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Figure 9.4 Risks flow both ways
This is particularly a concern for Type I providers who work with limited options in terms of market spaces, choice of customers and pricing freedom. The infrastructure must also be adaptive enough to support the differences among the business infrastructure and operative environments of several customers. Costs are a matter of fact while pricing is a matter of policy. Therefore service providers should have adequate controls to safeguard their interests in the long term, while continuing to support their customers flexibly through a wide range of scenarios.
On one hand, service providers must be sure that the compensation is complete and commensurate. On the other hand, the case they make should be reasonable. They have to take into account, for example, that certain returns on investments are not immediate but distributed over the lifetime of services and service assets. The risks they assume with new services and customers often pay off in the form of demand from other customers (from economies of scale) and demand for other services (from economies of scope).
Additions or changes to the Customer Portfolio should be preceded by an evaluation of risks that the service provider is willing to assume on behalf of the customer (Figure 9.5). Customers are similarly interested in filtering risks from service providers to an acceptable level. Risk Analysis and Risk management should be applied to the Service Pipeline and Service Catalogue to identify, contain and mitigate risks within the Lifecycle phase.
Figure 9.5 Risk management plays a crucial role in service management
Case example 15 (solution): A strategy for service risks
The service provider assures a minimum level of systemavailability in the event of a system failure. Though call centre services remained functional, the degradation in performance had a severe effect on the performance of business unit outcomes.
Besides protecting against system failures, there is a need to protect against service performance degradation, for instance, by isolating the business unit operations from the risks in its service provider operations. This can be done, for example, by dynamically routing callers to an alternative service unit with identical call centre service capabilities. The stand-by service unit is owned by the service provider or by a third-party service unit.
9.5.3 Service provider risks
Risks for service providers arise when uncertainty originating in the customer’s business combines with uncertainty in their operations to have an adverse impact across the Service Lifecycle. Risks materialize in various forms such as technical problems, loss of control in operations, breaches in information security, delays in launching services, failure to comply with regulations, and financial short-falls. The exposure to risks and resulting damages are measured in financial terms and in terms of the loss of goodwill among customers, suppliers and partners. While financial losses are undesirable it is at least possible to account for them and write them off against gains elsewhere. It is harder to measure or recover the loss of goodwill in terms of reputation, customer confidence and credibility with prospects. However, financial measures are easier to understand and communicate across organizational boundaries and cultures. To the extent possible, it is useful to communicate losses in financial terms, which are then used as indicators rather than direct measures.
Service provider risks vary by types of providers. The risk management plans and budgets of business units may cover their Type I providers. Type II providers operating with a market-based model assume a larger set of risks but stand to benefit accordingly. They assume risks similar to Type III providers in terms of marketing, new service development, financial liability and exposure to market-based competition. However, they distribute the risks across a larger customer base across the enterprise. They also have greater autonomy in managing the risks since they provide services on more commercial terms than Type I providers.
9.5.4 Contract risks
Customers depend on contracts as a means of implementing their own business strategy and achieving specific objectives, and as a means of allocating and managing most, if not all, operational risks associated with the business outcomes.43 The concept of ‘contract’ includes formal, legally binding contracts as well as less formal agreements between business units and internal groups and functions. Risks that threaten the ability of the service provider to deliver on contractual commitments are strategic risks because they jeopardize not only operations in the present but also the confidence customers will place in the future. For example, failure to increase the capacity of highly leveraged assets such as infrastructure impacts a wide range of contractual commitments. Infrastructure is a strategicasset, and risks that impair such assets are strategic risks.
Risks are associated with contracts and span the Service Lifecycle. They are identified and assigned to roles and responsibilities within the functions and processes of the Lifecycle. This ensures that the risks are placed in context and tackled with the right set of capabilities within the organization. The impact of the risks and the underlying threats and vulnerabilities may not be limited to any particular function of process (Figure 9.6). The customer does not discriminate between the origins of risks. Coordination is necessary across the Lifecycle to manage risk.
Figure 9.6 Contracts portfolios translate into a set of risks to be managed
The set of risks to be managed depends on the commitments, contained in the Contract Portfolio, which define the designrequirements and operational requirements to be realized through Service Models and Service Operation Plans. The combination of the two complementary sets of requirements determines the risks to be managed. Service Transition is instrumental in identifying risks in contractual commitments. The risk management is applied from the period before the commitments are made, through Service Design, until the commitments are fulfilled through Service Operation. Design risks arise from the failures or shortcomings in converting requirements into attributes of services and service models. Operational risks arise from technical and administrative failures in supporting the service model in operation. Together they determine a superset of risks to be managed actively across the Lifecycle.
9.5.5 Design risks
Customers expect services to have a particular impact on the performance of their assets, which is utility from their perspective. There is always a risk that services as designed fail to deliver the expected benefits utility. This is a performance risk (Figure 9.7). A major cause for poor performance is poor design. There is also a risk that the utility of a service diminishes with a significant change in the pattern of demand. For example, some services are designed in ways that prevent them from being scalable. In the short term, terms and conditions related to demand in service level agreements might protect the service provider from penalties. It does not protect them from changes in customer perception about the suitability of the service.
The problem may be two-fold. There may be a lack of formal functions and processes in Service Design, which is different from the design of software applications and enterprise architecture. Service Design implements the principles of service management such as separation of concerns, modularity, loose coupling and feedback. Some Service Catalogues list as services items that are actually service components, functions and processes. These typically are applications, infrastructure and supporting systems that have been offered as services by default and not by design. Customers begin to use them only to face problems later as defects and failures emerge in actual use.
Figure 9.7 Risks from customer expectations
It is better to institutionalize a systematic approach to Service Design so that opportunities and resources are not wasted early in the lifecycle. Service Design processes and methods are a means to reduce the performance risks and demand risks of services. They take into account the type of customer assets to be supported, how those assets generate returns for customers, and the characteristics of demand they impose on the service to be designed. Service Design defines the best configuration of service assets that can provide the necessary performance potential and accept not only a specific pattern of demand but also tolerate variations within a specified range. Good designs also ensure that services are economical to operate and flexible enough to modify and improve. This ensures that performancerisks and demand risks do not result in high costs of utilized assets or opportunity costs from unutilized or under-utilized assets.
9.5.6 Operational risks
Operational risks are faced by every organization. Contracts are risk-sharing arrangements in which customers transfer ownership of certain types of costs and risks to service providers (Figure 9.6). Two sets of risks are considered from a service management perspective: risks faced by business units and the risks faced by the service units. A more complex view of risk is considered by taking into account the risks across an entire value net that includes partners and suppliers. This shared view of risks may be much more difficult to manage but may provide better visibility and control since the risks interact with each other. However, customers expect to be isolated from the operation risks of service providers. Poor risk management on the part of service providers may expose customer assets to risks and consequential loss. Service management prevents that from happening.
The systems and processes of Service Transition are able to filter such risks between organizations connected through services. The capabilities in Service Operation convert operational risks into opportunities to create value for customers. Their effect of removing risks from the customer’s business is the core value proposition of many services.
Procedures in Service Transition must be robust enough to ensure that this filtering capability is actualized: schedule pressures are likely to lead to demands for early delivery of new capability without the agreed level of warranty, leading to tensions when the service falls below the agreed quality.
Value to customers is realized in the Service Operation phase of the lifecycle when actual demand for services arrives. Warranty commitments require every unit of demand to be met with a unit of capacity that is available, secure and continuous within a frame of reference. There are four types of warranty risks each covering an aspect of warranty (Figure 9.8).
Figure 9.8 Warranty commitments are a source of risk
The Contract Portfolio is the basis for analysing short-term and long-term trends in demand from various sources. Each contract is a source of one or more streams of demand, each with its own short-term variability. Address short-term shifts in demand reallocation of resources without significant investments in new capacity. This is to avoid the risk of under-utilized assets during periods of low demand. If the trend continues, plan ahead of investments in additional capacity. Address long-term shifts with not only new capacity but also review the Service Catalogue to identify opportunities for resource sharing and consolidation. This requires engagement of not just Service Transition but also Service Design.
When shifts in average demand are long-term or permanent shifts, the solution is often to increase source capacities (an expensive option). If the increase in demand is not long-term or not sufficiently large, then increasing capacity may result in under-utilization of assets in periods when demand is low. An option is to have ‘multi-skilled’ assets capable of serving more than one type of demand. Variability in capacity due to failures, outages, absenteeism, or any other forms of disruption can also be handled this way.
When demand fluctuations are short and intermittent, adjusting the capacity of certain types of resources may be difficult or not possible due to various constraints. Analyse the characteristics of various types of capacity to understand the constraints:
Asset specificity. The more specialized capacity is for a service, the lower its usefulness may become for other services unless the two share a significantly high number of characteristics. A point-of-sale terminal has higher asset specificity than a PC workstation or storage device that can be repurposed. Asset specificity applies to People assets as well to a certain degree depending on the type of knowledge, experience and skills. Multi-skilled cross-trained staff with general management and administrative skills can be deployed on several tasks.
Scalability. It is possible to adjust or reallocate the capacity of certain resources such as storage and network bandwidth. Other types of capacity such as facilities, hardware and headcount have tighter constraints.
Set-up or training costs. It takes time, money and effort to set up and bring to productive state or redeploy an asset for a new task, purpose, or service. Set costs include adjustments, calibration and testing for the asset to perform better in the new role or context. People assets incur similar costs in terms of transition between assignments, new training and supervisory load.
Dependencies. The capacity of certain assets is unusable without free capacity of other assets. For example, a high-speed printer is not usable unless it is provisioned on a network accessible to the user domain. Similarly, it is not possible to add additional staff to a service function or process unless adequate resources such as workstations, software licences, office space and financial budgets are allocated.
Overloaded assets. Certain capacity is blocked simply because it is already overloaded beyond a factor of safety. Because of commitments made in service agreements and contracts, no further demand can be allocated to such capacity. For example, if a service contract supports a mission-critical function of a customer’s business, no other service may access the capacity of resources dedicated to the contract.
A certain amount of idle capacity is required to maintain a given level of contingency. A capacity buffer or headroom is required to respond to unexpected peaks in demand. Trade-off exists between efficiency in utilization of resources and the service levels they can support (Figure 9.9). This constraint is particularly strong in shared services environments.
Figure 9.9 Higher load factors can create backlogs under certain conditions
Variability exists not only in demand but also capacity. The effective available capacity of a resource may vary as normal or because of failures or outages. Both types of variability affect the performance of services because of imbalance leading to backlog. Manufacturing systems overcome such problem with production planning and control techniques just as the kanban system for line balancing and redesign of process flow or assembly. Similar methods are applicable in the case of services. Six Sigma methods have been effective in service industries.
Strategic plans and initiatives that depend on the quick adjustments of productive capacity should take into consideration the inertia or resistance from capacity constraints to rapid adjustments. The processes for developing service designs, transition plans and operational plans should also include an activity or step that considers these constraints. The agility or responsiveness of a service unit depends on the mix of service assets. If service assets with high inertia dominate a service model, changes should be considered in terms of improvements or replacement of those assets.
9.5.7 Market risks
A common source of risk for all type of service providers is the choice that their customers have on sourcing decisions. In recent years, Type I providers have faced the risk of outsourcing when customers sign contracts with external providers in pursuit of strategic objectives. Customers are willing to make that switch when benefits outweigh the costs and risks of switching from one type to another. Reducing the total cost of utilization (TCU) gives customers incentives not to switch to other options. While outsourcing and shared services are the dominant trend, insourcing (or perhaps the affirmation of status quo) continues to be a valuable strategic option for customers. This is the risk faced primarily by Type III providers and to a limited extent by Type II providers. Effective service management helps reduce the levels of competitive risks faced by service providers by increasing the scale and scope of demand for a Service Catalogue. Conversely, another approach is to modify the contents of the Service Catalogue appropriately so that customers perceive the depth and width in the Catalogue with respect to their needs.
9.5.7.1 Reducing market risk through differentiation
How do you ensure good returns from investments made in service assets? How do you find new opportunities for those assets to be deployed in service of new customers? From a customer’s perspective services bring to bear assets that are both scarce (i.e. customers do not have enough) and complementary (i.e. there is value in combining the customer and service assets). In a controlled and coordinated manner, service providers are allowing their assets to be used by their customers for gain. From a corresponding perspective, all service providers must maintain the assets most valued by their customers but not adequately provided by others. Unserved and underserved market spaces represent the most attractive opportunities (Figure 9.10).
Figure 9.10 Uncontested market space based on underserved needs25
For example, business process outsourcing (BPO) corresponds to the need of customers to have access to world-class business processes in functions such as finance, human resources and logistics. Customers do not want to invest their financial capital into the research and development of such processes. Customers pay a fee for using the business process, or simply for enjoying its outputs (e.g. invoices, claims or applications processes). They are free from the risk of operating or maintaining the process and keeping it efficient and compliant. They simply pay for the delivery of a given service level. Service providers have a larger basis for recovering costs in the form of service contracts, so they continue to innovate, improve and control the performance of the business processes and its enabling infrastructure. Network effects and positive feedback set in when customers receive the expected value from the BPO provider and influence the decisions of their peers.
A service provider may see this as an opportunity. It may assume the risks of investing in the design, engineering and development of a set of business processes that it would offer as services. It would also invest in the automation and staffing of the processes, and in ongoing efforts to increase their effectiveness and efficiencies. By offering these business processes as services, the provider can spread the investment across several customers and reduce the risks of not recovering its investments.
9.5.7.2 Reducing market risk through consolidation
Consolidation of demand reduces the financial risks for service providers and in turn reduces operation risks for customers. With an increase in the scale and scope of demand there is a reduction in the costs to serve the next unit of demand (Figure 9.11). The cost of unused capacity is also reduced through careful grouping of demand. Similar demand from multiple customer organizations can be hosted by the same set of service assets or service units. Fragmented pieces of demand are matched with the capacity to fulfil the demand. This leads to economy of scope for those particular service assets. On the whole there is an increase in the average return of assets realized by the service unit, and a reduction in the variation in returns.
Figure 9.11 Consolidation of fragmented demand reduces financial risks
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