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The New World of Cloud-Powered Outsourcing

By July 6, 2010Article

In the fast changing world of technology and outsourcing, many forces are at play. And for the outsourcing industry, any development – be it hardware, software, service delivery or something new – will change the business significantly.
Cloud computing is rapidly changing the climate of enterprise IT – and the outsourcing business along with it. The disruptive nature of the cloud model will mean outsourcers will have to adapt for success in the next era.
Outsourcers building cloud infrastructure
Two significant factors are currently creating a new wave of change in the outsourcing industry. First, enterprise software is increasingly being delivered over the cloud. This is impacting the hardware commitments that a business makes.
Second, we are now seeing a situation where high quality IT infrastructure capacity is quickly becoming a commodity. With delivery models being disrupted, IT service providers should get into a mode of investing massively in creating/provisioning an infrastructure that their outsourcing customers can leverage sooner rather than later.
This translates to an investment cycle from the service provider side as IT service providers invest heavily in capacity, virtualization, globalization and automation.
With these investments, service providers begin to get positioned as players that are able to offer capabilities that can transform the way organizations access and use IT services.
This trend begs the question: Why should the service providers be doing these infrastructure investments? While enterprise IT Capex investment is not declining, we are actually witnessing third-party service providers often have a greater capacity to do so, and have the ability to recoup the costs and investment faster.
After making these investments, service providers begin to provision services that meet their clients’ needs and thereby inject a new service paradigm in the outsourcing landscape. What does this paradigm look like?
Take a look at the increasing adoption of BPO/KPO and SaaS (aside from the cloud) and one gets a potent mix of disruption that leads to a new model for outsourcing: The BPO provides labor/service arbitrage with the ability to modulate and personalize “standardized” solutions. The next element in the mix – SaaS – provides the enabling process-centric bedrock support to BPO, while the latest ingredient – the cloud – acts as the delivery engine.
Contracts can block move to the cloud
The advantages of employing a cloud-based model of service delivery are well established now. In certain types of computing environments, embracing clouds can provide significantly lower costs, higher reliability, assured uptime, greatly enhanced flexibility , robust availability and up-and-down scalability configurable in real-time.
However attractive the benefits, the determination as to what, how, where and when to launch a new model of cloud service remains an issue that businesses have to grapple with – not unlike any other operational decision. Enterprise outsourcers also find the need to find a solution to the dilemma: Do they continue, modify or disband their existing outsourcing arrangements to embrace the new model and reap the benefits in terms of savings, ease of use and performance.
In respect of those businesses trapped in such arrangements due to existing contracts, what we find is that the nature of the engagement can sometimes pose challenges.
Consider this example. A variety of suppliers are engaged to provide “horizontal services,” say service desk management, server and storage management, end-user management and so on. But in most cases, enterprises parcel out their outsourcing contracts as application management services and infrastructure management services. Therefore, when seen as distinct buckets of services, many businesses end up awarding these as separate contracts with different service partners. So we can see Partner A extending application management services, while Partner B extends infrastructure management services to the same client.
This separation of service lines creates significant challenges to embracing a cloud-based service model because both application and infrastructure management services typically come together in the cloud and normally would get supported by a single service provider. Here is a case where the incumbent service provider’s interests conflict with a client trying to adopt a cloud model. This is a “first order challenge” – a conflict rooted in the existing models of engagement and so typically calls for a fundamental rethink on the outsourcing model per se!
Rethinking the outsourcing model
Like every other growing high-tech discipline, cloud computing is maturing every year. In the process, the cloud is getting more and more cost-effective due to, among other things, increased usage of automation, virtualization and self-service capabilities – all this aside from the ability to leverage global talent and cost pools. In a number of enterprises today, applications get mapped to infrastructure for governance and convenience and in most cases such mapping of applications to serves leaves substantial unutilized capacity at the enterprise level. The surplus capacity can be turned into profits through a judicious choice of leveraging the cloud model.
Some estimate that the wasted (over-provisioned / sub-optimized) capacity could be in excess of 80 percent – a very significant amount.
Let’s extend the math now: Inside business, typically one-third of sunk cost is attributed to application infrastructure and another one-third goes towards app maintenance. If we were to apply these proportions, we would see that somewhere around 10-15 percent of total internal IT enterprise expenditures are aimed at application setup partition and the resultant sub-optimized infrastructure across the board. With a cloud-based service delivery model, such costs could be recouped potentially for other new initiatives.
But how to recoup the costs? The outline of the cost structure shows scope for massive improvement but to realize this, we need to examine the work structure. The work structure governing such outsourcing arrangements indicates that the malaise could be in legacy outsourcing done “tower wise” (horizontally).
Currently, most outsourcing contracts are administered in this way. Typically in such arrangements, buyers engage multiple service providers for each of several IT services towers, such as server management, applications maintenance, end-user computing, and so on. A buyer typically selects one supplier for infrastructure-oriented towers and another for applications-oriented towers.
There is binding logic behind such arrangements: each tower calls for distinctly different skills and expertise and therefore, it makes sense to outsource to different partners based on the skills needed.
On the customer side, there exists a strong logic behind having tower-centric outsourcing partners supporting them. After all, by getting multiple IT service providers to support, buyers are able to pursue best-of-breed sourcing scenarios, foster healthy competition and optimize the cost structures of individual towers.
But, as a consequence of this approach, many enterprises have a range of services contractually assigned to different service providers. Today, many buyers have a range of IT services contracts spread across multiple service providers. Under such arrangements, by default, we see that contracts get optimized at the tower level. Then by extension, the cost and value get sub-optimized at the tower level. Conflicts between the designated service providers managing the different towers get managed by differing contractual terms and it is quite common to see such partners in a conflict.
After all, a contract can only specify a finite number of things – the dynamic real world can never be captured and agreed to in cold print, prepared for ahead of time, and managed over a time period of three, seven or ten years (the typical outsourcing contract periods).
Such an arrangement lends itself to the pregnant possibility of the overall cost and value getting sub-optimized.
For example, when service providers get paid on the number of servers that they support, it would be too optimistic to think that they would be supportive of efforts like virtualization and cloud computing!
Sometimes, gaps in skill among service providers may make them somewhat uncooperative towards initiatives planned at moving to the cloud.
Ditto with service providers managing the app tower: Their contract normally assumes managing a predetermined set of IT applications – wherein they can show productivity benefits over time owing to repeated usage and therefore reduce their costs on a running basis. Such arrangements could come in the way of cloud adoption but an environment migration might not have been envisaged in the original contract. Similarly, applications management suppliers are compensated to manage their assigned applications portfolios for a fixed – and often declining – cost.
Implications for vendors
The reality? The services business is a slow-moving industry. Over a period of time the common denominator across comparable service providers gets more strong and similar. In other words, over time, fast-growing and large service providers that are strong in only in one discipline between application development and management and infrastructure management begin to show comparable strength in both the disciplines individually and together. The advances in areas like the cloud accelerate getting at such a progress. As a result, service providers begin to compete aggressively on both these areas quite aggressively.
Seeing developments on both sides, it becomes clear that client interests would be better served by leveraging cloud computing. Through this fundamental change, they may engage service providers in a more mutually preferred basis. How? The simple answer is by not refocusing on the way programs get outsourced by towers along AMS/IMS but by bundling infrastructure and applications together into a single contract along functional areas with common measures of performance and drive better cost structure and operational efficiencies.
The way the cloud is disrupting the outsourcing business reminds me of the “horizontal vs. vertical” dilemma. In this case, outsourcers advocate a logical bundling of services around vertical business functions and their associated sub-processes, as opposed to a basket of horizontal IT capabilities packaged around infrastructure, desktop services and a broad set of applications. The IT demand management function gets organized around IT process areas covering infrastructure and applications to be managed by a single service provider.
Outsourced stack as ecosystem
Such an outsourcing arrangement can set the stage for looking at the outsourced stack as a configurable ecosystem. What does this achieve? Effectively, such an ecosystem becomes an outsourcing framework with a baked-in SaaS model that enables clients to receive typical cloud/SaaS benefits.
In the process, buyers drive supplier consolidation in a very measured way and in turn benefit from economies of scale, better commercial leverage and more streamlined governance arrangements.
Additionally, buyers will realize well-negotiated, forward-pricing mechanisms to continually optimize costs and get better returns. When managed well, better formulated plans can deliver substantial cost savings.
By carefully aligning buyer and provider interests through such arrangements, both parties can leverage the latent operational efficiency levers implicit in such arrangements. The whole span of measures of performance – SLA, responsiveness, issue resolution, and more – in such arrangements can be structured to make it become a very beneficial arrangement for both sides. The incentive framework for rewarding good performance can also be judiciously restructured herein.
In a nutshell, a revised cloud/SaaS model of outsourcing through service providers can help buyers in new ways resulting in lowered costs and improved operational performance – never-ending requirements in today’s business world. This calls for a majority of businesses with mature IT environments and outsourcing arrangements in place to look at recasting their existing contracts and embrace a new model of outsourcing governance.
This transition won’t happen by the flip of a switch. Moving into a cloud environment for consuming IT services requires a fundamental change in the delivery mechanisms that would impact almost all the stakeholders inside business. Users getting an opportunity to self-provision services enabled by such a model can sometimes throw the cost/expectations equation out of balance. But as in the case of a corporate AMEX system, control can be achieved with the proper communication and demand/consumption management over time.
The transition management into cloud also requires a tightly managed process for users while the switch happens in order to balance both the existing traditional cost model of operation as well as embracing new commercial models with new arrangements centered around cloud infrastructure.
My prediction?
The new world of cloud-powered outsourcing will become a reality faster than most organizations and ecosystems will be able to absorb this change.
S.Sadagopan is a senior executive with Mahindra Satyam. He is based in the valley and blogs at These are his personal views.

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