Financial Evaluation of IT Outsourcing

Developing a TCO model to evaluate a $100+ million savings opportunity

Challenge

A large Australian ASX (Australian Stock Exchange) insurance company, with operations and staff in Australia, New Zealand and South East Asia, had recently commenced a company-wide cost reduction program. The company had publicly committed to reducing its operational costs by AU$250m June 2019. The Chief Operations Officer (COO) had received two unsolicited IT outsourcing proposals outlining an opportunity to reduce IT costs by AU$100+m over 5 years.  The outsourcing proposals were jointly submitted by two vendors, who proposed that IT infrastructure was outsourced to one vendor and end-user computing, contact centre, network, telecommunication and service integration and management (SIAM) to the other vendor. As the client’s IT operation was primarily supported by in-house staff, the program leadership team acknowledged that it did not have a strong outsourcing financial modelling and investment evaluation capability, so the team at Technology Connect was engaged to determine if the vendor proposals would deliver the expected savings.

Approach

We applied our technology investment methodology and agile experience to rapidly design a dynamic total cost of ownership (TCO) model to enable the client to model potential outsourcing cost savings over the life of the proposed contracts. We leveraged our industry aligned service tower definitions to baseline the client’s current annual IT costs across the in-scope service towers. The baseline was then extrapolated across the terms of the vendor proposals using various dynamic assumptions such as inflation, business efficiency and retained capabilities. This was followed by normalising the vendor’s pricing proposals for valid comparisons. The model was designed to reflect gross and net savings (i.e. gross savings were exclusive of one-off costs such as transition & transformation fees, termination of existing vendor contracts and potential client redundancy payments) from a cash flow as well as a P&L perspective. The model was developed in collaboration with the client and the vendors to ensure that all parties were comfortable with the way in which the savings were modelled, whilst ensuring that each vendor’s pricing submissions were kept confidential. This transparency created a constructive dialogue between all parties as the financial evaluation model was continuously improved to adequately reflect the addressable spend of the client’s IT costs as well as continuous changes to the vendor’s pricing submissions.

Result

The client was able to determine achievable IT outsourcing savings from the two proposals. The model demonstrated that the client could realise savings of 11-18% (net versus gross P&L savings) over 5 years by executing an IT outsourcing strategy. As the model was designed to dynamically run complex scenarios, the client’s executive and program team were informed of the savings potential across various perspectives, e.g. overall and combined (both vendors, vendor by vendor, IT tower by tower and category by category (i.e. categories with an IT tower). The client was able to satisfy itself that key assumptions such as inflation and asset treatment (e.g. refresh of equipment) were realistically reflected in the financial evaluation. These perspectives provided critical inputs to the parallel commercial negotiations with the two vendors and the client’s executive decision forums (Group Leadership Team and Board of Directors).

Tom is the founder and Managing Director of Technology Connect. He has 15+ years of executive experience in maximising value from emerging technology investments. He has advised senior executives in the areas of technology investment strategies, digital transformation and value realisation across a broad range of industries and geographies including Australia, New Zealand, Asia and Europe.

If interested in further details of Technology Connect’s technology investment frameworks, processes and tools, or in how we assist companies maximise value from technology investments, please visit our web site on www.technologyconnect.com.au or contact us on info@technologyconnect.com.au