Outsourcing and Joint Ventures

[This is part of a series of posts describing how IT contracting compares and contrasts with  the structure described in the PMBOK.]


Business application owners may dream of hosting everything in a heavenly cloud.  However, somebody somewhere must own the tangible infrastructure elements.  For large enough applications, there can be economies of scale or competitive advantages in owning your own infrastructure.  In some industries, privacy, security, or regulatory issues dictate that an organization host its own infrastructure.  If your organization or client is large enough, this may be part of your project.

Hosting your own infrastructure means making decisions about how that infrastructure will be managed.  Historically, organizations that owned their own infrastructure also maintained their own IT staff to manage and operate that infrastructure, with augmentation from specialized contractors when needed.  (Please see the accompanying article about procuring IT support services.)  In the modern era, organizations have additional options for managing IT operations and infrastructure.  In order of increasing complexity, these options can be summarized as:

  1. Managed Services
  2. Outsourcing
  3. Joint Ventures

Managed Services

In the Managed Services approach, the management of specific parts of the infrastructure are turned over to an outside organization.  The ownership of the infrastructure generally remains with the contracting or “owning” organization.  The Service Provider provides day-to-day “care and feeding” of the servers, storage, networks, databases, middleware, and other components of the infrastructure.  The management services are likely to be delivered remotely (frequently from India.)

From a procurement perspective, the Managed Services are generally contracted on a unit price basis.  The Service Provider generally charges these services for a specific price per server, per network port, per device, per unit of storage, per data center, and by other units of measurement.  The actual contracting is somewhat more complicated, as described further below.

Managed Services provide the IT organization with considerable flexibility in what parts of the infrastructure and operations the organization wants to continue to handle directly, and which parts should be contracted out.  The result may still be significant complexity in how IT is managed and measured.  With this approach, the owning organization still makes major decisions about how things will done, but “farms out” the work.  In the Managed Services approach, there can be an unwritten assumption that the contracting organization has superior (or adequate) skills and experience in effective IT management, but seeks to move routine work to another party that maintains a collection of superior technical skills and special tools (or adequate skills at an attractive price.)

Outsourcing

The Outsourcing approach moves more responsibility to the Services Provider.  There are a range of options, overlapping both the more simple Managed Services and the more complex Joint Ventures.  With this approach, the owning organization moves many decisions about how IT operations will be managed to the Services Provider.  The contracting organization will likely retain IT Executives above a certain level, but the Services Provider will be utilizing all of their own IT Management and technical staff.  The infrastructure may be housed in a data center owned by the Services Provider.  The infrastructure may actually be owned by the Services Provider.

From a procurement perspective, the Outsourcing Services are roughly and conceptually based on a unit price basis.  The Service Provider generally charges these services based on the size and complexity of the infrastructure.  However, there are likely to be additional contractual incentives for cost savings and risk management.

Outsourcing provides the business considerable isolation from the operational aspects of IT services and the decisions made in support the IT operations.  In the Outsourcing approach, there can be an unwritten assumption that the Services Provider brings superior IT management than the contracting organization chooses to sustain.

Joint Ventures

If the first organization has transferred enough business opportunity and risk, then it ceases to be merely the “owning” or contracting organization.  If the second organization is providing business services at a high enough level, then it ceases to be merely an IT Services Provider.  As the business value, complexity, and bilateral nature of this relationship increases, then the relationship becomes more of a partnership or joint venture.

The details of these kinds of joint ventures exceed the space here, and the contracting details far exceed the kind of procurement contemplated in the PMBOK.

Pricing

Both Managed Services and Outsourcing are typically procured using a kind of complex unit pricing.  The contracts are usually individually contracted using semi-custom pricing.  The pricing is usually structured as a rate per unit per month, invoiced monthly.  Customers may initially want a simple monthly unit rate price, but suppliers frequently use a more complex rate structure.  These structures may include rate adjusters called dead band, contract band, “arcs,” and “rooks.”

For example, if a reasonable market rate for supporting a specific device is $10 per month, and the customer has 500 such devices, the Services Provider may structure the contract price around a $5,000 monthly rate.

A dead band of plus or minus 2% would allow the customer to add or subtract 10 devices from their infrastructure without a change in the monthly rate.  An Additional Resource Charge (ARC) of $8 would add an additional (discounted) unit price for each additional device above the base rate, once the number of such added devices exceeded the +2% dead band.  A Reduced Resource Charge (RRC) of $6 would provide a customer credit for each removed or unused device below the base rate, once the number of such removed devices fell below the -2% dead band.

A contract band of plus or minus 20% would allow the customer to grow or shrink their infrastructure by up to 100 devices and continue to be supported and billed according to the base rate, ARC and RRC rates.  Once the customer’s infrastructure grew or shrunk by 20%, a contract re-negotiation would be triggered.

These contracts typically include different rates for different levels of service, such as how quickly different kinds of technical issues will be resolved.

For contracts of more than a year or two, the base rate is likely to include an annual rate reduction based on the assumption of future economies of scale, improved tools, etc.

These contracts frequently include incentives for component up time and penalties for component down time.  Pages of terms and conditions will describe how up and down times are measured.

Outsourcing contracts are likely to include additional elements, such as incentives for cost reductions, process improvements, etc.

Transition, Transformation, and Steady State

Both Managed Services and Outsourcing contracts will include pages of dense text with definitions of Service Level Agreements (SLAs.)  These represent commitments of technical and business responsibility that the Services Provider will stand behind.  For various reasons, the contracting organization and the Services Provider need a “get acquainted” period at the beginning of the service period.  During this initial period new monitoring tools are being installed and both party’s staffs are getting their processes integrated.  One name for this period before the SLAs are effective is Transition.  Once all the tools and processes are in place, a formal handshake takes place. At this point, the SLAs (and their incentives and penalties) become effective.  The services contract enters the main contractual period, which can be called Steady State.

There is an important distinction between the kind of work that is and is not included in a Managed Services or Outsourcing contract.  In a traditional self-governed IT organization, a typical staff specialist will spend various proportions of his or her time building, testing, researching, changing, monitoring, fixing, and tweaking things.  Within Steady State, these kinds of contracts generally only cover the monitoring, fixing, and tweaking activities.  An IT infrastructure is usually a continuously changing and evolving entity.  However, these kinds of contracts are generally focused on the things that are not currently changing and not expected to change much over the life of the contract.  For Services Providers, infrastructure undergoing changes is said to be in Transformation.   Service Providers are delighted to provide assistance with Transformation projects, but at a price additional to the Steady State supporting rate.


[I welcome your comments and feedback based on your experience managing or procuring IT services projects.  Feel free to contact me directly.]

(Image courtesy of stevepb at Pixabay.)

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  1. Pingback: IT Contracting in the Real World | Carl Gusler

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