The Secrets of Cost Optimization in Outsourcing

May 24, 2016

Contributor: Laurence Goasduff

Cost optimization should be an ongoing effort, not a knee-jerk reaction.

It's a scenario that few would relish. You're a major telecom player with a first-generation outsourcing deal, and you are undergoing a massive cost-cutting program to drive down operational expenditure. You are locked into a long-term contract that has little room to maneuver, with the provider refusing to come to the negotiating table unless you agree to take on an enhanced portfolio of services. The pricing model is bundled, and the provider is reluctant to share any pricing details.

It sounds like a no-win situation but, in this instance, the client involved undertook an internal assessment with a consultant in order to understand the extent to which costs could be negotiated with the provider. A detailed "deal sheet" was prepared containing various items that needed an immediate fix — keeping in view both the long-term relationship and costs. Some tough negotiations around various failures ensued, and helped to bring the provider to the table.

“ Cost optimization should not be a one-off response to a difficult situation.”

"The bottom line is that the deal sheet helped drive the negotiations," said DD Mishra, research analyst at Gartner. "Cost and various other challenges under the contract became part of the discussion. Aside from the costs, a range of governance and operational issues — as well as contractual ambiguity — were also negotiated to pave the way for a healthy relationship."

While this may be a good example of how sourcing managers can drive down costs and maximize optimization, Mr. Mishra maintains that cost optimization should be an ongoing tactic, not a one-off response to a difficult situation.

"Faced with ongoing pressure to do more with less, sourcing managers need to constantly review the challenges facing their organizations and ensure that their contracts reflect these realities," he said. Mr. Mishra outlined three key challenges that sourcing managers face in implementing cost optimization initiatives, and how they might be overcome:

Challenge 1: Organizations often do not build into their contracts effective benchmarking terms or other key cost-optimization mechanisms to drive continuous cost improvement over the terms of a contract.

Sourcing managers need to include market benchmark terms in contracts, and embed scope-change options to leverage falling per-unit prices resulting from automation or efficiency improvement.

Challenge 2: Many outsourcing contracts do not allow for mitigated currency risk as they use U.S. dollars, allowing providers to take advantage of currency fluctuations and making the service expensive when the dollar is stronger than the delivery country's currency.

Evaluate the pros and cons of deals in local currency versus U.S. dollars, using historical currency fluctuation data. When possible, avoid currencies that have a risk of getting stronger. Consider options like hedging, or eliminate cost-of-living adjustments to prevent any losses from the currency fluctuations.

Challenge 3: Outsourcing contracts generally have a three- to five-year term, and do not include the ability to adopt new sourcing options like cloud services, automation or advanced concepts related to IoT that drive cost efficiency and value.

Sourcing managers need to build into the contracts the expectation that providers will deliver between 4 and 8 percent year-over-year productivity with innovative sourcing models. They need to work with the provider and business to use asset-light services (such as infrastructure as a service, software as a service, and business process as a service), remote infrastructure management, offshoring and automation to drive down costs over the term of the contract.  

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