Hidden Costs in ICT Outsourcing Contracts Reply

hidden-costs

Why are IT outsourcing contracts almost always delivered over-budget and over-schedule?  Why do IT outsourcing contracts almost always fail to achieve their planned value? How come IT contracts seem to be afflicted with this curse more than any other area?

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The common answer is that (i) the requirements change,  and (ii) that handovers from the pre-contractual phase to in-service management are always done poorly.  These are both true although hardly explain the complexity of the situation.  If requirements change were an issue then freezing requirements would solve it – it doesn’t.  The complexity of large ICT projects is derived directly from the fact that not all the requirements are even knowable from the outset.  This high level of unknown-unknowns, coupled with the inherent interdependence of business and system requirements, means that requirements creep is not only likely but inevitable.  Secondly, (ii) handover issues should be able to be solved by unpicking the architecture and going back to the issue points.  This too is never so simple.  My own research has shown that the problem is not in the handover but that the subtleties and complexities of the project architecture is not usually pulled through into the management and delivery structures.  Simply put, it is one thing to design an elegant IT architecture.  It is another thing entirely to design it to be managed well over a number of years.  Such management requires a range of new elements and concepts that never exist in architectural design.

The primary factor contributing to excessive cost (including from schedule overrun) is poor financial modelling.  Simply put, the hidden costs were never uncovered in the first place.  Most cost models are developed by finance teams and uncover the hard costs of the project.  There are, overall however, a total of 3 cost areas which must be addressed in order to determine the true cost of it outsourcing. 

True Cost of IT

1.  Hard costs.  This is the easy stuff to count; the tangibles.  These are the standard costs, the costs of licensing, hardware, software etc.  It is not just the obvious but also includes change management (communications and training).  The Purchasor of the services should be very careful to build the most comprehensive cost model based on a detailed breakdown of the project structure, ensuring that all the relevant teams input costing details as appropriate.

2.  Soft Costs.  The construction industry, for instance, has been building things for over 10,000 years.  With this level of maturity one would imagine that soft costs would be well understood.  They are not.  With project costs in an extremely mature sector often spiralling out of proportion it is easy to see that this might also afflict the technology sector which is wildly different almost from year to year. 

Soft costs deal with the stuff that is difficult to cost; the intangibles:  The cost of information as well as process and transaction costs.  These costs are largely determined by the ratio of revenue (or budget in terms of government departments) against the Sales, General & Administration costs, i.e. the value of the use of information towards the business.  Note that this information is not already counted in the cost-of-goods-sold for specific transactions.

Soft costs go to the very heart of how a business/government department manages its information.  Are processes performed by workers on high pay-bands?  Are workflows long and convoluted?  The answers to these questions have an exponential effect on the cost of doing business in an information-centric organisation.  Indeed, even though the cost of computing hardware is decreasing, the real cost of information work – labour – is increasing.  This is not just a function of indexed costs but also the advent of increasing accreditation and institutionalisation in the knowledge worker community.  Firstly, there is greater tertiary education for knowledge work which has hitherto been unaccounted for or part of an external function.  The rise of the Business Analyst, the Enterprise Architect (and a plethora of other “architects”) all serve to drive delivery costs much higher.  Not only are the costs of this labour increasing but the labour is now institutionalised, i.e. its place and value is not questioned – despite the data showing there seems to be limited economic value added through these services (i.e. no great improvement in industry delivery costs).

3.  Project Costs.  Projects are never delivered according to plan.  Requirements are interpreted differently, the cohesion of the stakeholder team can adversely impact the management of the project, even the sheer size and complexity of the project can baffle and bewilder the most competent of teams.  Supply chain visibility, complicated security implementations and difficult management structures all add to project friction and management drag.  There are many more factors which may have an adverse or favourable effect on the cost of performing projects. 

IT Transition Cost Graph

In the Defence community, Ph.D student Ricardo Valerdi created a cost model – COSYSMO – which isolated 14 separate factors peculiar to systems engineering projects  and gave these factors cost coefficients in a cost model.  Ultimately, each factor may be scored and the scoring then determines the effort multiplier, usually a number between approximately 0.6 and 1.8.  Naturally, when all factors are taken into account the overall effect on the contract price is significant. 

More importantly, for IT implementations, the “project” is not short.  IT outsourcing projects are generally split into 2 phases:  Transition and Transformation.  Transition involves what outsourcers call “shift-and-lift” or the removal of the data centres from the customer site and rear-basing or disposal of the hardware which allows the company to realise significant cost savings on office space. 

During the second phase – Transformation – the business seeks to realise the financial benefits of outsourcing.  Here, a myriad of small projects are set about in order to change the way a business operates and thereby realise the cost benefits of computer-based work, i.e. faster processes from a reduced headcount and better processes which are performed by workers on a lower pay-band. 

IT outsourcing  is not just about the boxes and wires.  It involves all the systems, hard and soft, the people, processes and data which enable the business to derive value from its information.  Just finding all of these moving parts is a difficult task let alone throwing the whole bag of machinery over the fence to an outsourcing provider.   To continue the metaphor, if the linkages between the Purchasor and the Vendor are not maintained then the business will not work.  More importantly, certain elements will need to be rebuilt on the Purchasor’s side of this metaphorical fence, thus only serving to increase costs overall.  The financial modelling which takes into account all of these people, processes and systems must, therefore, be exceptional if an outsourcing deal is to survive.

Enterprise Architecture: Is there any such thing? 3

I should preface this post by saying that I am a huge fan of enterprise architecture and have been for some time.  However, I posit that there is simply no evidence that enterprise architecture actually exists or will ever exist.

If EA were working or was economically viable we could have expected a decline in the global outsourcing market as businesses sought to integrate and consolidate applications along an enterprise metamodel.  However, this work predicates a level of control and ownership which is not consistent with applications/business process outsourcing.

Global Outsourcing Market

Definitions of EA aside, it seems clear to me that the economic benefits of EA simply cannot compete with the economic benefits of outsourcing.  In order to turn the tide, my personal opinion is that EAs need to be able to architect from the financial instead of the minutiae of the technical.  Stop trying to solve technical problems and start trying to solve business problems.  More importanlty – in line with the ‘E’ in enterprise – be able to cut through the petty bureaucracies and fiefdoms of middle management and begin to define business problems by calibrating financial statements with technical information.  In other words, how can technical architects analyse adverse financial variances on the monthly balance sheet and turn them into changes in the technical development or delivery?  What is the technical implication of a month-on-month 17.5% adverse variance on Indirect Labour?  Until these figures become the mainstay of an Enterprise Architect’s work then EA will never be able to compete with the simple value proposition of outsourcing, i.e. “it’s not working! give it to an expert.”

More importantly, in virtually all businesses (i.e. non-tech businesses) the company is defined by accountants and sales people.  Operations comes in close second and IT is so far at the back of the corporate parade that it can’t even hear the marching band play.  In order for Enterprise Architecture to morph into something useful – and something closer to what I imagine Zachmann imagined – it will need to deal with enterprise engineering.  This is the difference between systems engineering and Engineering Systems, i.e. the engineering of information between the various systems/functions in the business.  What is the atomic meaning of a cost variance in IT terms? 

Until EA/EE can truly grasp the complexities of the enterprise it will only ever be IT window-dressing.  In the meantime, I hope I’m wrong.

Qld Govt On Track to lose Billions Through Poor Outsourcing Reply

In a recent article in online technology ezine Delimiter – “Qld Health Preps Huge IT Outsourcing Deals” – Renai LeMay points out that the Qld government will need to spend an unadjusted $7.4 billion over the next 5 years in order to replace and upgrade 90% of its outdated ICT portfolio.

The question is whether it has learnt from the Qld Health outsourcing debacle with IBM and will it move forward with its best foot?  It is unlikely, given that HSIA seems thrust into the contracting process too early with too little.  With the pace seemed to be set by the Costello audit, the HSIA is now engaging in early vendor ‘discussions’ (IBM notably excluded) without even a detailed set of business requirements, system parameters and financial boundaries.

In letting vendors shape the early development of these outsourcing contracts the government is on track to lose billions.  This will happen for 3 primary reasons:

  1. Service Management will be overlooked – The failure of virtually all contracts is not in the structure but the management.  Although most experienced litigators have gasped at contracts (usually government) which seemed to have been designed to fail (largely due to something bordering on corruption or undue influence), most are not so designed.  Outsourcing contracts, more than any other, require detailed attention to the management of the service.  Ultimately, the difficulty lies in the paradigm shift from network support to service management.  In other words, the personnel in charge of servicing are now in charge of service management.  In most cases, these jobs are made redundant as the vendor takes them over (unlike TUPE laws in the UK).  Consequently, the knowledge is lost.  Purchasors can protect themselves against service decline by making the vendor buy key personnel.  Better yet, Purchasors should transition these key roles from performing the work to managing the service/contract.
  2. Deals will be too long – Vendors will push longer outsourcing contract lifecycles.  Although, prima facie, there is  nothing long with a long contract it is imperative that such contracts are designed to be managed, i.e. the focus is on the delivery and management Schedules and not the boilerplate of the Operational clauses.
  3. Tech bundles will lack modularity – Qld government loves to re-organise.  After each government their is always a paradigm shift in the Machinery of Government (MOG).  Departments shift and with them so do budgets and internal processes.  These are generally managed within departmental parameters with necessary roles and functions often going unfunded and unfilled for entire cycles of  government.  To reinforce Renai LeMay’s point, it goes without saying, therefore, that the government needs to develop a modular, multi-bundle architecture wherein departments can buy and sell service credits between themselves without limiting the overall strategic cost savings.

In summ, there are numerous ways in which Qld government can guard against the inevitability of cost overruns and poor, overly simplistic outsourcing contracts.  On the other hand, the vendor which offers these first will have a significant advantage.  in many cases, the difficulty will be in convincing QGCPO that novel and innovative contracting vehicles are there for the benefit of the Purchasor and not just vendor voodoo. 

CIOs warned against long outsourcing contracts Reply

In a recent article in online magazine IT News, government CIOs are actively warned against signing long term service deals.  Mike Lafford, from Gartner, advises government CIOs against long term contracts. 

Please, please, please, don’t sign ten year deals.
– Mike Lafford, Gartner

Logic favours a longer contract in order to squeeze more value for money from a vendor by allowing them greater economies of scale (i.e. more guaranteed revenue = more borrowing power = bigger, better service infrastructure).   However, Mr Lafford notes that the contracting process is so long and tedious that vendors artificially force up their margins to cover the enormous costs of business development and tendering.  Government departments, therefore in particular, do not see cost benefits.

Current outsourcing contracts show a level of sharp practice and degree of innovation usually reserved for used car sales

Lafford, however, does concede that there are 3 artificial factors which increase both the risk and costs for vendors, namely:

  1. Transition Costs are High – Departments  are told they place an unusually high management burden on vendors by ‘creeping’ into contracts.  Long evaluation periods and bespoke management structures all serve to drive up vendor costs.  Purchasors should align their management structures with the, relatively, inflexible service delivery of the vendors.  In addition they can give the vendor a 3-6 month Service Credit holiday  with a Buy-Back/Call Option at the en.  In this situation all current infrastructure remains in place and the Buy-Back option (purchase for the base cost of transition) is contingent on a stipulated average service performance level well below market benchmarks.
  2. Vendor Risk in Technology/Business Change – Primary risk is derived from reduced volume/numbers, e.g. in desktop support.  There are 2 possible ways to deal with this:  (i)  sign a deal involving multiple departments.  Hedge overflow costs buy buying and selling capacity amongst departments/teams.  Secondly, (ii) pay for the minimum not the maximum and then buy overflow capacity.  Departments and teams are always looking at headcount reduction so don’t buy at your maximum capacity but do expect/ensure good discounts (on an increasing scale) for more capacity.
  3. Inflexibility in Contracts – The current thesis is that long contracts are inflexible contracts.  This is nonsense, although technology contracts can be far more complex than PPP contracts, for instance, for the reasons stated above, i.e. lack of clarity in the future requirements.   The focus of most contracts is on the ‘operational clauses’, i.e. boilerplate governing standard business relationships.  Failure of outsourcing contracts, however, is almost always with the failure of contract management (by which we usually mean “service management”).  In order to develop a contract which changes over time, the focus of the contract must be in the Service Management Schedules. 

In summ, governments and businesses alike have to realise that someone pays for risk.  If they place risk with the vendor then the business/department ultimately buys it back.  To that end, I would usually recommend a 5+5 contract.  The trick, however, is not with the development of the KPIs but rather with the management of the service.  To that end, Purchasors should not underestimate the detail they need to go in to when developing their service management structure.

Governance is More Than Openness 1

In a recent blog Richard Sage (@BakedIdea) points out that governance is just a matter of openness and sharing.  If only life were so simple.  If this were the case then what of Enron?  What of the whole global financial crisis?  These people were open?  These people shared?  They had GAAP reporting duties – So what went wrong?

The simple fact of the matter is that (i) governance is more than just sharing, but (ii) less than the full apparatus of conformance which Richard sets out.

More Than Sharing

Governance is more than sharing.  It is about design and flow.  Financial institutions shared information internally and reported it externally but this made not one jot of difference to the near collapse of the global economy.  Collateralised Debt Obligations (CDOs) were so complex that it would take a long time to unpick each one.  It is essential to understand that if an organisation actively conspires to confound regulatory procedures then there is no governance structure that will catch it.

“Governance without design is somewhat akin to looking at a ball of multi-coloured string and trying to guess what the pullover will look like.”

Organisations (here I extend the net to government and not-for-profit) need to design for misuse.  Understand that cross-functional information flows require some degree of architecture.  Without the necessary degree of design in governable artefacts (e.g. cost models, delivery schedules and contracts) it is impossible to unpick them.  In fact, it is somewhat akin to looking at a ball of multi-coloured string and guessing what the pullover is going to look like.

Governance Is Less Than You Think

I believe that governance is only the set of structures necessary to give confidence to institutional shareholders  that their interests are being well looked after.  The functions are the business processes and technical systems which enforce and deliver them.  This is why corporate governance speaks only of Directors Duties and not of business process.  The how will be forever changing in our modern and dynamic world.

In the end, governance is counterintuitive to business.  Good governance is seen to reduce profits, to close off avenues of growth and to burden management with bureaucracy and nugatory process.  Yet good governance should clear the way.  It should lower the bar and reduce the hurdles.  In concert with a stringent and effective assurance process governance becomes light yet effective.  It delivers confidence without suffocating the organisation.

Leveraging social media data analytics to improve M&A – Lexology Reply

Social media part 3: leveraging social media data analytics to improve M&A – Lexology.

Data Analytics for M&AThere is no question that social media has a role to play in M&A activity.  In a recent survey by Toronto based international law firm Fasken Martineau; respondents reported that they were not only using social media to communicate deals but also for research and due diligence .

  • 36%  for research.
  • 48% for investigation.
  • 72% like LinkedIn to research personalities.  Only 50% said the same of Facebook.
  • 78% disclose transactions through Facebook and 44% use LinkedIn.

More importantly

  • 77% said they have no social media strategy, and
  • 65% said they have no intention of developing one.

DATA v SENTIMENT

There are 2 benefits of social media: (i) expert opinion, and (ii) trending sentiment.  Much of the hype behind the trends in Big Data are about connecting these 2 powerful elements with the hard numbers around corporate valuations.  For instance, an acquirer may wish balance valuations with the trending market sentiment and the opinions of experts.  An extreme example of this is the Facebook IPO where market hype vastly outweighed traditional valuations.  So much so that Warren Buffet said that he had no idea how the valuation was so high and that he just couldn’t value companies like this.  Social media is often seen as an echo chamber; a small community talking to itself.  Posts range from  self-aggrandisement to advertising puffery with very few hard facts and figures in between.  What few figures are there may be real, may be fictional or may be somewhere in between.  The value is in aggregating these figures but the algorithms needed to ensure that the right weighting is placed against the right number based on author, time etc (let alone how they account for hearsay).  the maths behind this is hard enough let alone the semantic interpretation by computers.  Needless to say, when this sort of calculating can be done it will be worthwhile for many and will be, initially, a very, very expensive service.

The moral of the story is  – BEWARE!

Social media remains useful for advertising and developing an extended network of sector contacts in order to deepen one’s contextual market knowledge.  However, as an analytical tool, to my mind, it is still out there with witchcraft.

Risk Management is a Team Sport Reply

Good financial risk management requires a high level team team effort and cross-functional collaboration.  Risks, by their very nature,  are highlighted precisely for the reason that the project team is unable to do anything about them.  If they could be effectively mitigated or avoided by a single function (e.g. Legal, Finance, Operations etc) then they would/should not have been placed on a Risk Register.

If the project were able to mitigate the risk themselves, alone, then it wouldn’t be a risk.

Dealing with these risks, therefore, requires not only close collaboration from multiple functions but it also requires the delegation and intervention from pay-bands which are at a higher level than the project, i.e. effective management of financial risk is expensive.  The corollary is that project teams should ensure that whatever risks they have identified are very important and cannot be dealt with by the project team.

WHAT DO BUSINESSES USUALLY DO?

Traditionally, risks that populate project risk registers will be well-known risks.  To be unkind, these will be statements of the blindingly obvious.  A menagerie of opinion, Google hits, speculation and wild guesses.   In the absence of an external assurance function, risk managers work for Bid Managers or project teams.  They are not incentivised to look too hard or too deeply at risk.  The last thing that either of these roles want is prying executive eyes or torches shined into dark and dusty corners of the business.

Most risk registers are populated with a menagerie of opinion, Google hits, speculation and wild guesses.

Future blogs will go into this area in greater depth.  However, in the absence of an external assurance function curious risk managers can assuage their intellectual integrity as well as supporting their boss by deriving their risks statistically.  By going back through 6-10 similar projects they can analyse, categorise and classify risks by a variety of quantitative and qualitative measures.  In this way, the Risk Manager will bring cross-functional experience to the project team and, hopefully, become a catalyst for inexpensive, collaborative risk management.