Outsourcing Strategies

Guidelines for Evaluating Internal
and External Resources for Major
Information Technology Projects

Department of Information Resources

Austin, Texas

June 1998

Acknowledgments

Barry Bales, Governor’s Center for Management Development
Linda Cohen, Gartner Group
Dean Davidson, META Group
Adam Martinez, Keane
William Martorelli, Giga Information Group
Scott McAfee, SAIC
Robert Tyner, Northrop Grumman
Brenda Winkler, Texas Workforce Commission

Department of Information Resources
P. O. Box 13564
Austin, Texas 78711-3564
Tel: (512) 475-4700
Fax: (512) 475-4759
www.dir.state.tx.us

Contents

Executive Summary

Introduction

About the Paper
The Outsourcing Environment

Making the Decision

Identifying Agency Needs
Decision Flowchart
Establishing Analysis Criteria
Cost-Benefit Analysis
Specific Cost-Benefit Criteria
Outsource What You Know
Decision-Making Bottom Line
The Next Steps

Implementing Outsourcing Successfully

Establishing the Contract Measurements
Selecting the Vendor
Negotiating Outsourcing Contracts
Planning and Managing Transitions
Managing and Evaluating the Contract
Managing the Renegotiation or End of the Contract

Appendix 1: Analyzing Functional IT Areas

Appendix 2: Legislation

Appendix 3: Reasons for Insourcing and for Outsourcing

Appendix 4: Sample Strategic Decision Matrix

Appendix 5: Sample Quantitative Cost Matrix

Appendix 6: Sample Qualitative Matrix

Appendix 7: Vendor Evaluation Process

Appendix 8: Transition Considerations

Appendix 9: Sample Contract Negotiation Elements

Appendix 10: Additional Resources and Information

Glossary

End Notes

Executive Summary

Purpose

Senate Bill 365 of the 75th Legislature requires that state agencies and universities consider the comparative benefits of using agency personnel contrasted with using outside contractors in their major information resources (IR) projects. This guide has been created to assist agencies and universities in their efforts to evaluate the costs and benefits of outsourcing and using in-house resources.

Issue

Agency and university information technology (IT) management staff face increasing pressures from new technologies and competition for trained resources when planning, developing, and maintaining IT projects. In response, managers have sought to use both internal and external resources to meet business needs effectively. External vendors have been utilized to meet agency demands, but concerns over rising costs and contract effectiveness have led to the need to reevaluate the decision-making process.

The decision whether to use internal or external resources must be made by:

• Understanding the needs and constraints of the organization
• Identifying and prioritizing the goals of the project
• Identifying and quantifying the appropriate measures for internal and external operations
• Conducting a cost-benefit analysis of the internal and external alternatives

Identifying Goals and Needs

In order to make an effective decision, one of the first steps is to identify the needs of the organization and understand why outsourcing may or may not be appropriate.

Reasons to Use External Resources

• To have access to technology, skills, and knowledge not internally available
• To improve business processes and enable organizational change
• To provide needed short-term services without adding to ongoing operational costs
• To focus internal IT resources on core strategic plans and projects

Reasons to Use Internal Resources

• To retain skilled personnel who are able to respond directly to agency needs
• To obtain needed services at lower overall costs
• To take advantage of employees’ unique insight into a project or the agency’s goals
• To have ownership and control over resource and personnel assets

Cost-Benefit Analysis

Once agency needs and goals have been established, a thorough cost-benefit analysis should be conducted. Organizations must identify all internal and external service costs and benefits to make an effective and reasonable comparison. Quantitative and qualitative measures are essential to determine the full impact of the staffing choice. Prioritizing objectives and identifying measures are essential to project success because they influence the costs and benefits of staffing decisions. The staffing decision is based on the opportunity cost of using internal resources and the identification of agency IT needs and costs. It also relies on an understanding of the complete costs of an outsourcing engagement. Some potential costs to consider are outlined below.

Costs of Outsourcing

• Contract management costs to the agency
• Effectiveness costs from lack of understanding of project objectives
• Higher project costs as organizations may experience greater overall project costs in order to access necessary skills and expertise that are unavailable internally
• Higher costs from inadequately defined requirements

Costs of Using Internal Resources

• Opportunity costs of staff time
• Ongoing costs for additional full time equivalent (FTE) employees
• Unpredictable costs as overtime occurs and as employees spend varying amounts of time month-to-month working on the project
• Effectiveness costs if in-house resources are not sufficient or skilled enough for the project

The key to a successful staffing decision is the cost-benefit analysis. Having a secure understanding of in-house operational cost, as well as an understanding of the true, total cost of an outsourcing engagement will enable the agency to make the best decision. Project success must always come from its ability to perform the desired service or activity. Identifying the best option for obtaining project success also stems from an understanding of the project processes: do you want the project done better, faster, or cheaper? The staffing decision is based upon the best use of agency resources, according to its needs and priorities.

Bottom Line

The decision whether to use internal or external resources on a project is determined by a mixture of both the hard dollar costs and the soft dollar—the more intangible needs, risks, and benefits—costs. Significant benefits will be realized from prioritization and determination of success criteria, as the agency is able to identify a complete and comparable set of costs and benefits regarding resource choices. Resource limitations, in-house skill sets and knowledge, and expected performance and outcome measures are important factors that must be analyzed in making the outsourcing decision. Establishing and analyzing quantitative and qualitative criteria provides a bottom-line total that indicates which staffing decision is most effective and states the reasoning used in reaching that decision. Outsourcing can be an efficient and effective alternative to using in-house resources, but a full determination of costs and benefits is required to make that decision. Successful decisions are dependent on having a clear understanding of all the options available.

Introduction

About the Paper

This document offers guidance to state agency and university personnel involved in making IT resource decisions. Outsourcing or insourcing can encompass a wide range of IT services, from a particular project to a functional area to all activities. Each situation requires a different understanding of priorities, measures, costs, and benefits. This paper cannot address all of these situations in detail, but it does focus on project and functional area outsourcing as particular areas of interest for the state. Be aware of the distinctions among types of outsourcing and identify the type of activity being evaluated as a primary step to assessing appropriate costs and benefits. Some considerations in this paper will be more relevant to specific types of outsourcing decisions.

The Glossary defines the terms as they are used in this paper. Readers are strongly advised to review the Glossary before using all or part of this document.

The paper is not intended to encourage or discourage outsourcing. The purpose of the paper is to stress that outsourcing or insourcing decisions should be based on a solid business case analysis of alternatives. The business case is always unique to the agency or university. This document offers general information on how to make an informed resource decision and provides references for more detailed information. Outsourcing is a key opportunity for state agencies and universities to leverage taxpayer funds, but ensuring its success requires the agency or university to be fully aware of the differences between the two resource alternatives.

How to Use the Paper

This guide will help you perform business analysis for proposed projects, evaluate performance, and develop recommendations for resource decisions. Potential uses include:

• Briefing new staff or project managers on business analysis techniques
• Supplying documentation to show executive management how decisions/recommendations were made
• Serving as a guideline that can be modified to fit individual agency or university philosophies
• Facilitating discussion on IT contract content and negotiations
• Providing a starting point for obtaining need-specific information (Appendix 10 has been deliberately provided to assist agencies and universities in obtaining topic-specific information of a more detailed nature)

The Outsourcing Environment

Changes in how outsourcing is defined and used have led to conflicting information on how to make an effective decision about outsourcing. State agencies and universities must ensure that they can identify their reasons for outsourcing, and specify costs and benefits before they can evaluate their options effectively. The use of external resources to enhance IT service offerings is complicated by the evolution of the outsourcing market and the wide range of services now available. IT managers need to be able to match their specific needs with both the correct service and the correct service supplier.

Originally, outsourcing was used primarily to contract for data center services and facilities management, as vendors provided economies of scale for mainframe use. In the 1980s, outsourcing expanded to include the goal of using only external resources and services to develop and manage all IT activities. The primary motivations were cost savings, the desire to avoid or defer high risk capital investments in new technologies, and the need to focus on the core business processes of the organization. Now, outsourcing can refer to any of the above options, as well as to highly defined contracts that “out-task” relatively small blocks of service, and to managed services contracts in which an organization monitors service provisions and alters their characteristics in real time. Outsourcing individual business functions is now a more common activity than outsourcing an organization’s entire IT infrastructure and management. Outsourcing literature now places less importance on hard dollar cost savings and more importance on the business benefits, the soft dollar (or qualitative) savings, and the strategic purposes of outsourcing selective pieces of the IT environment.

State government agencies continue to see opportunities to use external resource skills to develop IT projects. A 1996 study by the G2 research firm indicated that the state and local outsourcing market would continue to grow through at least 2001, with information technology projects leading the way.¹While the determination of whether to use internal or external resources always depends upon the unique goals and strategies of the individual agency, the following information illustrates some of the complexities involved with the decision process and offers a framework for decision making within an agency or university.

Making the Decision

A thorough understanding of both IT and business processes within the organization is necessary before making the decision regarding whether to outsource.

Successful projects result from strong in-house knowledge and understanding of agency requirements, processes, and service and performance measures. Assigning costs and benefits requires that IT management understand the agency mission, and how the proposed effort will support that mission. Choosing either external or internal resources is simply a question of determining what available option best enables the agency to accomplish its business objectives. Business objectives will differ based on whether you are evaluating global, sectional, or transitional outsourcing.

There are two alternatives for examining best uses of internal and external resources:

• Look at all IT activities within an organization. This includes the opportunity cost of staff time and ensures the best use of resources in light of the relative importance of other IT activities. A project intended for outsourcing may in fact use internal resources more effectively. In order to free up internal resource time, a different, unplanned in-house service may need to be outsourced.
• Evaluate a specific project or process to determine if internal or external resources would perform the task most effectively.

Identifying Agency Needs

The first step in the decision-making process is to identify agency needs. These needs set the framework and priorities for IT projects and activities.

• Address the strategic interests and goals of the agency. The agency strategic plan, the information resources strategic plan, and the agency performance measures should all be considered in the process of identifying agency needs and directions. The goals of the agency serve as a basis for determining project success. Core competencies, by and large, should not be outsourced. Depending upon agency resources and weaknesses, however, this may change if the agency determines that resources or knowledge from an external source would supplement the agency’s available resources.
• Specify the service to be provided and identify the reasons to consider outsourcing. Considerations include cost savings, enhanced service levels, the transition to a different technology platform, the need for increased technical knowledge and skills not present in the organization, or insufficient staff resources to accomplish specific tasks. There are many different pros and cons to outsourcing. Some of the major issues are presented in Appendix 3. These rationales should be recognized as costs or benefits according to the agency’s decisions about its business needs.
• Pace the decision process in a neutral framework. While outsourcing can be encouraged for non-IT reasons, the justification regarding the use of internal or external resources should be framed solely in business case terms. A sound analysis of options will be a strong support for IT management recommendations and decisions.

Decision Flowchart

To identify whether or not outsourcing is appropriate, several background questions must be answered. Figure 1 illustrates the analysis process that helps to ascertain if outsourcing is an option, or if in-house staff represents the best use of agency resources.

Figure 1. Outsourcing Decision Flowchart

Establishing Analysis Criteria

Once it has been determined that the use of external resources may be an option that would meet business needs, a cost-benefit analysis should compare both the internal and external resource options. A major problem with external and internal staffing decisions happens when the decisions are based on a lack of understanding of expected benefits. A 1996 DeLoitte and Touche survey² found that actual outsourcing contracts did not meet user expectations in any of the five areas surveyed:

• Vendor expertise
• Better focus on core competencies
• Improved quality/delivery of IT services
• Reduced costs
• Improved transition to new technologies

Chances for a successful outsourcing decision are maximized when

• The decision fully incorporates all known costs and benefits of internal versus external resources according to the type of activity under consideration.
• The contract is negotiated and managed effectively.

Knowing and comparing agency costs and benefits at the start enables the agency to make the best decision and act efficiently upon its decisions. It is important to compare costs as equally as possible, although confusion can arise for several reasons. Some of the problems and solutions are detailed in Table 1.

Table 1. Criteria Development Problems and Solutions

Criteria Development Problems	Solutions
Expectations regarding the project are unclear.	Do the planning at the start to identify the purpose of the project, the agency resources available for the project, and the specific type of outsourcing that would match the project.
A lack of understanding of the project makes it difficult to identify and weigh the costs and benefits of internal and external resources.	Allow sufficient time to research the project fully, contacting any internal or external experts available to the agency. Some resources readily available include other agency/university Information Resource Managers and staff at the Department of Information Resources (DIR).
Failure to compare the costs and benefits of internal and external resources on an equal basis leads to inaccurate analysis. A comparison of FTE costs to the contract total does not account for the soft costs included in the contract. Costs to the agency for in-house resources will be higher than a simple FTE count when soft costs are considered. Costs to the state as a whole may also be different from agency costs, as some operating costs may not be paid by the agency using the resources (e.g., utilities, floor space).	Evaluate the project on a matrix or weighted average list, providing consistent examination of the same options when discussing both internal and external options. A sample matrix used by the Australian government is included as Appendix 4. Be sure that costs are clearly documented and all formulas for deriving costs are identified. This enables you to see what costs are included.
An accurate analysis of costs and benefits is difficult to make because there are no priorities in place to help identify and measure the needs of the agency.	Use the State Strategic Plan for IR Management, Agency Strategic Plan, agency business plan, and Agency IR Strategic Plan to identify priorities and establish weights for each criterion. Involve stakeholders and ask executive sponsors for input.
The hard-to-quantify nature of some of the soft costs and benefits, such as “business advantage” or “access to expertise,” make these costs difficult to identify.	Identifying priorities and weights will help when including qualitative costs and benefits in the analysis. Establishing success measures that examine project outcomes in light of agency goals will add needed substance to the qualitative costs and benefits.

Cost-Benefit Analysis

Cost-benefit analysis enables decision makers to account for the full costs and benefits of outsourcing and insourcing options. The analysis helps to prove or disprove whether a project supports agency goals and outcomes in the most effective manner. Its value stems from its inclusion of both quantitative and qualitative measures. A simple cost comparison will not show all of the true benefits or costs of a staffing decision, although quantified dollar costs should always be included in

the analysis. An outsourced solution may prove to be more costly or require more time, but may still be the best solution to meet the needs of the agency or university. Such a decision, however, must be fully documented, with a comprehensive cost-benefit analysis in order to be justifiable.

Table 2 has been included to provide examples of costs and benefits to consider when attempting to isolate specific costs and benefits important to the project. The list is not intended to be exhaustive. Instead, it should serve as a beginning point for determining appropriate criteria. Some of the costs may be the same for both options. For example, if external resources are working on-site, they will have the same utilities cost as the in-house resources would have. In the same way, benefits may also be similar.

A final consideration regarding internal versus external analysis criteria is the importance of recognizing the full costs of the external vendor. Many times costs are not explicitly seen, but are accounted for in the fees charged by the vendor. The recognition of these embedded costs is necessary in order to make a consistent comparison between options.

Table 2: Sample List of Cost-Benefit Criteria

Quantitative Direct Costs	Insourcing Consideration?	Outsourcing Consideration?
Personnel costs	Yes	Yes
Fringe benefits	Yes	Yes—embedded in contract
Materials/supplies	Yes	Yes
Maintenance/licenses	Yes	Yes
Training	Yes	Yes
Contracts (e.g., if some maintenance/other peripheral services will still be performed by other vendors)	Yes	Yes
Telecommunications charges	Yes	Yes
New equipment costs	Yes	Yes
New software costs	Yes	Yes
Rent	Yes	Yes
Utilities	Yes	Yes
Travel	Yes	Yes—may be embedded in contract
Quantitative Direct Benefits	Insourcing Consideration?	Outsourcing Consideration?
Dollar value of staff time saved	Yes	Yes
Dollar value of new operating efficiencies (e.g., number of additional licenses to be processed)	Yes	Yes—may be evaluated on the basis of different technical solutions proposed by internal or external resources
Quantitative Indirect Costs	Insourcing Consideration?	Outsourcing Consideration?
Administrative overhead	Yes	Yes—embedded in contract
Divisional overhead	Yes	Yes—in some cases
Costs to other agencies or citizens	Yes	Yes—this is a project cost
Contract administration costs	No	Yes—this will include internal resources and time
Quantitative Indirect Benefits	Insourcing Consideration?	Outsourcing Consideration?
Service improvements to citizens	Yes	Yes
Support of state/agency architectures	Yes	Yes
Flexibility of solution	Yes	Yes
Qualitative Project Benefits and Costs	Insourcing Consideration?	Outsourcing Consideration?
Availability	Yes	Yes
Quality of service	Yes	Yes
Impact on staff, other agencies, citizens	Yes	Yes
Legal environment	Yes	Yes
Security	Yes	Yes
Sensitivity	Yes	Yes
Planning time	Yes	Yes
Project time	Yes	Yes
Operational risk	Yes	Yes
Technology risk	Yes	Yes
Relationship risk	Yes	Yes

The following appendices will be useful starting points for cost-benefit analysis tools:

• Appendix 3—Matrix to evaluate strategic considerations.
• Appendix 4—Matrix to evaluate quantitative costs.
• Appendix 5—Matrix to evaluate qualitative factors.

Specific Cost-Benefit Criteria

Begin the analysis with statements regarding the type of outsourcing under consideration (i.e., transitional or sectional) and the main project objectives. Costs and benefits will follow from the analysis, because each item is identified and weighted in light of these statements.

It is not possible to provide a simple criteria template for an outsourcing versus insourcing cost-benefit analysis. Each agency or university must determine the criteria, priorities, and weights for each project depending on its individual circumstances. The following criteria, however, are highlighted as important concerns that all internal/external resource decisions should consider.

Two Important Cost-Benefit Analysis Rules 1. Benefits are as important as costs. Even if an option may be quantifiably more expensive, it may still be the most effective choice for meeting agency needs. 2. A project will be difficult to justify or support if the project lacks specific, measurable goals and consistent, reliable information about the real costs and benefits of the project.

Quantitative Considerations

Dollar Costs

The total dollar cost remains one of the primary drivers for management interest in outsourcing.

• Cost savings are not always seen in outsourcing arrangements, depending on the reasons behind the outsourcing and the type of outsourcing used. For example, data center consolidation via outsourcing has provided some cost savings, but applications development and systems integration projects tend to rely more heavily on the need for expertise and resources, and can be just as expensive, if not more so, than the use of internal resources.
• Cost avoidance is also a consideration. Ongoing operational costs that may be avoided by outsourcing should be identified. Like cost savings, cost avoidances are dependent on the reason behind the outsourcing and the type of outsourcing used.
• Cost avoidance should not be used as a justification for making a resource decision, but can be considered as a potential benefit that may result from the decision.

Sample cost avoidances:

• Avoid hiring additional resources to support an application once it is in production.
• Avoid significant investments in technology that is constantly changing.
• Avoid loss of funding by meeting deliverables deadlines, etc.

In the analysis of options, three general types of fiscal costs should be examined: Project, Management, and Ongoing (see Table 3).

Management Costs Trap When comparing the costs of using external or internal resources, there must be agency management costs in both cases. Even if a vendor will be the “project manager,” agency resources must still be involved to ensure that the project meets the needs of the agency and that communication is occurring between the vendor and the agency. It is never possible to outsource responsibility for any project or activity.

Table 3: Types of Fiscal Costs

Type of Dollar Cost	How to Use
Project Costs	This is the cost for the life cycle of the project—e.g., the application development period, help desk staffing contract length, maintenance staff, etc. A careful detailing of external costs versus internal costs needs to occur here, to identify the full range of costs on both sides and to obtain a cost comparison that measures the same criteria in the same way. Sample criteria would be labor effort, time, hardware or software needed, etc.
Management Costs	Costs of managing the project. Regardless of whether a project uses internal or external resources, the agency will still be responsible for managing the project. If using internal resources, it will include the cost of the project manager. If using external resources, it will include the cost of the agency resources required to oversee the contract.
Ongoing Costs	Once the project has been completed, there will be costs to maintain and make needed enhancements. Either internal or external resources may do this, but if an external vendor has worked on the project, there must be a knowledge transfer plan in place so that agency resources can maintain the system.

Measurements

Measures are crucial to the success of a project, whether using internal or external resources. Quantifying the costs of providing IT services in-house and the vendor service provision costs provides a level playing field for making the most well-informed cost comparison possible. Measures also quantify the ability of both the internal and the external resources to meet end-user needs. Some measurement starting points are:

• Service levels *
• Price/performance benchmarks *
• Customer satisfaction surveys * Quantify Expectations
• Inventory of IT skills *
• Infrastructure and tool assessments *
• Opportunities for improvement *

Analyze the measures for strengths and weaknesses, and evaluate alternative options for making changes. The right measurements are essential for evaluating options available to the agency. Measures must be accurate and verifiable while measuring real areas of end-user need or IT effectiveness. The trend towards outcome or performance-based measures rather than work-based measures shows the importance of choosing the right metrics to reflect agency business needs. Metrics to consider for specific types of IT operations are included in Appendix 1.

Qualitative Considerations

Time

The time available to complete the project is an essential factor in the decision about what type of resources to use. Current agency IT resources may not be able to meet the project deadlines because of other responsibilities, resource shortages, or lack of needed skills. These facts will impact the cost of the project. It may be more cost-effective to complete a project with internal resources, but the timeline prevents that from being possible. Time, as shown in Table 4, will play a role in three parts of the decision-making process.

Table 4: Time Factors

Time	Significance
Planning time	Planning at the start is essential to all projects. Sufficient time is required to identify the project/service scope and define the project requirements and deliverables. Even more time is required if considering external staffing solutions, as the contract negotiation and management will rely heavily upon the identified goals, metrics, and deliverables. Negotiating advantages are in the vendor’s court when an agency has allowed little time for establishing terms and conditions and a statement of work. Since they vendor knows the agency’s project implementation deadline, the price for services will rise accordingly.
Project time	The needs of the agency during the life of the contract. Identify project deadlines, including interim deadlines if only a final implementation due date is known.
Ongoing considerations	Consider transition efforts or ongoing maintenance efforts when examining costs and benefits. How will the agency manage the project after its completion? If an external vendor has worked on the project, what is the length of the transition period, or is the vendor expected to maintain the system forever? What type of impact will these ongoing time considerations have on the cost of the contract, particularly on ongoing vendor contracts over time?

Outsourcing Risk Poorly defined goals and requirements and a lack of outsourcing contract management knowledge are two of the top reasons for IT outsourcing failures.3

Risk

Risk identification is an essential part of the analysis process. Risk affects priorities and costs and benefits because of its impact on project success. For example, using internal personnel who are more knowledgeable of the applicable goals, objectives and strategies of the agency’s project helps to assure that the project will meet the need of the agency. When outsourcing all or part of a project, the contract must clearly state these important factors in order to reduce the risk of having a completed project that does not meet the needs of the agency. Again, internal and external assessments regarding skill levels and the successful outcomes of the project will determine what factors provide risk elements in the project staffing selection.

Table 5 describes the three main areas of risk to examine.

Table 5: Main Areas of Risk

	Considerations
Operational Risks	The ability to meet project deadlines, outcomes, and required skills The ability to respond to changes in legislation, mission, and service definitions Balance between what IT needs and what the agency needs Agency commitment: top down support from executive management and end-user buy-in are critical success factors
Technology Risks	The ability of the project to respond to technology changes or new technologies Matching the project to the current technical architecture for the agency The Internet, for example, provided a surprise for many companies who signed outsourcing contracts prior to 1995—the Internet was rarely, if ever, mentioned in these agreements
Relationship Risks	When comparing external resource costs to internal resource costs, recognize the relationship risks that exist when external resources are chosen over internal resources. These risks include Expectations on service delivery Unexpected costs of outsourcing arrangements Vendor responsiveness to the need for improvements Vendor failure to deliver products on time Impact on staff—job satisfaction, morale, workload

Risks must be identified, understood, and prioritized. Identified high risk areas (having high impact and having a high probability of occurrence) must then be addressed. This process allows agencies to understand how the current selection of internal or external resources to support a project will impact the agency in future budgets, skills, and staffing levels. For suggestions on identifying software development risks important to an agency, consult the risk management guidelines of the agency or the DIR publication Quality Assurance Review Guide for Major Information Resources Projects. Consulting such resources in the analysis phase of the project rather than after the project has begun will result in a better understanding of the true costs and benefits of each staffing option.

Staffing

Resource issues are an important consideration in this cost-benefit analysis. The need to avoid pressuring already overworked resources may be an important consideration in the decision process. Alternatively, it may be important strategically for IT resources to be involved in a particular process because of a resource’s impact on agency service delivery. Understanding key staffing questions will enable the agency to identify previously unconsidered costs or benefits (see Table 6).

Table 6: Staffing Issues

Staffing Issues	Significance
Internal Resources	Identify current workloads. Are current resources able to perform additional duties? What are the agency priorities and time lines? Identify staff interest in the jobs that they perform. Are current resources kept motivated and interested in their job? Would the agency and the IR staff benefit from using existing resources on new projects that require innovation? Consider the impact on existing resources if an external vendor is procured. Determine at the beginning which internal members will be affected and plan for what will happen to them—will they be reshuffled, transferred to the vendor, or terminated? What will the impact on staff morale/retention be? Identify the skill sets required for vendor management in an outsourcing arrangement. Do internal resources have the necessary expertise? If not, should it be obtained? If so, are those people free to devote their time to the project?
External Resources	What are the capabilities of external resources? Ask for and evaluate resumes. Are the people needed for the project currently available, and will they be available for the life of the contract? How can you ensure that the people you want are permanently assigned to your project? Because of the competitive market for IT skills and services, vendors are also experiencing staff turnover. What will the impact of vendor staff turnover mean for project success? Do the vendor resources show the necessary qualities for your agency— e.g., match in work hours, culture and initiative?
Contingency Planning	Changes will occur during the course of the project If an external vendor is used, the outsourcing contract will end at some point. Change control procedures must be in place to monitor, track, and manage changes and their impact to the contract. Understand transition difficulties with outsourcing, whether evaluating a vendor-managed environment, managing an effort to take the service back in-house, or changing from one vendor/methodology to another. Know what staffing levels and skill sets will be required by such changes. Changes in outsourcing contracts are inevitable, and this information will be needed during the course of the contract.
Access to Expertise	Gaining access to expertise that does not exist in-house is a common reason for outsourcing, especially when taken in the context of budget/time constraints. Some emerging arguments against this argument are: Assigning internal resources to develop new projects and learn new skills may increase staff morale and improve staff retention as employees are continually challenged and given new opportunities. This does, however, require that time lines and training funds are able to support this option. Choosing to use internal resources for a new project and then outsourcing existing services may lower operating costs and ensure a more efficient and successful outsourcing contract. This is because the internal service is so well-known that it is easy to measure and quantify. It is then much easier to determine the success of the vendor in meeting the needs of the agency. It is also important to ensure that you have a knowledge transfer plan to avoid becoming dependent on one vendor for continued operation of the system.

Business Value

The overall reason why agencies are examining costs and benefits of using internal or external resources is to determine the best possible use of limited agency resources. Deciding that outsourcing is a viable option is usually because of one of two business value reasons:

• If it is determined that an external service provider can meet all business requirements at a cost lower than they can be provided by internal resources.
• If benefits are gained that cannot otherwise be achieved.⁴

It is the second point that provides the most scope for outsourcing cost-benefit analysis, as the lower cost argument is difficult to achieve, given the prevalence of soft costs in outsourcing arrangements and the fact that qualitative costs and benefits may be lost by comparing strict dollar values. The intangible “business value” concept must, however, still be pinned down to specific reasons and justifications. After completing a cost-benefit analysis, the agency may still consider that an alternative staffing acquisition method is better than the one shown by the analysis. If this happens, the appropriate weights and concerns have not been shown in the analysis. Establishing project objectives, outcomes, and primary staffing considerations should provide the agency with enough information to show a cost-benefit analysis that provides the best business value outcome. Using both qualitative and quantitative measures ensures that business value is accounted for in the cost-benefit analysis.

Outsource What You Know

Often areas that are poorly understood or projects that use unfamiliar technologies are targeted for outsourcing. This puts an added burden on staff to manage a contract and a vendor dealing with technologies that they do not understand. If an activity is not understood, how can the agency establish appropriate success measures for the vendor, verify vendor results, or take over after implementation? It may be worthwhile to spend the time and money to train staff on new technologies, so that familiar, well-understood, and well-measured activities can be outsourced, making contract management much easier.

Decision-Making Bottom Line

The cost-benefit analysis requires identifying, weighing, and evaluating all costs and benefits associated with an IT project. The costs and benefits presented here are only starting points for criteria identification. After the analysis is completed, compare and total all of the information gathered. If the costs outweigh the benefits for outsourcing, insourcing is the preferred option, and vice versa. If the analysis reveals that quantitative measures in hard dollar costs show outsourcing to be more expensive, but qualitative reasons that prefer outsourcing are more important, then you now have the tools necessary to justify the decision. The completed cost-benefit analysis will show why the agency has selected a staffing alternative, and what the most important factors in that decision-making process were. The measurements and objectives that explain how the decision supports the agency’s business objectives in the most effective manner possible will be explicit.

The key to a successful staffing decision is the cost-benefit analysis. Having a secure understanding of in-house strengths and weaknesses, as well as an understanding of the true, total cost of an outsourcing engagement will enable the agency to make the best decision. Project success must always come from its ability to perform the desired service or activity. Identifying the best option for obtaining project success also stems from an understanding of the project processes: do you want the project done better, faster, or cheaper? The staffing decision is based upon the best use of agency resources, according to its needs and priorities.

Significant benefits will be realized when priorities and success criteria are clearly identified from the beginning and the agency is able to identify a complete and comparable set of costs and benefits regarding staffing choices. Establishing and analyzing quantitative and qualitative criteria provides a bottom-line total that indicates which staffing decision is most effective and states the reasoning used in reaching that decision.

The Next Steps

If the agency chooses outsourcing as the best option to meet identified needs, implementing and managing the arrangement is the next step. Outsourcing can best be viewed as a cycle, beginning with the decision-making process and ending with the reexamination of the outsourcing contract, where you select again from available alternatives. Once an agency has selected the outsourcing option, it has the corresponding responsibility to follow through all of the steps of the process, constantly managing the contract and evaluating the results. Figure 2 illustrates the steps in the outsourcing process.

Figure 2. Outsourcing Process

Implementing Outsourcing Successfully

Implementation issues must be addressed after the decision to outsource has been made, with all of the costs and benefits totaled. Recognizing the complexity of the outsourcing arrangement provides a better understanding of the costs involved and enables the agency to develop a more successful contract.

Independent Verification and Validation External sources may be considered to assist the agency in managing the complexity of an outsourcing arrangement. Companies are available to help with defining statements of work, evaluating internal needs, negotiating, evaluating vendor performance, and providing quality assurance. While these services represent additional outsourcing costs, they can enable the agency or university to reduce outsourcing risks and accomplish agency goals.

Establishing the Contract Measurements

Measurements are the primary means to determine the success or failure of the outsourcing process. Measurements ensure that the vendor is held accountable, and they determine the success of the outsourcing effort. If good measurements are not in place when the program begins, the contract cannot be managed effectively.

• Start with measures identified in the cost-benefit analysis. These describe critical success factors where improvement should be seen.
• Measurements must reflect the specific objectives of the outsourcing effort and must be readily obtainable through business processes and procedures (some sample metrics for specific areas are included in the Appendix 1).
• Consider metrics in three different areas:
• outcome- and performance-based metrics
• quality assurance metrics
• work and operational metrics
• The objective is to measure the success of the vendor in meeting the business needs of the agency. These measurements will be the tracking mechanisms for contract management, so contracts should include specifics about what will happen if metrics do not meet agreed-upon expectations.
• Keep in mind that the type of contract signed will affect the metrics used. For example, outsourcing contracts for consultants and applications will require more outcome-based measures, while technical support contracts may use a number of performance- or work-based metrics. Measuring the success of a project in relation to its goals is essential for outsourced application development projects.
• Understand what is being measured to ensure that the appropriate business needs are being met and that analysis can be performed on the metrics selected. For example, tracking total costs does not allow for a breakdown of why costs increased. It will be important to know whether an increase was due to nonperformance or to an increase in functionality that improved operating efficiency.
• Define expectations in the contract. Metrics establish what is expected and what happens if expectations are not met. Use metrics that support business goals. If cost-effectiveness is a major decision driver, include contract provisions to encourage the vendor to reduce costs for the agency. Contracts can also use incentives to encourage vendors to surpass performance requirements. Cost increases due to the addition of other services from the vendor are avoided if expectations are defined so the scope of work is clear.
• Ensure that measurements can be tracked on a consistent and regular basis. Software is available on the market to assist in tracking some end-user performance-based metrics.
• Define the metrics and pricing structures explicitly in the contract. Anything not specifically addressed in the signed contract is simply not in the contract. Later changes can be construed as a revision to the agreement, with a corresponding expense charge.
• Determine how the contractor will be evaluated. Does the agency want a time-and-materials contract or a deliverables-based contract? There are important issues to consider on each side. A time and materials contract can lead to scope creep and a lack of vendor accountability for the final ability of the project to deliver the needed service. A deliverables-based contract requires that the agency have criteria to evaluate the deliverables on how well they meet defined expectations.

Selecting the Vendor

Before selecting a vendor or negotiating a contract, agency personnel should know what the outsourcing agreement will cover, what should result from it, how it will be measured, and what the reporting requirements are. Much of the preliminary work done in the cost-benefit analysis will pay off in the contract negotiation and management stages.

Requirements can be clearly communicated to the vendors in the Request for Proposal (RFP), so the initial responses will provide a full and clear picture of a vendor’s ability to meet the needs of the organization. The RFP must reflect the type of vendor necessary to complete the outsourcing proposal successfully. The vendor evaluation process is outlined in Appendix 7.

Understanding the emphasis of a vendor’s business, or what it is that drives the vendor, is essential in choosing the appropriate vendor to meet specific needs. For example, large companies are usually looking for extremely large contracts. Smaller contracts negotiated with large firms might not have as much impact on the company’s bottom line and are not likely to receive the same quality of treatment as larger contracts. Often, if large companies accept smaller contracts, they are looking for revenue to come from an application development process where the organization can use the product, but the outsourcing company has marketing and resale rights to the product.

A vendor selection team should be developed that recognizes all business areas impacted by the project. Key staff to include on the team are:

• Senior management
• Legal staff with contract expertise
• Technical staff and information systems analysts
• End users
• Financial staff

Vendor Selection Agency personnel should be sure that any agreement is entered into in accordance with applicable procurement laws.

Negotiating Outsourcing Contracts

The vendor selection team works through the evaluation of the RFPs to select the most qualified vendors for the planned outsourcing activity. To conduct negotiations with vendors, a smaller team is needed. Negotiation teams should include:

• Procurement staff expert in dealing with technology vendors
• Legal staff with contract expertise
• Outsourcing project manager
• Senior management
• Subject area experts brought in to advise the core team as needed (budget staff, technical staff, end users)

Although the actual contract negotiation with potential service providers should begin after transition plans are made and the negotiation team has concurred on negotiation strategies, contract negotiation occurs whenever anyone in the organization is in contact with a potential vendor. The vendor obtains a great deal of access to organizational information during the negotiation of outsourcing contracts. This access must be recognized in order for the agency to conduct other business agreements, do strategic planning, and work with other vendors.

A vendor who is awarded an outsourcing contract is in the unique position to identify agency strengths/weaknesses and use these observations to benefit the vendor in future negotiations. Service providers will also have many contacts with agency staff. For negotiations to be as successful as possible, all agency staff should be aware of the vendor selection process, and be diligent in directing all questions and inquiries from potential vendors to the negotiation team. These precautions discourage covert information gathering by vendors. Some questions posed by vendors may appear unrelated to current negotiations but are, in fact, attempts to gather valuable information about a pending contract. Some examples of these questions are:

• How many new or ongoing large projects are occurring within the agency? An answer to this question could give the vendor insight into agency staffing loads and anxiety toward meeting deadlines.
• Has the agency outsourced any other functions? An answer to this question could give the vendor information on agency negotiation skills and assessment techniques.

The groundwork done on internal IT evaluation and measurement positions the agency to successfully negotiate and establish an outsourcing agreement. The negotiation team can now focus on detailing the scope of the contract—identifying each party’s roles and responsibilities, and ensuring accurate and appropriate measures for tracking adherence to responsibilities. Appendix 9 contains some negotiation considerations.

Three Rules for Vendor Relations Vendor business goals are and always will be different from that of the agency. While vendors can be valued partners with agencies, recognize that the agency’s priorities and needs will differ, and be prepared to identify and resolve the differences that will arise. Management and responsibility always remains with the agency. Recognize that external vendors will make money on the outsourcing agreement somewhere, or they would not be willing to sign. Signing an extremely reduced-price contract in haste may lead to having to work with a vendor who is not responsive to agency needs and who sticks precisely to the letter of the contract, charging the agency for any additional services needed. The better the requirements and the statement of work are, the better the relationship between agency and vendor .

Planning and Managing Transitions

Often overlooked, a transition plan and related costs are critical to a successful outsourcing arrangement. Several types of transitions occur in any type of outsourcing contract, and all must be handled properly if the contract is to succeed.

• Plan for the transition from agency to vendor management or services. The plan should detail the costs involved in the transition process, and map the process by which the vendor becomes involved in the agency’s activities and/or projects. Potential impacts on internal staff and end users should be identified.
• Plan for changes in workflow that result from service changes in outsourcing contracts. End users must be kept informed of the goals and progress of the engagement, and their input must be included in outsourcing plans. End users will have expectations regarding how the change in IT services will affect them. These expectations must be managed to achieve user buy-in and sign-off on the outsourced activities. Educating employees and customers about new work methods must be part of the outsourcing plan.
• Plan for the transition from one vendor to another or from a vendor back to the agency at the end of the contract.

Transition periods can be painful for internal IT staff, vendor staff, and end users—and expensive for the agency—if a transition plan is not available to guide these efforts. Transition considerations are included as Appendix 8.

Managing and Evaluating the Contract

Once an IT service or process has been outsourced, the agency is not absolved of the responsibility for the service/process and its success.

Outsourcing that occurs because a process is not understood or in order to focus all resources on other processes will fail. Many organizations experiencing outsourcing complications have not paid enough attention to managing the contract. Contract management requires the ongoing participation of internal staff in the outsourced activity. Areas of involvement include strategic planning, quality assurance, phase containment, change management, and defining and monitoring the measurements. Contract evaluation activities are ongoing from the start, as internal staff work next to vendor staff and gauge vendor effectiveness in meeting established measures and/or deliverables.

Consider seven essential issues in the course of managing and evaluating and outsourcing contract.

1. In-house resources to manage the contract

Regardless of how large or small the outsourcing effort is, internal resources must always be assigned to manage the contract.

• Outsourcing a particular task requires fewer in-house resources to manage the contract. For example, help desk services have standard metrics and are usually well understood by current IT service providers, so fewer staff are required to oversee the contractor’s performance.
• A larger, more inclusive contract, such as one for outsourcing development projects or overall IT management, requires more in-house oversight because of the specialized measures involved and the importance of strategic planning to the success of these efforts.
• The management of an outsourcing contract requires a combination of in-house expertise. The outsourcing project team should be experienced in finance, agency processes, and IT activities. Specific technical knowledge may be required to oversee a project implementing new technologies or business processes. Legal counsel should always be an available resource. Oversight staff lacking these diverse strengths will not always be able to identify emerging problems and ensure a successful outcome.
• The oversight of an outsourcing contract requires that adequate controls and consistent lines of communication be established to check and resolve problem performance issues. The outsourcing project team must have the resources and flexibility to deal with unforeseen issues that come up during the course of the contract.
• The outsourcing project team is responsible for evaluating the success and performance of the outsourcing contract.

2. Communication

In managing outsourcing relationships, communication with the vendor is of utmost importance during the life of the contract.

• Knowledgeable internal staff must be available to identify problems and work with the vendor to resolve them.
• Vendor selection should have provided a vendor whose business/functional culture aligns with that of the organization, so that communication is fostered and developed to support the effort.
• Although benefits in overseeing staffing and utilizing resources can be achieved from outsourcing, the vendor relationship will be one of give and take. The agency may not have to worry about staffing issues, but the service provider could experience turnover and other problems.
• Selecting and working with a vendor where both sides can be flexible and are committed to agency improvement will create a beneficial atmosphere rather than one that degenerates into mistrust, rigidity, and strict adherence to the letter of the contract.
• Remain aware of vendor communication with other agency employees in order to identify requests for additional work from the vendor that may be outside of the scope of the contract.
• Communicate with agency staff and customers throughout the project. Ongoing vendor/IT staff communication facilitates outsourced work activities, but if the work is done without agency input, the end results will not enhance the ability of the agency to accomplish its goals.

3. Public control and accountability

Taxpayer funds are being used for the outsourcing agreement, and are subject to the Texas Open Records Act. Private companies seek to keep much more information about their business processes and solutions confidential, so the balance between the two must be maintained according to Texas law.

4. Documentation

All correspondence and communications with the vendor regarding problems, proposed changes, or the implementation of the outsourcing effort should be kept in order to resolve disputes or identify areas of strengths and weaknesses.

5. An ongoing review process

Reviews of the outsourcing engagement should take place on a regularly scheduled basis to ensure that monitoring is taking place, and to identify potential problems or issues early. The schedule may be driven by event, date, product, or issue, depending on the needs of the engagement. Incorporate input from end users in the reviews—do not focus on vendor, IT, or financial problems to the exclusion of the needs of end users.

Performance Reviews The performance review process should be kept separate from operational meetings. Performance reviews must focus specifically on success and performance issues, rather than the ongoing operational considerations that will otherwise tend to become the main topic of conversation.

6. Manage project requirements

Scope creep can occur during a project if a vendor uses conversations with agency resources to identify additional requirements and build a case for increasing project scope. In the same way, internal resources can add requirements not identified in the contract and cause price increases.

7. Plan for an exit strategy

Locking an organization into one firm will result in a loss of negotiating power. Most outsourcing contracts will come to an end at some point, and the better prepared the agency is to talk to other vendors or to take the project back in-house, the better off the agency will be. The outsourcing vendor will also be involved in the agency’s operations at the end of the contract. Recognize where the vendor is involved and plan how to separate from the vendor as quickly and easily as possible. Planning for unscheduled contract termination is equally as important as managing the scheduled end of an outsourcing arrangement.

Managing the Renegotiation or End of the Contract

Contract renegotiation is another element that is often ignored or minimized. Recognize at the beginning that the contract may change, or that the contract will end. The end-of-contract options are to:

• Re-sign with the vendor
• Work with another vendor
• Move to internal resource management

Any of these options involves significant agency time, money, and difficulty. Re-signing with the vendor may lead to higher contract costs as the agency becomes locked in to working with one vendor. Selecting a separate vendor will entail transition costs as one vendor moves out and another moves in. There will be a learning curve for the new vendor, along with additional management and resource costs to the agency. There are also new contract and negotiation costs since another contract needs to be signed and managed. Switching to internal resources requires that knowledge about the project exists in-house, and that adequate staff resources (time and personnel) exist to support it. Transition costs will again occur in this situation.

The groundwork for contract renegotiation is laid during the contract management process. Successful management of the outsourcing arrangement means that an ongoing relationship is maintained with the vendor during the course of the project. The agency has to try to position itself for a renegotiation where it can provide specific areas of concern, propose useful contract changes, and can still offer the possibility of ending the relationship with the original provider as a viable alternative.

The nature of the IT industry makes it difficult to predict needs and resource usage, so long-term contracts for services will need to change over the life of the contract. Understand that renegotiations will occur in even the best planned outsourcing contract, due to unforeseen changes in technologies or business needs, so be prepared to renegotiate and understand what types of leverage are available to the organization.

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