IT increases application development outsourcing despite disappointing strategic value

Half of all companies plan to increase their application development and maintenance (ADM) outsourcing this year, according to new research from tax and business consultancy KPMG and outsourcing analyst firm HfS Research.

That's not surprising, says Phil Fersht, CEO of HfS Research. "The more experience the buyer gets with outsourcing application development work -- coupled with the increased knowledge their provider develops of its institutional processes -- the greater the cost savings that can be achieved by moving more work out to the providers' lower cost staff." Increased adoption of Software-as-a-Service offerings and the desire to transfer legacy applications to third parties also continues to fuel growth in ADM outsourcing, says David Brown, principal in KPMG's Shared Services and Outsourcing Advisory.

But while the majority of the 399 outsourcing customers surveyed -- 88% -- are satisfied with the cost reduction and standard delivery performance of their providers, they indicated that outsourcers are falling short in other areas. Just nine percent reported that their outsourcing providers were very effective at achieving innovation, 11% said providers were very effective in accessing analytical capabilities, and 18% said they were very effective in gaining access to new technology.

If outsourcing customers are looking for someone to blame, however, they might start by looking in the mirror.

"Clients wanted cheap and cheerful, they got cheap and cheerful," says Fersht. "And there are many providers today specializing in the cheap and cheerful, who are really damned good at it. Some of them even openly discuss with analysts and advisors that their main strategy is to target HP and IBM renewals and undercut them by 30%."

While outsourcing buyers say they want more than low costs and standard delivery from their outsourcing relationships, their contracts tell a different story. "Gaining more strategic benefits from outsourcing, such as gaining access to premier talent, has a price and often organizations with a strong focus on maximizing cost savings contract with providers in a way which limits their ability to deliver premier services or premier resources," Brown says. "It is a case of 'you get what you pay for', and over the past several years many clients wanted to pay for as little as possible."

That's unlikely to change in the near term, says Fersht. "When you consider that most major enterprises began outsourcing administrative IT in the 90s -- and some even earlier -- you have to draw the line that if these are the results of two decades of engagements, it probably isn't going to get much better."

Nonetheless, the buyers surveyed said that their core areas of strategic focus when outsourcing include accessing better talent (70%), gaining access to better technology (62%) and improving analytical capabilities (62%). If they're serious about those goals, says Fersht and Brown, outsourcing customers will need to change their approach in several ways:

Say What You Mean

"Today, the vast majority of companies are failing miserably at communicating their strategic needs and encouraging their partners, or potential partners, to meet them," says Fersht. Outsourcing customers musn't leave it to their providers to define their needs for them. "Unless clients understand and define innovation," says Brown, "a provider cannot help enable it."

Loosen the Reigns

"Buyers need to consider giving providers more latitude in how they deliver new services," says Brown. "Overly prescriptive contracts and approaches can limit provider flexibility to introduce new and more innovative service delivery models."

Put Your Money Where Your Mouth Is

"When it comes to funding, few enterprises are willing to invest in either their internal or external resources to improve their provider relationships," says Fersht. "Instead, their managers persist in grinding their providers' prices lower and lower." Companies that are serious about joint innovation with providers will fund the relationships accordingly and share the benefits.

Seek Partners, Not Providers

"Providers have become integral to the success of the smart enterprise ... but their clients have to treat them fairly and engage them as an extension of their own enterprise, as opposed to the 'master/slave' model," says Fersht. "Pulling together a disparate set of executives across various internal and external entities and encouraging them to team together to improve the competitive nature of their enterprises is a critical capability."

Get Real About Capabilities

"Buyers need to be aware that providers are limited in what they can deliver in these high demand strategic areas. And the providers need to set the right expectation with the buyer to ensure there is a clear understanding of what can be delivered," says Brown. "It is a balancing act by the providers to be honest and transparent enough with their buyer, but also not hype their capabilities beyond their means during the sales cycle."

Contract for Co-Innovation

Those interested in a more strategic partnership with outsourcers will focus on collaboration, not cost, in negotiations. This "evolving skillset requires a shift of focus toward maximizing the size of the entire pie to the benefit of all participants," says Fersht.

"Smart operations leaders need to learn the capabilities of their providers better in order to create contracts that inspire co-investment and co-learning from both parties," says Fersht. Enabling your provider to develop technology and IP that can leveraged across their client base, for example, is one way to create value for both parties.

Stephanie Overby is regular contributor to CIO.com's IT Outsourcing section. Follow everything from CIO.com on Twitter @CIOonline, Facebook, Google + and LinkedIn.

Read more about outsourcing in CIO's Outsourcing Drilldown.

This story, "IT increases application development outsourcing despite disappointing strategic value" was originally published by CIO.

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