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The hidden costs of IT outsourcing

The transactional nature of IT outsourcing relationships could leave your organization exposed to charges you hadn’t bargained for. Here’s what to watch out for.

One of the biggest mistakes an IT organization can make when outsourcing is failing to consider the total cost of the relationship — including all the hidden costs that are likely to accrue. There has been little incentive to date for service providers to bring these looming financial risks out into the open, so customers much are diligent about identifying these additional expenses in order to manage or eliminate them.

“Motivated customers can take this a step further and press their potential providers for greater transparency in the sourcing process. If you want to avoid unexpected costs cropping up, push your vendor to be clear about what’s IT Outsourcingincluded and what to expect if the engagement flexes or scales,” says Phil Fersht, CEO of IT outsourcing advisory and research firm HfS Research. “More importantly, the whole industry needs to get past its transactional heritage and start pushing towards genuine partnerships that are invested in mutual success.”

Until the sector evolves, however, the onus is on the buyer to beware. To that end, here are some of the most common hidden costs likely to emerge during the course of an outsourcing engagement.

Lax demand management – IT outsourcing

Make sure that the approval process for new service is defined and followed. “Many clients suffer from scope creep because new services are easier to request,” says Randy Wiele, managing director at KPMG’s Shared Services and Outsourcing Advisory practice.

Unnecessary change orders – IT outsourcing

“When you have fixed internal staff, they often pick up the special projects and changes to how work is to be performed on the margin at no additional costs,” says Bob Cecil, the principal in KPMG’s Shared Services and Outsourcing Advisory practice. Not so in the outsourcing environment. To avoid death by change order, “you need to be attuned to being charged for every minor change in requirement or small effort,” Cecil says.

Consulting creep – IT outsourcing

“Most clients tell us it’s the cost of consulting during engagements that send costs spiraling unpredictably,” says Ollie O’Donoghue, research director for IT services at HfS Research. “Almost all digital and IT engagements are now consulting-led, which is pushing up costs.”

Even as other areas of IT service have embraced outcome-based pricing, consulting is still largely charged on a time and materials basis. “This can be jarring for clients expecting engagements to be priced in a certain way,” says Jamie Snowdon, chief data officer with HfS Research. While some enterprises will appreciate the increased value they get from getting their engagements right the first time, others will find the additional cost hard to justify.

Visa challenges

The Trump administration has proposed changes in the rules governing H-1B visas and has stepped up its enforcement of existing rules. “If implemented, these changes will significantly impact outsourcing service providers, especially Indian heritage providers,” says Daniel A. Masur, partner-in-charge of Mayer Brown’s Washington, D.C. office and a leader of its technology transactions practice. “The preferred service delivery model of many providers relies heavily on bringing offshore resources, particularly Indian nationals, to the United States using H-1B visas. Governmental action impacting the availability of such visas will impact the cost and availability of provider resources.”

Insufficient governance – IT outsourcing

“Without effective governance, many new services are not fully achieved,” says Wiele. “This is more about value loss than additional cost, but the end result is as negative.” Regardless of the strength of the contract, effective outsourcing hinges on defining, perfecting, and implementing not just new processes but also the roles for process owners and stewards, says Craig Wright, managing director with business transformation and outsourcing advisory firm Pace Harmon. “The ongoing commitment to establishing and maturing these processes, capabilities, and roles can be a significant cost overlooked by clients.”

Aspirational services – IT outsourcing

An outsourcing contract is drafted at a single point in time based on what a client believes they will need over the ensuing years. “However, client leaders change, the business evolves, and, frankly, what may have sounded good at the outset may not be needed in reality,” says Lois Coatney, partner and global leader for managed services at ISG. Someone must make sure that suppliers are actually delivering what was hoped for — and paid for — in the contract and eliminate those services that are not actually necessary.

ISG estimates that a contract loses 5 to 15 percent of its value simply by paying for more than what is actually delivered. “Buyers can prevent this by outlining the most important or costly deliverables and obligations within a contract and track their delivery over the life of the agreement,” Coatney says. “They should continually look for opportunities to reduce cost through the elimination of less important services and using the savings to trade up for new services.”

Failure to innovate

Companies may find themselves locked into traditional sourcing model at a time of dynamic change — and locked out of new technology opportunities like AI, robotics, or blockchain, for example. “In addition, companies are eagerly looking to update their existing sourcing relationships to support mobility, data analytics, or other components of their digital strategy,” Masur says. “Weaving these changes into an existing outsourcing relationship may be difficult, time-consuming and costly.”

Companies must also ensure that they actually benefit from any innovative solutions the provider does embrace. “Particularly in today’s world of advanced process automation, you need to be careful that the service provider is, first, incented to innovate on your behalf and, second, will pass on those innovation savings to you,” says Cecil.

Knowledge loss – IT outsourcing

Knowledge transfer and employee retention during the transition period and beyond is critical. “Ineffective knowledge transfer or high attrition from the service provider can result in loss of institutional knowledge which may never be recovered,” says Wiele. “This can increase the cost of delivery via bad decision-making or missed opportunities to improve processes.”

Duplication of work – IT outsourcing

When problems arise, the first instinct of new IT outsourcing customers is to fix it themselves rather than allow the supplier to take accountability to fix it, Coatney says. This leads to the client retaining more staff than needed and to the duplication of effort. “Be sure the roles of the retained staff have a clear remit that does not duplicate the responsibilities of the supplier,” Coatney advises. There can also be value loss if some business units opt out of the outsourced services altogether, says Cecil.

Employee disengagement

“Outsourcing providers rarely address transition risks and impacts other than those directly affecting their own scope of services, so the impacts on the retained organization are often overlooked,” says Wright of Pace Harmon. In first generation outsourcing deals, IT employees will need to transition from doing the work to managing the doing of it. “For deep technical resources this can be an unwelcome change in focus and they may feel out of touch if they can no longer get their hands under the hood,” Wright says. “As a result, attrition levels may increase and require unplanned hiring and training charges.”

Provider integration

Outsourcing providers deploy specific tools for management and expect their customers to adopt them as well. “Many organizations fail to realize that the introduction of vendor tools require retained resource and super user training to be effective and efficient,” says Wright. “[In addition], most IT environments have customizations to accommodate business differentiators and unique business models. Consequently, this often requires an investment in custom integrations.”

What’s more, customers that haven’t previously cleansed master and transactional data will have to do so to use the new tools most effectively. “Even if discovery tools are deployed, do not underestimate the cost of cleansing data and maintaining referential integrity on an ongoing basis,” Wright says.

Regulatory requirements

The global proliferation of privacy and cybersecurity legislation creates challenges for all companies, notes Mayer Brown’s Masur, but an outsourcing provider’s service delivery solution can exacerbate a company’s compliance challenges when the provider processes or stores its data in new or different geographies. “An outsourcing customer must pay close attention to whether the proposed service delivery solution will require it to incur the cost of complying with privacy or cybersecurity requirements it would not otherwise be subject to or expose it to potential liability in such jurisdictions,” says Masur.

Bubble costs

During any outsourcing transition, most providers will propose some form of secondary and primary support periods, and customers can anticipate significant disengagement charges as existing service providers perform knowledge transfer and support the new outsourcing provider. “Similarly, in addition to the transition charges, the new provider often expects to be paid for ‘run charges’ resulting in a client paying for disengagement of the current supplier, adding the new providers transition charges, and paying both providers’ run charge,” says Wright. These are known as transition “bubble costs.”

“Look to establish deals with the provision to ramp down incumbent services and provide knowledge transfer and other typical disengagement services without incremental incumbent vendor charges,” advises Wright. “Also, when sourcing the new provider, set the expectation in the RFP and at all subsequent stages that run charges prior to the full service commencement date will not be allowed.” Contact Musato Technologies to learn more about our innovative ICT solutions.

An article by Stephanie Overby

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