Rationalization Adds Complexity to Application Outsourcing Pricing

A combination of hyper-rationalization integration and  pricing pressure demands by enterprises on application outsourcing (AO) providers have driven AO prices down for the third consecutive year, according to …

“For sure hyper-rationalization will continue and this will impact core applications as well,” says Jimit Arora of Everest Group.

A combination of hyper-rationalization integration and  pricing pressure demands by enterprises on application outsourcing (AO) providers have driven AO prices down for the third consecutive year, according to a report recently released by Everest Group. Hyper-rationalization, or a structural and strategic reorganization taking rationalization to the next level, has been adopted by such corporations as Citi, JPMorgan Chase and BMW in order to streamline their legacy-heavy application portfolios.

Rationalization culled applications that stood out as no longer useful; hyper-rationalization examines core components of an enterprise’s portfolio and consolidates or discards unnecessary legacy applications that leave little budgetary room for the introduction of new technologies. Although businesses have long adopted rationalization as an application reduction strategy, the report released by the Dallas-based consulting firm examines enterprises that are taking the next, “hyper” step to reduce their legacy portfolios by as much as 60 percent, to strictly those essential to the enterprise’s strategic goals.

Jimit Arora, Vice-President of Everest Group, is certain about the future of hyper-rationalization adoption as enterprises seek to reduce costs and implement innovation. “For sure hyper-rationalization will continue and this will impact core applications as well. This should create opportunity for service providers to offer app transform services, however, also raises the potential to cannibalize existing app maintenance business.”

“Hyper rationalization is the extreme extent of traditional IT rationalization processes. It impacts rationalization of not only peripheral but core applications as well, resulting in tremendous simplicity and cost savings. It also goes beyond applications and focuses on underlying business processes as well,”says Everest Group Practice Director Yugal Joshi.

Legacy application reduction is no longer solely a concern to IT departments, but C-levels across the board also as businesses increasingly depend on technology and its associating rising costs. Additionally, with over 75 percent of IT budgets being dedicated to core applications, little room is left for new technologies and risks, possibly hampering enterprise long-term goals. Hyper-rationalization is a solution to this concern, although the report’s authors caution against simply disposing of applications as a cost-cutting measure but to take a holistic view of the company’s strategic future and validate each application’s use. Other considerations cited include a defined “end state,” understanding the Total Cost of Ownership (TCO) of the enterprise’s platform and effectively managing ensuing changes.

Enterprises have begun institutionalizing hyper-rationalization techniques that include partial or full application automation, now due to factors such as advances in cloud technology and cheaper infrastructure helping business dispose or consolidate less useful legacy applications. According to Everest’s report, enterprises adopting this budget reduction strategy are targeting a 50 to 60 percent decrease in applications ranging from front-line to back-end, core and non-core. Reduction of applications that are no longer useful to a business further allows for a reduction in management costs and complexities as well as increased business dexterity. An additional means of IT budget reduction increasingly explored is software-as-a-service (SaaS), allowing enterprises to access functionalities of legacy applications without the need for the entire, possibly cumbersome, existing application.

Advancing Cloud Technology

Advances in cloud platform technology is cited by Everest as a key driver behind this intensive reorganization strategy enterprises are taking on as it has forced businesses to examine existing applications and determine which can be consolidated or retired. The report also recommends, when considering the future of an enterprise’s application portfolio, examining which assist in advancing the business’s broader long-term strategy.

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Everest recommends enterprises not lose sight of quality when seeking cost reduction from AO providers, as at some point, reduced pricing will lead to decreased quality. It further warns to not push providers too hard, lest the enterprise be “dropped.” Service providers surveyed reported feeling pressure as their consumers demand decreased prices due to increased competition alongside increased cloud and SaaS usage as well as other hyper-rationalization techniques.

This has forced larger AO providers to offer unit-based pricing in order to gain advantage over both the niche market as well as their competitors. Arora points out that “The reluctance of pricing model comes from buyers and rarely from providers. Providers have advanced solutioning engines, financial engineering, and estimation processes to ensure that they are competitive in whatever pricing model the client chooses over the deal term. Challenge is that clients have unclear expectations, poor baselines, or are apprehensive of newer pricing models. For example, moving from a T&M to an output-based or fixed price model needs to be backed by change in budgeting, forecasting, and governance process for client. Which in itself entails cost and diminishes the business case.”

However, automation and other standardizations may benefit service providers, as they are able to pass those savings along to their clients. Now common pricing transparencies are currently expected of AO service providers, who should also expect demands by consumers for added value to any price increases.

Everest’s report mentions that although insourcing will be a future consideration for some buyers as both a cost-cutting technique as well as a method of gaining control over operations, the report predicts that the shift will be included incrementally.

This article was originally published by NSAM’s sister publication Global Delivery Report.

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