Monday, June 4, 2012

Managing IT: The Vendor Business Model


Business Model Drives People Strategy

IT vendor services are increasing playing a material role in the success of an IT department's mandate to serve its organization. No IT department can cover all aspects of technology and services anymore for their business stakeholders. There are just too many offerings available at a time where consumers of services and IT devices are resetting the rules of engagement, but adamantly choosing for themselves what they prefer to use. The IT department therefore has to rely on vendors to provide services and solutions to its organization, and meet these demands. 

These services and solutions vary from vendor to vendor. Without understanding the vendor's business models, and the way in which their services are packaged, it becomes hard for the IT department to effective manage its IT vendors, and to know how the vendors are to impact its operations and that of its business users. Unwillingly, IT departments are exposed to delivery practices of the vendors they choose, which can enhance their own success, or turn out to be costly and painful if it all goes wrong.

One of the main factors for successful IT service delivery, is the effective structuring and organizing of IT service's most important ingredient: its people. This is equally true for the IT department, and for the IT vendor. 

This blog elaborates and simplifies the main themes of services offered by so-called "IT Service Vendors", and addresses the factors in the management of IT people for each of these themes that determines success or failure.

In general we've found that IT service vendor companies are slow to realize that their chosen business model is a key driver for the way in which they structure and organize their people.  Most IT vendors has no clearly defined people sourcing and structuring strategy, because they have not clearly considered or defined their business model at the outset. Why is this a sad state of affairs for such a progressive industry? Because, many managers in these organizations are slow to realize that the business of IT services is more a business of managing IT people, and the way in which people are organized, than it is a business of technology. 

Clients ultimately pay for poorly organized vendor organizations through failed delivery, or missed value. Vendor organizations are at the coal face of IT delivery, therefore it is important to understand their business models, and how it contributes to IT departments meeting their obligations in their respective companies.


The Vendor and the Client for IT Services
The IT service vendor provides services and products to its clients. While these clients are IT departments and therefore the purchasers of the services, in many cases they are not the consumers for the services and products. The department has its clients - the organization at large - that is consuming the services of a vendor organization. 

Three simplified business models prevail in the IT Services Vendor landscape. Companies in this business may deploy a variation of one or more of these models. They are:
  • "The Body Shop".
  • "The Solution Shop".
  • "The Service Shop".

The Three Business Models

“THE BODY SHOP”:
The Body Shop is primarily concerned with selling or renting out IT Professionals at a market acceptable rate per hour/day. 
These vendors assemble a team of highly capable IT Professionals with advanced and specific skills, and then rent them out to the client for defined periods. Members of the team are employed or contracted as independents. The assumption is that the vendor’s IT Professionals are the most capable in the tools applicable. They are also in short supply, or only needed temporarily, therefore justifying the “talent for hire” business model. 
A client may only require access to this skill for a limited period, and it doesn’t make sense to recruit a permanent employee for this need.
  • DEMAND: The demand for IT Professionals in these organizations are determined directly by the market. Usually a short turnaround is required because of a “crisis” or a new project is to be launched imminently. IT Professionals are engaged through flexible contract engagements instead of permanent employment.
  • OVERHEAD: The IT vendor organizations aims to have the lowest overhead possible (They may typically resell contractors rather than having employees waiting around for client engagements). Therefore, one may often find that these vendors are subcontracting contractors, and the same contractors may be available through several vendors. There is a low management oversight requirement from the Vendor, because the IT Professionals are usually managed by the client's managers, or by another professional charged with the management overhead for the engagement. This is a business model attractive to immature small vendors, or contract recruitment companies.
  • CAPABILITY: This business model demands and dictates Top IT professional capability. The IT Professionals for hire need to be the best there is, and scarce, else, the business model fails. A premium contractor rate can usually not be justified for lower skilled more available resources. Client companies just employ these lower skilled and more available people outright. There is little scope or incentive for the vendor to develop talent in this business model.
  • RISK: Most, to all risk for the outcomes provided by these professionals are with the client. The vendor has only one primary risk: That is to ensure that the most capable individual is available to the client, when required, at an acceptable rate. And, then to guard their own bottom-line against incurring salary expense, if the IT Professional is not engaged with a client for any period of time.
  • JUSTIFICATION: This business model is justified in the market because it provides a client flexible access to premium IT Professional capability. The vendor has a variable cost resource with low risk and margins varying between 10% and sometimes as high as 80% depending on the skill and scarcity of the expertise. The challenge for the vendor is engaging these professionals and keeping them associated with their organization. To do this, a vendor may choose to specialize in a market or technology niche, which promises the professional association, market access, training and development opportunities. The challenge for the client is to be sure that the professional indeed meets the skill requirements, and can work within the client organization culture without too much disruption.
“THE SOLUTION SHOP”: 
The ”Solution Shop” is when a vendor is contracted by the client for a business change or product outcome (Solution). The outcome is usually delivered through a project engagement with a well defined Charter, Scope and Statement of Work (SOW). It has a defined beginning and end with agreed outcomes. The vendor is rewarded for this outcome, or for the effort and the outcome.
The are a number of ways the vendor may be engaged by the client. It can be a fixed price engagement putting the risk on the vendor, or a cost plus engagement where the risk is shared between the parties. However, when it is a time and materials (T&M) engagement it places the risk back with the client, and then it does not qualify for the “Solution Shop” business model, but is rather part of the “Body Shop” model.
The solution model has prevailed as one of the dominating models for IT vendor business pre-2000. However the business risks associated with pricing engagements, and also the vendor ‘s challenge to keeping employees engaged after large projects or implementations, has made this an unpopular way for vendors of doing business. 
A vendor can easily find itself out of business when projects go wrong, or when there are no follow-up work for staff after or between projects. This usually results in mass staff redundancies every so often, to keep vendor businesses afloat in tough times. 

Solution vendors are also at the mercy of their technology platform relationships. Many solution organizations have seriously seen diminished business if their platform partner's solution falls out of favour in the market, or the platform partner changes its preferred go-to-market approach. 
Some vendors safeguard against these risks by engaging a percentage of contract resource from vendors using the “Body Shop” model, and therefore they can buffer their exposure through contractor variable cost and less fixed employee overhead. They also may represent multiple platform vendors to guard against the risks of changes on the platform partner's side.
  • DEMAND: Demand determination for IT Professionals in the “Solution Shop” is based on solution implementation requirements. Vendors are challenged with short term planning for resource requirements per these engagements, that may vary from a couple of weeks to several months or even years (less so). Once a vendor reaches a critical size and position in the market with a steady flow of engagements, then determining IT Professional resource demand in this model becomes easier. This business operating model requires highly competent IT professionals to minimize the vendor’s delivery risks. It also requires a vendor to engage these professionals with a more binding relationship for the same reason, which results in permanent employment being preferred over contract resource arrangements. Organizations deploying this model pays the highest salaries in the industry.
  • OVERHEAD: This business model has the highest overhead for the IT vendor. As mentioned, highly capable IT professionals are engaged on permanent employment basis. The model requires a high management overhead due to the number of permanent employees and the risk the vendor wears. This all needs to be managed. The vendor may find that it cannot keep all employees billable all the time. There will be periods when employees are on training, or between projects, and this further contributes to risk and costs to the bottom line of the vendor organization.
  • CAPABILITY: The vendor is carrying part or all of the outcome risk and therefore has some capacity to use less qualified and cheaper resource together with top IT Professional talent. In this way the cost structure can be lower with the possible margin and reward per engagement being higher. This business model provides some scope for training and talent development, depending on the vendor’s appetite and capacity for risk.
  • RISK: As mentioned, the risk for the solution outcome is either with the vendor, or shared with the client. The vendor has additional risk in managing its IT Professional employee’s utilization and overhead when not utilized.
  • JUSTIFICATION: This business model is justified in the market because it provides clients with less risk and a larger upside for the vendor. The vendor has more scope for reward because it wears or shares the risk with the client. The vendor can scale his organization because a longer planning window is available. There is also scope for training and IT talent development, which increases the vendor’s capability to grow the organization with less expense. Depending on the variable cost component (contractors) utilized by the vendor, there are more sustainable gross margins available of between 10% and 45%. However, consider that these margins can be wiped out quickly by IT people not being utilized, finding themselves on the bench, while the vendor continues to pay their salaries, The risk cost of projects going wrong or overrunning is another factor that makes this a risky, and all too often, money losing business (a phenomenon common in IT). 
“THE SERVICE SHOP”: 
A client contracts the “Service Shop” for a continuous delivery of a service or business outcome. These service outcomes may include access to infrastructure, software, or people or may include business outcomes. Business outcomes include examples such as paying employees during the monthly pay-run, processing customer support calls, paying creditors, ship orders, and more. The latest developments in "cloud" solutions on offer is a simplified extension of the "Services Shop".
A service is not a once off engagement for the “Service Shop”, else it will be classified under the “Solution Shop” business operating model. The key distinguishing factor for the “Service Shop” is that it provides repetitive and continuous outcomes, with support, usually in larger quantities.
Business Process Outsourcing (BPO) and "Cloud" solutions are good examples where IT vendors are re-inventing themselves as “Service Shops” providing continuous and repetitious business outcomes to clients, regardless of the technology and staff complement used to effect this outcome for the client.
Typically clients are not interested in acquiring the tools or processes used by the vendor for delivering the service. The outcome is procured at an acceptable agreed price, and the rest is up to the vendor to work out with minimal disruption to the client's business.
More recently "cloud" software developments are also considered as such a service. This is because of the continuous nature of software maintenance requiring routine upgrades, enhancements and evolution in the business context. The IT Vendors that are recognizing that as service, this requires a different management approach, is having good success in making their mark in the IT industry. Software development companies have typically grasped this concept and is dominating the market space in their ability to routinely execute software development in a standard and consistent manner on masse, while evolving it along client demands as a service.
  • DEMAND: The demand for IT and other Professionals in this business model is determined by the vendor company, and not the client. It is based on a rate of throughput and complexity of the service that they are expected to deliver to the client. These service agreements are of longer term or duration, and therefore the IT vendor can thoroughly plan their resource and management requirements, to meet their delivery objectives and cost model.
  • OVERHEAD: This model offers a lower people overhead. This is due to two prevailing factors. Firstly, because the service requires repetitive tasks to be executed, the processes can be standardized and a fair amount of automation included. Less, and lower skilled IT Professionals are required to do the brunt of the work. It provides opportunity for lower skilled resources to be included, because they are expected to execute along tried and tested routes or standard practices. Secondly, the continuous nature of the outcomes allows the vendor to plan and train junior professionals to standard practices, making the overall labour force more affordable. The risk of professionals not being engaged, as is posed in the “Solutions Shop” model is limited due to the longer term service engagement, and typical larger scale operation. A mix of professional capability levels are used with a strong lead IT Professional, and a number of junior members in training, to deliver the service outcome.
  • CAPABILITY: The level of IT Professional capability is mixed, with a larger proportion of junior people. It is the ideal model providing the greatest resource development, training and procurement flexibility.
  • RISK: The risk in the “Services Shop” is significantly lower for two main reasons. The vendor has more time to get it right, standardize practices, and he can use lesser qualified and cheaper resources to delivery the outcome or service on offer to the client. It does however suppose that the vendor is capable and mature in the offering, else they will not be price competitive, and the outcomes may not meet client expectations.
  • JUSTIFICATION: This business model is justified in the market, because it provides clients with less risk and a cheaper alternative to the prevailing procurement solutions available. The vendor has more scope for reward, and the business model is more forgiving from a resource and cost perspective. Why are IT Vendors not making more from this model? I believe the primary reason is that the scope of service are not yet well defined in the market. That vendors haven’t yet defined and delimited service offerings that truly deliver value to customers, and that IT vendors just simply lack the maturity of rigorous, repeatable processes to deliver high quality repeatable outcomes integrated with customer organizations and processes. Service offerings in some sectors are easier to define like payroll processing services, but in other sectors it will require creativity, and a customer willing to consider and try such offerings and accompanying benefits from IT vendors.
We will look closer in future Blogs at the above models and how each play a role in the success of IT service delivery.
Hendrik van Wyk

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