How do you justify using a third-party vs. doing ourselves?
Recently I was with a room full of IT directors, discussing the importance of performing cost-benefit analysis before going to the management/board for approval. Someone asked, “How do you justify using a third-party, when we can do it ourselves? The math always makes it cheaper for us to do it in-house.”
The room split on that point and my immediate reaction was “not necessarily”, as both an accountant and a technologist, I love numbers, but to make an equation or a program work, you need to give it all the data. When determining the right answer for utilizing a third-party or staying in-house it is more than just the hours required to complete a task, there is a time value to money.
Why do you use third-party vendors?
If you believe that employee cost is a “sunk” cost and are essentially “free” why would you ever use a third-party? Today, few organizations are able to do all tasks in-house, specialization, technology, lack of resources and the speed of change has made it nearly impossible. While all organizations need to have a robust third-party relationship management program, to protect both themselves and the vendor, below are a few of the most common reasons third-parties are utilized:
- You need an independent view, oftentimes you have long tenured employees, which is incredibly valuable to the organization. It can also be limiting, sometimes having a new point of view to suggest updated processes, new technologies or to resolve specific issues is helpful.
- You need an expertise you don’t have internally, you can figure it out but a third-party can do it faster. For example, implementing a solution, selecting software, or conducting a fraud investigation, all can be done in-house, but third-parties have focused experts, contacts in the industry and often can share insights, discounts and leading practices.
- Share the liability, it requires specialized training and typically offers a guarantee of some type. For example, cybersecurity, the rules change constantly, requiring focus. Utilizing a third-party is often required as part of insurance policies.
- Just as vendors have specialties, so do your employees. There are many things that make your organization unique that only your employees can maintain, or special projects that would be best handled by people with institutional knowledge. Outsourcing tasks that will free time for your “institutional specialists” is a better utilization of resources.
- Is it cost effective? Today, many operational areas have been commoditized and have become very cost effective to outsource. For example low risk – repeatable tasks such as patching, everyone on Microsoft has to patch, rather than dedicating a resource to keeping up with all the alerts etc. you use a vendor that focuses solely on that task.
- Special projects, one-time needs, interim resources can back-fill or help perform needs in lieu of hiring. Mergers are a great example, there is a lot of work to be done in a short amount of time. Focus needs to be on joining the organizations but the day-to-day needs to be maintained. Everyone will pitch-in but there are only so many hours in a day. Using a third-party allows you to better meet the needs for a short time period.
How do you make the math work?
The goal of a cost benefit analysis is to confirm that the project has been thought out and all reasonable care has been given to include the costs and possible gains to the organization. In addition to a risk and benefits and assumptions statement a typical cost benefit calculation includes:
- Implementation fees: Include one-time set-up fees, software, equipment annual fees and monthly depreciation
- Monthly service fees: Volume or user based fees, typically ongoing for the life of the contract
- Other expenses: Expenses required to make project viable, marketing, and training, etc.
- Reduction in expense: Current expenses no longer needed, existing contracts, equipment, space, staff time (efficiency gain), etc.
- Projected revenue: Anticipated income based on project
After our discussion with the IT directors, rather than including internal resources in the implementation fees or considering a “sunk cost”, add another item.
- Internal-utilization expense: Include the specific resources, time allocation and an estimated rate. Add a comment field to include what project they will give up in lieu of this, or the number of hours they will work a week.
This will allow you to provide the decision makers the appropriate data, a true fully-costed internally staffed and third-party alternative. As well as the trade-off, if we spend time doing Project X, we can’t do Project Y.
Ultimately, there is a time value to money, as leaders we have to make the best decision based on the information provided.