What is Value Leakage?

An introduction to Value Leakage in the context of IT sourcing.

Most simply put, value leakage in the context of IT sourcing refers to the gap between an actual business case and its initial expectations (usually in the form of a baselined business case). This typically appears as an increase in costs compared with expected costs.

However, value leakage should not just be characterized as an increase in anticipated costs, but also as missed opportunities to deliver benefits. And these may not have been identified in the original business case.

You may therefore think that all value leakage occurs post-signature, once the deal is up and running. Whilst this is often the area that gets the most attention, in reality, value leakage can occur at all stages of a sourcing process: deal design, contracting, implementation and in the post-contracting “run” phase.

Miles Underwood

Partner, Digital Transformation

KPMG Switzerland

Lutz Gerhards
Lutz Gerhards

Senior Manager, Digital Transformation

KPMG Switzerland

Pre-Contract Leakage

The path to value leakage is sown with good intentions. Programs are typically started to address specific business needs or objectives. However, once initiated, too often there is poor alignment between business and technical requirements, with the technical requirements being captured without sufficient consideration as to whether these are genuinely needed.  

The typical area where we still see this problem regularly occurring is with “gold-plated SLAs”, where e.g., availability or response time SLAs are contracted that are well beyond the actual business need. However, we increasingly see this situation also arising with contracting for modern cloud services, which typically come with predefined and fixed terms. While traditional SLAs may be renegotiated if they are later identified to be more than required, there is often little room to adjust the standard cloud services agreements prior to the renewal period, making it critical to properly assess and understand the service needs before entering into a contract. Failure to do so can result in the procurement of services that do not meet business requirements, leading to overpayment and value loss.

Following this thread, another common area concerns the precise articulation of scope. Poorly defined scope boundaries often cause a double whammy of value leakage. Firstly, there is an increase in cost if additional, critical services are added that were not initially identified in the design phase. Secondly, these are usually added post-signature when commercial leverage is reduced.

We see similar challenges when dealing with unknown deal-impacting variables during the contracting process, such as ticket or asset data. It may seem reasonable to deal with these unknowns with a post-contract verification process, but this is essentially kicking the can down the road, and often significantly impacts the eventual price of services, and consequently, the expected value.

The contract defines the supplier’s responsibilities and obligations. Therefore, within reason, if something is not in the contract, then the supplier is not obligated to deliver it. Safety mechanisms such as well-written sweep clauses will only provide limited protection. So the strategy of relying solely on the due diligence carried out by incoming suppliers to identify scope and any associated problems only sets the scene for commercial disputes and issues later in the relationship.

Post-Contract Leakage

It is likely that the reader will be familiar with most sources of post-contract value leakage, and these are often linked to the inability to capture the promised benefits. They generally fall into three buckets: a failure to implement the service (including transition), sub-optimal performance monitoring or ineffective governance.  

When it comes to implementation, the main cause behind value leakage is delay. Delays in transition, such as those related to the incoming supplier not ramping up resources or knowledge as quickly as expected, can quickly translate to a situation where it takes longer to start obtaining the expected benefits. It can commonly result in dual run costs or additional payments to extend support from an existing supplier, impacting further the expected business case. In our experience, most of the issues related to transition stem from clients and suppliers not spending the necessary effort up front in planning the transition (including an agreement on the toll gates that must be achieved to affect a seamless transition and to go live with a service), and then effectively managing the process.

In performance monitoring, value leakage appears in the form of services that have been paid for but not delivered. We see clients struggle with managing the complicated set of obligations that exist in big services contracts, which need to include client’s own obligations as well as the suppliers’. Some of these obligations are distributed across multiple contract schedules, but even the more obvious services can be under-managed, such as SLAs. The increased work and risk for SLAs represent a cost that is passed on to clients, and it is amazing how infrequently these are scrutinised, often with credits going unclaimed.  Furthermore, a failed SLA should trigger a root cause analysis process that looks at how similar failure can be prevented, which is often a value-adding process – yet, is often completely disregarded.

Financial topics are an obvious place for value leakage. There will usually be a wide variety of individuals (on both the client and supplier side) involved in the delivery of a service, and the associated invoicing for that service. On many occasions, these individuals do not have a detailed view of the contractual commitments, let alone a full understanding of the trade-offs and expectations discussed during the initial structuring and implementation of the deal. For deals with complex pricing mechanisms, this lack of information can lead to missed benefits, or in some cases, no provision for supplier bonus payments, resulting in nasty surprises! 

Furthermore, we often see that the rigor around the charging process, from initial quotations and purchase orders through to invoice payments, is sub-optimal. This ultimately results in incorrect charging for services and a divergence from the initially expected business case. These issues tend to arise in situations where there is ineffective governance, driven by organizations not having the capacity and/or capability to manage these partnerships.  

The Solution

An understanding of where value leakage occurs is a starting point but doing something about it in a sustainable manner requires both focus and investment. This is where the rubber hits the road: without sensible investment in value leakage prevention capabilities, a significant portion of expected third-party business case value can continue to slip through organizations’ fingers.