Customer value creation in outsourced IT projects
Over the years there has been a sharp increase across industry verticals on the number of IT projects that are outsourced to external service providers. While many of these projects have enormous potential to bring business value to the end customers, because of factors associated with outsourcing, the potential values are not realized in a majority of the projects. This paper explores the value creation process, various theories of value creation, the value enablers in a typical IT project and associated challenges in an outsourcing environment. This paper further evaluates how collaboration, innovation and knowledge management can help the project team deliver value to the customer.
Introduction - Modeling and Deriving Value from Business Processes—Different Paradigms
The subjective theory of value defines value as the ability of an object to satisfy the wants of any given individual, as the object is both useful and scarce. The theory recognizes that one thing may be more useful in satisfying the wants of one person than another, or of no use to one person and of use to another. This concept is contrary to intrinsic theory of value that holds that there is an objectively correct value of an object that can be determined irrespective of individual value judgments, such as by analyzing the amount of labor incurred in producing the object.
In an enterprise environment the business processes are designed and run to create value for the enterprise, which essentially benefits the investors, customers, employees, partners/vendors and society at large.
Porter (1985) had developed “Value Chain,” which depicts a set of vertical primary activities and a set of horizontal support activities in organizations that create value. (See Exhibit 1.) A value chain is a chain of activities where the products pass through the activities of the chain in order, and at each activity the products gains some value. The chain of activities gives the products more added value than the sum of added values of all activities.
Exhibit 1: Value Chain from Porter (1985)
The ultimate goal of a Value Chain analysis is to maximize value creation while minimizing costs. The costs and value drivers are identified for each value activity. The framework has evolved as a powerful analysis tool for strategic planning.
The Value Chain model, as a linear, mechanistic view of business is based on the industrial age production line. This type of limited process perspective is woefully inadequate to understand the complexities of value creation in an enterprise. Further, most approaches to analyzing business relationships have not taken into account the role of knowledge and intangible value exchange as the real foundation for value creation.
Additionally, the Value Chain model is not adequate to model complex situations of the services industry, and sequential value creation process gave way in recent times to more complex frameworks like Value Networks and Value Grids.
Allee (2002) defined Value Network as a web of relationships that generates tangible and intangible value through complex dynamic exchanges between two or more individuals, groups, or organizations. Any organization or group of organizations engaged in both tangible and intangible exchanges can be viewed as a value network. A Value Network essentially comprises participants, transactions and deliverables and can cover tangible value adds as well as intangible value adds. Exhibit 2 depicts a Value Network between a service provider and a customer.
Exhibit 2: Example of Value Network
The term “value chain” suggests an orderly progression of activities that allows managers to formulate profitable strategies and coordinate operations with suppliers and customers. The “value grid” concept extends this view, to see value creation as multi-dimensional rather than linear. In a Value Grid, the vertical dimension describes multiple tiers from primary inputs (raw materials) to end users; the horizontal dimension describes opportunities at the same tier across parallel value chains; and the diagonal dimension describes opportunities for integration between value chains.
The vertical dimension in a Value Grid can be exploited, for example, by influencing demand both downstream and upstream within a traditional value chain (e.g., a chip manufacturer increases demand by making computer buyers more aware of its chip sets); by modifying information access; and by exploring multi-tier penetration. In the horizontal dimension, companies can leverage economies of scale and mitigate risks due to fluctuating demand (e.g., a vehicle manufacturer produces high-quality engines for cars but also lawnmowers and go-carts). The third dimension, diagonal dimension, can be exploited by pursuing a combination of horizontal and vertical options.
The grid approach allows firms to move beyond their industry lines to identify opportunities and threats. It forces the managers to understand the power balance between suppliers and manufacturers. Though value grid provides a powerful concept to derive value from the organizational processes and develop strategies for growth, it has been exploited in limited areas in different enterprises.
IT as Value Creator for the Enterprise
IT in an enterprise has evolved a long way from cost of doing business to reduction in operational cost and improving business process efficiencies. Today the primary purpose of IT organization and IT project is to provide value in a traditional sense, i.e., on the cost side of the operations.
However, though a majority of the IT organizations manage their budgets and projects effectively, very few IT managers can show, or are truly sure of, the value they actually create for the enterprise. And CFOs are even less certain if they get enough for what they pay for.
IT projects in an enterprise are typically expected to add tangible or intangible value through the following accomplishments:
- Utility of the system developed/enhanced
- Tangible features/functions
- Design, usability
- Innovative use of technology
- Experience of collaboration
- Ease of relationship
- Commitment to partnership
- Product experience
- Customer enthusiasm
- Business Benefits
- provided solutions
- Impact on end-customer
- Cost reduction
- Timely/quality of delivery
- Delivery model, methodology, tools
- Various aspects of project management
- Contract terms/service level agreement (SLA)
- Payment terms (for external IT providers)
- Total cost of ownership (TCO)
- Return on Investments (ROI)
While some of the above factors contribute to positive value creation, there are a few factors that only contribute to negative value when they are not present in the IT organization or the IT project.
Though it has been possible to identify the factors that contribute to value creation in IT engagements, no quantitative model is available to evaluate value derived from IT engagements. The closest indicators of value creation are qualitative feedback, such as Value for Money, or financial metrics, such as TCO or ROI.
The linear Value Chain model may not be well-suited for the complexities associated with tangible and intangible outputs from IT engagements. Value Network models; on the other hand, focus on collaboration in IT engagements and would be a more structured approach to evaluate value delivered for the enterprise from IT engagements.
Additionally, going forward, creating business value through IT will be less about reducing costs and more about innovation. Business today expects IT initiatives to not only cut cost through automation but also to provide value on revenue growth, expansion of services and markets and other intangibles.
Some of the approaches that IT managers look at to create value for the enterprise follow:
- Analyze enterprise-wide IT initiatives and categorize them under cost-side initiatives or revenue-side initiatives based on the stated objectives of those initiatives.
- Keep revenue-side IT investments as iterative with incremental budgets so that progressive clarity can help adapt the execution approach and eventual value derived.
- Look at cost-side initiatives for improvement in productivity, automation of repetitive processes and usage of tools during software development/maintenance processes.
- Exploit high-level of collaboration between business and IT for idea generation and idea validation. While it is the business process owners who define what needs to be done by IT systems, the IT team can provide many suggestions and ideas about innovative use of technology and thereby arrive at optimal solution jointly.
Challenges in Value Creation in Outsourced IT Projects
It can potentially be easier to demonstrate value delivered by internal IT departments of the enterprise, but it is extremely difficult to demonstrate the same for outsourced IT engagements. The reasons include the following:
- Lack of understanding of enterprise's business objectives on the part of the IT provider:
- Most of the IT providers tend to stick to the documents and discussions associated with the project at hand and do not have holistic understanding of the organization's business strategies or objectives. In several situations the association between the IT provider and the enterprise is too short to get the grasp of the complete business context.
- Limited knowledge of industry domain by the outsourcing provider
- As the outsourcing provider's main skills are in the IT project execution, the team normally comes with limited understanding of specific industry domain and business processes. Additionally, the people who work on outsourced projects move across projects for different clients, and they tend to be transactional in executing project tasks. These trends inhibit in delivering additional business value.
- Contract-driven and SLA-driven project execution
- Almost all IT projects outsourced today are bound by hard contract terms and SLAs. A strong set of legal terms and conditions inhibits the IT provider from focusing on innovation and forces the provider to “give what is asked for.” The net result is a functional IT product, service or system delivered on budget and schedule but it provides little value add to the enterprise.
- Excessive focus on technology solution
- Being technology-focused organizations, it is a natural tendency for IT services providers to look at the application of state-of-the-art technological advances, frameworks and methodologies for the clients, sometimes without analyzing if the end results are ultimately beneficial for the clients.
While IT services providers are aware of the challenges, the people managing outsourcing relationships are also focusing away from simply managing the performance of the service provider and moving towards value creation. Many of them realize that managing performance cannot be the ultimate goal and are exploring options to address this.
Addressing the Challenges, Evolving Best Practices
Different IT services organizations are addressing the issue of value creation in different ways. Value creation is perceived as a significant competitive differentiator for any IT services organization. The customers also understand the need for moving beyond managing project performance by deliverables and SLAs and exploring additional value-adding mechanisms.
The key focus areas in delivering value to customers can be categorized under the following headings:
The customers and IT service providers who are exploring value creation options recognize the importance of partnership, instead of only technical competency, to execute a project. While there could be many service providers who have technical competency to execute an IT project, very few of them can operate in a partnership model with the right attitude, flexibility and willingness to assume/share risks.
Though most of the IT service providers agree to operate in a flexible model with the right attitude, alignment of organizational cultures of the two organizations plays an important role in making such collaborations successful.
Also, in order to evaluate collaborative ability and flexibility of IT service providers, many customers look for alternate pricing models, such as risk-reward model, profit-sharing model and deferred-payment model (based on actual realization of benefits from the IT systems). This is an area where most of the IT service organizations fail to be flexible, as these options do not gel well with their own business model.
While there are technology solutions to customer's business problems, there are opportunities for business innovation to deliver real value to the customer. It is true that IT projects are seen more as operational activities, but IT services organizations need to bring together diverse talents and skills to see how IT projects can deliver innovative business solutions—that is, not to just reduce the cost of IT projects but also to contribute to the business growth of the customer. IT service providers and projects should see how they can support activities that lead to new markets, products, and service strategies, i.e., revenue side opportunities.
This perspective is completely different from the traditional outsourcing model where the projects are created to reduce cost of operations or cost of development. The customers as well as IT services providers do not have a cookie-cutter solution to innovate jointly and effectively, and this requires people with the right skills and an organization climate that promotes innovation. The fact that an IT service organization is external to the organization does not help in innovation, which requires a high level of collaboration between two organizations.
The other track of innovation centers around an IT service provider's own delivery model. As technology keeps advancing, the methodology of software development and maintenance is also evolving, and it is up to the IT service providers to consider how efficient and effective its software delivery model can be to address the business needs of the customers. Though this track is not on the revenue side of the innovation, it is equally important for the customer.
Effective usage of organizational knowledge can help foster value creation in outsourced IT projects. As an IT service provider is external to the organization, the knowledge available to the project team is limited and proper knowledge management initiatives are necessary to provide values beyond the technical deliverables. Without a sound knowledge base, there is no way an IT service provider can innovate and provide additional business benefits to the customer.
The knowledge management initiative should ideally be a joint initiative between the enterprise and IT service provider. While the customer can provide information on its business processes, policies, procedures and strategies, the IT service providers should build on competencies in the areas of the customer's industry vertical. For example, if an IT service provider intends to create value for an automotive manufacturer beyond developing a system, then it should develop its own automotive industry body of knowledge; analyze industry-wide problems, issues, and market trends; recruit domain specialists from the automotive industry; and ensure that the project teams are equipped with needed knowledge before engaging in projects. This also requires a systemic way of delivering to and sharing the knowledge and information with the employees of the IT services organization.
While these initiatives could become costly investments for the IT service providers, they go a long way toward developing systems that provide differentiating business results for the customer.
Summarizing—Looking Ahead at the Future of Outsourced IT Projects
The focus on outsourced IT projects is gradually shifting from pure cost advantages to value creation. As the executives in the enterprises are getting more experienced with outsourcing, they are also demanding value for money and structuring deals and contracts and overseeing projects in a way that contributes to values beyond cost advantages. It will be imperative for the IT service providers to look beyond tactical cost playing and focus on collaboration, innovation and knowledge management to deliver value to the customer.
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© 2007, Arindam Das
Originally published as a part of 2008 PMI Global Congress Proceedings – Sydney