EquaSiis Market Assessment

Data, Research and Analysis on the Global Business and IT Services Markets

Effective Governance Yields Outsourcing Value

Mike Beals, Vice President, EquaSiis Enterprise
Stan Lepeak, Managing Director, EquaSiis Global Research

The value and importance of outsourcing governance in an outsourcing effort is in many ways
self-evident and intuitive. Outsourcing governance is the vehicle through which buyers can ensure
the benefit is achieved. Given the increasingly complex nature (e.g., multi-sourced, multitower,
multi-geography) of outsourcing today, good governance is more important than ever. EquaTerra
continues to find, however, that many buyers struggle with their outsourcing governance efforts.
This is due to inadequate resources, skills, processes and tools. It is also due to the lack of
information or inability to build a solid business case required to make the investment to improve
these capabilities. One aspect of developing such a business case is clearly assessing and
understanding current state governance capabilities and efficiencies or inefficiencies as the case
may be. This Market Assessment paper reviews the results from recent EquaTerra research that
assesses and measures the operational performance characteristics of buyers managing major
outsourcing efforts.

The Details

Outsourcing Governance Overview

EquaTerra has long stressed the role and importance of outsourcing governance to the success of
outsourcing efforts. EquaTerra‟s direct client experience and market research studies have found
a direct correlation between the quantity and quality of governance investments and the success
and satisfaction of outsourcing efforts. This is not to imply that the more a buyer spends on
governance, they happier they become. Rather it means that there is a minimum investment
threshold needed to ensure that buyers can field and support adequate and skilled outsourcing
governance resources, processes and tools.

EquaTerra has identified six key capabilities that enable outsourcing governance success. These
capabilities can be categorized further and are mapped to the competing priorities that buyers
must balance in their governance efforts: risk mitigation against desires for value realization.
These categories are highlighted below.

Risk Mitigation
Finance and commercial management: the ability to ensure contractual obligations are being
met by both parties and verifying the invoice reflects the service quality received and
provisioned
Compliance management: ensuring effective compliance with regulatory, safety and privacy
requirements
Issue and problem management: appropriate mitigation of issues and resolution

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Value Realization
Change and program management: manage demand for services as well as leverage and
focus on service provider capabilities
Service quality management: create optimization through standardization, defined
performance and satisfaction levels
Communication management: business requirements and relationship alignment

Both risk mitigation and value realization are critical to outsourcing success. Outsourcing buyers
tend to focus on the risk mitigation issues spending much of their time and energy on contractual
or financial issues leaving very little time or focus on the areas that create the most value. Failure
to perform either well will lead to value “leakage” in the outsourcing effort. This leakage can take
the form of dollars spent unnecessarily in governance, missed cost savings opportunities, or the
failure to achieve broader business case goals like process improvement and innovation. Figure 1
illustrates the potential value leakage from poor or inadequate outsourcing governance.

Figure 1 – Potential Value Leakage from Poor Outsourcing Governance

Minimizing leakage is critical. Effective risk mitigation can help ensure that costs remain in line
with projected usage and costs. Creating efficiencies in the risk management function can reduce
the cost of outsourcing governance itself. These cost savings can flow to the bottom line or buyers
can reinvest them in improving outsourcing governance capabilities. It is easier to measure the
“hard dollar” (or € or £) costs and benefits of good governance than its impact on value creation.
Ensuring outsourcing achieves the intended savings or the projected business case will also
resonate with financial and executive management outside of the governance organization.

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Gaining the support of these constituencies is needed to get the approval for the investments in
governance and tools required to improve outsourcing governance capabilities and ultimately the
value achieved from outsourcing.

Seeking to better quantify the potential benefits from effective governance, EquaTerra launched a
market research study (see Figure 2) to complement and extend findings from its own client
outsourcing governance experiences. The balance of this paper will review and interpret the
results of that study. For more information on general outsourcing governance best practices,
please refer to the following Perspective paper as well as to the EquaTerra Library.

EquaTerra conducted this market study in the first quarter of 2008. It surveyed over 300
North American buyers actively engaged in governing and managing their organizations’
information technology and business process outsourcing efforts. Seventy-nine percent of
respondents were director or manager level, with the balance in vice-president or
executive management roles. Twenty-six percent of respondents were from organizations
with $100M to $1B in annual revenues with the rest coming from larger firms. Twenty-nine
percent of respondents were from firms with revenues in excess of $25B annually. All major
industries were represented led by banking, financial services and insurance (18 percent of
respondents) and manufacturing (13 percent).

Figure 2 – Study Method & Demographics

Market Study Findings

Some level of outsourcing governance inefficiencies will exist in any organization. The magnitude
depends both on the scope and scale of the outsourcing effort and the sophistication of the
buyer‟s outsourcing governance capabilities. The market study assessed outsourcing governance
activities in ITO and BPO (see Figure 3). Average total contract value (TCV) under management
by study respondents was in excess of $100M.

Outsourced Outsourced In the process No plans to

Functional Area
2+ years < 2 years of outsourcing outsource
Information Technology 59% 17% 10% 14%
Finance, Accounting & Administration 24% 12% 9% 55%
Human Resources 23% 10% 13% 54%
Procurement 15% 11% 17% 56%
Customer Care/Call Center 37% 16% 14% 33%
Industry Specific Services 35% 16% 10% 39%

Figure 3 – Levels of Outsourcing

Prior EquaTerra research and client experiences have found that buyers tend to invest more in
outsourcing governance, or minimally make better investment choices, after they have been in
outsourcing efforts for more than two years. Outsourcing satisfaction levels also tend to rise after

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two years. Market study respondents included a mix of buyers who had outsourced both greater
and less than a two year time frame.

Respondents had reasonable though not exceptional success in achieving the benefits sought
from outsourcing. On a scale of one to five, where one represented benefits not at all achieved
and five represented fully achieved, responses ranged between 3.1 and 3.6. Benefits sought
included the usual mix of cost reduction, cost avoidance, process improvement and seeking to
redirect focus to more strategic activities. Most respondents planned to expand their existing
outsourcing efforts either in the same or new functional areas or into new business units and
geographies. Twenty-two percent planned to maintain current levels of outsourcing while just four
percent planned to curtail or eliminate their outsourcing efforts. Arguably, the buyer sample
measured in this market study represents “typical” outsourcing users in today‟s market.

Outsourcing governance spend levels fell within the ranges EquaTerra typically finds in
outsourcing efforts of this profile (see Figure 4). Forty-one percent of respondents estimated their
outsourcing governance spend at three to five percent of TCV annually. A full 20 percent of
respondents did not know their annual spend levels or spend was not tracked. Given the
potentially large size of outsourcing governance spend (basic math shows that three percent of a
$100M contract equates to $3M spent annually) buyers that do not know or do not track
outsourcing governance spend are in the dark around the details of a large annual expenditure.
Minimally, these outsourcing governance spend numbers highlight the volume of potential leakage
that can occur in a typical ITO or BPO effort – not to mention the savings often sought in a
contract of this magnitude.

While measuring total outsourcing governance spend is important, it is more valuable to

understand where the funds are spent and tracking the value of that spend. As with all business
functions, there is much administrative work, or transaction-type work, in outsourcing governance.
The degree to which buyers can streamline or limit the time and effort spent on these tasks
determines how much they can focus on more strategic aspects of outsourcing governance –
activities to support value creation – while simultaneously maintaining or lowering cost levels.
Buyers need to assess the costs associated with these administrative tasks as well as their
performance levels. As the outsourcing governance marketplace matures, buyers will be able to
comparatively assess or “benchmark” their cost and performance levels against those of their
peers EquaTerra has developed assessment diagnostic for outsourcing governance to help
buyers better assess their performance against those of their peers.

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Figure 4 – Outsourcing Governance Annual Spend as Percent of TCV

There are a number of key operational metrics associated with outsourcing governance
administration. EquaTerra reviews these metrics when helping clients assess the efficiency of their
governance operations. They include the following:

Number of FTE‟s in the outsourcing governance organization and their fully loaded costs

Number of service providers and service provider relationships being managed

Invoices received monthly from outsourcing service providers

Estimated percentage of invoices that are inaccurate or wrong

Time spent per month in hours and/or FTE‟s on invoice verification and recovery/reconciliation

Percentage of invoices received:

Electronically with summary information

Electronically with detail level information
Non-electronic or paper-based

Time spent per month in hours to calculate chargebacks (when programs are in place)

Estimated percentage of service provider service level credits that are wrong or inaccurate

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 Time spent per month in hours to manage service level credit programs (when programs are
in place)

Time spent per month in hours dealing with contractual issues (e.g., researching the contract
for specific deliverables, affirming scope, definitions, language, etc.)

Time spent per month in hours dealing with or “rehashing” issues dealt with previously (e.g.,
re-addressing the same contractual problems, looking for the same information)

Most of these are relatively “hard” metrics. The issue often is whether the governance organization
has the information and/or time to capture and verify the metrics. Once the metrics are in hand,
the governance team can perform a benefits calculation on potential performance improvements.
As part of this it is also important to understand how much improvement is realistic to expect.

There are no broad industry accepted outsourcing governance performance “benchmarks”

available in the market. Invoice verification is a time consuming process for most outsourcing
buyers, yet the magnitude of these projects warrant careful review of work performed and money
spent with service providers.

EquaTerra has captured cost and performance levels for these outsourcing governance
operational metrics shown in Figure 5 during several years of client engagements. The recent
market study findings add broader market context and validation to those findings. Both are
represented below.

Level found in
Outsourcing governance metric
market study
Percent inaccurate/wrong invoices 9%
Invoices – electronic summary 33%
Invoices – electronic detail 40%
Invoices – non-electronic 27%
Percent inaccurate service level credits 11%

FTE equivalent staff in governance team 9

Hours spent verifying invoices/month 35
Hours spent to calculate chargebacks/month 41
Hours spent on contract review/month 44
Hours spent “rehashing”/month 34

Figure 5 – Common Outsourcing Governance Performance Metrics

Dealing with inaccurate invoices may seem a normal cost of doing business. In an outsourcing
effort with a short-staffed outsourcing governance team, however, dealing with these inaccuracies
can prove a huge and costly headache. The following is a typical scenario.

First buyers have to expend a fair amount of effort to identify any potential discrepancies. When a
discrepancy is found, supporting detail will determine if they should pay or dispute the invoice.

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Even if the supporting detail is provided electronically with the invoice, it usually involves re-
entering this information into spreadsheets to verify correct calculations. This can take weeks to
investigate and resolve, and many times the service provider has to manually query their
operational and billing systems for the information. Further complicating this issue, many
outsourcing service providers negotiate a provision into client agreements stating that the buyer
has a limited amount of time to dispute an invoice and to recover fees that were incorrectly paid
(that is, 30 days to dispute, and 60 days to recover). After the specified time period, the money
reverts back to the service providers, so the timeliness of information is critical.

When making the decision to live with or fix these types of inefficiencies buyers need to
understand the potential benefits from fixing them or at least lessening them. EquaTerra finds
buyers often underestimate potential impact of invoice errors and missed service level credits. To
help illustrate the potential benefits EquaTerra has developed an outsourcing governance benefits
calculator (see Figure 6).

Figure 6 – EquaTerra Outsourcing Governance Benefits Calculator

The scenario represented in Figure 6 is a buyer with outsourcing relationships totaling $250M TCV
over five years with three service providers. Using average numbers from the market study,
assume the buyer has a total of nine FTE staff in the outsourcing governance team, with two

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focused on invoice verification and processing. Average invoicing accuracy is 91 percent. The
buyer‟s goal is to reduce invoice errors by two percent and reduce service level credit errors by
one percent. Because of those reductions, the buyer wants to redeploy staff previously
remediating those errors and achieve a labor reduction of productivity improvement gain or 10
percent. If the buyer is able to achieve these relatively modest goals, the monthly bottom line
savings exceed $130,000 and total potential savings exceeds $8M. This clearly illustrates the hard
dollar value of improved outsourcing governance operational efficiency.

How are Governance Organizations Responding?

Targeting lucrative cost savings and cost recovery from improved outsourcing governance
efficiency is a laudable goal. The challenge is successful execution. EquaTerra finds that more
outsourcing buyers appreciate the value of good governance, especially those in second
generation or later outsourcing efforts. This was borne out in the results of a separate market
study on global outsourcing trends that EquaTerra conducted 1Q08. This study found that the
governance model was cited as the top critical success factor in next generation outsourcing
efforts (see Figure 7). Buyers that recognize the importance of good governance are also
dedicating more, or at least more skilled, resources to outsourcing governance efforts. More
importantly they are looking at how to improve outsourcing governance capabilities rather than just
devoting more bodies to its support.

Figure 7 – "Next Generation" Outsourcing's Critical Success Factors

There are many ways buyers can improve outsourcing governance capabilities. The most obvious
is ensuring skilled and experienced staff are placed in key roles. Outsourcing governance must

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become a valued role and career path, not a transitory position or home of last resort to former
members of outsourced functions. Buyers must also define clear roles for outsourcing governance
team members and processes for outsourcing governance activities. Ad-hoc processes and roles
are a prime cause of inefficiencies.

To maximize cost savings, buyers must minimize the time and effort spent on administrative
outsourcing governance activities while simultaneously improving the efficiency. A key means to
do this is through process automation. EquaTerra finds that too much outsourcing governance
work today is performed manually with the usual associated high levels of inaccuracies and
overhead. Automation of outsourcing governance activities through the greater use of dedicated
software tools (beyond Excel) offer some of the greatest potential long-term opportunities to
improve efficiency and to help reduce costs.

At the more strategic level buyers must ensure their outsourcing governance investment matches
the intent of the outsourcing efforts being supported. A relatively straightforward “lift and shift”
outsourcing effort focused on maximizing cost reduction does not require a large or complex
outsourcing governance to support it. More strategic or transformational outsourcing focused on
process improvement and innovation requires higher skills and deeper outsourcing governance
capabilities.

How are Outsourcing Service Providers Responding?

In some respects outsourcing service providers face competing goals when supporting their side
of a buyer‟s outsourcing governance effort. From one perspective there is money to be made if a
buyer is lax around tasks like invoice verification. If the client is unaware that an outsourcing
service provider is not meeting its contractual obligations due to weak governance capabilities, the
service provider does not have a strong, immediate incentive to point out the shortcomings. In this
case no news is good news.

Strategically, however, it is in the outsourcing service providers‟ best interests to work with clients
that are skilled in outsourcing governance. When the service provider is held accountable the
buyer is in a much better position to understand the value and benefits the service provider is
delivering. Both sides are better able to proactively identify problems and work to remediate them
before they grow and threaten the long term viability of outsourcing. As the scale, scope and
complexity of outsourcing efforts grow this becomes even more critical.

Service providers continue to improve the software applications and tools they use to support
outsourcing governance. This benefits buyers but does not detract from the need for buyers to
invest in their own outsourcing governance audit and automation. Minimally, provider tools do not
support other provider tools. And, provider tools are not ideal to audit service level credits and
verify invoices. The service providers‟ ability to automate and streamline the transmission of key
operational data to the buyer will benefit both the buyer and the provider.

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The Advisor Perspective – Critical Points to Consider
EquaTerra continues to find that poor or inadequately supported outsourcing governance are a
root cause in underperforming outsourcing engagements. EquaTerra advisors polled in the 1Q08
EquaTerra Pulse survey offered the following advice to buyers on how to improve their
outsourcing governance capabilities.

“Continually check to ensure the two parties are aligned. Regularly assess the capability of
your governance team and audit the level of adherence to the governance processes. Do you
have the right people with the right skills?”

“Buyers must remember they are not outsourcing their accountability. They have to find that
line between „managing‟ and „governing‟ (oversight) – a difficult mandate for line managers
who are thrust into governance.”

“Don‟t force fit individuals into governance roles - identify the required skills and enlist
resources appropriately.”

“Service credits are not a punitive mechanism. Relationships should not be adversarial.
Rather, you should be looking to encourage the right behaviors through a „win-win‟ approach.”

“Don‟t over-engineer governance. Make governance something that is real, practical, and can
be implemented. Focus your resources on the biggest impact areas by using experienced
resources and advisors. Use automated tools to accelerate your governance resources.”

“Go for a more integrated approach and a true partnership, instead of only mentioning
partnership but managing the relationship as a traditional buyer/seller situation.”

“Make sure to implement state-of-the art technology to support governance as this will not only
increase effectiveness but also reduce governance expenses and thus positively impact the
baseline of the outsourcing initiative.”

Relative to the last point, buyers need to leverage outsourcing governance software tools and
applications to assess their outsourcing governance operations. Scenarios presented above show
the tangible cost savings buyers can gain from improving the efficiency of administrative tasks.
More importantly, improving outsourcing governance capabilities creates a foundation for
improving the more strategic and critical aspects of outsourcing governance around relationship
management and value realization.

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Figure 8 – Mapping the Work of the Outsourcing Governance Organization

Figure 8 illustrates the totality of outsourcing governance work. EquaTerra estimates that 50
percent of governance work falls in this lower left/transactional quadrant and that it is possible to
automate up to 40 percent of that work. Automating invoice verification, calculating service level
credits, and collecting information and reporting accounts for much of this automation. Of the
remaining 50 percent of governance work, EquaTerra believes that another 40 percent is
consultative and 10 percent strategic. There is also the opportunity to automate some amount of
this work by providing scorecards to highlight issues and document repositories for quick
reference. This will also aid in helping buyers perform more rapid and quality decision making.

There are important benefits buyers can gain once they have automated the transactional tasks
and focused more on consultative and strategic work. One is to address the issue of consumption
management. Regardless of whether a buyer has to deal with base service fees with additional
resource charges (ARCs) and reduced resource credits (RRCs), the buyer will pay more if it
consumes more resources from the service provider.

Most organizations outsource to get to a „future state‟ often with a targeted cost reduction. This
means that buyers want to shift the delivery of services from old, manual delivery mechanisms to
self-service, and automated delivery mechanisms. The outsourcing business case is based on a
set of assumptions around consumption patterns, and more specifically, the adoption of the new
services (e.g., HR self-service applications, improved help desk support, access to new
knowledge based services). Buyers that do not have adequate consumption management
processes and tools in place – and therefore visibility into actual consumption levels of services -
are flying blind. If new services offered are improved, users are naturally likely to consume more of
them, driving up outsourcing costs.

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Using invoice verification as an example, even if the buyer receives the invoice and consumption
detail that supports fees charged, it will not know which resources are out of variance with
business case assumptions. It will also not know which users or business units are the culprit. This
highlights that the more a deal depends on transformation and the adoption of new services, the
more critical it is to have demand forecasting and consumption management tools in place.

Buyers are increasingly developing higher-level relationships with their outsourcing service
providers for the purpose of transforming their back-office functions. The implication for service
provider relationships is that buyers must select a service provider not only for its operational
effectiveness to cut costs, but as a strategic business partner who understands the industry and
the key to help you achieve your business objectives. Instead of telling its service provider what to
do and how to do it, buyers inform the providers of their business objectives and let the service
provider use its recommended approach, given its expertise and knowledge of best practices.

So what does this mean from a governance capability perspective? It means that buyer skill sets
have to include things like program management, change management and strong
communications capabilities. It also means that buyers will need to facilitate regular, structured
joint-planning sessions between the collaborative provider(s), the retained organizations, and its
business units, in order to create value.

If the buyer‟s governance team has the wrong skill set, or is totally bogged down doing work such
as verifying invoices and performance reports, it will not have the skills, or time to effectively
facilitate the innovation necessary to accomplish transformational objectives. EquaTerra typically
sees a relatively small amount of savings from operational efficiencies and many millions of dollars
in benefit expected from arriving at that future state.

Conclusion
As typical buyers expand their outsourcing efforts in terms of function, scope, scale, number of
service providers and global delivery, good outsourcing governance is more important than ever to
outsourcing success. While EquaTerra sees a growing appreciation of the importance of
governance to outsourcing success, it still finds that many buyers struggle to deploy the adequate
resources needed to support outsourcing governance efforts. Buyers must build a stronger
business case to garner the investment required to improve capabilities, but must also enhance
the performance of current operations. Focusing on improving the efficiency and effectiveness of
administrative outsourcing governance operations is one area where buyers can both save money
and free up resources for more strategic governance. Buyers should review their options to
improve capabilities in these areas, including the greater use of process automation through
support software applications and solutions.

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 About EquaSiis Media Contacts
EquaSiis, an EquaTerra company, provides software and services that Ron Walker, EquaSiis
improve the business support services lifestyle for shared services, +1 858 486 6035
outsourcing practitioners and service providers. The software, ron.walker@equasiis.com
EquaSiis Workbench and EquaSiis Enterprise, is a framework for
Lee Ann Moore, EquaTerra
collaboration used during the service delivery assessment and
+1 713 669 9292
sourcing process to assist in analysis and decision making for shared
leeann.moore@equaterra.com
services or outsourcing. EquaSiis provides intelligence and
optimization for the delivery of business support services across the
entire organization. The company also offers service providers market
intelligence, research, customer satisfaction and trending data through
its Insights group. For more details about EquaSiis‟ research offerings,
please contact Stan Lepeak, stan.lepeak@equasiis.com.

www.equasiis.com

Copyright © EquaTerra 2009. All rights reserved. The prior written permission of EquaTerra is required to reproduce
all or any part of this document, in any form whether physical or electronic, for any purpose.

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