Innovation Report Cognizant-WBS 2011
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Transcript of Innovation Report Cognizant-WBS 2011
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Innovaon in Outsourcing:A Study on Client Expectaons and Commitment
Dr. Ilan OshriAssociate Fellow at Warwick Business School
and
Dr. Julia KotlarskyAssociate Professor at Warwick Business School
Warwick Business School and Roerdam School of Management
Commissioned by:
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Innovaon of outsourcing
Table of content
Execuve innovaon.....................................................................................3
Trends in Outsourcing...................................................................................6
Innovaon in Outsourcing: The challenges...................................................7
How this Research was Conducted...............................................................8
What funcons have been outsourced.........................................................9
The Importance of Innovaon to Business Success.....................................10
The Innovaon Challenge in Outsourcing: Clients Expectaons................11
Enabling Innovaon in Outsourcing: The Role of the Contract...................12
Types of Innovaon and Contractual and Relaonal Governing
Approaches.................................................................................................14
Sourcing Models and Innovaon in Outsourcing........................................15
Measuring Innovaons in Outsourcing.......................................................15
How to Achieve Innovaon in Outsourcing: The Innovaon Ladder...........17
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Innovaon of outsourcing
Execuve Summary
The outsourcing industry is set for a new challenge: to understand
how innovaon can be realized from outsourcing engagements. While
innovaon has been explored and prized within businesses for decades,it is a relavely new topic in the context of outsourcing. And as such, the
percepons what innovaon in outsourcing actually means, what inhibits
or enables innovaon in outsourcing, and what client rms are willing to
do to ensure they benet from innovaon in outsourcing are sll being
dened.
This report provides insight into some of the crical aspects in innovaon
in which both client rms and vendors have taken interest in recent
years. We go beyond the simplisc approach we have seen in some
recent reports, that advocates for the development of trust and close
relaonships between client rms and vendors as the main enablers ofinnovaon in outsourcing. In our view, innovaon in outsourcing can be
properly understood only when both contractual and relaonal aspects
are examined as well as the nature of the innovaon, i.e. incremental or
radical, is explored. Further, we posit that the sourcing model applied has
also an impact on the ability to innovate.
The results of this study, which is based on the responses of 253 CIOs and
CFOs from the largest rms in Europe, send a clear message innovaon
from outsourcing is crical for business performance to the majority of
rms. Also, the majority of the client rms consider the innovaveness ofthe vendor as one of the key criteria in vendor selecon. We also learned
that the majority of the respondents expect vendors to turn ideas into
improved processes (56%), transform exisng products (55%), or help
transform exisng processes (53%). Clearly, client rms expect vendors
to deliver innovaon that has an impact on the rms operaonal and
strategic performance targets.
However, client rms sll have reservaons regarding how innovaon
can be facilitated in outsourcing. For example, when asked How such
expectaons will come into eect?, 66% of the client rms indicated that
an outsourcing vendor should free up in-house resources, so the clientrms sta can focus on higher value acvies, implying that innovaon
is sll perceived as core and therefore should be kept in-house. From a
contractual viewpoint, 53% of the respondents either did not include or
were not aware of the inclusion of clauses that compensate vendors for
innovaon introduced in the outsourcing project. We also learned that the
vast majority of the rms are using xed price contracts (78%). Only 42%
are using me and materials contracts and 21% are using joint venture
with a prot sharing clause.
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Innovaon of outsourcing
The analysis of data points at the following insights:
From the above conclusions, and based on the extensive research we haveconducted in the outsourcing industry, we have developed the Innovaon
Ladder framework. The framework is made of six steps that guide
execuves in their quest for innovaon in outsourcing. The uniqueness of
this framework is that it corresponds with commonly-applied outsourcing
lifecycle frameworks. These are the key steps:
Client rms take for granted that incremental innovaon will bedelivered in outsourcing; however, they now take an interest in how
radical innovaon can be achieved
Mul-sourcing as a sourcing model is strongly associated with radical
innovaon
Among the three contract types examined (xed price, me and
materials and joint venture), joint venture was found to be strongly
associated with radical innovaon
Step One: Strategize innovaon, in which execuves need to consider
what type of innovaon is expected (i.e. incremental or radical) and
what the expected impact of this innovaon is at the operaonal and
strategic level;
Step Two: Design measurement instruments, in which execuves
are required to develop the instruments based on which the
improvements achieved through either incremental or radical
innovaon will be assessed;
Step Three: Assess vendors innovave capability, in which execuves
are required to develop a methodology which guides them to
consider the innovaveness of the vendor as part of the other vendor
selecon criteria;
Step Four: Design a contract for innovaon, in which the contract
should be craed to include performance targets and compensaons
for incremental innovaon and a clear roadmap to form partnership
in order to achieve radical innovaon;
Step Five: Build relaonships, in which the client rm and the vendor
invest in mechanisms that support the on-going development and
renewal of their relaonships as a complementary element to the
contractual approach;
Step Six: Measure innovaon, in which the client rm monitors andveries meeng performance targets in incremental innovaon and
the health and performance of the radical innovaon network.
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Innovaon of outsourcing
The journey to achieving innovaon in outsourcing is in infancy and as such
it needs aenon and nurturing from the pares involved, but at the same
me it needs systemac and clear innovaon delivery system to ensurevalue created for all involved.
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Innovaon of outsourcing
Trends in Outsourcing
Recent years have witnessed an unprecedented growth of the outsourcing
industry. By the end of 2010, the market for informaon technology
outsourcing (ITO) worldwide was reported as $270 billion and for businessprocess outsourcing (BPO) $165 billion. Recent esmates predict that in
the 2011-14 period ITO growth will be 5-8% per annum and BPO growth
will be 8-12% per annum. Soon the BPO market size worldwide will
overtake the ITO market1. It is common to talk of Brazil, Russia, India and
China as the BRIC inheritors of globalisaon, oering both oshore IT and
back-oce services, and also, with their vast populaons and developing
economies, huge potenal markets. However, the phenomenon of
oshoring and oshore outsourcing is certainly expanding, with, on our
count, some 120 centres developing around the world. Furthermore, as
rms become more savvy consumers of outsourcing services, they apply
various sourcing models. The mul-vendor sourcing model is sll by farthe most popular trend among client rms2 , though some client rms
experiment with bundled outsourcing services3. Also, we have reported
recently on a surge in seng up oshore capve centres in India and
central and Eastern Europe and the dynamic nature of goals pursued by
such centres, despite some on-going media reports about the death of the
capve centre4,5.
In this regard, we have seen a shi in decision-makers mind-sets from
focusing on low costs, which was typically considered as the main reason
for rms to engage in outsourcing, to access talent and skills not availablein-house. Results of our research indicate that saving costs has become
a secondary driver of outsourcing6. Clearly, the outsourcing industry has
entered a new phase in its evoluonary path in which clients are shiing
from focusing only on costs saving to realizing value. In this journey, client
rms need to develop tools that will allow measuring the returns on their
outsourcing investments beyond the one o costs saving and vendors are
required to demonstrate how long-term commitments translate into value-
adding organizaonal outcomes. Our 2009 study conrmed that the vast
majority of client rms have not yet embarked on a systemac approach to
measure the returns on their outsourcing investments7.
1Oshri I., Kotlarsky J. and L.P. Willcocks (2009) The Handbook of Global Outsourcing and Oshoring, Macmillan, London2Oshri I., Kotlarsky J. and L.P. Willcocks (2009) The Handbook of Global Outsourcing and Oshoring, Macmillan, London3Willcocks L.P., Oshri I. and J. Hindle (2009) Clients propensity to buy bundled IT outsourcing services, White Paper for
Accenture.4Oshri I. (2011) Oshoring Strategies: Evolving Capve Center Models, MIT Press, Boston, MA
5Capve centre strategies are discussed in detail in Oshri I. (2011) Oshoring Strategies: Evolving Capve Center Mod-els, MIT Press, MA. In this regard, weargue that the capve center has been one sourcing model within a broad range of
strategic opons that client rms ulize in order to maximize the return on their outsourcing and oshoring investments6Oshri, I. and J. Kotlarsky (2009) The Real Benets of Outsourcing, A WBS white paper for Cognizant.
hp://www.quanfyingoutsourcingbenets.com/default.asp7Oshri, I. and J. Kotlarsky (2009) The Real Benets of Outsourcing, A WBS white paper for Cognizant.
hp://www.quanfyingoutsourcingbenets.com/default.asp
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Innovaon of outsourcing
Innovaon in Outsourcing: The challenges
As the on-going search for real benets in global sourcing shis from costs
saving to adding value, and from the operaonal to the strategic level,
client rms are also raising their expectaons regarding the potenalto benet from innovaons delivered by their vendors. In management
terms, innovaon can take the form of a new product or service oered to
clients or a new process through which an organisaon develops products
or delivers services. Innovaon can also be anything that is state-of-the-art
and also anything which is new to the organizaon. For example, seng up
a network of suppliers for certain business processes previously provided
from in-house.
Innovaon does not come easy, whether as an in-house process or through
external partners. When in-house, inera forces oen obstruct aempts
to innovate and break away from old ways. And when sought throughrelaonships with external partners, innovave eorts face addional
challenges, for example, agreeing and monitoring how each party involved
in a collaborave venture should contribute to the partnership as well as
benet from the value created.
The outsourcing context poses addional challenges to achieving
innovaon between a client rm and a vendor. One of the main reasons
oen cited by CIOs for failing to achieve innovaon in outsourcing is the
uncertainty about the nature of innovaon desired from the vendor, and
also the inability to design a contract that is on the one hand migangclients exposure to be exploited by the vendor and at the same me oers
compensaon for extra work and innovaon delivered by the vendor.
Put simply, most outsourcing contracts do not accommodate these oen
contradicng requirements properly.
Despite this contractual challenge, client rms sll seek innovaons from
their outsourcing engagements. Among the key drivers for innovaon in
outsourcing are limited resources and capabilies within the client rm,
shortage of specialist talents, management of mulple risks, aracng
talent in the companys non-specialized areas, and reducing me-to-
market. As globalizaon intensies and many more rms quickly becomeglobal players, the inuence of these drivers will only have a bigger impact
on the rms performance, pressing execuves to seek innovaon through
partnerships.
So how can companies innovate through various ways of sourcing? Very
oen client rms have an ad hoc approach to achieving innovaon from
outsourcing arrangements. Such an approach oen fails to leverage
organizaonal learning and may also result in the unintended loss of
knowledge. An ad hoc approach also cannot create a culture in which
external contribuons are accepted or welcomed. Moreover, it is very
dicult to measure innovave processes and outcomes when companies
innovate on an ad hoc basis. As academics with over 20 years of combined
experience in the eld of outsourcing, we observed that the topic of
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Innovaon of outsourcing
innovaon in outsourcing is poorly understood. For this reason, this
study is set about understanding (i) what client rms expect to receive
from vendors in terms of innovaon and (ii) what are the key factors that
inuence the extent to which innovaon can be delivered in outsourcing
relaonships.
How this Research was Conducted
What funcons have been outsourced?
This research, conducted by Warwick Business School in collaboraon
with Cognizant, focuses on understanding whether CIOs and CFOs achieve
innovaon through their outsourcing arrangements. We also examined the
factors that posively aect innovaveness in outsourcing.
The ideas presented in this paper are based on original research conductedat Warwick Business School (UK) and carried out by Dr. Ilan Oshri and Dr.
Julia Kotlarsky. The researchers also conducted semi-structured interviews
and held discussions with experts in the eld of outsourcing, including CIOs
and CFOs from leading mulnaonals with headquarters based in Europe.
The ideas in this paper are also based on a quantave survey, which was
carried out in partnership with research organisaon Vanson Bourne. The
quantave survey sampled 250 CIOs and CFOs from companies with
revenues from $500m up to over $1bn (51%) from nancial services,
manufacturing, logiscs, retail, ulies, telecom and other leading sectors
in the UK (50%) and other European countries such as France, Germany,
Denmark, Sweden, Switzerland, Belgium, Netherlands and Luxemburg.
In our previous report, carried out in 20098, we analysed the funcons
outsourced recently. Table 1 brings together the results from the March
2009 and the recent study to allow a comparison in trends and therefore
make some conclusions about the expected growth of specic outsourcing
segments.
Clearly, BPO has grown strongly between the two studies. While only33% of the 2009 respondents reported that they outsourced business
processes, 47% of the later studys respondents have done so. This result
corresponds with other studies which predict that BPO will overtake ITO by
20159.
As Table 1 shows, IT and IT-enabled business processes are sll the most
popular candidates for outsourcing. Based on the later study, among the
vast range of services outsourced, IT infrastructure and data management
is on the top of the list, being outsourced by 58% of the surveyed
companies, followed by IT and technology consultancy and ERP support
(53% each).
8Oshri, I. and J. Kotlarsky (2009) The Real Benets of Outsourcing, A WBS white paper for Cognizant.
hp://www.quanfyingoutsourcingbenets.com/default.asp9Oshri, I. and J. Kotlarsky (2009) The Real Benets of Outsourcing, A WBS white paper for Cognizant.
hp://www.quanfyingoutsourcingbenets.com/default.asp
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Innovaon of outsourcing
We also observe a signicant increase in BPO projects, in parcular,
in ERP implementaon and integraon. In the later study, 53% of the
respondents reported that they engaged in such projects against only 41%
in 2009. Other business processes, such as Finance and Administraon,
HR, Payroll and many others which in the past were largely moved oshore
to capve facilies because of data security and control issues, nowadays
are increasingly outsourced to third pares. For example, compared with
the results of the 2009 survey, in the more recent study we observe a
signicant increase in outsourcing of such business processes (from 33%
to 47%). Furthermore, large European rms tend to outsource more
knowledge-intensive processes such as CRM and business analycs (i.e.
data warehousing and business intelligence systems), which were not
so popular in 2009. We see a signicant increase in outsourcing of these
processes compared to early 2009 (29% outsource CRM in 2010 comparedto 22% in 2009, and 26% outsource data warehousing and business
intelligence compared to 18% in 2009).
While IT infrastructure and data management is sll the most popular
funcon to outsource, we have observed a small drop between the earlier
and later surveys in the number of rms reporng on such engagements.
While these results are surprising, we dont think that they represent
a long term decline trend. Consistent with Gartners recent report, we
agree that the ITO market is maturing and will probably maintain a 5%
compounded annual growth in the next ve to seven years.
Table 1: Funcons outsourced in 2009 and 2010
March 09
IT infrastructure
and data
management
IT and
technology
consultancy
ERP maintance,
upgrades,
implementaons
and integraon
BPO: nance
and amdin,
HR, Payroll,
Helpdesk, Call
Centre, Sales and
Markeng
Soware Tesng/
Soware Quality
Assurance
Soluon Design
and System
Architechture
CRM (including
master data
management,
customer
experience
management)
Data
warehousing
and business
intellience
systems
70%
60%
50%
40%
30%
20%
10%
0%
November 10
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Innovaon of outsourcing
The Importance of Innovaon to Business Success
Tradionally innovaon has been perceived as one of the sources of
compeve advantage in fast changing industries. To keep up with
market forces and changing consumer tastes, rms need to be innovaveby tapping into both internal and external knowledge. Indeed, 64% of
the responding rms believed that their ability to be more innovave
contributes to the nancial performance of their organisaon. Seventy
per cent of the respondents also thought that the innovaon they have
achieved through outsourced business arrangements had contributed
to the nancial performance of their organisaon. And 53% of the
respondents indicated that innovave capabilies demonstrated by the
vendor are either important or very important in their vendor selecon
criteria.
However, selecng a vendor capable of innovang successfully, eitherincrementally or in a radical manner, requires a robust, methodological
approach that turns not only ideas into successful products, but also
ensures the appropriaon of value created through the innovaon.
Indeed, research has persistently idened the management of innovaon
as one of the key weaknesses in rms ability to build an innovaon
capability. It seems that rms have a ow of ideas generated either
internally or through external change agents; however, translang these
ideas into a successful commercial product or service has always been the
challenge. When asked: Would you benet from an innovaon frameworkthat could guide all your stakeholders through the journey of translang an
idea to a dened product or service? 58% of the respondents replied that
they would indeed like to have such an innovaon framework. And, 67%
of the respondents also believed that it is possible to formalise, repeat and
maintain innovaon within their industry. However, when asked regarding
their willingness to invest in such service, only 50% of the respondents
indicated that they were willing to pay for an outsourced service which
will formalise, repeat and maintain innovaon within their industry, and
only 45% were willing to pay rates higher than standard for an innovaon
framework provided as a service by their outsourcing partner and that will
demonstrate a return on investment.
Clearly, client rms value innovaon and acknowledge its impact on
business performance. Furthermore, they also see the importance
in obtaining a framework that will allow them to build and retain an
innovaon capability that outperforms their compeon. However, the
majority of rms sll do not see the value in paying extra for such services,
even if the vendor is able to show a return on the investment.
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Innovaon of outsourcing
The Innovaon Challenge in Outsourcing: Clients Expectaons
Client rms expect their vendors to help them innovate. Innovaon in this
regard can be delivered not only through the oering of new products,
services and processes, but also via the transformaon of exisng
processes. According to the results of this study, the majority of client
rms expect vendors to either turn ideas into improved processes (56%),
transform exisng products (55%), help transform exisng processes
(53%) or help turn ideas into new products (see Table 2). However, when
asked how such expectaons will come into eect, 66% of the client rms
indicated that an engagement with an outsourcing vendor should free
up in-house resources that can focus on higher value acvies (see Table
3). Clearly, such a belief implies that the vast majority of client rms
sll consider innovaon to be core to the rms value chain and as such
should be carried out in-house. Therefore the majority of client rms sll
rely on their own knowledge-base for innovaon, failing to recognize thatinnovaon can in fact be a service. Oen such a shi in mind-set requires
not only an extensive change management process within the client rm,
but also a re-skilling exercise of the retained talent and experse to realize
their ability to focus on managing relaonship for innovaon rather than
just managing supply contracts.
Table 2: Expectaons from the outsourcing partner in terms of innovaon
Table 3: How your outsourcing engagement will result in innovaon
80%
80%
56%
44%
67%
55% 53%49%51% 52%
45%
58%54% 54%
70%
70%
60%
60%
50%
50%
40%
40%
30%
30%
20%
20%
10%
10%
Help turn ideas intonew and improved
processes
Help transformexisng products and
services
Help transformexisng processes
Help turn ideas intonew products and
services
0%
0%
Total
CFOCIO
TotalCFOCIO
Free up internalresources that can
then focus on highervalue acvies
elsewhere
Mack an impack tothe companys boom
line by approachinga business problem
from a dierentperspecve
Helps me to developnew collaborave
virtual team structuresto access the best
talent required on eachproject
Helps me to insgateand maintain a
culture where I canapproach projets
dierently rst meall the me
66%63%
70%
43% 41%
30%
43% 42%
35%
42% 40%
25%
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Innovaon of outsourcing
Enabling Innovaon in Outsourcing: The Role of the Contract
Outsourcing arrangements are based on contracts and therefore
understanding which contract is more likely to accommodate innovaon
is key. To our knowledge, the link between contract types and innovaonin outsourcing has never been studied before and the implicaon for
how rms set up contracts to achieve innovaon is therefore poorly
understood. To start with, in order to achieve innovaon in outsourcing,
both clients and vendors need to cra contracts that oer incenves and
that nurture innovaon. In this regard, contracts should include clauses
that incenvize vendors to think about innovaons regardless, of the
nature of the process or system outsourced. There is a mispercepon
that some contracts are not designed for innovaon, such as cket-based
contracts or fees for service. However, we came across several examples
that demonstrated the wide possibilies available to the vendor to
innovate, despite relavely unfavourable contract terms. For example, inone cket-based contract, the vendor improved the service provided, a
process innovaon that resulted in a reducon in the number of ckets
generated by the client rms clients. The vendor was movated to
innovate by the contract that oered higher margins per cket should
the number of ckets drops down, while the client rm was sased with
this improvement as their customer sasfacon feedback has signicantly
improved.
Our study shows that the vast majority of contracts are fee for service
(78%) and cket-based (47%), suggesng that most deals are based onxed fees for a specied service. Non-xed price contracts, such as me
and material account for 42% of all outsourcing contracts10. Considering
that the vast majority of the rms opts for xed price contracts, we see
a challenge to achieve innovaon in outsourcing engagements. One
execuve we interviewed discussed the challenge as one that is similar to
the chicken and egg analogy. He explained that seng up a collaborave
environment for innovaon depends very much on the steps each side
take. But because of resource management, there will always be the issue
of who is paying for all the goodwill?
Yet, this scenario does not mean that innovaon in outsourcing cannot beachieved in relavely rigid and inexible clauses in the contract. We would
expect that clients would include clauses in the contract that will improve
exibility in payments when the vendor is going the extra mile. However,
when asked, our results show that 53% of the respondents either did not
include, or were not aware if such clauses were included in their contract
to compensate vendors for innovaon introduced in the outsourcing
project.
10Total percentage of contracts is higher than 100% because some client companies surveyed engaged in several out-
sourcing relaonships, some with dierent types of contracts.
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Innovaon of outsourcing
Types of Innovaon and Contractual and Relaonal Governing Approaches
There are numerous types of innovaons that academic and professional
literature have discussed in recent years. Among the more popular
innovaon types are incremental, radical, systemic, architectural,autonomous, disrupve and disconnuous innovaon. At the same
me, innovaon can be in the form of a new product, service or process.
Incremental and radical innovaons have, by far, been at the centre of
academics and praconers aenon. For this reason, we have focused
in this study on how either incremental or radical innovaon can be
achieved in outsourcing. There are two governing approaches to manage
outsourcing arrangement: one is a contractual approach that emphasizes
the formality of the relaonships between the client rm and the vendor
through the relavely high dependence on the contract as a governing
mechanism. The second is a relaonal approach which brings to the fore
the interpersonal relaonships between sta from the client and vendorrms that drive collaboraon between the pares and form partnership as
the cornerstone of the outsourcing governing structure. We actually see
contractual and relaonal governing approaches as complementary rather
than substutes, which means that client rms will seek to leverage on
relaonal aspects to promote a collaborave atude while ensuring that
the outsourcing project meets the clauses specied in the contract. In this
regard, our study sought to understand the link between innovaon types
and the governing approaches.
Our results show that radical innovaon is strongly associated with bothcontractual and relaonal governing approaches. The results of this study
also suggest that client rms seeking radical innovaons in outsourcing
should rst develop strong contract management capabilies and then
complement those with relaonship management capabilies to ensure
that the pares shi their atudes from a transaconal approach to a
collaborave mode.
An example provided by the CIO Downstream of Shell illustrates how
innovaon in outsourcing can take place. We have learned that the most
acute and contemporary challenges are shared with the vendors of Shells
outsourcing ecosystem, with the hope that one or more vendors will comeup with a proposal how to tackle such challenges. Once a proposal is
made, Shells management will seek funding for the soluon and will form
a joint venture with the vendors to arrive in a contract that clearly denes
the investment required by each party as well as the appropriaon of value
created and intellectual property issues. In this regard, Shells approach
conrms our results that joint venture contracts are more likely to lead to
radical innovaon.
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Innovaon of outsourcing
Sourcing Models and Innovaon in Outsourcing
There is an on-going debate around which sourcing model is more likely
to deliver innovaon to the client rm. This debate has centred around
two sourcing models: bundled services and mul-sourcing. On the onehand, a bundled service sourcing model, in which the client outsources
mulple business funcons to a single vendor, implies strong relaonships
between the client rm and the vendor, a trait which is imperave for
the collaborave innovaon atude in outsourcing sengs. However,
bundled services also pose a threat to client rms lacking strong sourcing
capabilies in the form of being locked in and therefore not being able
to switch vendors when performance deteriorate and innovaon is not
delivered. The alternave, which is now the dominant sourcing model, is
mul-sourcing, in which the client rm outsources part of its value chain to
mulple vendors.
The results of the survey show that mul-sourcing sengs are more likely
to deliver client rms radical innovaon from their vendors than any other
sourcing models.
Measuring Innovaons in Outsourcing
The results of the survey show that mul-sourcing sengs are more likely
to deliver client rms radical innovaon from their vendors than any other
sourcing models.
Table 4: Do you measure the value or the innovaon delivered by your vendor (CIOs and
CFOs perspecve)?
70%
60%
50%
40%
30%
20%
10%
0%
Yes No Dont know
From the above results, it is evident that the vast majority of C-level
execuves fail to measure the returns on either outsourcing or innovaon
investments made in their relaonships with vendors. From interviews
we have held, we learned that many client rms do not quanfy the value
that a business funcon contributes to the compeveness of the rmbut rather prefer to compute the cost-base of this business funcon. Such
an approach drives client rms to focus on cost reducons as the main
objecve sought from vendors while expressing desires to see value and
43%
35%37%
61%
20%
4%
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Innovaon of outsourcing
innovaon delivered in outsourcing engagements, yet without building
a capacity that allows them to properly manage and measure innovaon
outcomes and impact. This atude is in parcular a source of concern as64% of the respondents in this study conrmed that they are now invesng
more in outsourcing partnerships than they did three years ago, hinng
that client rms seek to ghten relaonships with vendors and leverage on
the relaonal approach in order to incenvize the vendor to innovate. Such
a combinaon of desires and deeds calls for the examinaon of required
steps that we believe will lead clients rms to benet from innovaon in
outsourcing.
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How to Achieve Innovaon in Outsourcing: The InnovaonLadder
We developed a framework that we call The Innovaon Ladder (Figure 1)
to help client companies to incorporate innovaon in their outsourcingstrategy. The emphasis in our approach, as opposed to some other
studies we have seen, is that we believe that the innovaon strategy
should be integrated into the outsourcing strategy of the client rm. We
acknowledge that some rms, such as Shell, prefer to execute innovaon
with their outsourcing vendors outside the on-going outsourcing
relaonship; however even such rms should consider implemenng some
of the steps described below. In this regard, the Innovaon Ladder is a full
cycle approach from the beginning of the outsourcing relaonship unl
the delivery of innovaon. Yet, client rms can pick and choose some steps
depending on the breath of innovaon sought and on the nature of the
relaonship they establish with their vendors.
Figure 1: The Innovaon Ladder in Outsourcing
Step 1: Strategize innovaon
A journey into innovaon in outsourcing should start at the early stages of
strategizing the outsourcing project. These early stages of the outsourcing
life-cycle oen involve the idencaon of objecves and the potenal
areas for improvement derived from the outsourcing engagement. At
that point in me, it is imperave that execuves will consider the impact
expected on the rm, from operaonal or strategic perspecves, and the
two levels of innovaons: incremental and radical (see Figure 2).
Lessons learnt
Revise for next outsourcing cycle
6. Measure innovaon outcomes
5. Facilitate relaonships building
4. Design a contract for innovaon
3. Assess vendors innovave capability
2. Design measurement instruments
1. Strategize
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Figure 2: Impact of Incremental and Radical innovaon on the Operaonal and Strategic
levels of the client rm
In principle, execuves should consider the four areas of improvements
when strategizing innovaon in outsourcing. To start with, execuves
should discuss the incremental improvements expected at the operaonal
level in business processes that are considered to be non-core to the rms
compeve posion. Such business processes can be, for example, nance
and accounng, human resource management and procurement, whichare becoming prominent candidates for outsourcing; however, with lile
aenon to the improvements sought to be achieved from the vendors.
Client rms should also seek incremental improvements in crical
operaons outsourced to a third party service provider. One example of
such business process is business analycs. Our study reports that 26 % of
the respondents outsourced business intelligence to a third party service
provider. In this regard, execuves should consider incremental innovaons
in a crical business funcon that benchmark with best pracces in the
industry. For example, execuves can ask: what gaps exist between our
level of crical operaons and the industry best performers level of thesecrical operaons?
Combining the areas of improvements in non-core and crical business
operaons will allow execuves to form their wish list of incremental
improvements. These can be clearly specied and described in any type
of contract and that corresponds with the enhancement of the rms
operaonal compeveness. In including in the contract rewards, such
as sharing of savings achieved from improved processes would movate
vendors to put eorts in such improvements.
Improvements in
crical operaons
Improvements in non-
core operaons
Incremental Radical
St
rategic
Operaonal
ImpactLevel
Innovaon Type
Consider
game-changers at
industry level
Transformaon of
services, technological
plaorms and
methodologies
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Execuves should also consider radical innovaon that can be achieved in
their outsourcing engagements. This would require execuves to consider
the transformaon of exisng services and technological plaorms but
also scenarios in which the soluon or the process through which thedesired outcome will be achieved is not yet dened. In terms of the impact
at the operaonal level through radical innovaon, execuves should
discuss what services and technological plaorms are candidates for
major transformaons. Such decisions can be made by considering specic
service performance, cost/value raos, and benchmarking against cross
industry service performance.
The fourth, and most challenging strategize stage, should be about
problems or strategic moves that are sll unknown and therefore the
soluons for them are sll to emerge. Here we are considering the
impact at the strategic level of radical innovaon. Execuves shoulddiscuss scenarios of major shis in the industry landscape and competor
strategies as a threat and an opportunity to shape their compeve
environment. In this regard, execuves should ask the following quesons:
what business models may emerge in the industry? What business models
may become obsolete? What new services and service delivery methods
may emerge and how prepared are we to either shape the environment
or benet from such changes? Decision markers at this stage may also
consider entry to new markets and/or new industries as a strategic move
of the rm, or as a result of mergers and acquisions that create a need
for execuves to re-consider how to maximise benets from new markets/ industries. The purpose of such discussions is two-fold: rst, to shi
execuves aenon from focusing on the operaonal/transformave level
in outsourcing to consider strategic issues that are sll to emerge, as a
response to the dynamic and highly compeve environment; and second,
to discuss and formulate a framework within which such challenges will be
shared with trustworthy vendors.
By bringing together these four aspects of innovaon in outsourcing during
the early stages of the planning, the client rm will be able to devise an
approach to realizing the innovaon potenal from each seng. Below we
describe in depth each of the following steps.
Step 2: Design measurement instrument
As a second step, client rms need to develop the measurement
instruments for the incremental innovaon expected to be delivered by
the vendors and design a framework for which radical innovaon will
be pursued with selected vendors. The measurements for incremental
innovaon should be developed against the benchmark in the industry.
With this, the objecves captured in Step 1 will be translated into specic
expectaons regarding incremental improvements expected from their
prospecve vendors. While designing measurements for incremental
innovaon (e.g., % of cost reducon, % of improvement in me-to-
marker or a % reducon in process duraon), it is important to relate
these targets to Key Performance Indicators (KPI) of the clients rm and
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to Key Success Factors (KSF) at the industry level. In this stage execuves
should ask the following quesons: which of our services/technological
plaorms/methodologies are lagging behind the standard performance in
the industry? Which of our business funcon candidates for outsourcing
are key for our operaonal excellence? The answers to these quesons
will assist execuves in idenfying the services and technologies that
are candidates for incremental innovaon and also to realize the
expected improvement measurement as benchmarked against industry
performance. This analysis will address the design requirements of
incremental innovaon in the early stages of the outsourcing engagement.
The contract should also have a clear reference to how the vendor will be
rewarded if it improves the measurements further (e.g., bonus as % of
addional cost savings that result from process improvement).
The design of a collaborave framework for radical innovaon shouldtake a dierent approach. As the challenge is not clearly dened at
the operaonal and strategic levels, client rms should devise a radical
innovaon framework to create condions within which preferred vendors
will be introduced to signicant and game-changing challenges that require
radical innovaon. The radical innovaon framework includes procedures
and processes within the client rm that scout threats from compeon
and markets, and translate those into descripve scenarios that can be
shared with external partners. The radical innovaon framework should
also outline the knowledge sharing plaorms, their parcipants, structure
and frequency of interacons between the parcipants, to ensure that
vendors bidding for the outsourcing project are aware of the commitmentrequired from them in exploring radical innovaon opportunies, which
would allow them to budget for addional resources required for such
acvies. Last but not least, the radical innovaon framework will include
a proposed contractual approach once the client rm and vendor(s) have
agreed on the best way to tackle transformave and game-changing
challenges. Our recommendaon is that a joint venture arrangement,
separate from the on-going outsourcing engagement, will be the main
vehicle through which radical innovaon is carried out.
Step 3: Assess vendors innovaon capability
Having carefully craed the measurement requirements for incremental
innovaon and devised a plan (and a framework) for achieving radical
innovaon, it is now the me to develop a set of criteria upon which the
innovaveness of the bidding vendors will be assess. While the results
of this study suggest that most client rms consider the innovaveness
of their vendors as one of the vendors selecon criteria, to our best
knowledge, no study has so far revealed what these criteria were, as well
as how they should be applied in the context of incremental and radical
innovaon.
Based on research we have conducted and input from leadingconsumers of outsourcing services, we come to the conclusion that
in incremental innovaon, the relevant selecon criteria should seek
proven evidence of improvements made in same scope, complexity and
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cricality to operaonal excellence of business processes, services and
IT plaorms. This proven evidence can be in the form of referral leers
from the vendors exisng and past clients, vendors case studies about
improvements made in business processes and IT plaorms and an outline
of the approach to meet improvement measurements submied as a
project plan. Further, vendors should also provide similar evidence for
their relaonship capabilies, which, in the case of incremental innovaon,
are complementary to proven abilies to provide soluons according to
the specicaons. These inputs will allow the client rm to systemacally
compare between the various bidders concerning their incremental
innovaon capabilies.
Assessing capabilies to carry out radical innovaon is far more
challenging. Based on our research we argue that client rms should put
the emphasis on understanding the relaonship capabilies developed bythe potenal vendors and then seek complementary delivery capabilies
in the form of technical and service development capabilies. We advocate
for this approach for two reasons: rst, as the challenges requiring radical
innovaons at the operaonal and strategic level are sll not clearly
dened, and because the success of seng up a collaborave framework
depends to a large extent on the relaonship developed between the
client and vendor, client rms should focus on clearly mapping out the
relaonship capabilies developed and applied by the vendor rm.
Second, in many examples of radical innovaons we have come across, it
was the result of a consorum of several rms (usually client and several
vendors) that were able to bring together experse and knowledge fromvarious domains to arrive in a game-changing product or service. Once
again the relaonship aspect is coming across as imperave for facilitang
collaborave framework between mulple vendors that are part of the
consorum of rms that bring together disnct experse and capabilies.
The relaonship capability implies a suppliers willingness and ability
to align its business model to the values, goals, and needs of the
customer11. For example, this capability is evident in the vendors atude
to connuously educang exisng customers about state-of-the-art
developments in the areas related to the clients business; exibility
to accommodate changing or addional client requests, and adapng
organisaonal design and governance structures to those of the client12.
To assess the relaonship capabilies of the bidding vendors, client
rms should seek evidence from past projects regarding the procedures,
processes and personal interacons set up and used by the vendor.
We believe that only by examining the wide range of communicaon
channels between clients and vendors, one can in fact understand how
the relaonship side has been accommodated. Therefore, client rms
should seek evidence about weekly and bi-weekly meengs set and held
between the vendor and its clients; evidence regarding forums, portals
and databases as knowledge sharing mechanisms; and evidence regarding
11Feeny, D., Lacity, M., and Willcocks, L.P. (2005), Taking the measure of outsourcing providers, MIT Sloan Management
Review, 46(3): 414812Oshri, I., Kotlarsky, J., and Willcocks, L.P. (2007a), Managing dispersed experse in IT oshore outsourcing: Lessons
from TATA Consultancy Services, MIS Quarterly Execuve, 6(2): 5365.
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interpersonal relaonships between the vendors sta and clients
personnel. This informaon can be gathered through referrals to the
exisng customer and informaon available on the Internet such as blogs,
social media websites and professional magazines.
Step 4: Design a Contract for Innovaon
Once the vendor selecon phase has been concluded, the aenon of the
pares involved is shiing to the contract and its content. One very clear
result from this study is that most outsourcing contracts are not designed
to accommodate innovaon. Many of these contracts focus on dening
service levels, pricing and penales, lng the aenon of the vendor
to a maintenance mentality as well as the clients mind-set to monitor
outsourcing performance based on well-dened SLAs. Accommodang
innovaon in outsourcing contracts requires a dierent atude.
Contracts that accommodate incremental innovaons should elaborate on
both improvement targets and innovaon process that will commit both
client and vendor to follow and monitor, including desired targets and
rewards if these targets are outperformed. In this regard, and oen beyond
the regular SLA clauses, the incremental innovaon clauses should be
specic regarding the relaonship mechanisms put in place by both client
and vendor that will support the vendors eort to deliver incremental
innovaon according to the improvement measurements.
The clauses in the contract that refer to radical innovaon should provide
an elaborave descripon of the methodology through which vendors will
become partners. In this regard, the contract should describe the process
put in place to share transformave and game-changing challenges with
the vendors, the expected parcipaon from the vendors in such forums
and the preferred legal agreement to pursue soluons in the form of
radical innovaon by one or more vendors. Our recommendaon is that
this kind of partnership will be established where a clear specicaon of
resources, capital is dened as well as the approach to appropriate value
and manage intellectual property is outlined.
While our guidelines for tailoring clauses for incremental and radical
innovaon stand in various contexts, we also took note of a general
approach by client rms regarding xed price contracts and innovaon.
For example, client rms refrain from oering open-ended clauses in the
contract that incenvizes vendors to innovate. Such clauses could have
been in the form of bonuses for innovaon delivered beyond the scope
of the project or a me and materials pricing component for innovaon
within a xed price contract. Our study provides addional support to such
clients tendency to refrain from oering incenves to actual innovaon
delivered by the vendor. We examined this maer in view of contract
types and have come to the conclusion that such an approach harms the
relaonship aspect in the outsourcing engagement. Indeed, the client
rms concern, which is anchored in the belief that client rms should
avoid having loosely-dened clauses, is well jused; however, it is also
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a risk that clients can migate. For example, we have learned that in a
cket-based contract, the client and vendor devised a pricing model which
incenvized the vendor to reduce the number of ckets logged onto the
system through signicant end-to-end service improvements and as a
return the vendor gained from higher margins per cket processed. Weview this example as radical innovaon at the operaonal level which was
migated based on the actual outcomes delivered by the vendor.
Step 5: Facilitate relaonships building
It is without doubt that building relaonships between the client rm and
the vendor is imperave for the success of either incremental or radical
innovaon. However, as opposed to some recent studies on innovaon
in outsourcing which advocated for an investment in trust regardless of
the type of innovaon sought, we posit that relaonships play a dierent
role in incremental and radical innovaon. We have already discussedthe various ways client rms can represent the potenal leverage for
innovaon through relaonship management. At this point in me, we
wish to discuss how relaonship management should be executed in
incremental and radical innovaon.
Our results indicate that in the case of incremental innovaon, the
relaonship between client and vendor comes second to the contract
regardless of the contract type (all but joint venture). We therefore
advise client rms seeking incremental innovaon to focus on developing
relaonships with their vendors as a complementary element to
monitoring the contract. Further, we argue that relaonships inincremental innovaons should in fact be facilitated through the formal
channels, which are already captured in the contract. Some examples
of such mechanisms include the regular meengs, shared portals and
communicaon procedures which are elementary in each outsourcing
project; however, becoming imperave for incremental innovaon.
Radical innovaon, however, begs for a dierent approach according
to which client rms need to invest in the interpersonal side of the
relaonship with the vendor, as a complementary step to the contractual
approach. Our extensive research about outsourcing suggests that it
is imperave that trust and rapport between senior managers (e.g.,
relaonship manager) will be developed and renewed to encourage
a collaborave atmosphere between client and vendor sta . While
personality clashes and cultural dierences might play a negave role
in developing rapport and trust between individuals from the client and
vendor teams, there are always opportunies to enhance the relaonship
dimension by organizing informal social events, the use of social media
tools and through open and preferably face to face communicaon
channels. Clearly, it takes a major commitment from senior managers to
develop a collaborave atmosphere, which in our view is only one enabler
among many to set up and launch a radical innovaon project.
13Oshri I., Kotlarsky J. and Willcocks L.P. (2007) Global Soware Development: Exploring Socializaon in Distributed
Strategic Projects, Journal of Strategic Informaon Systems 16 (1), pp. 25-49.
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We also see opportunies in harnessing social media and open source
plaorms to support relaonship building between clients and vendors.
Social media plaorms that serve as collaborave tools will enhance
the collaborave experience of the client rm in parcular when vendor
and client teams are remote. Similarly, Web 2.0 plaorms will enablestakeholders to co-innovate and co-create services regardless of their
physical locaon.
Step 6: Measure innovaon performance
As reported above, client rms fail to measure the return on innovaon
delivered by their vendors. In the academic literature there is general
agreement that innovaon improves business performance. It ows from
this that client rms should invest more in understanding the nature of
innovaon delivery, its impact on the operaonal funcons within the
value chain, as well as on the rms strategic posioning within the market.
Such an exercise will allow decision-makers to realize the value delivered
by partners and will inform execuves regarding the opportunies that
emerge in outsourcing relaonships. We think that most of rms can, in
fact, measure the return on the outsourcing investment, in a quanable
form, should they follow steps 1 and 2 of the Innovaon Ladder. For
incremental innovaon at the operaonal and strategic level, client rms
should have developed clear measurement instruments as part of step 1
and 2. These measurement instruments may have to be revisited during
the project lifecycle. Using the measurement instruments as reference
points, the client rm should seek to evaluate whether its incrementalinnovaon targets have been met.
Radical innovaon is more challenging to measure; however, the client
rm should seek both qualitave and quantave inputs regarding
performance. In terms of qualitave feedback, the client rm should
seek input regarding the quality of the network created to arrive in radical
innovaon. Periodical surveys among members of the joint venture
consorum regarding the quality of collaboraon, movaon to contribute,
assessment of each partners contribuon and intenon for future
collaboraon can provide an indicaon regarding the health of the joint
venture consorum and the potenal to tap into this pool of experse infuture projects targeng radical innovaons. Quanable measurement
tools to assess the impact of the radical innovaon on business
performance should be in the form of benchmarks against industry
performance. In parcular, as radical innovaon was sought to improve
the compeveness of the rm either through operaonal excellence or
strategic posioning, the client rm should judge the impact of the radical
innovaon through industry-wide performance indicators. For example,
the quality of service provided, represented through various measurable
indicators such as customer sasfacon, is one performance indicator that
can be used by service rms.
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Step 6 is not the last step in the innovaon ladder. If anything, it is a step
that calls for reecon and a stage that oers an opportunity redesign the
innovaon framework. Feedback collected during these six steps should
serve the client rm in its journey to achieve innovaon in outsourcing.
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Summary
As the outsourcing industry matures and the range of outsourcing services
extends to higher value acvies, client rms raise the bar regarding
their expectaons, seeking the delivery of high impact innovaon from
their vendors. This report brings together the expectaons of client rms
regarding innovaon in outsourcing as well as the willingness of client
rms to invest in creang the condions for innovaon in outsourcing.
It is evident from our ndings that client rms seek both incremental
and radical innovaons. Further, client rms see the engine of growth
fuelled by innovaons delivered by their vendors across technical business
domains. However, only vendors with both innovave and relaonship
building capabilies will be able to take on the challenge. In parcular,
vendors who tradionally invested in long term relaonships with their
clients, understanding their business processes and technical plaorms,
and closely collaborang with them on improvement project acrossthe value chain will be able to oer high impact business and technical
innovaons to their clients. Yet, both client and vendor rms will need to
ramp up their innovave capabilies to address acute challenges revealed
in our study. First and foremost, clients and vendors will need to follow
a systemac innovaon lifecycle, outlined in this report, to ensure that
the desired innovaon is captured in the objecves of the outsourcing
project as well as aligned with the business objecves of the client rm.
Further, understanding how value is delivered to the client rm through
innovave projects and agreeing on methods to measure value of
innovaon in outsourcing is another imperave aspect of this latest trend
in outsourcing.
As the outsourcing industry is facing addional changes, such as a
growing adaptaon of the mul-sourcing model and the emergence of
cloud compung as the technological plaorm through which business
services will be delivered, vendors innovaveness is becoming ever so
important to dierenate its services from compeon and enhance its
compeveness in the industry. In this regard, innovaveness should
go beyond the technical domain to demonstrate the vendors ability to
transform business processes across the value chain as well as introduce
management innovaons that oer exibility and agility to the client rm.For example, vendors can innovate around contracts to seek a sweet point
that brings together the ability to rely on long term relaonships with
the rigor needed from a detailed contract. Indeed, the path to achieve
signicant innovaon in outsourcing travels through the crossroads of a
relaonal and a contractual approach.
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About the Authors
Dr. Ilan Oshri is Associate Fellow at Warwick Business School. He is
also Associate Professor at Roerdam School of Management (The
Netherlands) and Associate Fellow of the LSE Outsourcing Unit. Heis the co-author of six books on outsourcing and oshoring including
Oshoring Strategies: Evolving Capve Center Models (MIT Press, 2011),
The Handbook of Global Outsourcing and Oshoring (Palgrave 2009),
Outsourcing Global Services (Palgrave, 2008), Knowledge Processes in
Globally Distributed Contexts (Palgrave, 2008) and Standards-Bales
in Open Source Soware (Palgrave, 2008). His work was published in
numerous magazines and journals including The Wall Street Journal, MISQ
Execuve, Communicaons of the ACM, IEEE Transacons on Engineering
Management, European Journal of Informaon Systems, Journal of
Informaon Technology, Management Learning, Journal of StrategicInformaon Systems and others. Ilan is a regular speaker in internaonal
conferences and a keynote speaker in corporate events and seminars. He is
the European Editor of JIT and also the co-founder of the Global Sourcing
Workshop. (www.ilanoshri.com)
Dr. Julia Kotlarsky is Associate Professor at Warwick Business School. She
is also Associate Fellow of the LSE Outsourcing Unit and holds vising
posion at Vrije University Amsterdam (The Netherlands).
Her academic and consultancy work revolves around managing knowledge,social and technical aspects of globally distributed soware development
teams, IT outsourcing and oshoring. Julia is a regular presenter in
internaonal conferences and convenons. She published her work in
numerous journals including the Wall Street Journal, Communicaons
of the ACM, MISQ Execuve, European Journal of Informaon Systems,
Informaon and Management, Journal of Informaon Technology. She
is co-founder of the Annual Global Sourcing Workshop now in its h
year (www.globalsourcing.org) and co-author of several books including
The Handbook of Global Outsourcing and Oshoring (Palgrave, 2009),
Knowledge Processes in Globally Distributed Contexts (Palgrave, 2008),
Outsourcing Global Services: Knowledge, Innovaon and Social Capital,Palgrave (2008) and others. (www.juliakotlarsky.com)