Let us begin this conversation with outsourcing itself. Outsourcing is a business practice in which services or job functions are farmed out to a third party. In information technology, an outsourcing initiative with a technology provider can involve a range of operations, from the entirety of the IT function to discrete, easily defined components, such as disaster recovery, network services, software development or QA testing. Companies may choose to outsource IT services onshore (within their own country), nearshore (to a neighbouring country or one in the same time zone), or offshore (to a more distant country). Nearshore and offshore outsourcing have traditionally been pursued to save costs.
The business case for outsourcing varies by situation, but the benefits of outsourcing often include one or more of the following:
1. lower costs (due to economies of scale or lower labour rates)
2. increased efficiency
3. variable capacity
4. increased focus on strategy/core competencies
5. access to skills or resources
6. increased flexibility to meet changing business and commercial conditions
7. accelerated time to market
8. lower ongoing investment in internal infrastructure
9. access to innovation, intellectual property, and thought leadership
10. possible cash influx resulting from transfer of assets to the new provider
Some of the risks of outsourcing include:
1. slower turnaround time
2. lack of business or domain knowledge
3. language and cultural barriers
4. time zone differences
5. lack of control

Now in your question you have mentioned that you are a tech start-up, which means you are into information technology (IT) outsourcing. Let us look at IT Outsourcing and discover the problems you might face. Traditionally, outsourced IT functions have fallen into one of two categories: infrastructure outsourcing and application outsourcing. Infrastructure outsourcing can include service desk capabilities, data center outsourcing, network services, managed security operations, or overall infrastructure management. Application outsourcing may include new application development, legacy system maintenance, testing and QA services, and packaged software implementation and management.

In today’s cloud-enabled world, however, IT outsourcing can also include relationships with providers of software-, infrastructure-, and platforms-as-a-service. In fact, cloud services account for as much as one third of the outsourcing market, a share that is destined to grow. These services are increasingly offered not only by traditional outsourcing providers but by global and niche software vendors or even industrial companies offering technology-enabled services.
The appropriate model for an IT service is typically determined by the type of service provided. Traditionally, most outsourcing contracts have been billed on a time and materials or fixed price basis. But as outsourcing services have matured from simply basic needs and services to more complex partnerships capable of producing transformation and innovation, contractual approaches have evolved to include managed services and more outcome-based arrangements.
The most common ways to structure an outsourcing engagement include:

A. Time and materials: As the name suggest, the clients pays the provider based on the time and material used to complete the work. Historically, this approach has been used in long-term application development and maintenance contracts. This model can be appropriate in situations where scope and specifications are difficult to estimate or needs evolve rapidly.

B. Unit/on-demand pricing: The vendor determines a set rate for a particular level of service, and the client pays based on its usage of that service. For instance, if you’re outsourcing desktop maintenance, the customer might pay a fixed amount per number of desktop users supported. Pay-per-use pricing can deliver productivity gains from day one and makes component cost analysis and adjustments easy. However, it requires an accurate estimate of the demand volume and a commitment for certain minimum transaction volume.

C. Fixed pricing: The deal price is determined at the start. This model can work well when there are stable and clear requirements, objectives, and scope. Paying a fixed priced for outsourced services can be appealing because it makes costs predictable. It can work out well, but when market pricing goes down over time (as it often does), a fixed price stays fixed. Fixed pricing is also hard on the vendor, which has to meet service levels at a certain price no matter how many resources those services end up requiring.

D. Variable pricing: The customer pays a fixed price at the low end of a supplier’s provided service, but this method allows for some variance in pricing based on providing higher levels of services.

E. Cost-plus: The contract is written so that the client pays the supplier for its actual costs, plus a predetermined percentage for profit. Such a pricing plan does not allow for flexibility as business objectives or technologies change, and it provides little incentive for a supplier to perform effectively.

F. Performance-based pricing: The buyer provides financial incentives that encourage the supplier to perform optimally. Conversely, this type of pricing plan requires suppliers to pay a penalty for unsatisfactory service levels. Performance-based pricing is often used in conjunction with a traditional pricing method, such as time-and-materials or fixed price. This approach can be beneficial when the customers can identify specific investments the vendor could make in order to deliver a higher level of performance. But the key is to ensure that the delivered outcome creates incremental business value for the customer, otherwise they may end up rewarding their vendors for work they should be doing anyway.

G. Gain-sharing: Pricing is based on the value delivered by the vendor beyond its typical responsibilities but deriving from its expertise and contribution. For example, an automobile manufacturer may pay a service provider based on the number of cars it produces. With this kind of arrangement, the customer and vendor each have skin in the game. Each has money at risk, and each stand to gain a percentage of profits if the supplier's performance is optimum and meets the buyer's objectives.

H. Shared risk/reward: Provider and customer jointly fund the development of new products, solutions, and services with the provider sharing in rewards for a defined period of time. This model encourages the provider to come up with ideas to improve the business and spreads the financial risk between both parties. It also mitigates some risks by sharing them with the vendor. But it requires a greater level of governance to do well.

IT organizations are increasingly looking for partners who can work with them as they embrace agile development and devops approaches. “Organizations are rapidly transforming to agile enterprises that require rapid development cycles and close coordination between business, engineering and operations,” says Steve Hall, a partner with sourcing consultancy Information Services Group (ISG). “Global delivery requires a globally distributed agile process to balance the need for speed and current cost pressures.”

Outsourcing is difficult to implement, and the failure rate of outsourcing relationships remains high. Depending on whom you ask, it can be anywhere from 40 to 70 percent. At the heart of the problem is the inherent conflict of interest in any outsourcing arrangement. The client seeks better service, often at lower costs, than it would get doing the work itself. The vendor, however, wants to make a profit. That tension must be managed closely to ensure a successful outcome for both client and vendor.
Another cause of outsourcing failure is the rush to outsource in the absence of a good business case. Outsourcing pursued as a "quick fix" cost-cutting manoeuvre rather than an investment designed to enhance capabilities, expand globally, increase agility and profitability, or bolster competitive advantage is more likely to disappoint.
Generally speaking, risks increase as the boundaries between client and vendor responsibilities blur and the scope of responsibilities expands. Whatever the type of outsourcing, the relationship will succeed only if both the vendor and the client achieve expected benefits.

Some of the notable pitfalls are as follows:

1. Switching providers instead of addressing root causes: IT leaders understand the importance of agility in the digital era, and they’ve put in place shorter outsourcing contracts — often with multiple providers — to maintain that flexibility and leverage. However, some outsourcing customers are too focused on changing providers and lose sight of the role their organizations play in the engagement. They “spend too much time trying to switch providers and not addressing the core issues,” says Wiele of KPMG, “which are going to be a problem with any provider.” IT service buyers should take the time to fully understand their role in a successful sourcing relationship rather than reflexively blaming the service provider.

2. Focusing on solutions, rather than problems: “The most common mistake is to take a technology focus, which is easily done given the substantial digital hype that’s out there these days,” says Ollie O'Donoghue, research director with outsourcing research firm and consultancy HfS Research. “Buying the latest shiniest toy rarely delivers results.” IT leaders instead need to invest time in determining what business problems they’re trying to solve, or outcomes they want to achieve, before signing any IT services deals. That means bringing business peers and users into the conversation. “Bringing in a diverse range of stakeholders from across the business will help bring in fresh perspective and will help reimagine challenges, or open the scope of an engagement to areas of the business that had previously been left out,” O'Donoghue says. Focusing on procuring the lowest price for pre-defined solutions is less common than in the past, says Abhishek Sharma, vice president of pricing assurance with outsourcing consultancy Everest Group. “Manifestations of this could be frequent change requests and demand for ad-hoc specialist resources that come at a premium fee, both of which dilute the business case and impact the confidence in outsourcing,” Sharma says.
3. Contracting for innovation: Companies are struggling to compete in the dynamic digital era, so it’s only natural that they look to their IT service providers for help. The only problem is that it’s nearly impossible to write an RFP for disruption. “Clients complain that they don’t get creativity and innovation from their service provider. However, they also want to run this procurement process in a traditional RFP manner with tight rules with no flexibility,” says Jimit Arora, a partner with IT services at Everest Group. “Our experience suggests that in a majority of situations it is not the service providers but the enterprises that are the true limitation for achieving innovation.” Clients that want something different must build an environment and culture that encourages that, says Steve Hall, president, EMEA, and partner, digital solutions at technology research and advisory firm Information Services Group (ISG). “Create innovation forums. Engage your business stakeholders. Engage the provider team and show respect for their ideas,” Hall says. “Innovation comes from leadership to create the conditions for innovation. You may not be able to execute on all the ideas but doing none of them is a sure way to dampen the creative juices of both provider and client teams.”
4. Relying on an outsourcing template: IT leaders should never defer to another organization’s approach. “Instead ensure there is thoughtful contemplation of organizational needs and think critically about how to scope and specify outsourcing transactions that add value in your unique situation,” says Marc Tanowitz, managing director for business transformation and outsourcing advisory firm Pace Harmon. “Outsourcing best practices require determining the proper scope, financial framework, and risk profile for your enterprise and its objectives, goals, and culture.”
5. Playing hardball on terms and conditions: Insisting on overly stringent terms during outsourcing negotiations can impact the provider’s business model and come back to bite the customer. “Certain contract tenets have a direct bearing on price and, in our experience across multiple engagement reviews, the cumulative impact could be as high as 5 to 7 percent of the total contract value” says Sharma. “While contracting, the objective of negotiation should be to ensure alignment with the organization’s requirements and not to put the provider in the tightest situation.”
6. Underestimating the human impact: Many IT and business leaders fail to plan for the significant change required in an outsourced environment. As a result, they tend to encounter significant barriers to achieving their intended outcomes. Too often, leaders assume their current organization can handle the new service delivery model until it suddenly becomes clear they cannot. “Don’t assume your staff in place is the right team to manage the services,” says Hall of ISG. “There are important relationship skills required to work with a third party — some people can learn them, some people never will. One difficult team member can break the work of many thoughtful people.”

IT leaders should “actively and honestly communicate, addressing specific stakeholder group concerns and needs,” says Anshul Varma, managing director with KPMG Shared Services & Outsourcing Advisory. Ensuring key employees have a secure transition process, developing retraining programs, and bringing in new talent as needed is essential.
7. Insufficient focus on transition: The hand-off from the retained IT organization to the service provider is a pivotal point in the outsourcing engagement, and one that requires significant planning and oversight. Companies that overlook transition strategy are likely to suffer delays in or loss of benefits, loss of stakeholder confidence and support, and business disruption, says Varma.
Outsourcing customers and providers should begin any engagement with a clear and agreed-upon understanding of the baseline environment — including processes, systems, service levels, volumes, contracts, and exceptions — and explicitly plan out the knowledge transfer process. They should develop contingency plans and mitigate the impact to key work activities, such as a company’s quarterly financial close, with overlapping staffing in the beginning, advises Varma.
IT leaders should also plan ahead for items with long lead times, such as technology that will have to be built or acquired or team members that need to be recruited. Most important, they should build a strong transition team or program management office capable of rolling with the punches. The key is to “be creative,” says Varma, “and not get bogged down with constraints too easily.”
8. Inadequately investing in governance: A robust governance model and framework — which includes the service delivery management team, business stakeholders, executives, and the vendor management team — is a must. “Without this, misunderstanding often occurs around who makes decisions and how they are made, where issues should be escalated, and who the relationship counterparts are between the two organizations,” Hall says. That results in infighting, degraded service, unmet demand, and cost overruns, says KPMG’s Varma. IT leaders should also note that the governance model and framework for the early stages of the outsourcing relationship will need to evolve for steady-state management, Sharma says. “Build the key stakeholders into the governance model and keep them involved.”
9. Managing by service-level-agreement (SLA): SLAs, which detail the expectations of service type and quality from a vendor and provide remedies when requirements aren't met, remain a critical component of any IT services contract. While well-thought-out SLAs are necessary, they are not sufficient to ensure provider performance in an outsourcing engagement. “Selecting and managing the right service levels is a critical process and a living process,” says ISG’s Hall. “It’s not once and done.” IT service buyers must review and look for ways to improve them throughout the life of the contract. “And while solid service levels are good, in the agile world providers and clients are turning to outcome-based contracting, using aggregated service-level metrics, to achieve better results in outsourcing,” Hall says. “This needs a strong governance relationship to work well.”

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