Understand which model works best for managing outsourcing services in a consumption-based pricing model.
There are effectively two models for managing outsourcing relationships, whether it’s for IT and infrastructure services or for BPO. The services industry has been pushing a managed services environment as the best practice. But in reality, this is not the best practice for all types of outsourcing.
Passive management implies that you are managing to service levels. It’s very consistent with the book I wrote in 2000, Turning Lead Into Gold: The Demystification of Outsourcing, in which I advised buyers to let their service providers — the experts — do their job. Get out of their hair, hold them to the outcomes and don’t micro-manage them. That’s the philosophy, and it comes through in the managed services space, whether it’s applications, infrastructure or BPO.
But as I recently blogged in service-level agreements are dead, the challenge with this model is that the providers just meet the service levels stipulated in the contract and don’t meet your organization’s changing needs.
The alternative is actively managing outsourcing. In this model, you don’t hand over the responsibility to the provider. You much more intensively, actively manage the relationship. In fact, you’re the day-to-day manager of the services. Services managed in this model look like staff augmentation or pay-per-use services.
Service providers understandably prefer the passive management. But certainly a significant portion of the industry is actively managed.
Here’s my advice on why should you choose one model over the other.
Pros and cons of passive management
The advantages of passive management are that you leverage the provider’s expertise and scale and you can hold the provider accountable for the services it provides. The disadvantage is those services don’t change even if your needs change.
In the passive management model, you rely on the contract to align your interests and the provider’s interests. You never have perfect knowledge when you construct a contract, so it’s imperfect in its conception. Furthermore, contracts become more imperfect over time. Even the best constructed contract will, over time, get out of alignment with your interests because your interests will change.
In addition, passive management of an outsourcing relationship puts your organization at risk for having “outsourcing bloat,” meaning you’ll pay too much for the outsourced resources.
Pros and cons of active management
In the actively managed model of outsourcing, it’s harder to capture the benefit from the expertise of the service provider. You potentially dissipate the provider’s economies of scale. You also have more investment in time in your own governance because you have to have feet on the street.
In this model, you leverage a different kind of expertise: skilled people rather than organizational knowledge. There is some question as to how much organizational knowledge can actually be applied anyway. To avoid dissipating the economies of scale, you need to be more thoughtful in terms of how you use the provider. But you can constantly align the provider against your changing needs and, over time, capture the productivity benefits that you get from that, rather than having them accrue or sharing them with the service provider.
Moreover, service providers are more responsive when governed in this model. They deal well with the nature of imperfect knowledge because you have the power to iterate in real time.
Which model is best in a consumption-based world?
These are two very different models for managing outsourced services. Both are valid. But I believe, as we move to a consumption-based world, that the actively managed governance vehicles will start to have increasing prominence. In a fast-changing world where technology is closely aligned with business needs drives towards an actively managed vehicle over a managed services / passively managed vehicle.
I think this has very significant implications for designing the relationship with a third-party outsourcing provider. Keep in mind as you design such a relationship that it acts counter to where the service provider would like to take relationship governance.