The cost of innovation and outsourcing
A recent Gartner report presented the results of an effort to measure the perceived level of satisfaction customers had with the “innovation” being provided by their IT outsourcing vendors. The study claimed that the results were a measure of both technical and business innovation. From the perspective of outsourcing vendors the results were not flattering.
As someone who works in the outsourcing sector, my inbox soon started filling up with invitations to webinars on how to add “innovation” clauses to existing outsourcing agreements. The confluence of the two events soon had several questions buzzing in my brain like “How does one become an expert in a new topic of general interest, in a matter of a few weeks?” but recognizing how quickly the marketplace can produce and certify “experts” I set it aside for more important questions. For example;
- What exactly do they mean by Innovation?
- Who should pay for innovation?
- Who owns the innovation?
- How can outsourcers technically innovate when their customer’s insist on maintaining control over the architectural “stack?”
- How do you write up an SLA for innovation?
- What are the dimensions of innovation in a multi-vendor outsourcing situation?
- Why do they expect IT outsourcing vendors to be business innovators?
The latter question was motivated by how important “cost reduction” is and has been in outsourcing relationships and the nature of outsourcing itself, the others, because concepts such as “innovation” can be so nebulous.
There are many different reasons one can recite to justify why outsourcing makes business sense but let’s face it; cost reduction is the main reason it has grown so rapidly in the last 20 years or so. Lowering costs has dominated both consumers and providers of outsourced services. Outsourcers have scoured the globe searching for the cheapest resources they could hire, to satisfy the insatiable demand of their clients to shave IT budgets further than they already had. As a result, most people now think outsourcing and off shoring are the same things. I suppose it is possible, but does anyone really think innovation can be done on the cheap? Profit margins are already so thin even the biggest outsourcing vendors may find it difficult to justify investments.
This will be an interesting topic going forward. There is no question that outsourcing vendors could do a better job on many fronts. For example, they do a poor job when it comes to financial and demand management. I hear this all the time; organizations have no idea what they are paying for, how to budget for the future or how to allocate the costs across their business hierarchies. In some respects IT vendors ought to be flattered by the requests to help innovate. These are exciting times in the IT industry again. It is a signal of how important technology has become to achieving corporate goals as technology may be the primary reason organizations can enter new markets. However, this may also be the time that organizations start thinking of other reasons for outsourcing non-core business functions, besides getting it cheap.
The article was really insightful. And I am curious whether it is feasible to offer IT innovation as a service to client companies. Client will pay for the innovation service and provider with their wide industry knowledge can assign resources to discover ideas and offer it to clients. Both parties will have incentives if done so. But again if scope and metrics are determined.
I see no reason why IT innovation cannot be outsourced. Outsourcing is just one of several legitimate ways to deliver IT services, including internal IT and shared services. However, they will not be commodity services, nor driven purely by cost. Instead, they will likely be services associated with the business processes that the client side depends on for competitive advantage.
The article was really insightful. And I am curious whether it is feasible to offer IT innovation as a service to client companies. Client will pay for the innovation service and provider with their wide industry knowledge can assign resources to discover ideas and offer it to clients. Both parties will have incentives if done so. But again if scope and metrics are determined.
Thanks Ram
No idea if there is a market for a pure play innovation outsourcing service. However, since I wrote this blog there has been a fair amount of activity on how to add innovation clauses and activities into ITO, BPO etc., contracts.
The most effective model I have sen between the client and partner is to agree a mutual target for either cost reduction or growth. Whilst this might not be binding it helps to align the strategies of both organisations and sharpen the senses.
That seems to be the way it is going Brad, for those seeking innovation from their outsourcing providers. I believe they are calling it the "vested outsourcing" model now. The BPO agreement your organization has with Microsoft is always referenced as an example of the model.
Is the cloud business model the solution to effective IT innovation?
Within the current Cloud Business Model we would find 1) hosted applications to which we outsource data (salesforce.com is one example), 2) the external cloud (servers provided by a cloud provider outside the firewall) and 3) the internal cloud (servers provided inside the firewall).
We have over the last 12 months seen 2 trends for cloud deployment 1) cost (optimisation) confirmed with Total Cost of Ownership (TCO), 2) demand (to deliver to new business needs to which we are not able to cater within the existing perimeter).
To meet the emerging business needs, we can identify a hosted application provider to cater to the identified demand where salesforce.com, box.net among others would be examples that could rapidly enhance the IT Value Proposition or the creation of an external cloud (applications bundled in to services with an underlying architecture) where the needs of the client can be modelled and stabilised rapidly to meet “go to market” constraints. These can then be brought to an internal cloud if desired (NASA first started to use the external cloud to model emerging demand, that was later brought on to an internal cloud).
In “The cost of innovation and outsourcing” (http://www.enterprisecioforum.com/en/blogs/goddardd/cost-innovation-and-outsourcing) Doug Goddard points out the lack of innovation within the outsourcing sector. The reason from my point of view is the lack of incentive as none of the outsourcer that I have talked to are able to brake down their cost model TCO (total cost of ownership), and even if they could clients are not prepared to pay for improvement. With an external cloud business model, innovation* as new service models that would reply to emerging business needs can be tested and validated / discarded with a minimum amount of investment.
* Innovation can be disruptive (significant) or continuous. My research demonstrates that innovative business models demonstrate continuous innovation on a constant basis. Most innovation that is seen as “disruptive” is in fact a significant impact on a business model that is generated by the sum of a number of continuous improvements.
"The reason from my point of view is the lack of incentive as none of the outsourcer that I have talked to are able to brake down their cost model TCO (total cost of ownership), and even if they could clients are not prepared to pay for improvement. With an external cloud business model, innovation* as new service models that would reply to emerging business needs can be tested and validated / discarded with a minimum amount of investment."
By the way Martin, if you have published anything on the topic above, particularly the failure of outsource vendors to understand their cost structure, I would be very interested in reading it, as it relates directly to the work I do.
Thanks,
Doug
Martin, thanks for your comment. Let me try take a stab at answering by first referring to some very recent empirical data in the outsourcing and shared services space. Without going into the details, the data shows that the buy side is actually very happy with the job outsourcers have done to lower costs. So if cost reduction is the measure of innovation, things look rosy. However, innovation is not limited to cost reduction, in most cases, and on those metrics the story is not a happy one for outsourcing vendors. They get low marks for such things as transforming business processes, forcing change in operations, providing access to new technology and of course, for providing new and creative methods for increasing business value, or innovation.
Moving forward, organizations are showing a great interest in the following things; better access to what they call standardized business processes, greater flexibility to scale their global operations, improved access to IT support functions and the old standby, driving out immediate operating costs.
Now to answer your question, the demand for cloud computing looks pretty robust, but it isn't as strong as some might think, given how much attention the technology is getting. For example, there appears to be a greater demand for re-enginnering current business functions, or for moving business support functions into a shared sevices model, than there is for software as a service subscriptions. There also appears to be a greater demand for IT infrastructure in the cloud, than for software as a service. What confuses me a bit, is why re-engineering business processes is not associated more closely with cloud technology. Perhaps, that is the opportunity for cloud technology, putting those two things together.
Nice to review this thought-provoking post again with so many great comments, I think outsourcers, actually from CIO perspective, I prefer to call them professional IT Service providers, quite a few of them also the cloud providers, the innovation capabilities they could offer to their clients is as Steve Jobs pointed out: the essential to innovation is to connect the dots. Those IT leaders work with their clients cross industry, cross culture, accumulate many success stories and even more failure anecdote, by often, when we go to their website, we may read some success user case, usually not so much failure story, I think all the partners should work more transparently to connect innovative dots, and revitalize the legacy industry via some fresh idea from other industry or other culture., etc. And yes, how to manage the innovation via discipline and metrics.., etc, back to Doug's sets of questions. thanks.
Consumers are expecting more of what Cohen & Levinthal (1990) call "Absorptive Capacity" from their outsource partners. They are expecting for outsource companies to figure out ways to perform the IT lifecycle, whether they are hardware or software or a combined integration, with less drain on their organization. Outsourcing firms would do themselves and their clients a favor by conducting their own integrated R&D. In the article cited earlier the authors state that "absorptive capacity is generated in a variety of ways. Research shows that firms that conduct their own R&D are better able to use externally available information." This information is what consumers are looking for, and paying outsourcers to bring to the partnership. These activities are outside the scope of gold industry certifications, and are grounded in MIS, which is where I am focused. Automation in information systems R&D is something IT outsourcers should invest in so they can limit the amount of offshoring required while providing services to a broader base of customers with higher quality at lower cost.
Cohen, W. M., Levinthal, D. A. (1990). Absorptive Capacity: A New Perspective on Learning and Innovation. Administrative Science Quarterly 35. p. 128-152.
Thanks for the link. I have a long standing interest in the role reasoning by analogy plays in epistemology.
I would love to see another post from you...this one has the most comments of any since we started up in February...lightening could strike twice-:) Try video as well...we are pushing hard on that now...
The comment was in reference to the article above and what it suggested about how we obtain knowledge. Sorry for delving into a little philosophy there. That was one of my majors, in addition to computer science and politics.
Hi, Doug, good connection regarding innovation, outsourcing and metrics and nice set of questions to ask your IT partners.
I think you are right, the next generation of outsourcing, should be right shore, focus on innovation and agility, no matter they are cloud vendors or IT consulting firms, their expertise are not only technical only, more importantly, should deliver the outside box thinking, culture wisdom and process innovation, the CIOs may also need revitalize the SLA, and measurement to encourage those innovative initiative and extra mile effort thanks
Thanks for the comments Pearl. It will be interesting to see what works best, motivating the innovators through financial penalty or financial insentives. I'd be interested if anyone already has some empirical evidence. For example, does sharing the rewards result in a bigger piece of pie for everyone?
The biggest risk for vendors will likely be in business transformation initiatives, as one would almost have to be blind-folded and tied up not to show a savings on platform virtualization. That is assuming one is even trying to measure innovation, as many still seem to believe that measuring it is equivalent to inhibiting it.
One would hope financial incentives would work the best. How would you penalize a vendor for not innovating...not performing, perhaps, but not innovating?
Fear can be a good motivator too but I agree, at first blush, incentives would seem to have the greatest probability of success.
I know fear has motivated me when I was editor of several publications....fear of missing a story and getting scooped....that's the name of the game. The parallel would be the CIO at your competitor doing more innovative things than you. That's healthy fear...then there's devious fear....politics, violating policy to outmanuever a rival etc.
A new Gartner study suggests that IT "investment" decisions are shifting away from the CIO to the CFO so it may be more of a case of CFOs worrying more about what other CFOs are doing. This shift makes sense to me since IT people, in general, do seem to be limited when it comes to understanding finanacial analysis and with the emphasis on uniting IT and corporate strategy, finacial analysis is a big part of that game..
Doug, I think you have to put some perspective around that Gartner study. The study is irrelevent if it was not segragated by comnpany size. In forty years I have yet to see where the CIO made any significant investment decision. By the Grants of Authority at most companies, the CIO doesn'have the authority to make a decision of any consequence. The same holds for the CFO's I've worked with, they, like the CIO offer opinions, but it is most frequently the CEO, executive committee or the Board who caries the the most influenct.
I'm not a fan og Gartner studies without knowing the demographics of the study. If I can't put myself in the group to compare, the study is nothing more than interesting reading.
Good points Jim. To be honest with you I didn't really spend much time on the report or examine the methodology. I do recall them talking about how CFOs preferred to invest in analytic projects and new applications so perhaps they were trying to measure investment decisions after the overall budgets were determined at a higher level.
I wonder if the CIO ever led the investmernt decision. Or the CFO.
Depending on size and scope of the investment, it's the CEO who ultimately decides...or even the board. The CEO consults the CIO for capabilties and the CFO for financial impact and consequences. I do not believe the CFO makes the investment decision per se, although his or her input can be instrumental whether the investment is made or nixed.
Are you saying that the CIO is losing infleunce?
If the Gartner report I referenced is represetative of reality then it does look like they are losing control of IT decisions, to the CFO. As you know IT "investments" are just IT projects, viewed from the perspective of service portfolio management. For example, the study found a 15% increase in the number of projects the CFO is approving, from the last time the survey was conducted. It also found that ""only 32% of CFOs said they see the CIO as a strategic partner." As to whether CIOs ever led IT decisions, isn't that why the position was created in the first place, so IT could report directly to the top of the house, rather than going through the finace department?
Since we advocate for the CIO, I find that only a third of CFOs consider the CIO a strategic partner pretty depressing. That report suggests the CIO is getting shoved out of the C suite.
Part of the problem is they may not speak the C suite language. I was in a meeting with a CEO last week flogging the products my company sells, which among other things, automate the financial and demand management processes in service portfolio management, and he told me I was the first IT guy who had ever talked about IT projects as investments. I don't know if he has had limited access to IT people or not but that struck me as very odd, given how long things like ITIL have been around.
This is clearly a thought-provoking post, but no one has given concrete examples of innovation or an outsourcing concern that innovated. We've largely talked about innovating as an abstraction.
The reason I ask is that as community manager, I'd like to steer conversation in the direction about specific innovation so perhaps we can show works and what doesn't. Please chime in.....
John,
In our EA we actually embed sufficient semantic intelligence (details on relationships between people, places, and things) so that original work products can be rated -- a menu of algorithms and models, that include ratings for judges, mostly automated. As far as I know this is the state of the art now at the bleeding edge, but should only be taken in context of the holistic EA -- without the proper structure in place, including security parameters, data valves (patent pending), and modules that relate to each other between the organization, groups, project teams, and knowledge workers, it just isn't possible to deliver within any known physics to me.
With the proper structure, accountability, and balance of security and transparency, the digitized work environment that favors innovation, instead of the current status quo which favors IP theft, can be extended to anyone internally, co-innovation partners, and/or outsourced contractors. Never know where the next great idea, innovation, or formalized IP will come from -- geniuses are born every day, often in places we least expect or our media consumption attempts to convince us of, so it's wise to be ready for it, and frankly self-destructive to attempt to make martyrs out of people who are quite often substantially more intelligent than their bosses, and who are often not conditioned to be loyal. So it goes in the modern day digital workplace environment..
The NOA awarded National Rail Enquiries, in the UK, an award for outsourcing innovation and best practises, as one example. They attribute their success to such things as a multi-sourcing model - no primes, rewarding suppliers financially for success, including innovation in the tender process, treating suppliers as strategic partners, output-based contracts, measuring on more than just SLAs and several other reasons.
Hi Doug,
Is that innovation or great performance driven from best practices? Is there a difference? I think of innovation as something unique and novel.
John
I think their award might have been as much for creating a culture of collabarative innovation as anything. They were lauded for growing 20% every year, while reducing their costs 20% every year. I think they are close to a billion in sales, with a staff of 25. I don't know what actual technical innovations their outsourcing partners have provided, but they are in the information and database business, so they are likely in the form of software or platform improvements. I assume their innovation culture has resulted in actual innovations, hence the reward. On the culture side, they are being singled out for the way they integrate their suppliers into corporate strategy, structure their contracts, for multi-sourcing, for innovation governance, keeping senior people involved througout, and that sort of thing. Some consider those to be innovative ideas as well.
I tend to think of innovation as a new idea (i.e. new service, new product) that improves existing operations, and can be measured on the bottom line, or creates new markets and new streams of revenue, that can also be measured. Most outsourcing relationships probably measure innovation solely in terms of gradually reducing costs, or operational innovation, over time.
Doug
>>>I tend to think of innovation as a new idea (i.e. new service, new product) that improves existing operations, and can be measured on the bottom line, or creates new markets and new streams of revenue, that can also be measured.<<<
I agree - innovation that is tangible and quantifiable. I still would like to read about concrete and replicatble examples - ones that others could apply, improve or use to inspire other ideas..
Well that's the entire core issue about intelligence, learning, and innovation -- there is a very strong disincentive not to share case studies as what you seek is among the most valuable competitive differentiators in business. The CIO community is frankly not famous for rewarding innovators, but rather rewarding handsomely those who exploit innovators. Most of the real innovators in the enterprise today are absolutely completely paranoid about sharing anything, as are their customers who usually demand an NDA-- rightfully so-- global vendors have proven to promote any competitive advantage found in a client otherwise to their entire ecosystem, thereby destroying much of the substantial investment from the client who should have been rewarded for taking early stage risk, not punished. The problem only gets worse as the percentage of market share grows in a particular sector. When a market leader has 20% of the overall market it's not nearly the problem as when a market is dominated north of 60%-- at that point primarily only one company, or a functioning duopoloy, benefit from innovation, and while they can command enormous pricing, there is very little competitive differentiation for customers. That's the situation in most of the enterprise market today.
Yes and no on sharing. Some hire PR departments to trumpet their innovations. Others keep it under wraps.
All you need to do is visit some airlines and travel web sites to see innovations. Who or which airline invented the idea of checking into a flight w your iPhone or tablet? What are the articulated beneifts and ROI? What companies are using tablets en masse and replacing notebooks? Data center and database innovations?
I have always felt the devil is in the details...not the other way around.
John-- I am not seeing much evidence of understanding this topic here frankly. Even after attempts, the direction isn't even close to what experts discuss in private, or decision makers. CIOs are not known to be terribly understanding of this issue-- so that could be the problem. You can ask I suppose, but you may find that it does more harm than good. Our intel is exceptional on this topic. For sure I will stand down as I see nothing but disincentives here to engage-- best of luck.
John
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Here is a list to all of the NOA winners in 2011. There may be some good examples in there for you. The awards are based on originality and innovation.
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Doug
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http://www.outsourcingyearbook.com/wp-content/uploads/2010/11/oy2011_01_03.pdf
HI All -
How do you expect an outsourcer who does not know your buisness model intimately, lives the daily challenges and ultimately understand the end client to have a clue about innovation? Sure they can help streamline development, provide better quality code (one would hope) and deliver at a lower costs (perceived lower costs). But without the intimacy, innovation is unsurmountable.
Look at how China has taken all our innovation and used it against the US. China is a mass production environment with limited skills relative to creativity and innovation. I don't see any difference with our outsource partners - they take our ideals and try to resell back to us.
/jim
I see two very important issues here Jim -- one being competency, in part due to knowledge, and the other being risk.
1) I agree with you on the competency and knowledge aspect, particularly within this context, and it is directly connected to risk, so for example in our system we provide for adaptable security measures-- I don't see how it could be done otherwise frankly. However, it's also true that one never knows in advance where innovation might come from, so in my view it's best to expect it and plan for it primarily for three reasons-- one is to capture valuable information, if not innovation; incentivize contributions whether used or not; and to prevent costly liability and/or litigation. Boiler plate agreements from lawyers tend to prevent innovation, not invite, and only go so far anyway for protection in the real world.
2) In most organizations, risk is the primary reason not to outsource core level innovation. However, it's also true that we live in a very complex web of relationships now in most industries with co-innovation, multi-faceted partnerships, co-ownership of ventures and companies, contracting, etc. etc.
One of the biggest risks I see in enterprise IT is risk through vendors in large scale installs. I recently communicated with a key person in testing a large enterprise product a few years ago-- a global market leader, and they were very concerned about sharing sufficient information regardless of legal protection with the vendor, and the consultant, for very good reason-- the vendor has a very strong incentive to share that knowledge with competitors in selling the same system across the global economy. I am quite confident that this is how much of the trade knowledge finds its way into competitors today.
So systems that attempt to manage the knowledge and innovation process must be not only secure, but provide sufficient adaptibility to foster innovation with whomever is to be included in the loop, internally or externally, which requires a menu approach tailored to the situation, and given the installed investment, delivered at a very low cost on top of a legacy stack. Quite the challenge no?
Hi Jim
When I first heard that the market was expecting more innovation from their outsourcers I was surprised too, based on the fact that cost reduction has seemed to be the biggest driver in outsourcing relationships. As I said in the blog post, most people think offshoring and outsourcing are the same thing. Outsourcers are usually not privy to stategic corproate plans, do not control the architectual stack and are tasked with delivering what are considered non-core, commodity services. To me the biggest leap is expecting them to modernize the business model. Finding ways to make technical operations more efficient, maybe, putting together the architectural stack for custom cloud development, perhaps. Outsourcers are normally not incentivized to even find operational improvements, other than cheaper competition.
I think you are correct to be sceptical, under the current circumstances. IT outsourcing will probably not reach the same value level it has in electronics manufacturing, for example, if the thinking stays the same.
Thanks for commenting,
Doug
Jim,
Welcome to the Enterprise CIO Forum. You raise some great points. Your skepticism about innovation and outsourcing would make for a great blog post. You are first to raise the intellectual property and business knowledge issues w respect to outsourcing. I am surprised no one raised it to this point given this thread has 34 comments.
So you see the outsourcing vendor in a traditional and very specifric role? Nothing more, nothing less?
Hi Doug,
I think the criteria for Outsourcing is slowly and steadily moving away from cost focus to competency focus..Now a day’s enterprises like to focus or pump in the energies in building & developing the core competencies and outsource the support services to low cost regions (Captive or 3rd party); while in the process they do end up cost advantage, more of by-product...And with rapid Technology evolution; it has become next to impossible for enterprises to keep up with speed..More and more new corporations and SME’s have little in-house IT shops…This is also driving more and more enterprises flow with outsourcing model, especially newly formed corporations have little in –house IT shop….SME tie-in with outsourcing model and keeping themselves in Demand side…everything else taken care by Supplier / Outsourcing Vendors
Case in point! Operations of below SME dairy firm are completely automated from milk sourcing to selling; tracking of resources and payments…Dell Inc provided the Technology consultancy including Hardware, Software and Integration modules …Dell innovated a work environment which completely Virtual. Owners just focus on core business..
On other core point, Innovation, I strongly believe innovation is level of response to business entities and its challenges, with Technology as the enabler. Not necessarily a rapid response but a creative, unseen solution. And by large it’s a situational and varies upon the challenges, and challenges are possibly driven by cost compulsion or business execution/ operating model or infrastructure / skill gaps or regulatory /environmental reasons.
At the end of the day, innovation is application of technology to Business processes…which means knowledge of Business Processes is as essential as technology toolkits.
Case in Point Bechtel Inc, San Francisco based EPC giant (http://www.Bechtel.com) invented a new computing model based on Private Cloud…It has transformed all of its services, spread across 50 countries, from distributed to centralized Cloud model in a seamless manner. Inter-operability with customers and vendors is one of the key drivers of this initiative
Ravi...
Hi Ravi
Thanks for the comment, really liked your two examples. Those two companies sound like they are well down the path of modernizing their archtectures, and adopting a cloud computing model. In the dairy farm case, the innovation originated with the outsourcing vendor, it seems to me. Do you know where the innovation originated from in the second example? Did they work on it together, perhaps?
Thanks,
Doug
Ravi, Welcome to the Enterprise CIO Forum. I like the idea of innovating and lower costs as a byproduct - when it works. It requires a different and more expansive mindset....one wonders if it can really when CFOs take the lead on IT decisions...
http://www.enterprisecioforum.com/en/blogs/jerry/cfo%E2%80%99s-leading-it-decision-making
Hi, Doug, interesting topic, today, when we talk about outsourcing, it maybe more connected with your cloud strategy, to spark the innovation beyond the cost saving.
I like your set of questions there:
1. What exactly do they mean by Innovation?
Now every organization strive to build up the agile enterprise, fast response, customer centric, so beyond the product innovation, these days, we also talk about the process/service innovation, business model innovation, leadership innovation., etc.
2. Who should pay for innovation?
3. Who owns the innovation?
I think both the customer and vendors own part (their interest part) of innovation via the process negotiation
3. How can outsourcers technically innovate when their customer’s insist on maintaining control over the architectural “stack?”
As we categorized, from IT delivery perspective, innovation is more about business process improvement, it intent to deliver the better result with the lower cost, should be win-win situation for both party.
4. How do you write up an SLA for innovation?
I think today's Cloud computing may provide the right opportunity to revitalize teh SLA, with the spark of innovation and more precise measurement.
5. What are the dimensions of innovation in a multi-vendor outsourcing situation?
Interesting question, do you mean how to brainstorm among the multiple parties, deply the overlapping or grey area., etc.
6/ Why do they expect IT outsourcing vendors to be business innovators
I think it's critical, today's software project is not just for automation's sake, the purpose of the most of complicated projects are improving the business process and deliver the better result with lower cost, so innovation are the key from all those perspective. thanks.
Hi Pearl, and thanks for taking a great stab at answering those questions. Now to answer yours:
``5. What are the dimensions of innovation in a multi-vendor outsourcing situation?
Interesting question, do you mean how to brainstorm among the multiple parties, deply the overlapping or grey area., etc.`
I was asking whether multi-vendor or best of breed outsourcing strategies are any different from situations where IT has been outsourced to a single vendor on the question of innovation. For example, does it make any difference with resepct to the ownership of the innovation?
