Innovation Report Cognizant-WBS 2011

8/2/2019 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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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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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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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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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 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 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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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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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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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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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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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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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 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


18/26


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


20/26


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.


21/26


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


22/26


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.


23/26


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.


24/26


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.


25/26


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.


26/26


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)

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