Corporate Finance

Evaluating third-party application managers

Increasingly sophisticated and complicated business applications are pushing chief financial officers to consider outsourcing their application man...
A CFO InterviewSeptember 23, 2013

Increasingly sophisticated and complicated business applications are pushing chief financial officers to consider outsourcing their application management, according to experts. In deciding whether to outsource application management, CFOs should evaluate potential managers in four basic areas, said Peter Marston, applications research manager for International Data Corp. in Framingham, Mass. First, look at the quality and reliability of the service. Second, examine the vendor’s viability, including the strength of its cash flow and resources. The vendor relationship is “not something you just look at for one year,” Marston said. “It’s five years plus that you’re looking at.” Third, consider the price, and fourth, look at how quickly the vendor can have the application built or the project completed or started, he said. While packaged applications– such as those sold by SAP, Oracle and Sage– dominate business applications today, some companies still build their own software for specialized applications or have third parties build them, Marston said. So application managers may be called on to manage the custom-built applications as well as the SAP and Oracle packaged applications. The application manager may also do testing for rollouts or new enhancements or an upgrade of a packaged application, he said. According to John Parkinson, an affiliate partner of Waterstone Management Group, a CFO’s evaluation a potential application manager should include several rules of thumb. One is make sure that the prospect understands your industry and the nuances that make it different, even with something as standardized as payroll, whether it is compensation models, how bonus and commissions are paid and the taxation of perks, for example. “’Show me who else you do it for besides me’ is a good test,” Parkinson said. The CFO should also make sure that the company wouldn’t be the biggest or smallest client of the application manager, he said. If you’re the biggest client, the manager may be distracted from normal business practices because you dominate their agenda. If the company is one of the smallest clients, then “you’re probably going to get lost in the weeds,” Parkinson said. CFOs should also look for a pricing model that is sophisticated but not overly complicated, and that allows the company to pick an “a la carte” level of service. How should a CFO decide whether to bring in a third party to handle application issues? “A lot of times, from a CFO perspective, since they’re the ones really in charge of the purse, it tends to be on the cost savings,” Marston said. “If they’re using a packaged application in-house and in-house resources to manage that on an ongoing basis, then they’ll probably look at not only the software and hardware costs to keep that running, and what sort of maintenance fees they’re paying on an annual basis, but also the labor that’s behind it; how much labor they have dedicated toward it.” “So from that cost perspective (CFOs will) look at what sort of labor and IT costs are necessary to keep that set of applications breathing and the lights on from a maintenance aspect,” Marston said. One cost reduction that the chief information officer might seek is reducing labor to maintain these systems on ongoing basis. “If I can’t do that cheaply, do I need to bring in a third party that can do it more cheaply and provide a service level assurance that things are not going to go down that my business is dependent upon?” Marston asked. “There’s a pretty complex net of interdependencies that have to be evaluated, but quite simply, from the CFO’s lens, it’s really about the costs. You break those categories down into labor costs and productivity versus the cost of procuring software and the maintenance fees you may get charged,” he said. “A few years ago, I saw a lot of organizations trying to squeeze more value out of their existing systems, and just keep things going,” Marston said. “Now, there seems to be more organizations out there that are less hung up on leveraging those existing investments because they’re seeing more value in adopting something that’s new, something that’s packaged, and easier to maintain, if they’re going to do that internally,” he said. “Or, they’re getting some guidance from advisors to streamline operations through utilizing outsourcers.” Traditionally, outsourcing was a “run my mess for less” business model, Parkinson said. The dominant theory was that outsourcers had scale that few individual companies could achieve, and they knew better how to run the application portfolio more efficiently and more effectively. The outsourcing of application costs, and potentially making them operational costs instead of capital expenditures, was very appealing to CFOs, Parkinson said. “CFOs really liked that. If you get them in bar, after a good round of golf, they’ll tell you that they always struggle to keep the depreciation model smooth (with capex) so that they don’t get unanticipated fluctuation in earnings,” he said. But because the application environments were never stable, many of the second and third generation outsourcing contracts were cancelled or modified about halfway through their duration because of all of the change orders, Parkinson said. “The idea that you could take a moment-in-time snapshot of your application environment and its management requirements, and work with a third party to say: ‘This will be like this forever and what will it cost to run it this way’ neglected the fact that the day after you signed the agreement, you’re going to want to change things,” he said. “And your outsourcing partner, no matter how smart they were, would find it very difficult to give you the efficiencies and operational effectiveness promised,” Parkinson said. So application outsourcing agreements were replaced by managed services contracts, where the service provider would take on the uncertainty risk and figure out, up front, how to make ongoing changes to the company’s essential app environment, Parkinson said. A retailer in specialty fashion using Oracle’s retail suite, for example, would go to a managed services provider expert in retail services via that platform, he said. The managed services provider would figure out a price not just for managing hardware or keeping software current, but making sure the capabilities need to manage the business were kept up to date over the period of the agreement.

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