IS FRONT-OFFICE OUTSOURCING POSSIBLE? Reply

In a word – Yes. Although it is probably not possible to outsource an entire front office capability it is possible to outsource key elements so that the capability is (i) better supported, and (ii) more effective.

OUTSOURCING TEENAGE PREGNANCY

In a particular UK outsourcing company the account manager of a Local Government account in a in a poor area once asked the CEO of the Council if he felt that more IT would help him. The CEO snapped back that unless the account manager could solve teenage pregnancy with his IT then to stop bothering him! The question remained: could we help reduce teenage pregnancy through the use of our services? At the time no single process or set of processes existed which was particularly focused on the reduction of teenage pregnancy. Social workers merely had a bag of blunt tools which they applied on a case by case basis, usually after the fact (or in cases of extreme and obvious risk).

It would be ambitious. The area in question had the UK’s youngest grandmother. She was 28. Many young girls saw their only way out of the poverty cycle was by falling pregnant in order to get a council house and benefits. Regardless of the social problems this causes the sheer drain on the public purse is immense.

On an investigative trip to India where the outsourcing delivery partners were visited the Use Case was put to them. 3 areas were focussed on:

  • Analytics. Analysing and correlating large volumes of data is key. This is not something that social services did nor could they do. Analysis would not only require the infrastructure but it would also need the personnel to input and interpret the output.
  • Security. Data security and anonymity is critical. Employing local people was a key differentiator of the vendor and sending personal data offshore would be sensitive. Data would need to be cleaned, anonymised and then transmitted. Only when analyses were made and returned would results be matched with identifying indicators.
  • Reporting. Reporting needs to be intelligent and intuitive. The analysis could not spit out typed reports but rather would need to target social workers directly and inform them of specific risks and link the risks to benefits, programs, policies and guidance in and around the entire area.

CONTRACTING FOR COMPLEXITY

Being part of such a complex capability would be very daunting for a business. Outsourcing vendors typically eschew complexity. Profit is based not only on an economy of scale but also on lower pay-band workers performing the tasks (typically in countries where labour is cheaper). Any increase in complexity adds the need for managerial oversight which adds the indirect (non-chargeable) costs of higher pay-band workers. Complexity is not good.

In order to avoid this in front-office outsourcing the vendor needs to get the customer to perform service orchestration. This is where the customer performs the oversight and configures the services as they wish. This does not mean that the vendor is just crunching numbers in the background. Rather, the vendor provides a level of human interpretation on the analysis as well as feeding them back into a vendor rep in the social services environment who can then ‘push’ the information. This last part is essential because the vendor is likely only to be financially incentivised on the basis of lower teenage pregnancy. Dealing with public service apathy and stagnant processes at a personal level is critical.

LEGAL LIABILITY

What if it goes wrong? Vendors are now part of vulnerable people’s lives. If something goes wrong who carries the liability? Should the vendor provide warranties for the services? Or simply guarantee results year by year? These areas are untested. However, it is likely that vendors will only warrant the technical aspects of the services which is not really front-office outsourcing. One way around this is to ‘own’ a number of key roles or at least the role specification. In this way they can realistically provide warranties for some of the outcomes.

In the end, front-office outsourcing is not only possible but it will be increasingly necessary in the future in order to provide vendors with the differentiators necessary to maintain profits. The most critical issues will be getting vendors to deal with complexity without paying too much for the additional risk and in a way which allows them to take on the overall liability as well. The front office is a prime source of differentiation but it can be ground captured by outsourcers so long as they are smart about both complexity and liability.

CONTRACTING FOR CAPABILITY: the future of outsourcing Reply

Outsourcing only works for vendors. It does not work for customers. Revenue curves for vendors show a slight increase since 2008 for global outsourcing growth but the picture is less clear for customers. When looking at the economic-value-added (EVA) for businesses before and after outsourcing deals most show a nett decrease, which is to say only that they are weaker after the deal but not necessarily because of it.

The reasons are myriad however there are a few standard reasons:

  1. outsourcing is usually part of cost reduction activities of panicking organisations.
  2. there is usually a nett decrease in headcount which wipes out the value-added aspects of reduced costs.
  3. the customer’s SG&A costs usually rise due to the increased management activity needed in finding and using information.

Due to these reasons there is a feeling in the market that outsourcing does not work despite the claims of vendors. Therefore, vendors have increasingly (certainly since 2007) seen themselves fighting for an ever shrinking slice of the economic pie. The greatest sources of competitive advantage have been reputations and economies of scale. All, however, have been scrambling for a differentiator that does not involve reducing their own profits.

MIDDLE-OFFICE OUTSOURCING

One large UK outsourcing outfit saw the writing on the wall. It felt that it would not be able to compete with the lower labour (and similar outputs) of India-based companies. It rationalised that eventually it would be squeezed out of the back-office (i.e. highly standardised financial processes) outsourcing and infrastructure hosting markets. It would, it rationalised, need to move into middle-office outsourcing. Front-office outsourcing, on the other hand, is largely fictional as it encompasses the customer-facing aspects of a business which is where the key differentiators are.

Middle-office outsourcing (such as a council planning approvals process) is unique because it involves less repetitive processes and sometimes ad hoc activities.  Success here is necessarily predicated on a flexible IT infrastructures (often service-based, i.e. SOA) and a sophisticated management which is able to choreograph technology-based processes and services.

COMMERCIAL CAPABILITIES

Being able to outsource the middle-office involves positioning the vendor into a customer’s capability. A capability is the ensemble of systems, processes, people and information/data necessary to do something. In business terms this means all the stuff that is necessary to perform a process. Technically, capabilities are specifications of an enterprise’s Value Chain, so in broad terms a business will have about 20-ish key capabilities. All capabilities are, necessarily, linked. The closer one gets to the front-office the more these capabilities need to (i) be performed and supported in real-time, and (ii) they also need to consume information and services from elsewhere in the business. For instance, in our planning approvals process example the vendor will have to (a) log approvals in real-time, (b) consume up to date information on structures and utilities, as well as (c) access information on business rules (i.e. council policy, governance, law etc). As with any outsourcing activity, more narrowly focused personnel on lower pay bands are used to perform tasks more ably supported by better technology. All these aspects not only add to the complexity (and therefore the price) but also to the potential liability. When offering low pay band workers to crank the handle on repetitive processes liability is something a vendor wishes assiduously to avoid.

DEFENCE CAPABILITIES

Capability is a term much abused but little understood in Defence circles. Much of this is because Defence does not use a standard value chain. Although there is a business model for most western Defence communities (Inform > Project > Operate etc) there is no need for a value chain because there is (i) no need to differentiate, and (ii) planning and financing is based on the use of ‘unlimited’ funds to confront external threats (i.e. Treasury tends to play second fiddle during war).

The military user will often class themselves as a ‘special’ customer. The defence industrial complex is a special environment for the simple reason that they are providing equipment which – if the enemy is successful – is useless to the customer by the time it enters service. Unlike the commercial enterprise, where such a situation would mean they lost some competitive advantage/margin, in the military such a situation is untenable. The purpose of a military capability is therefore to change quickly and radically over time in line with the threat. Corporate structures are notoriously incapable of maintaining the same tempo of development, even with lavish operational funding. The purpose of ‘Contracting for Capability’ is to solve the problem of commercial-lag whilst still providing a cost effective and commercially robust means of contracting.

THE CONTRACT: A COMPLEX ADAPTIVE SYSTEM

This is possible by viewing the capability environment as a complex evolving system which requires the commercial deal to be a complex adaptive system. This is not new to the law. Building and construction deals have been taking this approach for years and German franchising law has excellent precedents showing how risk may be judicially assessed throughout a large, distributed network of commercial entities – for a common purpose or effect.

Figure 1 – Shows how commercial deals fail to keep pace with and support military capabilities.

‘ROLES’ – The Key to Capability

The key difference between commercial and military capability is that in the military environment the vendor cannot own the people. In business, the customer will transfer the roles over to the vendor. In the military equivalents of the middle and front offices (i.e. front line and forward echelons) the vendor will never own the people. Soldiers will always perform critical tasks. This will remain a constant for some time to come as soldiers do not say (i) “the computer isn’t working”, or (ii) “do I get overtime?” etc.

Although a vendor cannot own the people it can own the ‘Role’ or the role specification, i.e. the processes, information and systems that a role uses. In this way, a vendor can support the core functions of a role without hindering the actual person’s ability to go outside the boundaries of that specification to ensure that something is done. For instance, a aeromedical evacuation must take place regardless of whether a computer is not working. The airman performing the tasking may have at their disposal a sophisticated orchestration of processes based on flight availabilities, supporting gunships, bed availability and surgeons on duty. However, if the network is down it is unacceptable to let a soldier die just because the computers are not working. That airman must now use their deep knowledge to work the radios and help save a life. On the other hand the military is largely incapable (and unwilling) to integrate the vast array of ICT necessary to develop the initial systems.

Figure 2 – ‘Contracting for Capability’ using commercial communities to support capability clusters.

COMPLEX CAPABILITY

The example of an aeromed evacuation is somewhat simplistic. The example above refers to the Deep Target Attack capability. This capability may be performed by submarine/ship-launched missile strike, aircraft or even Special Forces. The choice is a military judgement. In the case of a submarine launched method the enemy will try to prevent this through anti-submarine naval activity (ASW). The submarine needs to close to striking distance, reach launch depth and then withdraw safely. How is it possible to support such a process which involves very long and expensive R&D lead times, long into-service acceptance testing, new training and tight export controls as well as restrictions on the use and sharing of sensitive information?

The trick is to incentivise the commercial community to do some of the thinking for the military. Instead of having to wade through the commercial treacle of Defence procurement the following steps could be taken:

  1. Base contracts on Capability Increments. In this way, the vendor is obliged to keep pace with threat evolution and the development of capabilities.
  2. Outsource the Role Specification. This will ensure that the military community is forced to involve its commercial delivery partners (without being hamstrung by systems).
  3. Create Commercial Communities around the support to certain key systems/clusters of technology. This is similar to German franchise systems whereby all parties are legally obliged to discharge their contractual obligations in line with a common purpose. This will circumvent the horrific impasses usually experienced in alliance contracts.

Contracting For Capability is a logically sensible concept which simply builds upon the work already achieved in the Enterprise Architecture community (especially MoDAF, MoDEM and the IDEAS Group). It is not overly complex nor is it a step too far. Once again, the real question is whether Defence and industry have the sophistication and diligence to complete the task.

McKinsey – Why the Customer pays for Risk Reply

In the forthcoming McKinsey Insights article “Avoiding Blindspots in Your Next Joint Venture” the authors point out some of their recent research into the failure of JVs. Further to my previous post about the need to design accurate risk models into a JV/Alliance/PPP, the authors note:

“At the beginning of any JV relationship, parent companies naturally have different risk profiles and appetites for risk, reflecting their unique backgrounds, experiences, and portfolios of initiatives, as well as their different exposures to market risk. Parent companies often neglect this aspect of planning, preferring to avoid conflict with their prospective partners and getting to mutually agreeable terms—even if those terms aren’t best for either the JV or its parents. But left unaddressed, such asymmetries often come to light during launch, expand once operations are under way, and ultimately can undermine the long-term success of the joint venture.

Certainly, some JVs must be rigidly defined to be effective and enforce the right behavior. But when that isn’t the case, JV planners too often leave contingency planning to the lawyers, focusing on legal protection and risk mitigation without the business sense, which shows up in the legalese of the arbitration process and exit provisions. Both tend to be adversarial processes that kick in after problems arise, when in fact contingency planning should just as often focus on the collaborative processes that anticipate changes and create mechanisms or agreements that enable parent companies to adapt with less dysfunction. As the head of strategy for one insurance company noted, “If a JV is set up correctly, particularly regarding governance and restructuring, it should be able to weather most storms between the parents.” Such mechanisms might include, for example, release valves in service-level agreements, partner-performance management, go/no-go triggers, or dynamic value-sharing arrangements and can allow a joint venture to maintain balance in spite of partners’ different or evolving priorities and risks.”

Designing proper risk models need not be adversarial. In the hands of a skilled lawyer or commercial manager it is a sharp and powerful weapon at the negotiating table. This does not mean that the contract is not a win/win deal. On the contrary, insight into the proper and necessary allocation of risk is essential for a win/win deal. Anything else is simply wilful blindness. In fact, a more mathematical approach to risk modelling lays the foundation for a negotiating process that is more inquisitorial rather than adversarial. The primary questions remain: is the management sophisticated enough and does the business have the stomach for it?

The Customer Always Pays for Risk: risk allocation in large and complex contracts Reply

A recent report in The Australian (17/12/13) newspaper into the Air Warfare Destroyer (AWD) debacle states that the project is already $106M of its $618M budget for 2012-13 (a wastage of over $2M a week). The article states that the project delays are a combination of “shipbuilding bungles, infighting between partners, Defence budget cuts and a cultural clash with the ship’s Spanish designer, Navantia.” Poor efficiencies at the ASC in Adelaide and little coherence in the support phase are also contributing to the mess but the AWD Alliance still maintains it is on track because its emergency funds have not been exhausted.

The AWD Alliance is the “unwieldy and largely unaccountable” body responsible for the AWD project. The alliance is made up of ASC, the Defence Materiel Organisation and Raytheon Australia. The “secretive” alliance is apparently fractured by internal disputes, with the DMO blaming the ASC. The ASC, in turn, blames Navantia. Further still, the ASC is also blighted by a “poisonous” relationship with its primary subcontractor, BAE Systems.

This is a contracting issue:

  1. There is no issue with the Spanish design. This design was picked as part of a strict and comprehensive procurement process. If the ASC did not perform the requisite due diligence on the engineering then it should not be in the game of building ships.
  2. In multi-party construction contracts poor site efficiencies are largely a result of (i) cumbersome management, and (ii) poor depth of vision into the total supply chain. Both issues should have been obvious and ironed out at the contracting stage.
  3. There is no doubt that budget cuts and legislative change pose a high degree of risk. However, if the revenue curve of the corporate entities were subject to ill winds from Canberra then those teams did not do their jobs.
  4. Lastly, if a project is eating its emergency/contingency funds then it is an emergency and it is definitely not on track.

So, what’s wrong with Alliance contracting?

John Cooper, writing in the journal of Building & Construction Law (2009 25 BCL 372) notes that alliance contracting is increasingly popular in Australia. Promoted by contractors and adopted by some state governments it is seen as a way to overcome the problems said to be associated with “more traditional forms of contracting”. From this I assume he is including PPP contracts and their PFI/PF2 subset.

Alliance contracts are supposed to be more conducive to collegial management and better outcomes because:

  1. They are governed by a charter of principles and not the black letters of a strict contract.
  2. Each party (theoretically) operates in good faith (although, unlike German franchise law, not necessarily to the mutual benefit of the project).
  3. There is an understanding of “collective responsibility”
  4. There is a socially enforceable culture of “no-blame, no dispute”.

In fact, all of these points are patent nonsense and the article in The Australian and the Australian National Audit Office report on the same project clearly highlight the complete ineffectiveness of an Alliance contract in this instance.

At the heart of the problem is the risk model. Alliance contracts are popular for Defence because (i) the government underwrites the requirements risk (i.e. future requirements creep), and (ii) they do not have to expose this as an additional cost. So, the project appears to be good value for money. In fact, DMO is to blame here because it knows that it would never be able to get the AWD it wanted if it had to expose/pay for the risk. This is standard Defence sharp practice and to my mind borderline procurement fraud. By getting the government to underwrite the risk the DMO ends up getting the ship it wants at a bargain price. It ends up paying way over the odds but the project would never have been approved if the risk had been exposed. The price would simply have been too high.

In a standard construction contract the client would not underwrite future risk. So, the builder would cover this through (a) additional systems engineering to uncover and cost future dependencies, (b) they would insure against certain risks, and (c) they would then add this into the cost model, i.e. the customer would end up buying the risk back. In the end, the customer always pays for risk. Even if the builder has to absorb hefty liquidated damages for lateness the customer will still pay for them down the line in more aggressive management practices or exorbitant extension-of-time claims and even larger margins on acceleration costs. The customer always pays for risk.

NETWORK RISK

The primary cause of these problems is an unsophisticated and uneducated approach to contracting. Underlying these is the simple fact that risk cannot be allocated if the allocatee does not endorse the allocation. In fact, I would posit that risk cannot be allocated at all. Risk must be bought and sold in order for (i) a party to be truly incentivised to deal with risk, and (ii) the risk to go away. The last point is critical. In standard risk flow-down models risk never goes away. Rather, it simply flows down to the party with the least bargaining power to offload it. In the end, the customer always buys the risk back. In a network model, risk is sold to the party who wants it the most. In the end, they absorb the cost (or a certain percentage) based on the value they will reap in the event the risk is realised.

For instance, the network model below at Figure 1 is based on a large outsourcing contract. A multi-divisional outsourcing company won a contract to deliver products and services to a government body. Part of that contract was the hosting of IT infrastructure, a portal for public access and a billing application. The latter of which was being coded from scratch. In this model, the risk that the code for the billing application is held in escrow and the risk that the billing application will not be ready or fit for purpose (significant) is sold (i.e. the contingent risk) to another company in the model. In this way:

  • the purchaser of the risk get a (partially finished) billing application at a knock-down price (if the risk is realised).
  • the primary outsourcer can simply pass the application on to the former without having to find a suitable programmer in mid-flight, and therefore
  • the primary outsourcer does not need to insure this risk (so much), and
  • the original application company are greatly incentivised, lest they lose their R&D costs.

Additional vehicles (other than escrow) for contingent risk may be:

  • Step-In Rights
  • Holding other titles and licenses in escrow
  • contingent transfers of other property.

In all the cases something happens automatically. There is no better way to make this happen than for someone to profit from another’s poor performance. In such cases, the vampiric action of the vestee is swift justice for sub-standard management. When risk is realised, the vestee swoops and kills. There can be no greater motivation for either party. The primary question is whether a business has enough faith in its management to set up contracts in this way. Although a network model of risk is, technically, the best means to manage risk in large and complex contracts the businesses need to decide whether they have the management sophistication and the stomach to deal with risk in this way.

Figure 1 – Model of “Derived Risk” in a large outsourcing contract.

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.

Corporate Fables: the value of enterprise storytelling Reply

Corporate storytelling is developing a huge following and it’s not just for CIOs.  Larry Prusak loves it, Patrick Lencioni has elevated it into a fine art and everyone seems to be getting the storytelling bug.  Stories are great because they help people from disparate backgrounds develop a common understanding of a problem or vision – one that sticks.  Storytelling has the power to corral even the most difficult of us and motivate us to play our part in the corporate journey.

Executives love stories because they require almost no detail, no plan, no roles and responsibilities and no changes in remuneration.  Done well, they can convince people into delivering more for less pay and when they don’t stories will shame those same underpaid workers into delivering the goods.  What’s not to like about storytelling?

Corporate Storytelling

At large UK outsourcing establishment there was an underperforming account in the Midlands.  Legend has it that the CEO of the local authority berated the account manager with the legendary phrase:  I’ll buy more IT when you can solve teenage pregnancy!” The account manager duly skulked into the corner and got on about his job of providing outsourced IT services.  What should he have done?  He should have used that story to develop truly value adding services which would have (i) increased the profitability of the account, (ii) built trust between him and the CEO, and (iii) possibly helped try and solve the actual problem.

He didn’t, so I did.  I went to India and spoke to our outsourcing partners.  I tried to engineer an end-to-end process whereby we could harness the incredible intellectual latency of our outsourcing partners, Genpact and Patni, to develop an integrated process for analysing local authority data then identify and target girls at risk for tailored social services.  In this way we could break the socially debilitating cycle of early teenage pregnancy whilst pushing account revenue into the stratosphere.  We needed to do this in a way that enabled us to retain the confidence of our customers as well as created buy-in from internal management.  So, we made sure the data security was right and that the project was aligned to the new corporate strategy of a greater push into outsourcing the middle-office.

I told the story.  I told it again and again but I used it to tease out the detail of the development process, the customer engagement process, the revenue model and the customer benefits.  Because, for every executive who smiled at the heart-warming vision there were 3 contrary developers, engineers and other middle managers who tried to shoot me down with the detail.  My story explained the engineering process.  My story was the glue which pulled all the systems engineering together and that is how I believe enterprise storytelling can help organisations.

The Complexity of Cost (Pt.1): problems with ICT cost reduction Reply

cost reduction

In a crisis the company P&L statement can be a useful starting point for cost reduction programs.  Over the long term, however, general ledger entries do not have the required level of detail to garner the requisite per unit analysis (McKinsey, May 2010).  Unfortunately, few companies do not have systems which can analyse the complexity of cost and spend in order to make accurate and detailed changes.

In the following series of blogs we will highlight the problems with standard ICT cost reduction & management programs and detail how to structure and run one effectively.

The key to an effective ICT cost reduction & management program is detailed cost modelling.  Most financial systems do not capture costs at the right level of detail for businesses to perform accurate and detailed cost reductions.  Businesses need to perform intricate spend analyses and build up intricate cost models for ICT which highlight the following:

  • The capabilities which various ICT components support (and where in the Value Chain they lie).  Only through this level of visibility can the business consolidate their ICT spend.
  • The HR and process dependencies which are indirectly attributed to various ICT elements.  Only with this level of detail can ICT remove duplication and redundancy.

In the absence of this granularity, cost reduction programs invariably fail or fail to stick.  In fact, McKinsey & Co note that 90% of cost reduction programs fail.  Only 10% of these programs actually succeed in realising sustained cost management three years on.

In a typical IT cost reduction cycle the following happens:

  • Headcount is reduced.  The remaining people then have to work harder (but with fewer skills, because tasks are pushed to the lower pay bands) to achieve the same amount of work.
  • Many, often unique, soft skills are also removed (from experienced people in the higher pay bands) in the redundancies.
  • Overall service levels decrease.
  • Further cost reductions are then required and some applications and services are axed.

In simple businesses this is not a problem.  In large and complex businesses the outcome usually follows a vicious cycle, namely:

  1. The firm still needs to retain a significant management overhead in order to deal with complexity.
  2. In these cases, poor transfer pricing and high overhead allocations mean that perfectly good, competitive core business process seem cost-ineffective.
  3. Critically, Kaplan notes in his seminal work “Relevance Lost: The Rise and Fall of Management Accounting” that the increased costs of  processes leads to outsourcing of perfectly good processes.
  4. Capability suffers and the  business loses competitive advantage.
  5.  The business is no longer able to deal with the level of complexity and complexity reaches an inflection point.  The business outsources the whole problem (eg, large ERM programs with much customisation),  getting locked into  horrific terms and conditions.
  6. Core business is lost and competitive advantage is reduced. Remaining managers pad out their budgets with excessive risk and contingency in order to shield themselves from further cost reductions.
  7. Overheads increase again and the business eventually prices itself out of the market.

cost reduction.accenture

In a recent (2010) Accenture survey on general cost reduction effectiveness in the banking industry, 40% of  respondents noted that the program has reduced overall ICT effectiveness and impacted adversely on both customer service and general management.

in order to reduce costs effectively without impinging on capability as well as making new costs stick, it is essential to view costs and spend at the most granular level possible.

In our next blogs we will go into detail how to structure and run an effective ICT cost reduction and cost management program including effective ICT cost modelling.