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RampRate

Knowledge is power for CFOs weighing the risks and rewards of high-impact IT services deals.

If you haven’t reviewed the performance of your IT services in at least 18 months, chances are good that 20 percent or more of your spending is being wasted. As experienced CFOs who manage technology-buying decisions know, however, there’s a strong reason to hold back on plans to optimize hosting, networking, content delivery and other services. The promised value must be balanced against the layers of risk, time, cost and conflicts of interest that are inherent to most deep-cutting change — whether outsourcing in-house functions, changing vendors or expanding existing contracts.

Because of these value-destroying layers, radical change is a minefield that can easily cripple an IT organization and cost well-meaning CFOs and CIOs their jobs. However, IT service procurement founded on a framework of transparency and street-level market benchmarks alongside continuous improvement and performance management can help build a new market ecosystem that cuts out the layers of fat and helps expose the underlying value of IT services change. Using this ecosystem approach, rewards are amplified while risks are controlled and mitigated.

The Upside of IT Services Change

RampRate’s work with some of the top buyers and managers of IT services at Global 2000 companies has shown that even enterprises with budgets in the hundreds of millions of dollars can quickly find themselves paying above-market rates and deploying technology in suboptimal ways. A thorough benchmark and optimization exercise will reduce overall costs by an average of 20 percent or more, even for relatively recent deals.

There are many market shifts that contribute to making IT services arrangements suboptimal over time:

1. Content delivery costs have dropped an average of 40 percent in each of the last three years, but many businesses locked themselves into multiyear contracts for negligible discounts before and during this decline.
2. While network costs are down, high-density data center space has become scarce, causing an uptick in pricing. Several vendors unceremoniously increased rents for large customers that lacked appropriate contractual protections, with the intent of forcing them to move out in order to resell the space to smaller, higher-margin clients.
3. Only three of the top 10 content delivery networks have not changed ownership in the last three years. Those that weren’t acquired by market leader Akamai (Speedera, Nine Systems, Netli and Red Swoosh) were picked off by IP transit providers (Vitalstream by Internap; SAVVIS by Level 3) or other industry giants (Kontiki by VeriSign), or were a small piece in large corporate mergers (AT&T), with varying levels of disruption to the customer base.

Many more inefficiencies show up when examining internal shared services. For example, enterprises with significant investment in high-density data centers still retain legacy hardware, taking up space that could house 10X the computing capacity. Myriad point-to-point connections persist despite the potential for consolidation into economical VPNs and MPLS architectures. Server farms run fallow as virtualization is taken halfway and then abandoned in favor of dedicating machines to applications using a fraction of the capacity.

It’s Not Anyone’s Fault

If you’ve been in your job for a while, you might be cringing at how the aforementioned facts resonate in your organization. If you’re new to the team, you may be looking at the veteran staff with a jaundiced eye. But, with a few rare, egregious exceptions, decisions to stay the course and let IT services continue at an inefficient pace aren’t misguided. Rather, they call our attention to the uncertainties, delays and unforeseen costs of radical change.

According to Deloitte Consulting’s 2005 study, “Calling for a Change in the Outsourcing Market,” 70 percent of participants have had negative experiences with outsourcing; 25 percent reversed their outsourcing decisions; 44 percent did not see cost savings; and 57 percent ended up absorbing costs that they believed were included in their contracts with vendors.[1] In this environment, many CFOs and CIOs are justified in waiting until discrepancies between current practices and market standards amount to a significant competitive disadvantage.

Eight Layers of Overhead; One Layer of Value

The root causes of these negative outcomes vary widely (see Figure 1). Most often, changes in IT services fail because of some combination of the following:

1. Excessive risk – Enterprises often are not equipped to accurately forecast the risk of IT services engagements – whether it’s downtime, purchase of unused capacity, inability to get required capacity or other factors. Worse, there is no single best way to respond to risk – some measures that reduce it in one set of market condi-tions exacerbate problems in other circumstances. And risk is not just technology-related: Predicting which vendors will end up acquired or in Chapter 11 is tough, not to mention the less-quantifiable cultural issues that are critical in complex deals.
2. Excessive cost – Many costs remain hidden until after the contract is signed. In one recent example, a major consumer entertainment company was slammed with hundreds of thousands of dollars in space-reservation charges when its ISP ran out of data center space. This changed the price of future flexibility from a free right of first refusal to a major monthly expenditure. Without clear knowledge of the best practices in delineating services scope, companies may be left paying more than they expect to.
3. Locked-in commitments – Business needs change frequently, and flexibility is often worth a hefty premium. However, for IT services vendors and internal service organizations, locking in the customer to a long-term commitment is standard practice. One multinational technology vendor, for example, required its internal business units to provide advance warning of 12 months before opting out of any shared services, which prevented the company from taking advantage of favorable market conditions for external hosting.
4. Salesmanship and FUD (fear, uncertainty, doubt) – Many IT services commodities are bundled into complex packages and given fancy names to prevent apples-to-apples comparisons. Genuinely worthwhile innovations may be labeled risky and unproven by internal staff who feel threatened or by less-nimble competitors.
5. Stale market knowledge – Even seasoned market analysts rarely know every vendor in the market. CFOs, procurement managers and IT staff, with many other responsibilities on their plates, have an even harder time staying current. As a result, there is a good chance that the best fit for any given deal was not even on the radar.
6. Agency problems and conflicts of interest – The wheels of commerce are often greased with personal favors and motivations. Whether it’s football tickets for good customers or IT managers thinking, “No one ever got fired for buying IBM,” many people have trouble keeping perfectly objective in the face of personal rewards.
7. Long procurement timelines – It takes time to obtain a clear picture of available options and minimize value-reduction factors, but many organizations would gladly sacrifice cost and risk to hit their time-to-market targets. In many cases, however, IT services still wind up a roadblock in seeking fast time to market.
8. Consultants adding billable hours of complexity – Many sourcing advisers are available to take charge of an IT outsourcing project. However, with time-and-materials billing, their incentives are rarely aligned with the imperative for speed, and despite their best intentions, they often promote extended timelines.

More often than not, these layers are long-established parts of the IT services ecosystem and cannot be stripped away by simple mandate. Budgetary cuts without a good follow-through plan can lead a company to accept long and risky contracts from subpar vendors or drawn-out consultant studies. And while, on average, technological advancement makes IT services change profitable despite all the difficulties, the sheer volatility of the path makes it a true minefield for CFOs.

From Minefield to Gold Mine

To change the outcome and drive value from IT services change on a consistent basis, CFOs must reset the tone of the entire discussion. Rather than focusing on a single aspect such as cost, risk or time to market, they must create balance among all aspects of value and sacrifices to be made.

Here are specific, effective methods of carving away deal overhead, as illustrated in Figure 2:

1. Risk control – No one can remove all risk from IT transactions, but extensive due diligence across key parameters of performance, best practice SLAs predefined in request for quote (RFQ) documents and multivendor sourcing for easy failover can combine to reduce the risk of a terminal failure in an outsourced relationship from 25 to 2 percent.
2. Market-based costs – By utilizing market benchmarks from recent deals of similar size, customers can define firm and credible price ceilings. By utilizing best practices for contractual terms and knowing the specific IT service disciplines inside and out, buyers can ensure that no obscure categories of charges arise after the contract is signed. And, with a neutral arbitrator engaged, future disputes can be resolved.
3. Flexible contracts – From opt-out clauses to midterm benchmarking to renegotiation advice, there are multiple paths to ongoing contract optimization, even those signed for long periods. The key is to plan for changing needs or market conditions well in advance, based on the industry’s history and experiences of peers.
4. Apples-to-apples comparisons – To avoid being swayed by marketing hype and FUD, the best bet is to cast a wide net using a standardized quote format based on accepted, vendor-neutral terminology, and then evaluate the results using a balanced scorecard approach, with weights assigned to financial and nonfinancial attributes of quotes, as well as vendor capabilities.
5. A deep pool of prequalified vendors – While you’re unlikely to tap in to the right level of responsiveness from vendors right away, your approach should be to never stop looking, to be thorough in due diligence and to always seek vendor staff with real power over customizing prices and deal terms. It can take anywhere from a month to two years to appropriately “train” vendors to remove the salesmanship, focus on value and deliver their best quotes the first time – but the effort is well worth it. It also pays to research vendors even before a deal comes up, but all vendor self-reporting should also be cross-referenced with reviews from clients, analysts and research firms.
6. Fully transparent decision-making process – Vendors will almost always pay someone for getting your business. If at all possible, you should find out who it is – usually a master agent, consultant or other party – and make sure they share the bounty with you. It is also very desirable to have third parties (as well as internal decision makers) document their fees and decision factors in auditable reports.
7. Deal acceleration – To drive deals through the system quickly, you will need an established process by which vendors and other third parties are prepared to abide. Setting clear direction in pre-built SLAs and market-based price targets will help you skip the RFIs and RFPs and go straight to clear, easily comparable quotes – but only if vendors are convinced you will accept a quote in no other form. Don’t be surprised if your first several deals get bogged down, but if the third transaction is still not firing on all cylinders and multiple months are elapsing before a decision is made, some external help may be needed.
8. Flat-rate and success-based fees — In some instances, external help may be the cause of the slowdown. To ensure there isn’t an obvious misalignment between the need for speed and consultant fees, some combination of flat rate retainers (to ensure speed) and success fees (to ensure quality work) are imperative.

The Tools You’ll Need

Good will and a well-reasoned approach are not the only things you will need to turn IT services into a driver of value in your organization. To transform the market ecosystem into a favorable one that can be optimized continuously to retain balance between risk and reward, you will need two key resources: market-based data and a deal acceleration process with buy-in from all parties (see Figure 3).

• Market-based data on pricing, capabil-ities and contract terms. In optimizing IT services, knowledge is power. You must always use real market data from real-world transactions to dictate the terms you will accept. Ideally the data should be from your peers and gathered on an apples-to-apples basis in terms of usage volume. The bar must be set with precision – set it too low and money will be left on the table; set it too high and only the most desperate vendors will be left. The same principle applies to contract terms. It is most important that vendor capabilities match their commitments. An SLA is made to be broken; for example, guaranteeing 100 percent uptime is becoming a standard practice even though the goal is practically impossible (even the well-known “five nines” target is considered out of reach for data centers by the Uptime Institute). However, in most cases, service credits will not be nearly enough to compensate for the business loss of derailed service, so choose your vendors carefully.
• A process-based approach that brooks no digressions by vendors or internal staff. Your organization is in a negotiation from the first contact with a vendor. Showing lack of market knowledge and discipline, allowing personal relationships to influence decision making, and letting any vendor feel complacent in a relationship – will all delay the sourcing process by focusing the deal on negotiation or, in industry parlance, poker playing. With market data on your side, you should not negotiate; you should dictate. Procurement should start with a finely honed RFQ – or, if you’re bold and knowledgeable enough, and don’t have much time, a prewritten contract. Vendors should be told the exact requirements in a neutral language, and a predefined format should be used for all quotes. If the direct sales organization does not conform to these demands, go to the channel and negotiate to receive a part of the master agent kickback in the process.

When All Else Fails, Get Some Help

If you buy IT services continuously, it will be worth your while to develop these resources and competencies in-house and build your own procurement ecosystem, much like Wal-Mart did in retail. If, on the other hand, IT services are not a core competence, or, conversely, are so mission-critical that initial failures are unacceptable, a third-party adviser may be useful.

Whether engaged as a data source, deal engine or a complete ecosystem, an outside adviser can help turn IT services change into a consistent gold mine by following the path outlined above. n

Endnote

1. Deloitte Consulting, “Calling a Change in the Outsourcing Market,” April 2005, www.deloitte.com/dtt/cda/doc/content/ us_outsourcing_callingachange.pdf