How To Transform IT *without* Outsourcing

N. Dean Meyer, founder and head of NDMA, calls himself an "organizational mechanic." He examines mechanisms inside organizations that can make or break performance — mechanisms like culture, structure, workflow, and resource governance. In 1999 Mr. Meyer published a 100-page treatise titled, simply, Outsourcing. He recognized the reality that many companies were looking to outsource some — or all — aspects of operations for the wrong reasons. In this interview, we ask him to re-examine his findings and tell us what he's learned since then.

 

Your book, Outsourcing, came out six years ago. In many ways, it seems to be about how not to outsource. What was the genesis for writing the book?

N. DEAN MEYER:

The concern that led to that book was the feeling that outsourcing was a fad, that people were doing it because everybody was talking about it, whether or not it was the right thing to do. In the process, a lot of careers were being ruined — careers of hardworking, qualified staff within companies. We had to look at why this was happening. On the surface, one would think that outsourcing should be more expensive since vendors have to make a profit, despite all kinds of claims of savings. But I found that, in many cases, money wasn't the real issue. Many of the reasons came down to, "We don't like doing business with our internal service provider. At least if we outsource, [the service provider] will treat us like a customer."

It turned out that the reasons business units were giving for outsourcing IT were all things that we knew how to fix if we had a CIO who wanted to build a healthy organization. So that led to the book.

That's a great idea, but how does an organization achieve health?

It takes an internal service provider that is itself a vendor of choice. It delivers great value and is a pleasure to do business with. That starts with a corporate CIO who understands that IT is a business within a business. Then it requires systemic change in the IT organization to earn the position of vendor of choice through performance. Sometimes the issue is structure. For example, many IT organizations are missing the account rep function, which is a subset of what I call "Consultancy." They have no full-time client-facing function that cultivates customer intimacy and strategic alignment.

In many cases, the resource governance processes are an issue — convoluted bureaucratic processes make it difficult to buy anything from IT, or a budget processes whereby we budget for expense codes like travel, training and compensation, and in doing so, cripple the IT function and still have no idea what the budget does and does not pay for. Then, clients expect infinite service for a finite budget, and nobody really knows what's covered or not.

And, of course, integral to running an entrepreneurial business within a business is the notion of actively using extended staffing, that is, using vendors and contractors as part of your staff, not as an alternative to your staff, and bidding their solutions right alongside homegrown solutions, as alternatives you offer.

OK, so I am a new CIO coming into an organization just as dysfunctional as they come. How do I start on that road to transformation?

I just got back from Switzerland where I met with a CIO of a corporate IT organization. The place we began is with a leadership team workshop within IT that explored the business within a business paradigm. Of course, at first, we were [hearing] things like, "But we really know what is best for [you, the customer]" and, "But we have to protect the corporation from those unruly users," and "They have to do business with us because there are economies of scale…" After a morning of discussion, I believe the senior leadership team within IT came to understand the importance of a business within a business perspective.

The next step is self assessment: How are we doing? In their case, it turns out they have less than 50% market share, given their high degree of decentralization and outsourcing — an indication that they have work to do. I briefed them on the five organizational systems: culture, structure, the internal economy, methods, and metrics, and we talked about various ways to get started. We talked about which ones are good starting points and which are really bad places to start. For example, culture is relatively quick and easy and makes a good starting point. Structure is far more complex and is not a good starting point. There are parts of the resource governance processes that make a very good starting point.

And then I also talked about a more visionary approach where, as a leadership team, they would spend time flushing out, in detail, what they believe it would take to be a world-class organization, their vision of what a ideal organization does. I don't mean some little paragraph. I mean a couple of dozen pages of detailed statements of what should be expected of the organization.

From there they could do gap assessment, and where they found gaps, they would drive those gaps to root causes. Why would our good people produce disappointing results in this area? The root causes would be systemic factors — the five organizational systems. That would position them to put together a multi-year action plan that would address all five systems and really build a showcase organization. So they are now contemplating where they want to start: with a visionary planning process or by jumping right in and getting some traction on one of the five organizational systems.

It seems frequently that in new outsourcing engagements, internal IT organizations don't stand a chance because they don't have a full understanding of what it is they're delivering.

Exactly. There are many reasons why they may fail to gain the business, even if they are a good value. It could be that they don't know how to present themselves as a business within a business with clearly defined products, clear contracts, with project approval processes that make them easy to do business with. It could be that they are missing a sales force — that is, the account rep function. It could be that they lack skills like proposal writing where they present the alternative in full life-cycle cost and everything clients need to know to choose. It could be that their internal processes are broken such that they can't be trusted. They over-commit — rob Peter to pay Paul and gain a reputation at being unreliable at everything — or that they don't set aside enough unbillable time. They scramble so hard to meet unrealistic demands that they take no time for technology innovation and training, and so they are rightfully perceived as technologically obsolete. There are lots of reasons why they may fail to compare well to outsourcing, but all of them are within the grasp of the IT senior leadership team, and in every case we can fix these problems at root cause and get the organization back on the right track.

You write a lot about the behavioral approach to cultural change. Can you explain that?

Culture is a mixture of values, feelings and attitudes on one side; and habits, practices, and behaviors on the other. This is a cycle. Values drive behavior, certainly; but the converse is also true: Behaviors drive values. The only interesting question for leaders is where you break the cycle. I know that values-based leadership has been quite popular, but those who advocate it will tell you that it takes a generation to change culture. The reason is, you can't tell people what to value or how to feel.

Instead, look to learning theory, which points to a behavioral approach. Don't tell me how to feel; tell me what to do. We craft very clear principles of behavior to implement values like entrepreneurship, customer focus, and integrity. With the behavioral approach, we've seen massive cultural changes in very large organizations in about 10 months. By that I mean, 80% of the people practicing 80% of the behaviors 80% of the time. It's noticeable to clients, particularly themes like customer focus and integrity; and it's noticeable to our staff, particularly themes like teamwork, cooperation, empowerment, and interpersonal relations.

This kind of assumes that the IT staff cares about this stuff.

They should care. It is their careers, their client's well-being, and their shareholders' value that's at stake here.

Do you find IT staff sitting there rolling their eyes, as if this is just another management "flavor of the month"?

During the rollout process, staff is engaged not only in learning the principles, but in fixing them — that is, in commenting and questioning and bringing up issues and opportunities for improvement. I think it is the case that striving to be a vender of choice can, at the same time, build an organization as employer of choice. A great organization is great for both clients and staff. Staff really wants to feel appreciated– to feel they have good relationships with clients and that their work is meaningful. By building great relations with clients and aligning with clients' strategies, it becomes a great place for staff to work.

IT staff typically see outsourcing as a threat. Are you suggesting that these internal changes would reduce that threat?

Wouldn't it be so much better if we proactively embraced contractors and vendors as part of our staff? If we proactively benchmarked ourselves against them? If we proactively offered external solutions as well as internal in our client proposals such that all that work is coming through us and not around us and our jobs grow into managing the contractors and systems integration rather than just coding?

How do we go about benchmarking ourselves?

Price is the only realistic benchmark. The problem is very few organizations know how to calculate the true cost of their products and services. Traditionally, there have been all kinds of problems doing this, such as, "There are things that we have to do for the good of the corporation that the competitors don't have to do. If those get amortized into the price of client products and services, it will distort us upward and make us look bad vs. the outsourcing even if we are a better deal."

It wasn't until fairly recently that we had the tools and method to accurately cost all IT products and services. Now, there is a very straightforward tool kit. It is called "Budget-by-Deliverables," which allows IT organizations to develop a budget and fully cost project services, and at the same time extract a rate sheet that is comparable to outsourcing.

Can you give some basics of Budget-by-Deliverables?

Sure. The first challenge is to break the IT organization into its component lines of business. We find in many cases a manager is running two distinct lines of business. Even thought they report to the same boss, they have very different products and services and should absorb indirect costs differently.

The second step is for everybody to brainstorm their products and services. I don't mean a product catalog; I mean the actual projects and services they expect to deliver in the coming year. Then there is the synchronization process where we link up prime contractors and subcontractors within the IT organization. One group may sell a project, but it depends on other groups as part of its team for delivery. Those other groups I call subcontractors. So, we link up primes and subs so that we can later add up the full cost of the project or service.

Then we begin to look at our cost structure. We look at our staffing, including managers, secretaries, full-time, part-time, and contractors, and understand what percentage of their hours each year is actually billable. By billable, I don't mean that money changes hands; I mean usable on projects and services. You have got to set aside time, obviously for vacations and holidays, but also for things like professional development, project research, writing proposals to clients, improving your organizational processes, administration, and so on. That unbillable time is essential for sustaining the organization. So the right answer is not 100% billable. If your unbillable time is too great, that means too much overhead and your price will be too high. If your unbillable time is too little, that adds up to eating your seed corn and you will be out of business in no time. There's a sweet spot in that curve, but it differs for each different line of business within IT.

The billable time ratio is critical to calculating cost per billable hour. We calculate the cost per billable hour as a blend of staff, contractors and vendors, with the appropriate billable time ratios for each. That rate gets assigned equally to all the rows. You don't want a client saying, "Hey, do my row with staff, not contractors, because they're cheaper." It is not a client's choice. So we apply the blended cost equitably to all rows.

Then we come to a relatively more traditional part of the process, and that is sorting out your expenses. If you picture the process as rows, then these are the columns: compensation, travel and training. Expenses that are specific to a product or service are called "direct." But there are also indirect costs. Training your staff is an indirect cost that would be spread over all of the products and services in that particular group.

Then we look at what one group sells to another in IT. For example, infrastructure engineers sell "platform tuning" to the infrastructure operators that deliver the service. The cost of that engineering service is transferred to the operations group and then spread over all of its service rows.

And finally, we look at overhead and spread that over all of the deliverables. When you add up primes and subs, you get the full cost of every project or service, fundamental to portfolio management and strategic alignment.

To calculate rates, within each group, you take all the rows sold in terms of a given unit, like all the rows sold by the developer hour, and add up the total cost, divide by the number of hours, and you get a price per hour that is fully comparable with outsourcing.

How easy is it for people to learn how to do this, and how long does it take?

This is done in a participative way because you don't want your internal IT finance person doing your operating plan for you. The first time through requires about five months — obviously not full time. In future years, you unplug some rows because they are done; you add some other rows in; you revisit the numbers; and there you are. It is actually going to be easier than traditional budget processes.

Are people shocked at the expense of the work they are demanding from internal IT staff?

There are many surprises in this process. In some cases, we see projects and services that are far more expensive than we thought and the perceived value is low. In other cases, we see the indirect costs that really aren't necessary, so we can improve our value by bringing those down. But generally, I think people find that when you compare apples to apples, internal costs are very fair compared to outsourcing.

Do you find that managers who are succeeding with transformation efforts are constantly repeating themselves?

Absolutely. You have to keep driving home past messages while introducing whatever is new at each point in the process. We close every leadership workshop with communication planning. By that, I don't mean some party-line, as if we're hiding something. Everything should be wide open. We talk about what we know at this point and what we don't know. We agree to communicate what we do know and not to speculate about things we don't know. Then we talk about how we're going to communicate, anywhere from "Answer when asked," or "Informally in staff meetings," up through very formal communications like off-site meetings, small group sessions, and written communication. We close every workshop at every step in the process with that kind of planning. The more you communicate, the better the odds of your success and transformational change.

Have you got any success stories you can share?

At a large healthcare supplier in the northern Midwest that runs hospitals and clinics, their corporate IT function was under pressure. Clients were decentralizing IT; clients were talking directly to vendors rather than working through corporate IT.

They did a number of steps in the process. They did the vision and gaps — the transformation planning — and that alone took their leadership team to a new level of understanding of the business within a business paradigm. Then, they implemented a cultural change, followed by the Budget-by-Deliverables process.

They hadn't yet gotten to structure when the CIO was hired away by another firm. That in itself is a sign of success. His successor is more of a caretaker than a change agent, but even so, I now hear that client business units are asking corporate IT to take over their decentralized groups, because they now see that corporate IT can manage IT staff better than they can. Corporate IT is actively bringing in vendors as part of their staff. Clients no longer feel they need to play those vendors against corporate IT. Rather, they trust corporate IT to help them manage those vendors. So, even though they didn't finish the process, I would call them a success story.

Does outsourcing even have a role in the perfect organization?

Use of vendors and contractors is a good thing. They provide flexibility in capacity (both staff and infrastructure), bring specialized skills, and in come cases offer economies of scale that cross corporate boundaries.

But remember that vendors and contractors are morally obliged to look after the best interest of their shareholders, not yours. The question is not whether there's a role for vendors and contractors. The only question is, who in your corporation — people working for your shareholders — is best qualified to manage those vendors and contractors and ensure the best interests of your corporation?

Internal IT staff can put together their proposals with their knowledge of the internal infrastructure and the technology directions and technology standards, using vendor products as part of that picture. They can ensure that anything vendors do is well aligned with the interests of the corporation.

A scenario. I'm a mid-level manager and the executive that heads my division comes to me and says we are outsourcing IT. What is the best way to respond? Should I volunteer to become part of a task force involved in scoping out the work of the providers, or should I just get my resume dusted off?

Is this a politically-driven decision? Is it a done deal? That can happen when the vendors schmooze the CEO on the golf course. One vendor in particular trains its partners to say something like, "You know, your internal IT people are pretty good in normal times, but these are exceptional timesÉ" We have heard that exact line all over the United States from this particular outsourcing vendor. So, if they have succeeded at end-running the CIO and convincing the CEO to outsource, it may be too late.

But if there is any window of opportunity for rational discussion, then the right answer is first to try to sell extended staffing instead of outsourcing, and then to sell the CEO on a program of building the internal IT organization into a vendor of choice. This would be far better for shareholders.

Remember, internal IT staff have an inside advantage. They don't have to make a profit, so they should be well positioned to compete. The key is apples-to-apples comparisons.

What you will typically see is a vendor saying, "I can do 50% of what they are doing, for 80% of the cost. So I am going to save you 20%." Well, wait a minute. What exactly are the deliverables of outsourcing? That is typically clear. What are the deliverables of internal IT staff? That is often unclear. So what internal IT leaders have to do is scramble to define and cost their products and services as a basis for apples-to-apples comparison. In those situations, we would begin with that budget by deliverables process that I described earlier.

What if outsourcing is already a part of the scenario and my organization appears to be controlled by the vendor? How do I extract us from that vendor?

If the contract is controlled by IT, then there is no reason you can't assert some influence. The problem is when the business is going directly to the vendor, and staff is out of the loop. Their only hope there is to earn back some market share, that is, try to find some foot in the door deal — some little things that staff can do for that business unit to earn credibility. Once they have built a little more credibility, then perhaps, they can talk about moving the vendor contract under them rather than leaving the vendor reporting to the business unit directly.

You wrote your book back in 1999. Have your thoughts about outsourcing undergone any changes since then?

Technologies come and go. Vendors come and go. And their sales tactics come and go. But I don't see any change in the fundamentals. Economic trade offs haven't changed. The nature of organizations and human behavior haven't changed. And there is still a lot of frustration with internal staff because they are not run like a business within a business. I think the fundamentals I wrote about then are every bit as relevant today.

Useful Links:

NDMA
http://www.ndma.com

Fundamentals of activity-based budgeting and operational planning
http://www.ndma.com/web05/web2298.htm

Budget by Deliverables
www.budgetbydeliverables.com

Examples of Entrepreneurship principles
http://www.ndma.com/web05/web2030.htm

Mr. Meyer's column, "Beneath the Buzz," in CIO magazine
http://www.cio.com/blog_view.html?ID=502