Co-operating with competitors offers a new option

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Running the IT infrastructure of any organisation is an expensive business. In these difficult times, with an increased focus on reducing such costs, all possible options are being considered. Some of the more high-profile approaches to cost reduction include developing software in cheaper offshore locations or outsourcing parts of the organisation. Both are becoming increasingly popular with businesses large and small.

A slightly different approach to traditional outsourcing is co-sourcing. This involves combining the IT operations of two or more separate companies into a dedicated, standalone business and reducing the overall cost of operation by exploiting economies of scale. Co-sourcing is perceived as being more business-friendly, as it retains the alignment of values and goals between IT and the business that can be lost in traditional outsourcing deals.

In truth, co-sourcing is rare and difficult to implement. It needs the right mix of technology configuration, regulatory approval, geographical alignment and business appetite. But there is a growing body of evidence to suggest that co-sourcing is a viable option.

In 2002, Ireland’s two largest banks, AIB and Bank of Ireland, embarked on an ambitious plan to create a co-sourcing joint venture to provide IT infrastructure services to both banks. This initiative was taken to an advanced stage and although blocked at the last minute by the European Merger Task Force on competition grounds, the rationale for the scheme remains compelling. In fact, the banks planned for the joint venture to become the core of an IT infrastructure ‘utility’ providing a purer form of ‘computing on-demand’ than is now being touted by many prominent IT companies, such as IBM.

The concept has been applied with more success in other countries. In 1993, a pure co-source led to the creation of the SDC Group (www.sdc.dk), a successful company that now provides IT infrastructure services to more than 80 financial services organisations in Denmark. In August 2000, Lloyd’s, Barclays and Unisys came together to create iPSL, a joint venture to provide cheque-clearing services. Although this was less of a ‘pure-play’ co-source because of the involvement of IT outsourcer Unisys, iPSL had an explicit goal of becoming a ‘utility’ clearing house for specific market segments.

More importantly, many organisations have realised that co-sourcing is potentially a natural next step in the evolution of outsourcing and are actively investigating the idea as the model of choice.

Why co-sourcing?

Like other traditional strategic sourcing initiatives, co-sourcing is fundamentally about driving down service costs, improving the quality or professionalism of service delivery and focusing the company on core (as opposed to IT) activities. In addition to helping to reduce overall headcount and/or capital investment, it also provides for a stimulating IT-focused career for IT specialists.

Although traditional IT outsourcing deals generally promise to deliver these benefits, a properly executed co-sourcing partnership can bring even more to the table. Specifically, co-sourcing can deliver closer alignment of IT goals and values with those of the business and increased productivity through genuine economies of scale. Co-sourcing also leads to lower capital investment and costs through ongoing standardisation and capital ‘value-creation’ from previously unvalued or under-valued assets.

Traditional IT outsourcing arrangements introduce an inherent tension between the business and the IT partner. The outsourcer’s primary motive is to maximise revenue and profit. This can only be achieved at the client’s expense, although the client has a fundamental objective of reducing its costs.

Apart from the obvious win-lose nature of any negotiation, this very often leads to the development of complex pricing arrangements, protracted negotiation on service changes and reluctance on the IT partner’s behalf to make any new investment in the venture. It has also led to the failure of several high profile outsourcing deals, and a feeling (certainly among some IT professionals) that outsourcing benefits only the outsourcer.

With co-sourcing there is no such tension. The profits from the joint venture vehicle go to its owners — in other words, its customers. These can be returned to customers in the form of lower unit costs, or in the form of a dividend. Whatever the split, an agreed level of ‘retained earnings’ for re-investment in technology allows the joint venture to build and maintain a better service portfolio. In this way, the IT provider remains just as focused on reducing cost and providing higher levels of service as the business.

Economies of scale

Economies of scale will help reduce cost in any outsourcing arrangement. In co-sourcing, if the partners are both in the same business, additional benefits are possible because the IT environments will in all likelihood be similar. In the case of the proposed AIB and Bank of Ireland co-sourcing venture, both parent organisations had almost identical computing environments — including mainframe, ATM, midrange, networking and desktop.

The economies of scale argument are obvious for large organisations, but co-sourcing also makes sense for smaller and, in particular, medium-sized companies. First, these businesses tend to have similar computing environments, even across sectors. Second, the cost of operating these smaller environments is greater than it is for their larger competitors: put simply, a firm with 200 desktops will never generate the economies of scale of a large bank or a multinational organisation. But bringing the IT infrastructures of a number of medium sized firms together can very quickly generate similar scale.

It is worth bearing in mind that substantial economies of scale don’t necessarily come from running multiple applications on the same box. Unless existing hardware has significant excess capacity, the cost of replacing kit that has already been heavily depreciated in the books may not be worthwhile. Instead, efficiencies in operations and staffing levels are often much more achievable, particularly where coverage of different technical environments on extended hours, shift-working or 24/7 operations are required.

Reducing capital investment

In the initial phases of establishing a co-sourcing arrangement, much of the focus will be on driving out the economies of scale described above. In the longer term and with careful planning, opportunities for capital investment efficiencies also arise. These may include co-ordinating the timing of upgrades to network or communications infrastructure, server processing or storage capacity and standardisation of desktops.

Desktop maintenance and administration, in particular, typically represents the largest single per-user cost for organisations, yet many are individually too small to reap the benefits of standardising on a small range of workstation or laptop configurations.

Although typically not the main driver in a co-source, the potential for capital value-creation is generally of interest to a company’s shareholders.

Because co-sourcing results in the creation of a separate commercial vehicle, a company’s IT costs and assets can be separately valued by the market. Usually this value is higher than the value of the assets when they are embedded in the parent company’s valuation. Even in the current under-performing market, IT service companies with a pipeline of guaranteed revenue have value. This added value in real commercial terms can be combined with the potential to optimise tax and balance sheet effects.

Co-sourcing is not easy to implement, but if the right set of circumstances prevail it is worth considering as an alternative to traditional outsourcing in some cases. In certain sectors — typically those where there is a tradition of collaborative working — and for certain businesses — usually those that need to achieve the scale of larger rivals — we believe co-sourcing can be employed to reduce the cost of IT, while ensuring a close alignment of IT goals and values with those of the businesses.

Critical success factors

The conditions for a successful co-sourcing venture have as much, if not more, to do with the pre-disposition and approach of the people involved, as with the underlying IT environment. In our experience, the factors most critical to success include:

• A progressive, open-minded approach to IT management that allows all sourcing options to be explored
• A committed executive team, convinced of appropriateness of the co-sourcing and the business case for doing it
• Identifying and engaging a suitable co-sourcing partner — taking into account business, technical and location considerations — but above, all one who is committed to the venture
• A small but strong core team, including representatives from both partners’ organisations and experienced external advisors, with the authority and expertise to drive the programme forward
• Engaging IT and business people in understanding their new responsibilities and establishing the processes and procedures to operate the co-sourcing arrangement
• Communication, communication, communication — internally and externally and at all levels to ensure a smooth transition to the new operating environment.

The author is Principal Consultant at Kainos, a systems integrator based in Dublin and Belfast that focuses on eBusiness, CRM and business process improvement. For more information go to www.kainos.com.

25/09/2003

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