Jon Fuller, director of operations and co-founder of Centrix, tells Data Centre Management about sourcing options for companies

Today, companies have many sourcing options.   On one end of the spectrum are ‘insourcing’ alternatives.  A company can, for example, make a particular capability in a traditional business unit, or it can source it from a separate part of its business.  It can also establish a captive offshore operation.  In all these cases, the company owns and operates the source.  At the middle of the spectrum are joint ventures.  A company can draw on managed-services programmes for the capabilities it needs, tapping an external service provider to take over an internal function, or it can partner with other companies to create a mutual capability.  In each of these cases, ownership and operations are shared.  Towards the other end of the spectrum lie offshore outsourcing options.  A company can use domestic service providers to provide a capability.  It can call on a business process outsourcer to change the way some part of its business works, or it can outsource one or more business functions to an offshore outsourcer.  All of these options carry a degree of risk.  For example, ‘in-sourcing’ option is often seen as the lowest risk whereas offshore outsourcing option carries the highest risk to a company.

Between 1940 and 1980, the basis of competition was determined largely by the assets a company owned, whether factories, infrastructures or raw materials.  But during the last decade, successful companies moved their focus from owning assets to owning capabilities.

Now, we’re entering a third phase of competition, in which companies will compete based on how skillfully they can exploit capabilities owned not just by themselves but by others as well on a subscription based method.  The way a company manages its sourcing network under the subscription based framework lies at the very core of this new mode of competition.  In the years to come, subscription based sourcing strategy will be increasingly indistinguishable from competitive strategy.

Flawed sourcing practices destroy value

Today, businesses grow and build market share by being better than their competitors.  But because business leaders crave certainty and because shareholders prefer steady and predictable performance, it is understandable that companies tend to stick to existing ways of sourcing.  If the sourcing model is not broken, there should be no need to fix it.  But even as senior executives congratulate themselves on getting a grip on the business in uncertain times by sticking to existing ways of sourcing, they may be creating bigger problems for the future.

For example, senior executives thinking which parts of their IT or business function should be outsourced and which should be in-sourced usually ask themselves: Does the specific IT or business function provides a strategic advantage or is it a non differentiating activity from the competitors?  If the function is a core activity, they keep it within the company; otherwise it is a candidate for outsourcing.  Unfortunately, the decision making process is not that simple.  Over the last 3 years, we studied 50 European and US companies that had grappled with the issue of sourcing IT and/or business functions, and we found that in most cases traditional outsourcing methods led to below par performance and disappointment among executives. 

To understand the failure of this approach, consider its underlying assumption: that executives can place big bets about their markets, future technologies, and suppliers’ capabilities and motives with great deal of certainty.  The truth is that they simply cannot.  Today’s business world is global, complex, unpredictable, and too turbulent. In spite of this, we have seen time and time again, senior executives sign five to ten year outsourcing contracts without considering that they often cannot predict, with confidence, how business conditions will change even in two years – let alone what technologies will be available then.  They turn to external sourcing to gain access to the latest technology and low-cost labour with service level agreements (SLAs) without taking into account how an external service provider’s need to maximise its profits will impact the outcome.  For those reasons, the issue of whether an IT or business function is core or a commodity is secondary.  A company’s primary objective should be to maximise flexibility, choice, and control so that it can pursue different options as it learns more or as its circumstances change.  A subscription based sourcing method precisely does that.  Subscription based sourcing also helps to maximise competition – because a company can see and compare the service bundle and its price offered by one provider with another provider, just like a customer can compare an item on a restaurant menu between two restaurants.  For this reason, senior executives should not make a decision whether to insource or outsource.  Instead, they should create an environment in which potential suppliers – both external companies as well as internal departments, such as IT – are consistently competing to provide IT or business services on subscription based method-making services and associated charges completely transparent.

Our research found that companies that neglect subscription-based pricing model and prefer traditional sourcing (both insourcing and outsourcing) based on conventional SLAs or similar techniques perform poorly.  This is because companies are encouraged to institutionalise best practices, freeze them into place, focus on execution, stick to their knitting, increase predictability and get processes under control.  These approaches establish stability as the key to performance.  As a result, companies are built to support stable strategies and bureaucratic structures, not to change.  Unfortunately, customers do change.  They want new and different services and products, and they want to be able to get hold of them in new and different ways.  So, sourcing methods have to change.  But companies often find it hard to register and respond quickly to this.

From our research over the last three years, we found that most companies struggle to transform their sourcing methods.  They typically enter a fast or slow death spiral and eventually performance suffer and sometimes go out of business.  Before they know it, they become a legacy business, a sitting target for fast-moving new entrants.  They have failed to adapt to changed circumstances.  There is clearly not just a first-mover advantage when disruptive changes are involved; there is a new competitive advantage.
 What are the warning signs that companies may be falling into the legacy sourcing trap?  First, companies get out of synch with their customers.  Paying very close attention to customers sounds like a blindingly obvious.  But, it remains necessary because it is so rarely acted upon.  Another sign of a losing battle with legacy sourcing practice is the sheer frustration and anxiety that will be felt by senior executives to change – because changing sourcing practice is about hands-on action, and rational analysis of the current customers demand and no enjoyment.

Today, companies must be built around sourcing practices that encourage change, not those that hinder it.  Change is difficult because people are rewarded for stability.  But sticking to an outdated yet stable sourcing practice, company in a complex and rapidly changing business environment is following a recipe for failure.

Lack of enthusiasm among traditional service providers doesn’t help

Large IT and traditional service providers are, understandably, not keen on subscription based pricing models for their services.  This is because most of these companies are either products sellers and/or large-scale body-shops, and their business models are either based on economies of scale or volume of products they can flog to customers regardless of their customers’ need.
Our analysis revealed that continuous quest for lowest cost sourcing and doing business primarily with large IT suppliers did not allow companies gaining a substantial advantage over their competitors.  In fact, performance of those large IT suppliers steadily deteriorated.  So, why haven’t traditional IT suppliers been able to deliver the flexible services that match the expectation of these companies?  We found several reasons. For example, large traditional IT suppliers are unable to respond to unexpected changes in companies demand.  Almost all large scale IT suppliers have centralised their production and servicing facilities in low-cost locations (such as India, China, Philippines) to generate scale economies, and they are capable of only delivering lots of standard processes to companies to minimise service delivery costs.  When demand for a particular service raises unexpectedly, these large scale IT suppliers are unable to react.  Even when these IT suppliers respond, the costs of services climb exponentially.

Many CIOs are faced with legacy IT suppliers or incumbent IT suppliers of 20th century, who were selected based on their size and panoply of product offerings, and outdated sourcing practices.  These IT suppliers continue to use shotgun approach and promise to supply all kinds of products and services that instantly solve all kinds of customers’ problems.  But, these IT suppliers are not keen on providing transparent pricing and short-term contracts.

Yet, companies continue to source from large IT suppliers using the traditional sourcing approach, but unable to get return of their technology investments.  Large IT suppliers, continue to hold companies hostage with their proprietary technologies, fixed set of productised services, and long-term contracts.  But, it doesn’t have to be like that – and there is a better way.

What does all this mean?

However, smart companies don’t approach sourcing decisions on a piecemeal basis.  Rather, they look at the entire spectrum of options from a strategic standpoint, literally reinventing their companies by drawing together the right capabilities from the right sources at the right time.  That results not only in greater effectiveness, but also in flexible, agile sourcing methods that can be changed quickly to respond to changing market demands.