Do outsourcers really know the costs of deals they have won?

* If both sides are fair when negotiating deals, the customer will benefit in the end

Back in April, I discussed the issue of companies understanding their own costs in order to make good decisions about outsourcing. One reader recently suggested that I turn the tables and discuss the same issue from the outsourcer's viewpoint.

Unlike their clients for whom IT is a supporting cost, outsourcers are very good at understanding the actual costs of delivery as this is the core function of their business. The real question is not "do they know their costs?", but how good are they at predicting the costs of a deal during the proposal phase? This is where their margins and deal success are ultimately determined.

When an outsourcer is trying to win your business, they are often playing a very interesting game. They must clearly understand all of the requirements; what it will take in terms of human resources, hardware, software, etc., to deliver on those requirements, allow for surprises and contingencies, and yet make a profit. At the same time, they cannot lazily throw out a big number to be sure they can cover the costs as they have competitor bids to contend with. So they have to very carefully account for everything and put forth a competitive bid.

It can be very hard to know all of the costs at this stage. Outsourcers have experience on their side, working from the knowledge of costs from all of their past deals. This knowledge base is a key advantage and the large outsourcers are very good at leveraging their experience. However, every client situation is different. The art of making these deals is applying the knowledge of actual costs in past deals to the client situation of the current deal. This is where the lack of knowledge of true costs by the client can ripple into the outsourcer's cost estimates. Outsourcers must consider the following in estimating costs:

* Accurately estimate the costs.

It is key that the client has provided enough detail to make a good estimate. It is rare that an outsourcer will know everything they want to know, so it is a matter of knowing enough to make a good cost forecast. Related to this is having enough time during the sales cycle to work through all questions and ensure enough detail has been provided. There is a reliance on the client both knowing the current costs and being upfront and honest about them. The outsourcer can certainly point out where costs are too low, but some clients will reject that information and look for another vendor.

* Negotiate service levels that are achievable within the cost constraints.

Once the base work and costs are understood, the service levels must be agreed upon. This is also impacted by the client's understanding of their current costs as a reasonable balance must be struck between the level of service and the underlying costs.

* Know how you will manage scope creep.

If more resources, human or hardware/software, are required than projected, who will pay this cost? If it results from underestimating the work, it will be the outsourcer. If it is from scope creep (the project grows bigger than previously planned), it should be the client. The contract will need to anticipate a means for governing the project and resolving disputes so that additional costs can be appropriately assigned and controlled.

* Have a clear executive sponsor for the project.

Related to managing scope creep and resolving disputes is having an appropriate level of executive support on the client side of the deal to get things done. EDS was reminded of this issue recently on its large Navy contract. The project had gotten woefully behind schedule and costs were significantly higher than expected. It turned out one of the key problems was base commanders denying access and approving down times for EDS resources to get work done. Getting the project back on track required an edict from the top and establishing a process for getting work scheduled with the proper authority.

You might think that it is not a client's problem if an outsourcer is good at estimating their costs. But a bargain can become a problem very quickly as the outsourcer struggles to deliver on a deal that they seriously under bid. Clients should absolutely work hard to understand their own costs and be clear and accurate about the work to be done. This will help the outsourcer put forth a fair bid and a budget on their side of the deal to ensure a successful deal for both parties.

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Copyright © 2006 IDG Communications, Inc.

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