Sourcing Speak

In Part 1 of this blog post Time to Mind Your Ps and Qs we made the case that there is limited additional opportunity in continuing to pound on “P” in the P x Q = Total Price equation and that to achieve the next breakthrough the supplier community has to address Q. In Part 2, we addressed why more virtualization is not the real answer. Where are the next big benefits going to come from and who is willing to make the paradigm shift?

Continuing in our example from Part 2 where our Buyer was looking for $125M in savings over a five year term, if the virtualization dog won’t hunt (well enough) what dog might? Perhaps x86 hardware consolidation should be addressed in a different way in a sourced environment. What if instead of using 15,000 virtual images, applications could be stacked, like they are on other platforms like mainframes. While no application stacking effort would achieve 100% results, neither would virtualization. For simplicity in calculating the virtualization numbers we assumed 100% of the images could be virtualized and we will do so again for the application-stacking alternative. In both cases, what can be achieved in actual implementations will be less.

Let’s assume that each of the 15,000 O/S images runs one application instance. Then let’s take those applications and stack them inside let’s say three O/S images on each of 1,000 machines. We will still need the same amount of hardware, the same amount of virtualization software, which will cost $62.3M over the term, but then let’s stack the 15,000 application images in the resulting 3,000 O/S images. In that case our service fees would drop from $202.5M to $89.1M (15,000 * $225 for 18 months + 3,000 * $225 for 42 months) a projected savings of $113.4M over the term. The $113.4M is 90% of the buyer’s savings goal of $125M.

In Part 1 of this blog post (Time To Mind Your Ps and Qs), we made the case that there is limited additional opportunity in continuing to pound on “P” in the P x Q = Total Price equation, and that to achieve the next breakthrough the supplier community has to address “Q”. The current standard answer from suppliers on reducing Q is “virtualization”, but that won’t solve the problem, at least not entirely. Here’s why.

Assume we have a buyer with significant IT Infrastructure labor costs — say $125M per year. The buyer decides to go to market despite having a pretty good idea that its unit costs are roughly at parity with current managed services market pricing. The buyer’s objectives include, in addition to qualitative and risk mitigation goals, lopping $20M to $25M p.a. off the labor costs to manage its infrastructure. A five-year labor-only deal in the $500M TCV range is certainly going to attract plenty of interest in today’s marketplace. The buyer has made a strategic decision not to source hardware and software ownership to the supplier so, if necessary, they can “fire the maid without selling the house.” Furthermore, the buyer has decided to signal to the suppliers that its unit costs are near where it believes the market should be and winning this business is probably going to require a clever solution that addresses the Qs along with the Ps.

So, let’s first look at this from the supplier’s perspective. If you are the clever solution developer at a major supplier, you see a way out of this conundrum. You’ll propose a virtualization initiative for the buyer’s vast portfolio of x86 servers! And, since x86 services are typically priced by O/S images, you will still get the same amount of revenue regardless of the degree of virtualization, 15,000 images on 15,000 machines or 15,000 images on 1,000 servers — all the same to you, right? However, since this is a labor only deal and you will be reducing the quantities of something that isn’t in your scope, you have to change the way the buyer calculates benefits to include all the ancillary stuff they won’t buy from you anyway (i.e., floor space, energy, racks and, other than a couple of suppliers, the machines themselves). Starting right in the executive summary you will tell the buyer to think strategically, not tactically. That is, think about TCO, not just about this isolated deal when calculating benefits. You are still going to have to employ a lot of “weasel words” to deal with how virtualization will occur (and how fast) — but at least there’s a story to tell.

Traditionally, the mechanism for creating value in an IT Infrastructure sourcing has been to push down hard, real hard, on price — the “P” lever. The notion is that a sourcing will result in a lower unit cost for the labor needed to manage a device or deliver a service. The objective is to create as big a difference as possible between the buyer’s current unit cost and the suppliers proposed unit price. The reason for that is obvious: P * Q = Total Price.

To create value for the buyer by reducing the total price either P or Q has to change. Historically, P is what changes, because the buyer expects to have at least the same, if not a higher, quantity of things (devices, applications, project hours, etc.) as they have today. Like the last two decades, this remains the strategy behind most if not all IT Infrastructure managed services arrangements. Supplier’s value propositions are predicated on lower unit costs partially achieved through lower labor costs and partially achieved through improved productivity.

Yet, over the last several years the conventional alchemy has become less likely to create the benefit buyers are seeking. We are seeing a number of buyers whose unit costs are at or below the unit prices offered by suppliers. While it is hard to pin down exactly why buyers’ costs have declined, it is pretty clear that investments in technology and productivity or lower salaries are not the drivers. Generally, it appears to be the result of the weak economy and the constant pressure on IT budgets. IT Infrastructure organizations have been forced to reduce staff and leave open positions unfilled while the quantity of devices, storage and services have stayed the same or increased — reducing the unit cost. Service delivery risk has likely increased but we have yet to see a buyer quantify or price the added risk.