Archives for September 2013

Encourage the right behavior from your IT Outsourcing Service Provider

The long term success of your IT Outsourcing Contract and the accompanying Application Costing model lies in your ability to design it in a way that it encourages the right behavior from your IT Outsourcing Services provider. This is easier said than done.

In my previous posts, we have seen that an application management pricing model should be scalable, and transparent/granular.

Now we look at:

Best Practice #3: Encourage the right behavior from your service provider for Application Management.

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Required behavior has to map directly to the interests of your Provider

  • Your Application Services pricing model should encourage the right behavior with a provider.
  • The right behavior can only be encouraged if you take the providers interest into consideration
  • You must consider that a providers interest is to either increase revenue or margin or both. The conclusion being that the only way to encourage the right behavior on the long term with a provider is to see that his interests are worked into the model.
  • You could argue and say that the right behavior can also be encouraged by strict SLAs and a penalization scheme. However if this is done in an unbalanced manner, this can backfire with other consequences. E.g. a strict SLAs on a ticket resolution time can encourage the provider to manipulate the system to see that the number of tickets increases and the percentage of easy to resolve tickets increases so that the SLAs are met.

Map the Outcome and not the Input

  • Be careful to interpret and express the behavior you want – this should be expressed as an output that should be achieved, and not the input that goes into the system.
  • Therefore develop your Application Services pricing model based on outcome-based metrics and not input metrics.
  • This might sound obvious and intuitive at first – but you will be amazed at how many contracts are based on ticket-based pricing models.

Ticket based pricing for Application Management can backfire

  • Ticket based pricing models sound attractive at first as it creates the illusion of a flexible outflow of cash as opposed to a fixed price contract.
  • But tickets are an input based metric – if you pay a provider based on the number of tickets he solves, you should not be surprised when the number of tickets in your operation increase or at least not reduce. Do not encourage the provider to increase tickets…..rather encourage him to reduce them.
  • Distinguish between effort drivers and outcomes – your pricing model will have to be mapped to effort drivers but do it in a way that you encourage the outcomes.
  • So this means let your provider baseline his efforts based on the number of tickets today, measure him by the reduction of tickets, reward him by giving him the opportunity to redirect any saved effort in other value adding activities – like new implementation efforts. Don’t let your provider lose revenue in this way – as you will pay on the long run anyway.

Have you implemented pricing models in your organization which encouraged the right behavior? Did they succeed or fail? And why?

 

Next –  Best Practice #4 : Your Application Services Pricing model should be elastic. Stay tuned!

In this series, see also:

Best Practice 1: How to design a scalable IT Outsourcing contract
Best Practice 2: How to design a transparent and granular Pricing model

 

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How to design a transparent Application Management Services pricing model

Best Practice 2: Your IT Outsourcing Contract should be transparent and granular – and this should show in the pricing model

Transparence and granularity in an Application Maintenance contract directly translates to a price per application. An ideal model goes further and prices the service depth required on the application.

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Let’s look at transparency and granularity from various viewpoints to understand the needs of the design.

Viewpoint: Application Business owner

  • In the midst of signing a maintenance contract for an Application portfolio, the effect of the contract on an application should not be lost.
  • While a total price might make perfect business sense from the perspective of portfolio management, there are business owners who use and sponsor these applications. The pricing structure should be able to translate the costs and benefits of the entire portfolio bundling program to an individual application.
  • Else such an overall program could be stalled by the business department which feels that the costs to its applications have not been correctly allotted.

Viewpoint: Application Maintenance Contract Manager

  • A granular pricing structure – which means applications are either priced individually or according to a scheme that is laid down – greatly eases the job of a contract manager.
  • Granularity should go beyond just price for application and also model the various ebbs and tides that the service could take. Explore all the dimensions of your service whether it is service depth or service time e.g. some applications might need only level 2 support, other applications might need 24/7 support.
  • The more granular your model, the less discussion the contract manager would have while discussing portfolio changes during the contract duration.

Viewpoint: IT Procurement

  • Valuable procurement bandwidth can be saved if all service conditions are laid clear and separately priced in the form of factors.
  • Procurement can then concentrate on the larger ticket items and leave the management of the pricing to the contract manager of the application portfolio.

Viewpoint: CIO

  • A CIO will normally highlight the overall savings that have been achieved through the clustering of applications into an overall application portfolio.
  • However, he also has to demonstrate these savings to individual business departments – and showcase the overall benefit that they have achieved by taking part in the clustering program. He needs their support.
  • A transparent and granular pricing system serves such a cost allocation in a seamless manner. No more clumsy Excel sheets as an after-thought.

Effort put ahead of the curve in defining a transparent and granular pricing system, calibrating your application portfolio against it, and signing contracts based on this pricing system will go a long way in keeping the contract and change management smooth and frictionless.

Next –  Best Practice 3 : Encourage the right Behavior – stay tuned!

 

In this series, see also:

Best Practice 1: How to design a scalable IT Outsourcing contract

For a background of this topic, see:

The hidden inflexibility in IT Outsourcing Contracts
Are outsourcing pricing models skewed towards service provider needs
Do Standard Application Pricing Models really cover today’s needs?

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How to design a scalable IT Outsourcing Contract


Your IT Outsourcing Contract and the accompanying Application Costing model should accommodate any change to the application portfolio over the duration of the service contract.

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Design your IT Outsourcing Contract for Scalability by following these four main practices:

Allow for new portfolio entrants
    • An application portfolio is never steady state – it is under constant churn. Applications enter and leave a contract due to multiple reasons.
    • A predominant driver of such churn is the lifecycle of the applications – when
    • IT Make or Buy decisions can also lead to applications retiring or new ones entering a portfolio.
    • Design your model so that it scales not only with the size of the application portfolio but also with the individual nature of the applications – an application that today is serving only the users in the UK might tomorrow serve users in Asia Pacific. You should not be in a situation where you renegotiate the costs for with each such change.

 

Follow the Demand Curve
  • Design your contract so that the costs follow the curve of demand
  • Demand can come in multiple forms – in terms of time, services rendered, support required (additional hand-holding), and reaction time
  • Your negotiated costing model should flex with the demand enforced upon it.

 

Facilitate What-if scenarios
  • Go beyond following the demand curve – you should be able to predict its impact.
  • The demand on an application often depends on the costs of the impact of the demand. The change in costs of running an application in reaction to business circumstances should be pre-designed.
  • Make these changes easy to calculate – so that the model lends itself to developing what-if scenarios and the business cases of such changes.
Ride over the spurts of additional support
  • Scalability should also lend itself to temporary and foreseeable bouts of spurts in support required.
  • Discuss and negotiate the costs for such spurts. This prepares both sides – the IT service provider is aware that such an event could occur and at least prepares for emergencies in the operating model. Your IT team budgets for occasional spurts in costs.

In summary: Discuss and negotiate a scalable contract so that it gives peace of mind to both your IT team and the service provider. It avoids unnecessary friction during the management of the service contract.

Is your current IT Outsourcing Contract scalable? What are the dimensions influencing your scalability?

 

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Are IT Outsourcing Pricing models biased towards service providers?

Contemporary literature for pricing Outsourcing services addresses mostly the perspective of the provider 

Unfortunately contemporary literature on pricing of IT Outsourcing Application Management contracts largely deals with Application Pricing models from the perspective of a service provider:

  • Either they compare and contrast the the advantages and disadvantages of fixed price versus Time and Material models of pricing.
  • Or they advise on how to price to win – this takes the form of penetrative and skimming strategies. large_3881693277

Labor-based Pricing is unfortunately the norm Most commonly used pricing models (fixed price, time and material, volume based pricing) find their root in the labor costs of the provider. This is an input based pricing as each of these models are linked directly to effort drivers. These are the factors that go into the delivery of the services.

Environment-based Pricing is actually what you need

What CIOs actually need is a pricing that is based on the factors of their environment – and the ebb and tide in their environments. They need a way to transparently show the result of each change to the environment, and not each change to the input that the provider adds into the service.

This is the subtle difference – this is the difference between basing the price on the complexity of an application and its interfaces instead of only on the number of tickets that the provider has to solve.

So start encouraging the right behavior with your IT Outsourcing Provider The pricing model should encourage the right behavior. Creating a pricing model that is purely based on the effort drivers of a provider either unevenly balances the risk on each side, or removes the risk completely from the provider. The result: a service provider service provider has to take care of the inputs of the service instead of proactively trying to better the environment of the application.

As an example, ticket based pricing might appear attractive at first because of the variability of the price – but it might not encourage the right behavior in a provider who is paid based on the number of tickets they solve.  One would want to avoid a constantly increasing number of tickets – the first sign of a dissatisfied customer.

Is your IT Outsourcing Application Management Costing based on your environment and needs, or on the effort drivers of your provider?

See also:

The hidden inflexibility in IT Outsourcing contracts

Do standard application pricing models really cover today’s needs

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The hidden inflexibility in IT Outsourcing Contracts

In my last post, I raised the question on whether standard Application models seen in the market presently cover today’s needs.

To continue this exploration, let’s examine some hidden inflexibilities with typical IT Outsourcing Application Management contracts.

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Saving by bundling in IT Outsourcing
Over the last decade, there has been a trend in getting synergies through bundling applications of similar nature (technology, business process,…) in large scale application development and maintenance contracts.

IT Service Providers welcome this trend and hasten to show the benefits of doing so. This leads to multiple benefits through channeling the sourcing of skills, the standardization of service fulfillment across the applications, and a common project management and governance structure overarching the application portfolio.

But such Software Application Management contracts turn out to be inflexible in the long term.

Failure in converting Outsourcing benefit to price
The bundling benefit is typically translated into a fixed price contract with a provider. Such contracts show an immediate business case compared to the current cost of operation. Often this is coupled with the benefits of continuous improvement and a corresponding decrease in price over the duration of the contract. This looks good at the time of contract signature, and usually both sides start seeing the benefits of the arrangement during the first year of operation.

Outsourcing Contracts are not able to flex to the churn in the Application Portfolio
But more often that not, such contracts are signed for a fixed baseline of applications in the portfolio. Application portfolios are seldom stable. IT managers managing such contracts usually find themselves in monthly meetings haggling over the price increase due to each additional application entering the portfolio. The total cost of the application portfolio turns into a moving target. It starts getting difficult to track and capture the benefits of the continuous improvements originally promised during the contract changes.

Tables turn during delivery
These changes to the application portfolio happen well into the contract duration where the provider is no longer in a competitive bidding position, but in full scale delivery. Providers tend to take a harder stand in such change requests in an attempt to recover any margin leakages that have happened till date.

Do you have such Application Management contracts? Are you facing these problems?

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Do Standard Application Pricing Models really cover today’s needs?

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CIOs today face the daunting task of managing transparency of price in their ever-changing application portfolios. Today’s bleak economic outlook is compounding this pressure. Application maintenance and development for these portfolios are often serviced through large fixed-price contracts with service providers. Current pricing models fail to deliver on transparency and elasticity.

Standard pricing models fail to cover the needs of today
The reality on the ground can be humbling. IT Application portfolios of Fortune 500 companies have historically grown over the last 15-20 years and have typically between 800-2000 applications spanning multiple technologies and business departments in various stages of lifecycle (new, to be retired,..).

High churn in application portfolios compound the problem.
As application find themselves in different lifecycle stages, it is common to have a portfolio churn of up to 40% due to new applications being developed or old applications that retired during a contract lifetime of 4-5 years. IT is forced to react faster to business requirements, and the velocity of this churn is constantly increasing.

Standard pricing models such as Fixed Price contracts and Ticket based pricing models used in such contracts are not able to keep up with the churn in the portfolio.

I will be exploring this topic over the next weeks in a series of blogs. Stay tuned.

Is your current Application Portfolio Pricing Model working for you? What challenges are you facing?

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