Seven steps for governing outsourcing contracts

A recent international survey conducted by the IT Governance Institute (ITGI) found that buyers of outsourcing services are increasingly dissatisfied with their service providers and are prematurely terminating their outsourcing relationships.

While 76 percent of the organizations surveyed outsource at least one IT service, only 25 percent have a governance system in place to manage the outsourcing contract.

Governance of outsourcing consists of the set of responsibilities, roles, objectives and controls required to anticipate change and manage the introduction, maintenance, performance, costs and control of outsourced services.

It is an active process that the organization and service provider must adopt to provide a common, consistent and effective approach to the outsourcing arrangement.

As a strategic resource, outsourcing must be sufficiently governed. The book titled Governance of Outsourcing, published by ITGI, suggests the following steps to ensure proper governance of outsourcing:

Step 1: Examine the organization's business and operations strategy to ensure that outsourcing is acceptable and feasible
This will clarify the core activities, which should not be outsourced. The type of outsourcing relationship is determined by the requirements for services consumption. Where these are discrete, consistent and have simple characteristics, the relationship is market-based (services provided may be packaged as 'catalogue' items--discretely identifiable service units at a fixed unit price and with clearly defined service characteristics) and costs less to establish. More complex and longer-term service provision requirements necessitate a more integrated or partnership approach.

Step 2: Establish the outsourcing governance processes and framework immediately following the strategic decision to outsource
This ensures a formalized approach to manage all components of the outsourcing lifecycle and promotes clarity of the objectives, expectations, roles and responsibilities of all parties involved. Formalizing this through a governance schedule ensures a proper contractual foundation. Never outsource deficient processes. If the organization cannot manage it, it is unlikely that the service provider will be able to either.

Step 3: Ensure that the appropriate people understand, quantify and qualify the company's outsourcing needs, and ensure that the potential service provider is fit for the job, is reliable, and offers the resources the organization needs
This helps when developing the request for information (RFI). The request for proposal (RFP) is created, and service providers who respond to the RFI are invited to submit their RFP position.

Step 4: Plan for re-negotiation after 12 months to 14 months into the contract
This should be a standard process included in the governance regimen. Service level agreements (SLAs) and operating level agreements (OLAs) are defined at this stage as key components of the governance process. If the contract is global and provides services to multiple parts of the organisation (especially those spread geographically), it is imperative to include companion agreements for each country and a formal business case for each.

Step 5: Proactively communicate to staff members who are moved to the outsourcer and those retained by the organization
Consistent communication, road shows, forums, briefings and newsletters can help reduce the anxiety brought about by the outsourcing process. Proactive communication is appreciated and enables better control than reactive responses.

Step 6: Create a formal plan for transition (the transfer of service delivery to the supplier) that correlates to the contract and obtain signoff from both parties at each stage
Planning for the transformation of the business processes, operating methods, product and service creation, and delivery is integral to the total service contract negotiation. The plan must provide for the services to be benchmarked and measured, and for the management of the project cost.

Step 7: Ensure that there is periodic benchmarking (internal and external), in addition to day-to-day monitoring, as governance of the contract in its steady state is an active process
This helps ensure that the service provider will continue to add value, and it forms the basis for evaluations to support contract renegotiation or exit.

Among the organizations surveyed by ITGI, the primary reason for outsourcing was a lack of internal expertise (48 percent), followed closely by the need to reduce costs (42 percent). However, reducing costs is not as critical as adding value.

Service quality improvements, scalability, better risk management and freeing up internal resources to focus on core, value-adding activities are even greater benefits of outsourcing.

By treating outsourcing as a strategic business tool, and thus giving it the proper governance it requires, organizations are more likely to experience these benefits and achieve competitive advantage and increased shareholder value.

Alan Simmonds and David Gilmour, of GovIndex in the UK, are the authors of Governance of Outsourcing, the third publication in a five-volume series on IT governance published by the IT Governance Institute.