At one time or another, all our enterprise customers have asked us to help them determine whether their IT services vendor is overcharging them. The mystery of overcharging comes from having to prove a negative. However, we have significantly helped our customers by analyzing the potential sources of overcharging and their likely impact. By focusing on the right issues at the right time, customers can generate maximum savings for their enterprises.
Exhibit 1 outlines the sources of cost savings (or overcharges). By understanding the nature and impact of these sources, enterprises can review their contracts and billing to determine if they can reduce their cost. These components are:
Model Results and Conclusions
- Government taxes: Most U.S. states charge sales tax on hardware and software. However, 40 states do not collect sales tax on services. Many, if not most, vendors make mistakes on billing for state sales tax. Vendors that want to avoid problems with tax authorities tend to err on the side of caution and end up overcharging for sales tax.
- Vendor partners: The price a service provider can charge is directly related to the quality and volume of discounts it gets from its suppliers. Service providers with limited bargaining power with their suppliers can only cut prices so much before they jeopardize their business (as many ASPs have). Conversely, service providers that are a major sales channel for a product vendor can afford to offer better pricing on products than an enterprise could ever obtain in the open market.
- Geographic sourcing: Offshore sourcing is an option that is getting traction in the marketplace. Today, service offerings should include an offshore sourcing component and its associated savings.
- Vendor metering: Most vendors use weak reporting tools to monitor their services. Most users never check these vendor reports once the service is satisfactorily initiated. Given the amount of time spent negotiating SLAs, and the amount of change in a typical IT environment, it is startling to realize what little effort is spent validating the measurement of these crucial areas.
- Service-level agreements: Enterprises aggressively negotiate SLAs, but enforcing them (absent extreme non-compliance) typically is up to the vendor. The penalties are rarely significant. We have found that SLAs are valuable for helping enterprises identify areas for improvement or when deciding to change vendors, but are neither useful nor material for cost savings.
- Financing: Most established vendors offer financing and the best ones offer several options. Different options may vary in cost by only a few percent at most, but the flexibility these options provide can materially affect the service’s value to a customer.
- Component changes: Service providers change components continuously to make their businesses more efficient. Many vendors structure new contracts to share the benefits of efficiency improvements with the customer; make sure your vendor does. The contract should identify static components, such as platforms and networking, which rarely change, and dynamic components, such as the volume of help desk inquiries and seats provisioned, which change frequently.
- Market best practices: Finding the market-leading solution can result in significant cost savings, but only when technology is leading edge and not a commodity. Most technology, especially if a service provider has incorporated it into a service offering, is a commodity. Customers need to identify the leading vendors and quantify the cost differences.
- Market best prices: Most customers focus on obtaining the best price when negotiating an agreement. Although most service offerings are subject to a deep discount from list price, usually the customer with the best payment terms (pay as you go) is the one that receives the best service.
- Changes in customer usage: Customers change their IT environments when business needs change. Identifying provisioning they no longer need can save money; for example, having fewer users should lead to lower user fees. Eliminating processes or functions should reduce reporting and applications.
Active monitoring during the life of a contract will save more money (and also drive higher operating performance) than aggressive contract negotiations followed by benign neglect. Enterprises that can negotiate a flexible contract and actively manage a changing environment will win.
- Customers want transparency, operational excellence, and adaptability to changing conditions. As the services industry becomes increasingly competitive, relying on over provisioning or weak monitoring skills will not be successful. Vendors that can sharpen their pencils and aggressively manage their own operations will gain market share.
The Yankee Group originally published this article on 7 January 2003.
- A low price initially is not as important as minimum service levels. The key determinant of service in a difficult environment is how much money is still on the table when a disagreement surfaces. Payment terms usually have more impact than pricing on value delivered. Paying on the installment plan generally keeps the vendor’s attention.