Dynamic Outsourcing: Realising Value through IT Partnerships

1. Dynamic Outsourcing: Realising Value through IT Partnerships R. Lemuel Lasher VP & MD for BAE SYSTEMS Global Account, & President CSC Research & Advisory Services 8 February 2005

2. Innovation agenda: What’s in a Name ? Innovation is only a means to and end; Customers don’t want Innovation, they want Economic Value. • Innovation in Account Management • Innovation in leveraging IT and Intellectual Capital • Innovation in leveraging Capabilities

3. Our working hypothesis: • The market for Outsourcing is booming. • Strategic Partnerships for outsourcing of non-core activities are now an accepted “option” in a companies strategic portfolio. • This is because companies have realized real benefits through the outsourcing of context activities to another company that is focused on these context activities as their core business. • These transactions deliver: • economies of scale through demand aggregation • improved service delivery • leveraged capabilities • However, the full potential of outsourcing remains unrealized. • The principle reasons for this is an inadequate appreciation of the fundamental management and economic issues underlying the strategy CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher3

4. To believe the promise, or to trust the belief? And the dilemma has wings…one is what we think are the issues, and the other is what they really are…. Outsourcing Vertical Integration I believe..... I promise.... But both are beside the point !!!!!!!!

5. Understanding the Challenges (1): • Businesses often outsource because they do not understand how to get business impact from IT • But that oftenmeans that they do not understand how to get business impact from outsourcing IT either • Many buyers say they want business impact and innovation, but few are willing to pay or work for it • Many providers say they want to deliver business impact, but few are committed to delivering specific business results CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher5

6. Understanding the Challenges (2): • Shifting assets to the outsourcer has short term appeal, but constrains long term business operational benefit • Long-term deals are financially attractive to both parties, but the resulting customer lock-in can adversely impact relationships • For all the talk of 'partnership', customers often regard outsourcers as suppliers to be squeezed • Suppliers have little incentive to achieve things that are really valuable for the customer’s business • Excessive focus on cost savings damages relationships and inhibits innovation • When the relationship is strained, management overheads increase and opportunities are missed CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher6

7. Understanding the Challenges (3): • Customer governance • Outsourcing IT as a means of getting rid of problems that stem from internal management and decision-making processes • ‘Core competence’ • IT being seen as peripheral to the main business of the organization • Tactical orientation • Focus on short term financial and management gains at the expense of the longer term interest • Contract rigidity • The desire for control offered by detailed contracts inhibits innovation and the flexibility needed to handle changes in requirements or capabilities • Gaming the system • The customer has maximum leverage before the contract is signed; the supplier has the upper hand afterwards – neither situation is healthy CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher7

8. Poor Governance Leads To Poor Performance – Outsourcing Makes It Worse Typical Outsourcing Governance Execution Control Execution • Too much focus on compliance; not enough on innovation • IT function isolated from business • Business isolated from IT • Outsourcing provider kept on the outside • Accountabilitynot clear • Poor communications • No mechanisms for collaboration • Lack of leadership and stakeholder buy-in Governance Committees Business Users Retained IT Sourcing Management Account Management Service Delivery Provider Client

9. So if this is all true, it all comes down to: Strategic Alignment Governance & Management Processes

10. So what can we conclude from all this ? When we decompose the value chain in a strategic partnership, even for context activities, the re-integration of the two companies requires the application of design principles that are grounded in sound management philosophy and economic reality. If it is not, we will introduce increased “friction costs” into the relationship. CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher10

11. Why reinvent the wheel, when we can stand on the shoulder of giants? • “There are two key behavioral assumptions around transaction cost economics: bounded rationality & opportunism • All complex contracts are unavoidably incomplete and many complex incentive alignment processes cannot be implemented, because of bounded rationality. • To rely on contract as promise is fraught with hazard, because of opportunism. • Added value will be realized by organizing in such a way as to economize on bounded rationality and to safeguard transactions against the hazards of opportunism.” • Align transactions, which differ in their attributes, with governance structures, which differ in their costs and competencies, in a discriminating way” Oliver E. Williamson University of California, Berkeley Williamson’s work provides the framework for understanding the drivers

12. What are the drivers of “friction costs” ? • Strategic Alignment • Cultural fit • Business objectives • Measures of Success • Governance & Management • Charter • Structure • Constituencies • Retained IT Function • Size • Skills • Roles • Processes: • Commercial • Administrative • COF • Billing • Asset mgt.

13. What are the consequences of this ? The Dead Zone: When friction costs rise such that the net benefits are below the cost of capital. Dead Zone Danger Zone High Worst Case Scenario Inefficient Outsourcing Scenario Optimal benefit of outsource Friction Costs Internal IT Expected benefit of outsource Low As is zone Safe Zone • Friction drivers • Strategic Alignment • Governance & Management • Administrative Processes Low High Economies of Scale Source: CSC Research & Advisory Services

14. The correlation between integration, aligned objectives and innovation….. Finding the right level of centralization As incentives to take risks decrease….. ….the ability to settle conflicts and coordinate activities increases corp. with autonomous divisions integrated corporation joint venture alliance virtual company Credit: Chesbrough & Teece HBR decentralized centralized

15. Matching Organization to Innovation Credit: Chesbrough &Teece HBR type of innovation autonomous systemic Ally with caution exist outside Go virtual capabilities must be created Bring in-house Ally or bring in-house To organize a business for innovation, managers must first determine whether the innovation in question is autonomous (it can be pursued independently) or systemic (it requires complementary innovations). They must also assess whether the capabilities needed to produce the innovation can be easily obtained or must be created.

16. The framework for resolution needs to include….. Alignment Change Innovation • Risk/Reward Contracts • Gain Sharing • Performance-Based Contracts • Codes of Practice • High Level Interactions • Joint Projects • Flexible Pricing and Benchmarking • Annual Reviews • Triggers • Refresher Clauses • Continuous Improvement Programs • Innovation Funds • Dedicated Staff • Innovation Centres • Workshops • Strategic Provocateurs • Consultation But how……. ?

17. Alignment and Management of Operational Objectives Innovation in Account Management

18. Improvement Continuous Framework • The Continuous Improvement Framework (CIF) enables one to respond and adapt in an incremental fashion to business change, and provides a dynamic mechanism for alignment of objectives. IT Base Contract Best Practice Markets The Continuous Improvement Framework CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher18

19. Key elements of the CIF • Articulation of Expectations • Identification of Domains to be addressed • Agreement on Principles • Statement of Intent • Objectives, Current State Assessment, Targets (metrics and dates) • Elements in governance, processes and reporting mechanisms • Alignment of Incentives with Objectives

20. Business objectives set the IT agenda • Each business objective has a domain of focus: • Customer Satisfaction • Service Delivery and Operational Performance • IT Cost Reduction • Procurement • Business Units Value Add • Enterprise/Shared Projects • Strategic Business Development UK and NA • Each domain of focus has: • Clearly defined ownership • A set of principles • A situation analysis • Annual objectives • Key milestones • Measurement and reporting mechanisms CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher20

21. Service Delivery and Operational Performance - Principles • We will measure what ever is necessary to improve service delivery performance, regardless of the contractual obligation • We will meet or exceed the contractual commitments we have made as expressed in SLAs. Where the contract encourages the wrong behaviors, we will change the contract • We will aim to achieve the enterprise SLA performance levels at each business unit, even though this is not required in the contract • We will ……. • We will …….. • We will ……. CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher21

22. Alignment of Operational Objectives within Business Groups Known Issues Contractual Obligations /Stretch Targets Customer Survey Results Discuss & Agree Enterprise CIF Objectives Enterprise CIF Objectives Business Group Specific Survey Data Discuss & Agree BG CIF Objectives Enterprise CIF Action Tracker Business Group CIF Objectives Flow up /Flow down loop Business Group CIF Action Tracker

23. Outsourcing Partner Business Representatives IT Executive Management IT Operational Management Bus. SteeringCommittee IT SteeringCommittee E-Business Steering Committee IT OperationsManagement Business/IT Management Give Soft Relationships A Harder Structure Through Joint Governance Strategic Governance B U S I N E S S I M P A C T Executive Committee Strategic Agenda OpportunityTracking Operational Governance Customer Input Ongoing Value Delivery Business Users Outsourcer Account Team IT Managers PerformanceTracking CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher23

24. Customer Intimacy Operational Excellence Service Leadership Lines of Service Data Center Operations Distributed/DesktopServices Intranet/InternetServices Technical Services Transition Services Security Disaster Recovery Procurement Services Network Services Applications Consulting Business Process Customer Support Services (Help Desk) Client AccountExecutiveTeams Client Market Service Definition SDM Facing Facing Service Delivery Managers Line of Service Managers ChiefArchitect CSC Service Delivery Model CIF= Dynamically aligned Objectives & Incentives, within the context of the contract

25. The Value Improvemet Programme (VIP) Innovation in applying IT and Intellectual Capital

26. The objectives of the VIP • As part of the CIF programme, CSC & Corporate IT have a joint commitment to identify opportunities in the BAE SYSTEMS business community where a value of £50 mm profit improvement can be made by the end of 2004 • This will • Address customer satisfaction issues • Demonstrating that we do understand BAE SYSTEMS’ business • Increasing our pro-activity • Applying our experience of industry best practice • To achieve this, we must • Re-focus CSC’s efforts and jointly look to CREATE BUSINESS VALUE, whilst continuing to improve delivery of the baseline services and other contracted obligations • Have the right conversations with the right people in the Business Groups and elsewhere • Apply a structured approach to this element of our Account planning

27. Four key principles of the VIP • The VIP will build on existing initiatives, and will not replace any of them • The VIP will not question the fundamentals of the Contracted Services - e.g. • Baseline services • CIF • Business Development/Pioneer, expansion opportunities • The VIP will not try to change the world for BAE SYSTEMS • We will be realistic about the business value prospects and obstacles • The VIP will be run with a light touch • Focus on client delivery, not CSC procedures • Minimal governance framework consistent with control and coordination • Avoid “programmitis”

28. 1. Where, and how big, are the value opportunities? 2. Map value drivers against CSC propositions 3. Craft CSC Solution Ouverture Config. Mgt. BPR Studios Xplorer etc 4. Map synergies and spin-offs 5. Model business case and PBT impact – does it contribute to the £50m? 6. Agree contractual framework etc and begin work We will match business-led solutions to the value hot-spots We will maximise client input and business value focus at every stage

29. Cost Reduction CSC consultants deliver cost reduction through programmes that reduce waste, rework, and resource utilisation. Cost metrics are set up to accurately measure the impact of cost reduction on a project. With sustainable business process management improvements, compounded cost reductions are achieved realising significant value during and beyond the full programme lifecycle. By enabling various BAE Systems ERP systems to connect to the online trading exchange EXOSTAR, CSC helped to reduce the cost of sending orders to over 2500 suppliers. Cycle times were shortened and the quality of data was also improved. The results of this project are estimated to realise a significant return on investment in the first three years, and cumulative savings estimated at US $30 million on procurement by 2010. “Together, BAE Systems and CSC turned IT consulting theory into automated processes and real cash savings.That is a partnership with real currency”. Chris Coupland, Director IT & e-Business BAE Systems. COMMERCE CONNECTIONPROGRAMME Consulting Association Silver Award 2003 in the eCommerce Category for Best Practice Management.

30. Revenue Growth A key driver for BAE Systems’ growth is its relationship with the Ministry of Defence (MOD). CSC consultants are often embedded in client facing projects and the benefits derived from their work have a direct impact not only on BAE Systems, but also on BAE Systems’ clients and partners such as the MOD’s Royal Air Force. Working in partnership with BAE Systems, IFS Defence, Xelus, and the RAF, CSC provided core project skills from concept through to delivery of a radical supply chain transformation. These included supply chain consultancy, solution design, business process design, project management, business analysis and systems analysis. This radical programme was successful in realising a number of tangible and measured benefits, the most important of which was exceeding the Royal Air Force’s own expectations. This achievement was acknowledged by the Ministry of Defence (MOD) when it presented the MOD Procurement Award to the NISC Team. INTEGRATED SUPPORT CONTRACT (NISC) – SUPPLY CHAIN Minister for Defence Procurement Award 2003

31. Optimising Invested Capital The lean manufacturing approach is designed to unlock value through greater control of the level of working capital tied up in the manufacturing, operations or service process. This means reducing waste, work-in-progress, lead-times, and inventories. As part of the highly successful Combined Maintenance and Upgrade Business Process Redesign Programme (CMU-BPR), CSC Consulting was engaged to introduce “Lean” methodology for increasing the efficiency of the maintenance facility at RAF Marham, involving a full-time team of RAF and BAE Systems’ personnel. Using tried and tested techniques the team rapidly identified waste, established root cause and generated solutions. These techniques incorporated industry standard lean tools and methodologies such as Kaizen, SMED, 5S, Poka Yoke and TPM. TORNADO CMU – BPR PROGRAMME Above: The BAE Systems and CSC team pictured with Dick Olver, Chairman of BAE Systems, and Conrad Holmes, Squadron Leader of Royal Air Force, at the BAE Systems Chairman Award Ceremony, Edinburgh, November 2004.

32. Risk and Mitigation The cost of capital for a business is directly influenced by risks in its business environment. Therefore, measures undertaken to mitigate business risk items have a positive effect on value. Diminishing the risk register has a positive effect by releasing cost accruals and improving the profit margin. Taking the role of design authority for the design and build of a new class of nuclear powered submarines introduces significant risks of rework or programme delay. BAES identified effective configuration management (CM) as a key success factor. CSC Consultants were engaged to support the development of a comprehensive approach to CM, delivering improvements to relevant processes (particularly relating to the definition and control of baselines and the operation of the change management regime), systems (notably the introduction of a web-based document control solution) staff awareness and performance monitoring that have significantly mitigated the CM risks. THE ASTUTE CONFIGURATION MANAGEMENT

33. The North American Strategic Alliance Innovation in leveraging Capability

34. Summary Points on Strategic Alliance • Initially set up in August, 2001 to introduce each others capabilities and identify opportunities • Key Governance Principles agreed, including a commitment to identify and pursue opportunities that both parties believe we create a compelling competitive advantage when we combine our capabilities • By March 8, 2002, next meeting was held: • $50 mm of signed teaming agreements • pipeline of opportunities of $2 B • Since 1 January, 2002: • 41 contract wins of $1,089.22 mm • 35 contract wins where CSC is prime with value of $989.13 mm • 5 wins where BAE Systems is prime with value of $97.13 mm • One JV with a value of $2.86 mm • Total contract awards from CSC to BAE Systems in 2004 was $100,465,292.

35. Concluding points: • Opportunism and bounded rationality are the most fundamental human behavioral elements affecting the relationship. • Align objectives, goals and incentives to mitigate opportunism. • Align the organization and governance to business intent, process maturity & transactions to mitigate bounded rationality. • Strategic clarity on the optimum areas of focus for Innovation, within the context of level of vertical integration and the scope of the Partnership, is essential in order to properly define what Innovation means to both parties. • Govern collaboratively – include your partner in your governance structure. • Manage ambidextrously – make contracts flexible and give relationships structure. • Demonstrate commitment through the right behaviours. CSC Proprietary 9/3/2014 9:19:54 PM IE2004 Lem Lasher35

36. The CSC Office of Innovation

37. CSC Office of Innovation Goals • We are standing up formally an Office of Innovation, Solutions & Alliances, which will report into CSC’s President & COO; the goals of which will be. • Increase Market Impression of CSC Innovation Leadership • Bring CSC Innovative Solutions and ValueAddedServices to the market: (Most clients will have a mix) • Emergent Value Added Services • Discrete Directed Solutions • Harvest and Leverage Innovation from CSC and marketplace experiences worldwide • Instill Innovation in CSC People and Culture

38. CSC Innovation Programs Spectrum Baseline Value-Add Strategic CKP Executive Exchange Leading Edge Forum Research Services Accent 3 Innovation Administrator Client Innovation Center Client Innovation Project CSC Centers of Excellence Applied Innovation Workshop Innovation Process Manager Innovation Program Office CSC/Client Innovation Venture Technology Advisory Board

39. Innovation activities considered along a spectrum (LOS & Customers ContinuousImprovement) NewSolutionDevelopment SolutionCommercialization IdeaGeneration Client and LOSInnovation SolutionCommercialization Leading EdgeForum ResearchServices KnowledgeBrokering GlobalAlliances GSO • Identify leading-edge technologies and marketplace ideas • Provide CSC point of view on emerging technologies • Stimulate innovation in CSC and client cultures and manage Centers of Excellence • Research emerging business/IT needs and trends with clients, academics, and CSC thought leaders • Provide CSC points of view on key business/IT issues • Influence development of CSC’s solutions and marketing • Establish standards and processes for capturing and sharing info across the enterprise • Assist the BU’s and LOS in capturing relevant content(BU’s own the actual content) • Establish strong partnerships with leading business and technology Co’s globally • Jointly examine potential leading-edge solutions to solve customer problems • Serve as contact point for partner information • Coordinate the development (led by LOS) & operationalize specific solutions to solve identified customer needs • Work across the enterprise to bring maximum benefit of all CSC’s capabilities to customers

40. Leading EdgeForum Research AdvisoryServices Global Alliances GSO Customer Innovation Input Leads to Tailored Client Plans Customer Input and Feedback Customerand AE CSC InnovationCapabilities Technology/SolutionLife-Cycle Process CSC Office of Innovation OperationalFeedback/ ContinuousImprovement High-Level Technology Tracking Deploy Solution Develop Solution Investigate Technology Evaluate Technology Level of Maturity Reached Potential, Anticipated Business Value Quantified Savings or Revenue Stream SOE Build Docs Procedures Developed Client Plan IndustryLeadership BusinessResults