when applied in unique ways to meet specific business goals. When this happens, they become woven into the fabric of the business and strengthen the company's competitive advantage. CIOs are now choosing best-of-breed providers for each IT function over comprehensive outsourcers to ensure customized, high-quality service across the board.

2. Some functions are best performed in-house to retain competitive advantage
In the quest to cut costs, some companies outsourced functions they later discovered were critical to their ability to adapt to market changes and retain their competitive advantage. IT-enabled and IT-intensive processes are often the vehicles through which market challenges are being met; any loss of control over critical IT services can severely damage an organization's ability to compete.

IT service providers routinely deliver best-in-class service at low cost because they manage the provision of IT service as a business. The internal IT department needs to adopt those same standards and practices.

3. Outsourcing relationships must be flexible and evolve with your company's business
Frequently, companies make the mistake of signing rigid, long-term outsourcing contracts only to find later that their business focus has changed significantly. The effect of those changes can result in additional charges that erase the original cost savings and sour the client-provider relationship.

Innovative partner-style agreements are quickly becoming the norm as companies recognize the need for improved risk sharing and benefit reward models. The ability to modify the provision of service over the course of an agreement is sometimes more significant to a company's long-term success than a well-crafted set of penalties for below-standard performance.

The recognition of these three realities is leading many CIOs toward strategic sourcing of IT services.

A closer look at strategic sourcing
In its September 2002 report, "How to Build a Sourcing Strategy," Gartner defined strategic sourcing as "the dynamic delivery of internal and external, business—or IT—oriented resources and services to ensure that business objectives are met." The objective is to align IT with changing business needs more effectively, which is particularly important in light of the vital role that technology-enabled processes play today in the ongoing success of the enterprise. The three lessons discussed earlier are key components to the strategic sourcing approach.

Defining your strategic sourcing approach
In its report, Gartner concluded, "Strategic sourcing is not about technology. It is about leadership and superior management capabilities." Creating an effective strategic sourcing approach is not easy and requires a great deal of analysis and consideration. Figure A helps illustrate what you need to think about in your sourcing strategy.

Based on five main dimensions of strategic sourcing cited in the Gartner report, here are questions you should ask as you define your outsourcing strategy.

1. What are our current and anticipated business goals? It's no longer enough to just outsource current business processes or IT services—every sourcing decision needs to be considered in the context of the entire enterprise and the marketplace. At a minimum, your sourcing strategy should be based on:

• Expected evolution within the marketplace, including both service providers and business competition.
• Explicit business objectives, such as capabilities you plan to add.

2. What is our internal capability? The status of internal capability should be considered with a long- and short-term view of make or buy, that is, how much of the overall solution you want to handle internally vs. externally. The internal capability of many IT departments may be inadequate to fulfill the challenges they face. Typical symptoms of an inability to support expected innovation internally include:

• A passive or reactive relationship between IT and business units.
• A perception by business units of IT as a cost center that does not deliver innovation despite frequent cost-reduction campaigns.
• Significant use of external consultants without internal IT involvement.
• Poor results from previous sourcing attempts, especially when involving new solutions spanning multiple business units.
• Bad experience with outsourcing contracts driven by cost reduction.

3. Which of the available external market capabilities fit best with our goals? The IT services market is one of the more dynamic and chaotic marketplaces. As a result, companies need to understand the capabilities of service providers and how current and anticipated developments will affect their business needs. Are changes imminent in the service provider market? Are providers over-promising their abilities with emerging technologies? In short, the CIO's challenge is to match up externally available service capability with internal business goals and then balance that decision against the risk of change within the service capability, the business needs, or both.

4. Which sourcing model is the best solution for our needs? Creative sourcing approaches have evolved as organizations seek to avoid the problems of fully outsourced solutions without reverting to a fully in-sourced alternative. This is mostly a make-or-buy decision, with internal delivery and fully outsourced services at opposite ends of a service/solution continuum.

A company may have outsourcing initiatives that fit on different areas of this continuum. For example, it may use staff augmentation, which fits under technical skills, when it wants to retain ownership of the effort but needs expertise in a particular technology. On the other hand, it may outsource its order processing and invoicing functions, which are on the opposite end under business processes.

5. What capabilities are required for sourcing governance? Sourcing governance addresses capabilities needed to regulate and support multiple service providers, including management methods and processes, organizational roles and responsibilities, and service delivery rules and agreements. An effective governance model must cross traditional enterprise boundaries and become not only an integrated part of the business, but also part of the internal IT function and the external providers themselves (including even subcontractors and the provider's partners). Establishing effective sourcing governance is critical to the success of any sourcing strategy.

Clearly, strategic sourcing is a way to more effectively align IT with the business. The challenge for business executives is to find the best set of interconnected service solutions that meet the strategic needs of their organization.

Tech Republic originally published this article on 21 October 2003.