Avoiding the catch-22 of IT outsourcing

Two models (on the left) align with what Williamson refers to as “the market,” while two models (on the right) align with what Williamson coined as “corporate hierarchies.” In the middle, three models align with the hybrid approach for complex contracts for which Williamson advocated. These demand flexibility, continuous improvement, and investment in innovation. The key to optimizing your outsourcing relationship is picking the most appropriate sourcing business model for your situation — and architecting the deal points appropriately.

Selecting the right sourcing model

To pick the right model for your venture, it’s imperative to know the economic basis of each sourcing business model and the kinds of situations for which each fares best. Here is a breakdown of each model along the sourcing continuum.

The Basic Provider Model is transaction-based, offering a set price for individual products and services for which there is a wide range of standard market options. This model should be used only to buy low-cost, standardized goods and services in a market with many suppliers.

The Approved Provider Model is also transaction-based, but here, goods and services are purchased from suppliers that meet a pre-defined set of qualification characteristics — quality standards, proven performance, or other selection criteria. Organizations using this model establish a limited number of pre-approved suppliers from which buyers or business units can choose. If one supplier is not performing, you can easily replace them with another.

As organizations shift up the sourcing continuum, a key differentiator to success is consciously choosing to build stronger and deeper relationships with suppliers. Unfortunately, here is where far too many organizations get it wrong. They begin to say “strategic partner” and “innovation” yet fail to invest in rethinking their transactional approaches, thereby falling into the catch-22. To escape this trap, it is important to architect the commercial aspects of your outsourcing deal to align with the nature of the sourcing business model (see Figure 2 below for a cheat sheet on architecting the commercial structure for each model).

The first stop along a more relational approach is a Preferred Provider Model. IT organizations seeking to do business with a preferred provider often enter into multi-year contracts using a master services agreement that allows them to conduct repeat business efficiently. The model still uses transactional economics, but how the parties work together and achieve efficiencies goes beyond the simple purchase order.