The Science of Sourcing Governance
By Ernie Zibert
Copyright 2011 Ernie Zibert
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Table of Contents
This booklet has only one objective, namely; to demystify sourcing governance.
I will identify the formulae for the successful implementation and management of an efficacious sourcing governance framework. The intended benefit is that firms and service providers will be able to focus on the truly value-adding elements of the sourcing relationship.
Today, most firms replicate the infrastructure spend model in their sourcing governance. Specifically, most firms spend a disproportionate (significant) amount of their IT budgets “keeping the lights on”, which is yesterday’s news. Firms typically spend between 70% and 80% of their IT budgets on these lights (Gartner, IDC).
Firms also spend the vast majority of their sourcing governance investment on yesterday’s news. They are chronically bottom heavy, in that they have numerous operational level forums - Service Review, Change Advisory Board, etc. The higher order forums, involving strategic direction and executive participation tend to be at best cosmetic, but in the main, are not even scheduled. If you perform an analysis based upon time invested, the result would be closer to 90% of vendor management investment (spend) focused on yesterday’s news (IT Operations).
We continue to see evidence of pain when it comes to sourcing governance:
“With still a lack of robust governance guidelines to manage outsourcing contracts within many organisations, organisations are struggling with the issue of exercising control over the business outcomes they plan to achieve from their outsourcing contracts.” IDC Report, March 2008 – In the mind of the outsourcing customer.
We have substantial literature “showing the strong positive relationship between outsourcing governance capabilities and outsourcing success and satisfaction”. (Stan Lepeak, EquaTerra, 2009). Stan does state:
“Highlighting the importance of good outsourcing governance is the easy part. Much harder is figuring how to be good at outsourcing governance and getting the skilled resources, budget, software tools and executive support required to do so… this is just as importance to service providers as it is to buyers.” Stan Lepeak, EquaTerra, 2009
We now have a level of maturity where we can apply scientific principles to the area of sourcing governance. We can and should implement the formulae and adhere to the ratios which characterise the science of sourcing governance. The benefits will be cheaper, faster, smarter, better and greener IT operations and decisions.
It is easy to implement the science of sourcing governance, but not painless. What is clear is that effective governance is a prerequisite for sourcing success. In fact, numerous studies have shown that the value lost from poor sourcing governance ranges between fifteen and fifty percent of annual contract value (Cutter, Sourcing & Vendor Relationships, Vol 5, No 8, 2004; EquaSiis Market Assessment - Effective Governance Yields Outsourcing Value, 2009) .
The simple view of the science of sourcing governance is that it is the disciple of ensuring all parties involved in the sourcing relationship ‘do the right things, and do them right’. That is, make right decisions in the right way.
There are three elements to effective sourcing governance;
1. People
2. Processes
3. Tools
I will identify the formulas and ratios which must be applied in each element for a healthy and efficacious sourcing governance framework, that complies with ISO/IEC 38500:2008 - Corporate governance of information technology. More importantly, this paper formalises the relationships between these elements. I will answer the question of what is the relationship between the People, the Processes, and the Tools, to ensure the best sourcing outcomes.
Why do we need science around sourcing governance? Because when it comes to sourcing governance we do not know what we are doing in a systematic and comprehensive manner. The term governance is misunderstood. Why has this situation arisen? The simple answer is that the IT community has invested the past two decades or so in ensuring the processes for the effective operation of IT are understood. As a result, several frameworks have been developed, the most recognized being ITIL and COBIT. These frameworks have promulgated the disciplines around IT operations and audits, respectively. Unfortunately, the IT community did not make a comparable investment in the processes central to the efficacious governance of sourcing relationships. In fairness, back in the early 90’s getting IT operations sorted was the priority. Moreover, the vast majority of IT operations were managed in-house so relationships with other parties were a second order matter.
People – ‘Quantity and Quality’
The People element of sourcing governance is best described as having the right quantity and quality of resources to extract the maximum value from the sourcing relationship. What is required is the right organisational and account team structures and resources. What does this mean? It means having clear accountabilities and clear financial delegation within the firm’s retained organisation and the providers account team. Here is the first formula or heuristic; the customer (C) must ensure that it has invested a minimum of 5% of the annual contract value for the management of the sourcing relationship. Gartner has observed that firms invest between 3% and 17 % of the annual contract value (ACV) in the management of the sourcing relationship. The Carnegie Mellon eSourcing Capability Model for Client Organizations (eSCM-CL) states that governance costs should be between 2% and 12% ( eSCM-CL v1.1 Part 2, p. 262). I have selected 5% as a minimum. Customers must be aware that this investment will need to be higher for the following conditions; smaller relationships or deals, inexperience in the management of service providers (P), and where the relationship is transformational. This is expr essed as;
GOVERNANCE Customer Annual Spend Percentage (GOVcas%)
Where GOVcas% is the percentage of ACV that you should invest in governing your sourcing relationship, expressed as an integer (INT). The first element of this formula is basically capped at 6.75% for deals with a monthly contract value (MthCV) of $5,000. If your retained IT sourcing resources, typically referred to as the Vendor Management Office (VMO), have no experience make the second element equal to 5. If your VMO has only one year of experience make the second element equal to 4. In all other cases, apply the formula for the second element expressed in total cumulative years of experience of your VMO (CumYrsEXP). The final element is a flat overhead for the type of deal. I have used Gartner’s sourcing deal types. The customer should apply an additional 2% to the cost of governance if the deal type is Creation or Optimisation. (There are only four Gartner sourcing deal types [a 2 X 2 matrix] and they can be found on-line - http://www.gartner.com/it/content/507100/507130/newrealitiesaug16.pdf , see slide 13) These deals are characterised by business value add rather than the more straightforward IT efficiency deal types, which I refer to as, ‘Your mess for less’.
Examples:
Base end: MthCV = $5,000; CumYrs EXP = 5 years; Deal Type = standard (IT efficiency)
GOVcas% = INT(5(1.35) + (1.43) + (0)) = 8
In this scenario the customer should be spending 8% on the cost of governing the provider or $4,800 per annum, which equates to approximately one FTE @ 0.5 day per month.
Large end: MthCV = $100,000; CumYrs EXP = 20 years; Deal Type = standard (IT efficiency)
GOVcas% = INT(5(1.0) + (0.77) + (0)) = 6
In this scenario the customer should be spending 6% on the cost of governing the provider or $72,000 per annum, which equates to approximately 40% of an FTE or two staff investing one day per week managing this relationship.
Customers must also recognise that this investment must be added to the total cost of Services to assess the true financial benefit of the sourcing relationship. Without a clear and compelling financial benefit, firms must not outsource. Otherwise, they are violating Coase’s Law.
The other heuristic for the People element is to have invested in the minimum number of roles. Specifically, the customer must have three functions in its retained organisation. For smaller sourcing relationships these functions can be performed by one resource. The three functions are;
Minimum Best Practice Customer (MBPc):
Business Relationship Manager – to manage the relationship between the firm and the service provider, often called Vendor Manager, and to manage the interface between the business units and the service provider
Performance Manager – to manage the quality (SLAs), commercials, and value from the sourcing relationship
Finance Manager – to manage the cost of the Services
Translated into a formula this MBPc is:
Customer Sourcing Account Management (SAMc) Formula:
Subscript ‘c’ denotes Customer.
The service provider must have the following four functions. For smaller sourcing relationships these functions can be performed by one resource. The four functions are;
Minimum Best Practice Provider (MBPp):
Account/Client Manager – to manage the overall relationship between provider and customer
Delivery/Service Manager – to manage the delivery of contracted Services.
Business Manager - to manage all the corporate functions associated with the relationship
Finance Manager – to manage the billing and invoice function
Translated into a formula this MBPp is:
Provider Sourcing Account Management (SAMp) Formula:
Subscript ‘p’ denotes Provider.
Depending upon the deal scale and scope, the customer and service provider must ensure they have the 5 Rights. The right;
1. Number of resources
2. Type of resources
3. Organisational structure
4. Decision authority for each resource
5. Accountability for the governance processes
So far I have provided guidance on the number and type of resources. Specifically, stick to more than 5% of ACV for your customer team and ensure you have owners for each of the functions listed above.
In terms of bullet point three, the organisational structure, the best tip is;
Tip: ensure your organisational structure is clear, current, documented, communicated for both the customer and the provider Account team, and that it makes sense.
Guidance on bullet points four and five is provided in the Processes section below. In terms of people, both parties must ensure that the resources actively participate in the account governance structure. That is, each functional owner must participate in at least one governance forum.
Ratio: 1:1 functional ownership to governance forum participation.
What does this mean? If you are a Business Relationship Manager you must meet with your counterpart, the Client/Account Manager at least once a month, covering specific terms of reference.
In this section, I have discussed the ‘who’ needed for effective sourcing governance. I have introduced the link between who talks with whom. This will be expanded upon in the discussion on Tools.
Processes – ‘Completeness and Alignment’
As previously stated, the IT community invested significantly in the understanding and development of processes required for effective IT operations. Simply put, ITIL V2, has ten processes and one function (Service Desk) which encapsulates IT Operations. (I have specifically not referred to ITIL V3 as there is debate as to how many processes are prescribed!) COBIT V4.1 has 34 processes. We simply do not have an equivalent level of understanding or maturity regarding the management of sourcing relationships. We do not have a universally accepted best practice set of processes for the management of sourcing relationships. In fact, having worked on ITIL V3 during my time with HP, I remained concerned that the collective effort of wisdom produced one simple vague paragraph amongst the five books to cover the governance of service providers! Moreover, pick up any text on sourcing and you will not find a simple list of the governance processes. Google the term ‘sourcing governance’ and you will see what I mean. You will find a laundry list and maybe even be able to cobble one together from the texts, web-pages, blogs, etc. These laundry lists simply reflect the predilection of the service provider, advisory partner, and author.
This lack of maturity and discipline has resulted in high risk, lack of value and high level of dysfunction and reactivity in the management of sourcing relationships. The best advice afforded customers and providers are generalities about making sure the processes and decisions are managed well. But what are the processes? How do we know that the processes are the right ones and the list comprehensive?
The sourcing governance process principle is:
‘Not all governance processes apply to all relationships, but some governance processes apply to all relationships.’
There are twenty-five sourcing governance processes derived from experiential rather than empirical evidence (described in another booklet/blog). Furthermore, it is proposed that this set of twenty-five processes is comprehensive. That is, this set is generalisable to all types of sourcing relationships, regardless of scale, scope, or type.
For effective sourcing governance, the minimum best practice in terms of process ownership is;
Minimum Best Practice Customer (MBPc) & Provider (MBPp):
1. Contract Management
2. Issues Management
3. Service Level Management
4. Invoice Management
5. Service Request Management
Then;
6. Project Management (if there is demand)
Please note that the processes listed above do not appear in order of importance. The relative importance of these processes is dependent upon the deal type. The reason I separated Project Management is that is it not a necessary minimum process for an effective sourcing relationship. Depending upon the Services contracted there may not be any concomitant projects.
The best practice above means that someone in the customer’s organisation must be the sole owner of one or more of these processes for the relationship. The corollary is that the provider must also take and assign ownership of this minimum set of processes.
For the remaining governance processes, firstly establish ownership within both the customer and service provider. Second, establish the priority, and the relevance to the sourcing relationship of those processes. Finally, establish the requirement for a process document. Depending upon the maturity of the customer and provider, compliance with ISO 9001:2000 is sufficient. (That is, ownership, inputs, outputs, activities and key success factors for each process listed.) Then ensure all decisions are recorded in the relevant governance meeting minutes and the process ownership template (or contract) is updated.
What is needed for effective sourcing governance is the right number of processes identified for the particular sourcing relationship. Once identified as being relevant to the relationship at the particular point in time, these processes then have to have a customer and service provider owner.
More importantly, these processes must be allocated to the right governance forum.
Ratio: 1:1 process ownership to a governance forum.
COBIT V4.2 and ITIL V3 do not contain all the governance processes. Their etiology is from audit and IT operations, respectively, not management and good governance of vendors.
Why these five processes?
Contract Management: First and foremost, the “rules of the game” are defined/prescribed in the contract. Over the years I have heard both customers and providers argue the entire continuum of positions pertaining to contract management, ranging from “once signed put the contract in the drawer for a healthy relationship’ to ‘check every clause and make sure the bastards are delivering what they promised’. The bottom line for me is that the contact is the first rule for the relationship. In the absence of a contract, you simply have a constellation of stories (perceptions, predilections) which inevitably will result in dissatisfaction. You must ensure two things for effective Contract Management. First, that the contract is readily accessible to those who need it. Second, the contract is up-to-date.
Issues Management: To ensure the health of the relationships all issues must be recorded, owned and resolved appropriately.
Service Level Management: This is the performance heuristic in your sourcing engagement. Someone has to own this process as you a paying for a level of performance.
Invoice Management: Ensuring the financial benefit of the sourcing engagement is the prime success factor. This is consistently borne out by sourcing research.
Service Request Management: Effective management of the on-going requests for Services is paramount to sourcing success. For example, you must be able to efficiently add new users or software, modify or refresh operating environments, and retire software and hardware.
In this section, we have discussed the ‘what’ needed for effective sourcing governance.
Tools – ‘Discipline and Transparency’
In this final section, the third in the trilogy of effective sourcing governance elements, I present the tools. So far we have some people standing around and some processes they must own and some process they might own. How they fit together is further prescribed in this section. The theme for the sourcing governance tools is discipline and transparency. This is where the rubber meets the road. This is the factor which truly operationalises sourcing governance.
The first Tools formula is that for governance meetings. Every governance meeting should be expressed in terms of;
Governance Meeting formula:
Fmtg = (F,T,D)
The above formula states that all meetings have only three attributes, vis;
Frequency (F)
Type (T)
Duration (D)
Each attribute has a certain range. In the case of Frequency, the range or options are:
F = Daily, Weekly, Fortnightly, Monthly, Bi-monthly, Quarterly, Half-yearly, Annual
The Type of meeting is binary; T = Face-to-face or Teleconference
And the Duration is expressed in hours.
Examples:
An Account Review Meeting which is held monthly and has a duration of 1 hour is expressed as ARM(MF1).
An Executive Performance Assessment Meeting which is held every six months (half-yearly) and has a duration of 2 hours is expressed as EPA(HF2).
Why is this important? This formula allows for ready communication of the characteristics of the governance meeting structure. You can see from a meeting schedule and chart what meetings occur, with what frequency and their duration. I have provided an example below based upon a simple sourcing relationship.
Governance Meeting Structure:
The above schedule clearly shows that there are three governance meetings in this relationship. A Service Management Meeting (SMM), held fortnightly for one hour face-to-face on the second Tuesday of the month. The second SMM in the month is a conference call (T) on every forth Tuesday for one hour. An Account Review Meting (ARM) is held on the fourth Thursday of every month for one hour. Finally, there is an Executive Performance Assessment meeting (EPA) held every half-year on the last Thursday of the six-month. The executives meet in person for two hours. One other important characteristic shown within the schedule above is the timing of the meetings. As shown above, the SMM must occur prior to the ARM as they are inputs into this meeting. Moreover, in the month the EPA occurs it is a week after that months ARM. This permits the ARM participants to prepare for the EPA and mitigates against any surprises.
How many meetings should there be? There must be at least one and ideally a minimum of three. Why three? There should be a specific Service Review covering the theme of performance (SLAs). There must be an Account Review focusing on Finance (Invoice), Performance, Issues, Contract, Demand Management (if applicable) and Customer Satisfaction. Finally, there should be an executive forum to ensure minimal entropy from what was thought to what was bought.
Number of governance meetings:
Ngovmtg >= 1
In addition to the three meetings stated above, further meetings are dependent upon the deal type and characteristics of the deal. One caveat, you cannot have hundreds of meetings. If you adhere to the tools and advice listed here, you will not have too many meetings.
Range for governance meetings:
1 =< Ngovmtg <=30
Once the schedule is completed, the next Tool value-add is to structure the meetings to ensure internal consistency. The internal consistency is driven by which meeting’s outputs form inputs into other meetings. The most straightforward method of achieving this is by a meeting chart. (This tool is not needed for simple governance frameworks.) I have provided an example of a larger governance meeting structure in the figure below.
Governance Meeting Chart:
Every governance meeting has only five attributes.
Governance Attribute Formula:
Govmtg = Purpose + Participants + Inputs + Outputs + Scheduling
The Purpose for the meeting (Govmtg) dictates the other four attributes. For example, if the purpose of the meeting is to review the monthly invoice, then the participants must be those persons who are accountable or own Invoice Management, typically the Finance Manager. The inputs are the invoice and the contracted pricing model and performance reports (e.g., SLA report). The output is an agreed invoice. An invoice meeting must be scheduled to align with the timing of the invoice, typically monthly.
The key to effective sourcing governance is to ensure that all your governance processes have been assigned to a governance forum. I have provided below an example for the governance meeting chart used previously. I have only included the five plus one minimum best practice governance processes.
As a general rule, the terms of reference for a meeting must include at least one of the 25 governance processes. This is the ‘what’ for the meeting.
Governance Process Formula:
Govmtg => nGovprocess , where n = 1 to 25
Governance Processes assigned to Governance Meetings:
You need a minutes template to capture the minutes from these meetings. A standard template is recommended for all the governance meetings to ensure consistency. The last thing you want is to have your Operational Meeting minutes in bullet points in an e-mail, your Account Review Meeting minutes in a word document and your Project Review Meeting minutes in a spreadsheet. If you allow this you should also allow your executives to record their minutes on a napkin!
Governance Meeting Template:
Invest in one, they are free (download one from the net)
Tip: maintain a discipline with your meeting minutes to only record action items, decisions and reports tabled. Ensure that each action has one and only one owner and is dated the date of the meeting. I use the reverse of the extended date standard; YYYYMMDD. For example, 20110610-01 means that this is the first action item from a meeting held on 10 June 2011. This permits you to readily see the age of the action item.
Governance Meeting Documentation:
Store your meeting minutes in the cloud. Get over the confidentiality and security concern. This way you and your provider have access to all the minutes.
Tip: establish a generic governance meeting mailbox. This way you can ensure that meeting acceptances, input documentation, etc is accessible by more than one individual. Moreover, this future-proofs your Sourcing Account Management (SAM) from staff turnover.
Good Governance
The goal of good sourcing governance is simple. It is to make explicit the ‘rules of the game’ between the customer and the provider. In other words, good governance makes explicit, ‘who talks with whom, about what and when’. What does this mean? It means there is clarity on authority, accountability, and auditability (transparency). But good governance does not stop there. Good governance ensures that there are no gaps, no holes in the governance framework. Good governance protects against surprises. This is why the comprehensiveness of the governance process set is a critical success factor. Good governance also delivers the capacity to focus on the truly value-adding elements and not the transactional rear-view mirror investment seen today.
Good governance starts in the first week of the sourcing relationship. It must exist in Transition and it must continue throughout the life of the relationship, changing as both the customer and provider needs change.
All three elements of people, processes, and tools have to be right for efficacious sourcing governance. What does this mean?
I have clearly shown you who talks with whom (People), about what (Processes) and when (meeting schedule).
The final revelation is that all the resources must own at least one governance process and the governance processes must in turn be assigned to a governance meeting. This ensures that all the stakeholders actively participate in the governance for the sourcing relationship.
It is this final crucial step that most relationships miss. They leave this to chance, either knowingly or unconsciously, more likely the latter, and as a result the relationship drifts to an unpleasant place. The sourcing business model is a fragile one. As a result it’s most likely outcome is dissatisfaction and failure. Good sourcing governance is the key instrument to avoid this outcome.
What will this achieve? Efficacious sourcing governance will enable a revolution; a revolution which shifts sourcing governance from being a transactional retrospective IT agenda, to a proactive business value enhancing agenda. It will liberate its participants to focus on tomorrow-land. The things needed to insulate and ensure strategic alignment and success of the business.
Ernie Zibert is a senior IT sourcing professional and brings eighteen years international management experience across government, communications and media, and finance industries. His transferable skills include IT sourcing strategy and governance, and financial, relationship and commercial management of external service providers. Annual spend under management includes up to $200M AUD along with 20% savings.
Discover other titles by Ernie Zibert at Smashwords.com.
What’s the difference between a million and a billion dollar IT sourcing deal?
Ordering IT Services: Would you like CHIPS with that?
My blog: http://strategicsourcingblog.blogspot.com
For more information, contact Ernie Zibert at ernie.zibert@gmail.com
Thanks goes to Mohandass Ayyappath for his insightful comments and editing.