Outsourcing
Background
The meaning of the word "outsourcing" seems to have become clouded from overuse in the contract services market. That doesn't mean that we necessarily need new terminology, but clarification can always help. The discussion that follows is intended to help distinguish among and clarify various contract service offerings available to technology organizations.
Services Overview
While packaging variations abound, contract services can be categorized as illustrated below on a continuum from straightforward temporary labor to a full technology outsourcing agreement. With differences in grade along the way, some arrangements can appear confusing, but almost any agreement will eventually fall into one of these categories:
Conceptual Comparison of Service Approaches
Contract Labor
Frequently an information technology organization will need to supplement existing resources with contract labor to either meet project schedule goals or to borrow specialized knowledge not available within the department and not necessary to ongoing operations. Many small to medium contracting firms support this "body-shop" requirement for transient or temporary staffing. An advantage to this approach is that firms differentiate themselves based on the quality and availability of resources as well as depth of special skills. Contract labor is generally a short-term requirement, and contractual arrangements associated with it are typically straightforward. Contracts almost always include language about whether or not either party may attempt to hire the employees of the other. Some firms offer contract labor in a "try before you buy" model where a contract employee may actually be hired after some agreed period of time. Larger firms seldom attempt to support details, sometimes minuscule resource requirements.
Project Services
A project-oriented approach to contract services is one of the most common arrangements and is typical of consulting and systems integration firms. Here the vendor provides resources in the appropriate numbers and with the necessary qualifications to achieve some project goal—implementing an off-the-shelf accounting system, for example. The client is billed for labor and other costs as agreed. The two principal forms of project-oriented contracts are time and materials and fixed price. (Time and materials agreements with a not-to-exceed price are a variation on the fixed price model.) No matter which contracting model is chosen, the following project attributes must be clear from the start for the sake of both parties:
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What specific business/operational purposes will this project serve? |
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What are the work boundaries of the project? |
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What are the key points in the project to achieve by certain dates? |
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What things must the contractor deliver to the client by certain dates? |
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What measures will be used to monitor project compliance? |
If any of these attributes is left vague or undefined, project price, schedule, and/or outcome will be either unmanageable or end up high, long, and poor.
Facilities Management
Facilities Management (FM) is a variation on outsourcing in which the client typically continues bearing the capital costs of an information technology operation—computer room, computers, storage, terminals, workstations, etc.—but contracts with an outside party for the labor to staff and run the operation. In this basic form, the model makes little economic sense. By paying a significant premium to the facilities manager, the client is relieved of human resources management and little else. Facilities Management can be more beneficial if the vendor is able to bring significant additional value to the arrangement, typically in the form of software. In this case, concessions related to the cost of use of the software can make up for the premium price paid for resources resulting in similar costs to an in-house operation with the additional value of applications optimized or customized for the particular environment.
Facilities Management has fallen in and out of favor over the years in the healthcare market. Improvements in off-the-shelf applications have diminished the leverage that a Facilities Manager might have with a custom solution. Some vendors still offer this service approach in combination with some enhanced version of their product. Even in this case, release and version management can be cumbersome for a product version that is heavily tailored to site-specific preferences, and access to the latest functionality may lag significantly behind clients with conventional licenses.
Outsourcing
Outsourcing is a comprehensive service approach in which the vendor takes on full responsibility for an operation for a fee. The purchase of the capital assets of the operation from the client often distinguishes outsourcing from facilities management. The client then pays fees to the outsourcer for services. The outsourcer calculates fees based on the burdened cost of the resources (salary, overhead, profit) as well as some schedule for amortizing the purchase of the capital assets. In some cases, the annual cost of outsourcing may be higher than maintaining an in-house operation, but the infusion of cash from the sale of assets can be useful to the client in ways that justify some extra long-term expense. Frequently, the outsourcer will shrink the size of an acquired operation, thus making the multi-year cost very attractive to the client.
One variation of outsourcing is sometimes called "co-sourcing." In this model, the outsourcer and the client form a standalone services organization in which the two (or more) parties hold financial interest. Advantages include reduced ongoing fees for services for the client, and reduced up-front capital requirements for the outsourcer. By lowering the burden of amortization on the vendor, the client can achieve some cash flow relief. Since this arrangement is also more tightly mutual, both parties have an incentive for the operation to run as well as possible. This also an easier relationship to transition from—either back to in-house operation or to another vendor partner. Among the disadvantages of this form of outsourcing is additional contractual complexity in establishing the relationship as well as the influence of regulatory conditions under which healthcare facilities operate. These can make both the contracting and the day-to-day operational processes somewhat burdensome.
Outsourcing is not a cure for bad management. Badly managed operations tend to end up with unsatisfying contractual relationships at every level (and the scale of the dissatisfaction will generally matches the scale of the agreement). Curing critical existing management and process issues vastly improves the prospects of an outsourcing agreement. In some cases, contracting with the supplier for project services focused on operational improvement is an excellent test of how well the two organizations will be able to collaborate on as complex a business model as outsourcing. As a convenient rule of thumb, if a management team is not competent enough to manage the current in-house environment, they are probably not ready to undertake and manage an outsourcing arrangement.
Questions Every Manager Should Ask
Common arguments for large scale services agreements tend to revolve around some sort of apparently budget neutral (or even cheaper) alternative to accomplishing a project or a business process with in-house resources. For example, the case might be made that "we should focus on what we're really good at, our core business, and outsource the Information Technology function to a contractor." Every manager should ask various clarifying questions in sorting through the alternatives:
- Are we not demonstrating excellence or competence in the area proposed to be outsourced?
- If we are deficient, by what criteria are we deficient?
- If we have no measures in place, what are we really talking about? (What is the cost of non-conformance here?)
- If we have measures in place and are not measuring up to expectations, why, and what actions are required to improve? (What is the cost of non-conformance here?)
- What is the estimated cost of outsourcing or contracting for the services? Is that more or less than our operation currently costs? Is it more or less than our operation would cost after any necessary corrective action? If it is less, why? What does the contractor do better than we do? Why?
It is possible that in some scenarios, the issue is less a matter of focusing on the core business and more one of taking specific management action to improve an overall operation. As is the case practically everywhere, if a deal looks too good to be true, it probably is. If part of an operation is suffering under inadequate management, an outsourced arrangement will be at least as bad (usually worse) because of a natural informational gulf between the client and contractor. If a well run operation is outsourced for broader business and financial reasons, an organization can realize genuine benefit, but it is not automatic—continuing to manage closely will continue to produce results.
Summary
Each of these contract services approaches offers advantages and disadvantages based upon the circumstances and the parties involved. A general comparison is included here to illustrate how these models relate according to some relevant properties.
Comparison of Contract Services Approaches
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