Ways to Evaluate and Address Your Outsourcing Risk

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1 MRR J. Murphy Article 1 November 2003 Ways to Evaluate and Address Your Outsourcing Risk Every party entering into an outsourcing relationship wants the deal to be a successful one. Gartner s advice and recommendations can help enterprises manage risk effectively and address issues that could prevent a successful outcome. Keys to Success in Outsourcing Entering into an outsourcing relationship is all about leveraging competencies and managing risk. Failure to recognize and mitigate risk throughout the outsourcing life cycle leads to: Unrealized expectations Frustration with service Pricing that is out of line with the expected budget A deal that will be deemed a failure nearly 100 percent of the time Remember Murphy s Law: If anything can go wrong, it will and at the worst possible moment. Why should outsourcing agreements be any different? While considerable work may have gone into finalizing the deal, once the deal is done, it takes considerably additional effort to manage it into a successful relationship. It all comes down to balance expectations and results, risks and rewards, success and failure. Risk is inherent in every aspect of the sourcing life cycle. Agreements that are not balanced will end in failure. Management and perception of risk drive the different parties motives and actions. It is not simply a matter of drawing up a contract and living by it. Most people who have managed successful outsourcing relationships will tell you it was not the contract that deserved primary credit. Sound management practices, mitigation of risk and a focus on ensuring that results meet mutual expectations operationally and financially are typically the key factors that lead to success. Respect, understanding needs, and shared vision and goals are vital to success. What s done on a daily basis outside of the written contract is critical: Deal management and sourcing-office capabilities are needed to manage and mitigate risks and help keep both parties aligned and looking out for each other s success. Gartner Entire contents 2003 Gartner, Inc. All rights reserved. Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice.

2 Managing Strategic Risk Strategic Planning Assumption: By 2005, 75 percent of enterprises that fail to recognize and mitigate risk throughout the outsourcing life cycle will fail to meet their outsourcing goals because of misaligned objectives, unrealized expectations, poor service quality and cost overruns (0.6 probability). Tactical Guideline: Evaluation and selection of an external service provider (ESP) starts with a clear understanding of business needs. Sourcing management drives performance that supports the attainment of mutual expectations. Effective sourcing management is strategic in its importance, and is the key to achieving a relationship that fulfills expectations. As in any long-term relationship, you have to be honest regarding the attainment of mutual expectations and performance against those expectations, and you have to continually work at it. Test the chemistry early, and consider potential service providers ability to react to the need for innovation to keep the relationship growing. The following are key considerations: Doyoumatchupwell? Are roles and responsibilities understood and agreed? Do you have the confidence that each party will live up to its promises and is trustworthy in its actions? Do you have a scorecard for measuring success? Does a means exist to provide honest feedback relative to performance by each deal management team? Can you assess customer satisfaction and pricing relative to market conditions and trends? If the answer to any of those questions is no, you can expect that many unresolved issues will crop up that will give the sense that the deal is not working, and both parties will become frustrated and unhappy. Strategically, significant risk exists if the outsourcing strategy is designed to: Solve short-term business problems Atone for poor IT leadership Correct misalignment and achieve reconciliation between IT and the business Managing Tactical Risk Tactical Guideline: An outsourcing contract must be crafted to sustain the business through myriad changes. Tactically, you must build the right framework for success. Selecting a partner starts with a clear understanding of a business need and what capabilities and competencies in a provider are necessary to be successful.

3 Selecting a service provider requires knowledge of the provider s account team. Identify the members of this team and ensure that they are intimately involved during the selection process. See how they react to pressure and the need for a flexible approach and innovation. Do they take responsibility for their actions or do they always need permission? Be clear on your selection criteria. Ensure that the selection criteria are tied to attributes necessary to meet business and performance objectives. In an ideal situation, the outsourcing contract will be the artifact of the partnership. It will lay out business arrangements, performance expectations, governance mechanisms, and organizational roles and responsibilities. If crafted well, it will be a living document designed to support the need for constant business change. At the same time, it should help reduce the risk of ambiguity by setting expectations and being specific with regard to performance, cost and capacity leading to better pricing and performance. Mitigating Risk Tactical Guideline: Risk mitigation is focused on moving risks from major to moderate or minor levels. Mitigation is defined as to cause to become less harsh or hostile or to make less severe or painful. Outsourcing is all about mitigating risk. Risks must first be identified for each expected service. They should then be analyzed according to the following categories: Business process risk Can we manage the business? Technical deployment risk Have we deployed the right technical solution? Financial results risk Are we making our numbers? Economic realization risk Are we realizing the expected economic benefits of outsourcing? The risks should then be mapped according to their likelihood of occurrence and the expected impact on the business. For each major risk identified, a detailed risk mitigation plan must be created and agreed to by both parties. The risk mitigation plan should lessen the impact of realized risk by reducing the frequency of occurrence or the impact on the business, or hopefully both (see Figure 1). Figure 1 Risk Mitigation: Assessing Impact and Likelihood

4 High Impact on Business Major Moderate Moderate Risk Identify risk mitigation actions Major Risk Develop detailed risk mitigation plans Minor Minor Risk Accept or ignore Moderate Risk Identify risk mitigation actions Source: Gartner Low Rare Unlikely Moderate Likely Almost Certain Likelihood Sourcing Scenarios Tactical Guideline: Consideration of sourcing scenario risk helps drive the selection of appropriate services from the ESP, and mitigates operational and financial risk. A frequently asked question from Gartner clients is, How should decisions about what to retain and what to outsource be made? Selecting or retaining service delivery capabilities poses a considerable challenges on a number of fronts: planning, operational, financial, management and political. In assessing the risks of each scenario in-house or outsourced delivery (see Figure 2) the following issues should be considered: Figure 2 Sample Risks by Sourcing Scenario

5 Risk Categories Applications Developed Internally Applications Developed by a Service Provider Low High Low High Lack of Cost- Business Value Failure Operational Failure Low Speed to Operation Political Resistance Inhibited Future Flexibility Management Complexity Source: Gartner On the planning front, how likely is, and what are the consequences of, a failure to deliver the envisioned business value from this scenario? On the operational front, how rapidly can this scenario yield the required results in a reliable way? Does this scenario compromise the enterprise s future flexibility, and will it irrevocably remove future business options? Financially, what is the potential for costs to exceed forecasts, and by how much? What are the financial and business consequences of an operational failure in this scenario, and can they be mitigated? From a management perspective, how is the level of management complexity affected by this scenario, and could that complexity become unmanageable? If skills or knowledge are excised or transferred to another party, are they irrecoverable? What political barriers hold the potential to compromise the viability of this scenario, and can they be mitigated? Action Item: Ensure that the decision model for selecting among scenarios takes full account of the risks inherent in the organization today and in its envisioned future state. Risk Reduction Strategies Tactical Guideline: As part of the risk review program, the sourcing management team must continually assess the effectiveness of individual mitigation strategies and their operational, financial and managerial effects, as well as the application of lessons learned. When evaluating risk mitigation strategies, start with an assessment of the clarity of outsourcing objectives. Often, the true objectives are lost in the construction of the deal. In the drive to get the deal done, losing sight of objectives and the governance mechanisms necessary to support the deal can negatively affect the development of a performance-based outsourcing contract.

6 You have to assess whether the proposed service levels support the business and mission priorities. Have all alternatives been explored and the contingencies addressed? What changes in process and governance are required to improve the success rate? In developing a performance-based contract, performance metrics embodied in service-level agreements should provide an appropriate linkage of business and operational results with performance achievement, and include penalties for failure to meet agreed service levels. Performance attributes should be measured in the areas of processes, costs and client satisfaction, with appropriate trend analysis. Capacity controls that affect cost levers must be understood by all stakeholders, as well as the impact on outcomes either operationally or financially. Assets must be protected. Points to consider include: Does the ESP have an adequate asset management plan? Does a secure infrastructure environment exist? Will it support the applications load? Does a tested business continuity plan exist? Does a knowledge management plan exist to capture and transfer processes? Are lessons learned applied? Does the deal management team know where the program needs to go from here? Bottom Line Examine delivery alternatives and their inherent risks, and develop risk mitigation strategies to improve the odds of success. Ensure that the decision model for selecting among scenarios takes full account of the risks in the organization today and in its envisioned future state. Look beyond the standard contract terms and conditions to develop the rules and guidelines for managing complex relationships. Critically evaluate the maturity and complexity of new service offerings. Risk management is critical in any evaluation of sourcing options. Integrate risk management into daily sourcing management practices, because risk management and mitigation are never-ending processes. Written by Edward Younker, Research Products Analytical source: Jim Murphy, Gartner Consulting This article is an excerpt of a chapter from a new report, Successful IT Outsourcing: Strategies, Tactics and Management Approaches for Effective Strategic Sourcing. The report is an offering of the Gartner Executive Report Series, a new business venture of Gartner Press that provides buyers

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