Why It Makes Sense to Transition to Managed Services Model?

For the last many years, there has been an increasing perception that most organizations are moving from staff augmentation and fixed price models to a managed service model.

Most of us believe that almost all big organisations would have definitely moved to some form of managed service model. However, recently, while working on a couple of IT cost reduction exercises for “Fortune 50” MNCs, I was surprised to see that both these organisations with an IT budget greater than$1B were primarily using the staff augmentation model. Thus, I thought it would be interesting to understand staff augmentation and managed services models in detail and also illustrate how an organisation can gradually move to a managed service model.

Sandeep Gupta, Sr IT manager, A.T. Kearney

Is the Staff Augmentation model seeing the end of the journey?
For years, many information technology (IT) departments have relied on the staff augmentation model to increase their agility through rapid access to missing capabilities and skills. This leads to an avoidance of hiring/de-hiring costs, and does not have an impact on their operating model. Staff augmentation is always a good model when it is used for a shortperiod of time and for a specific purpose. But, when it is used over a long period of time, it creates many disadvantages such as:

a) Higher costs as contracted staff come at a premium than employees do

b) Inculcates a management style that does not plan

c) Fosters creation of knowledge silos which are limited to a person

For a long term perspective, organisations need to look at a model which can yield all of the benefits of flexibility and skill access that it seeks, while overcoming the major disadvantages associated with staff augmentation.

Are there reasons to adopt the managed service model?
A managed services model allows an organisation to outsource the management, operations and delivery of processes effectively to lower the total cost of the business. This model is attractive as the pricing structure is based on regular monthly billing around service levels and volumes, rather than per diem fees associated with staff augmentation. This greatly reduces volatility in costs and supports accurate and predictable budgeting.

Moreover, as compared to staff augmentation, the relative increase in costs in this model as business requirements grow and the service expands are significantly lower than the costs involved in further augmenting staff numbers and skills due to economies of scale, labour cost arbitrage and flexibility with staffing. 

Apart from this, the most attractive reasons in adopting this model  is that the supplier assumes the risk of transition and future operations based on an agreed, committed scope and tenure. This is contrasted by the loss of control and possible security issues in a staff augmentation model.

However, like any pricing model, one needs to watch out for the following risks associated with this model and ensure that they are handled appropriately before signing the contract. The key risks include:

Ability to define and monitor service levels--Since the model heavily relies on service levels, it is a must that organisations have the ability to generate and monitor these service levels. Inability to monitor service levels may result in a vendor overcharging due to lack of transparency

Single vendor dependency--Once a vendor is ingrained in the organisation, he may be reluctant to increase the scope

Does it make sense to move from staff augmentation to managed services? 
In order to optimise IT spend and provide transparency of IT costs to business, organisations need to adopt the managed service model. The staff augmentation model was and always will be a stop-gap arrangement to supplement necessary skills and it should be treated as such. Not more than 8-10 per cent of the IT budget should ever be allocated to augment contractual staff. 

The key reasons to move from staff augmentation model are these:

a)  IT organisations can focus on strategic elements—With execution commitments secured, IT leaders can focus on strategic elements rather than operational. The IT head can focus most of his time on strategic management rather than managing the execution.

b) It gives organisations a clear linkage between outcome vs money spend: With a managed service model, the expectation is to get an outcome based on service levels; while with staff augmentation, the expectation is to get the number of hours.

c) Better documentation: In a managed service model, the vendor assumes the risk of delivering the software at defined SLAs. This incentivizes vendors to produce extensive documentation as they cannot rely on individuals; moreover, this allows the vendor to move work across the global delivery network with ease

d) Implementation of latest tools and processes to enhance productivity: Vendors who provide managed services are generally large and serve multiple clients. This enables them to share the best in class tools and processes which otherwise is difficult to track and implement when an organisation primarily follows the staff augmentation model

e) A managed services model is a superset of a staff augmentation model: It delivers all the skills and flexibility of a staff augmentation model with providing “committed and documented” outcomes.

Four steps to transition to the managed services model:

Moving to a managed service will involve a systemic change in an organistion’s operating model. The organisation needs to follow a four-step process in order to implement the managed service model.

Step 1: Define 3 Ss--Scope, SLA and Sourcing Strategy

a) Scope: There should be clarity in the organisation regarding the intent of using the outsourcing provider. It can be either or a mixture of the three alternatives:

i. Run the business

ii. Grow the business

iii. Transform the business

Clarity in the objective will help define the correct SLAs and also help in shortlisting the right vendors. The most important, however, will be that the internal organisation needs to restructured in order to fulfill the objective; this may involve people, process, structure and governance

b)  Service Level Agreement (SLA): One of the most important aspects of the managed service model is the definition, capturing and tracking of SLAs. At this juncture, it is important that the organisation defines the SLA at a broad level and refines it as it further goes into the sourcing process. Some of the key SLA’s may include:

 i. Business SLA--Total cost of ownership(TCO) improvement, % improvement in process accuracy, etc

 ii. Development SLA--Planned vs actual, # of defects, productivity, etc

 iii. Maintenance SLA--System availability, response time, resolution time, etc

c) Sourcing Strategy: Once the outsourcing objectives are understood and SLAs defined, one should scan the market to understand the potential vendor landscape. This might be an initial super list of vendors who will satisfy the organisation’s strategic outsourcing objectives.

Step 2: Source vendors

 i. As a first step, undergo an exhaustive vendor shortlisting exercise internally based on secondary research data. The criteria may include vendor capability in a particular domain/technology, local FTEs, similar projects executed locally, etc. This exercise should ideally result in a list of 5-8 shortlisted vendors.

 ii. Organisations should then seek information directly from these shortlisted vendors either through a RFI or by having one-one sessions. This will help in collaborating the data collected through secondary research and also further fine-tune the vendor list.

 iii. Circulate RFP to the final list of vendors. Evaluate RFP based on criteria such as functional requirement, non-functional requirement, vendor capability, vendor commitment to SLA’s, price, etc. Select the final vendor and negotiate the final terms and conditions of the contract. 

Step 3: Transition

 i. Considering that an organisation is primarily using staff augmentation, it needs to transition over to a managed service model in a phased manner. A comprehensive transition plan (usually provided by vendors during RFP) is created, which illustrates how each business area would be transitioned to a managed service model.

ii. From an organisation’s point, it is important to identify key stakeholders and their role and ownership during transition. A marked difference would be the responsibility to manage vendors instead of managing applications

Step 4: Governance

i. Organisational communication and change management is the key to a successful transition to a managed service model. Till business and IT folks understand and buy-in to the concept of the managed service model, it cannot succeed.

ii. From an operational perspective, there should be a separate office created called “Vendor Management Office.” Its prime responsibility should be:

• Primary interface between the organisation and vendor          
• Ensure vendor visibility of the demand
• Track and ensure that vendor meets SLAs
• Ensure vendor remains competitive and current to what the market has to offer.

Pychaya Suksrinuch