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Get Creative

How to avoid the pitfalls of the traditional outsourcing model


COMPANIES CHOOSE to outsource for numerous reasons. However, the traditional model of outsourcing has flaws. The goal of this article is to introduce a strategy that companies can use to increase the effectiveness of their outsourcing relationships. Although this article will focus on application development, the principles can be applied to almost any outsourcing effort.

The Flaws
Typically, there are three things wrong with the traditional model of outsourcing. I chose the word "typically" very carefully. In IT-related outsourcing, some arrangements might address one or two of these characteristics, most, however, do not.

Compensation is tied to performing some predetermined actions
Most outsourcing arrangements have a well-defined contract that specifies what is expected of the vendor. Inherently, this negotiation leads to an adversarial confrontation where each side attempts to get the best deal possible.

Whether the contract is Fixed Bid and Time & Materials, you negotiate upfront for something to be done by the vendor. Usually this occurs before either side completely understands what the end result really needs to be.

The provider does not have a vested interest in the "project lifetime"
In most projects, you are contracting for someone to perform work for some or all of the "project lifecycle." When the project has been implemented, the creator then leaves. No one can predict if an application will require changes, but when it does there is a cost associated with making a change post-implementation.


Outsourcing: Get Creative
The Fine Print
Get the outsourcing service level agreement (SLA) right from the start.

The case against offshore outsourcing.

Darwin's Executive Guide to Outsourcing
All the need-to-know basics.

Inside Outsourcing in India
A guide to doing it the old-fashioned way. (From CIO Magazine)

Russia outsourcing deal points to lessons learned
What not to do. (From IDG Network publication, InfoWorld)

From the Store
Offshore Outsourcing: Navigating the Opportunities and Risks
A CIO Focus guide.

Knowledge is key, and familiarity is inherent with the creator(s). Most changes occur for one of three reasons: 1) Because all of the requirements were not spelled out in the beginning. 2) Because the requirements changed during the development. 3) Because the business changes after the application is in production. Regardless of the reason, thought, the customer is forced to absorb the cost of any changes over the lifetime of the application.

With software development, some experts have estimated that development represents only 30 percent of the lifetime cost of an application. If you build an application and the cost of development is $1,000,000, plan on adding another $2,000,000 or more on top of that over the lifetime of the application.

The customer is forced to absorb all the cost and risk
There are risks inherent with outsourcing, most of which are absorbed by the customer. If the project fails, comes in late or is over budget, the customer if forced to absorb that risk or cost.

The Standish Group, an IT research company, estimates that only about 30 percent of all IT application development projects can be categorized as successful, meaning on time and within budget. About 20 percent are complete failures and the remaining ones typically are either late or over budget (by roughly 150 percent). According to these numbers, when you outsource a project, there is roughly a 70 percent chance that you the customer are being forced to absorb a risk.

The interesting thing to note, after looking at these flaws, is that some of them are inherent in project work. Most of these issues are just exaggerated by the outsourcing relationship since you are dealing with a vendor.

A Better Approach
So, what are the best ways to approach outsourcing? The way that I think companies should be looking at outsourcing is through a license model: a combination of outsourcing (vendors developing custom applications) and the ASP model (where you pay to use the application, not have it developed).

Let me give you a couple examples of what I mean:
  • Your cell phone. You didn't pay to have it built or pay for the infrastructure behind it, but you pay for dial tone and the features that you want.
  • Cable TV. You don't pay for the box or the programs to be produced. You pay for your own customized lineup of channels that you choose
By having your vendor build the application and license it to you it puts the vendor on the same side of the table as you.

Think about what this means:
  • Risk is mitigated since you only pay for usage, not development
  • Faster ROI (return on investment) is achieved because you aren't paying for development
  • Maintenance, support and upgrades can be included in the license fee
This license model addresses all of the flaws in the traditional outsourcing model.

Compensation is tied to performing a predetermined action. With a license model, you are paying for the use of the application, not negotiating for set of activities to be performed or feature to be developed.

The provider does not have a vested interest in the "project lifetime." Now the vendor does have a vested interest beyond "building" an application. The relationship becomes a partnership. The vendor is focused on providing the highest quality application; otherwise, its costs rise with numerous changes.

It is important to state here that there is no way that you can estimate what changes will come through in the lifetime of an application. For a vendor to offer to make unlimited changes is commercial suicide. However, it is up to the vendor to clearly outline what changes it will make in the contract. Perhaps it is unlimited changes to the data model or X number of logic changes a year with some predetermined cost associated with additional changes. Whatever the structure of the contract, there is a way to make this work for both parties. Remember, this is nowa relationship-based outsourcing project; details can be discussed and settled in a mutually beneficial manner.

You are forced to absorb all the cost and risk You no longer have to worry about absorbing risk. The risk is with the vendor who is attempting to get your business.

What this really means for CIOs and application development managers is that they no longer have to beg for large sums of money from the CFO/finance committee. Also, you are free to build projects without getting approval for a capital expense. Finally, depending on how the license fees are structured, they may be depreciable.

Success Factor
The license model, however, is not a silver bullet. Without commitment from both the client and the vendor, the relationship will not work.

There are some critical success factors that can help you get the most value out of your relationships:

Remove barriers between the producer of the value and the consumer of the value. Without an understanding of the business and collaboration with the end users of an application, it will be difficult for vendors to deliver a project that delivers real business value. Furthermore, without this communication the vendor will have a difficult time controlling costs, which will jeopardize its ability to continue providing solutions using this model.

Establish the most productive form of collaboration possible. Whether it is face-to-face meetings, e-mails, instant messaging or phone calls, figure out the best way for the end users and developers to communicate and provide the tools necessary to facilitate that communication.

Delivery should be iterative. Don't wait until the end of the project to take delivery. Break the functionality into feature-sets that provide value and start using the application as it is delivered.

Test, test, test. Testing should be incorporated into the process, it should be done early and often, and both the vendor and the customer have to be committed to testing. The scope of testing should include functionality and features as well as usability.

How to Choose a Vendor
Although anyone can offer a license model, there are certain things to look for in a vendor:
  • A history of full project lifetime: Has the vendor built, maintained, supported and upgraded applications as part of its business over several years?
  • A history of operating in a license model: Does the vendor have expertise at these types of contracts?
  • Service level agreements: Whether it is normal business hours, 24/7, 99.9 percent uptime or any other measure, you need to pick some level and feel confident that your vendor can match your needs.

Offshore Development
Quite a bit of press has been given to offshore development services recently. Most of the reason for this coverage is due to the perceived cost savings. Today, companies use offshore development to take advantage of savings. This makes sense, but the money spent on development — regardless of the cost — is still only a portion of the lifetime investment that will be made in the system. Offshore companies can offer a license model, and might even be able to still offer lower price points than domestic companies. The license model, however, puts more focus on technology, intelligence and effective processes than hourly rate, so vendors that are operationally excellent have a distinct advantage in the marketplace.

This licensing model is just one possible answer to address the risk, cost and quality issues companies face when outsourcing, whether domestically or offshore.

Jon Strande, evangelist at Technical Services Associates in Mechanicsburg, Penn, a 20-year-old software and solutions provider, helps companies improve efficiencies, reduce costs and strengthen relationships through the use of technology. He can be reached at

Have you been looking for a new model for outsourcing? Have you found one?

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