IT Outsourcing: What You Don’t Know Can Cost You

When you get your bill from your vendor, how can you be sure that you’ve gotten what you’ve paid for? Here’s how CFOs can make sure that they’re sure.
Sunny GuptaJune 13, 2012

For many companies, operationalizing the management of IT-outsourcing contracts is becoming increasingly complex. While there’s no question that outsourcing can help fill gaps in IT  services, confusion about negotiated terms and conditions, a lack of transparency, and inadequate integration between cost and utilization reporting can cause your vendor costs to spiral out of control, ultimately jeopardizing the outsourcing relationship.

Because of this, executives who outsource IT services are increasingly divided into two distinct categories: proactive and reactive. Proactive executives monitor the IT services they’re paying for, ensuring greater transparency into how their IT budget is being spent. Reactive executives are content to analyze their contracts only as they come up for renewal or when an urgent issue arises. Reactive executives give little thought toward utilizing these terms of service to maximize their investments. Which category do you fall into?

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Despite their best efforts to get their arms around technology consulting, project labor, and support services, many executives can’t help but look at their provider’s monthly bill and wonder:

  • Are we being as efficient as possible with this contract?
  • Do we know if this contract is still cost-effective?
  • Are we sure we are being billed at the correct rate?
  • How many resources have been consumed?
  • Have the services we’re paying for actually been performed?

These are all legitimate questions, and more and more companies are finding that it pays to track down the answers. In fact, we’ve found that more than 30% of our customers were leaving money on the table because of ineffective management of IT-outsourcing contracts.

Traditional contract pricing typically includes a fixed fee for a contracted volume of services, with variation on fees for volumes above or below those target thresholds. Additional resources required are known as ARCs. Credits for reductions in services provided or resources consumed are called RRCs (pronounced Rooks). This ARC/RRC methodology was designed to account for service/resource fluctuations, but when customers lack visibility into the processes that determine ARCs and RRCs, they lose opportunities to identify how best to utilize the services the vendor provides.

With increased contractual complexity, this level of uncertainty is becoming much more than a mere annoyance. It’s costly, and a lack of definition and understanding can lead to even bigger headaches down the road. For example, most outsourcing agreements include predefined utilization thresholds. Like a cell-phone customer who racks up a massive bill because he has inadvertently surpassed his monthly quota of minutes, an outsourcing customer who lacks visibility into his or her server utilization is at risk for a similar unpleasant surprise when the bill arrives and there’s a significant overage charge that could have been avoided.

What are vendors doing to remedy these problems? Not much, apparently. And that means many customers are left feeling as though their IT outsourcers are leaving them in the dark.

For example, we have seen several cases in which the original cost model based on the outsourcer invoice data did not include utilization data. One of our customers (a Fortune 100 industrial manufacturer) had outsourced a considerable amount of its server and compute infrastructure to a large third-party services provider. Because pricing data is often owned and delivered by a different group (say, procurement) than utilization and performance metrics (owned by operations), the company had no unified view, making it difficult to identify consolidation opportunities. In the case of this industrial manufacturer, once it was able to unify its view, it realized it was buying more servers even though utilization of the servers it was already paying for was only running at an average of 15%. This translated to a waste of $1.6 million of capacity each month, which has now been avoided.

In addition, some vendors are notorious for sending customer billing data in two separate reports: one from finance, which accounts for base contract service levels and ARC/RRC adjustments; the other from project managers, outlining server utilization and other operational metrics. This bifurcated and disaggregated reporting structure creates ambiguity that inevitably ends up favoring the vendor. Why? Because without meaningful integration of the data from these two reports, customers don’t have a simple way to connect the dots and make meaningful business decisions.

What can you do to connect those dots? What steps can you take to more effectively manage your IT-outsourcing contracts? For starters, look for ways to marry technology-outsourcing cost data with information about utilization. This type of integrated analysis can help:

  • Optimize hardware utilization. Precise information about the server environment, including metrics that detail how servers are utilized, provides a better understanding of the resources consumed and the cost to consume them. Armed with these insights, you’ll improve your view of what resources should be optimized and which ones can be deferred.
  • Understand the TCO of your IT service portfolio: Determine the total cost, cost drivers, and business consumption of your IT services. Retained costs (associated management and overhead costs related to an outsourcing agreement) and other internal costs that fall outside the vendor contract (such as higher tiered levels of support that might be provided internally) should also be part of this analysis to enable you both to truly understand the total value that a given outsourcer is providing and to allow you to benchmark against comparable internal IT services.
  • Be prepared to review and renegotiate existing contracts. Contracts often contain clauses that allow you to renegotiate if your requirements have changed and specific services aren’t being utilized.
  • Uncover immediate cost savings. Analysis of integrated metrics can identify “quick wins,” such as moving provisioned services to a lower tier of service (gold to bronze, e.g.) without sacrificing performance.
  • Shift IT spend to “Change the Business” initiatives. By unifying performance, cost, and utilization data, outsourcing customers will be better equipped to optimize their “Run the Business” spend and shift more precious dollars to “Change and Transform-the-Business” initiatives that drive revenue and margin.

Remember: when your business depends on IT outsourcing, it’s imperative that you understand how to derive optimal value from your vendor contract. Once you start combining IT operational and financial data, you’ll gain actionable insights that will help improve your decision-making and lead to efficient, cost-effective management of both the IT services and resources your vendor provides.

In short, it’s time to put an end to all the uncertainties in your outsourcing contracts. Take a collaborative approach to begin finding the answers you need because once you do, you’ll discover that when it comes to managing IT outsourcing vendors, knowledge is power.

Sunny Gupta is CEO, cofounder, and president of Apptio, a provider of on-demand technology business management solutions.