Seven deadly sins of outsourcing

Seven deadly sins of outsourcing

Everybody's doing outsourcing, but not always well. When a deal goes south, you can bet it's because someone committed one or more of our deadly sins. Michael Durr looks at the outcomes. Read on and be saved!

Two ever-popular information technology (IT) news items are the droves of companies doing outsourcing and the large number of older outsourcing deals being renegotiated. Clearly, many enterprise and middle-market companies have confidence in outsourcing. IDC says that last year the US market for IT outsourcing totalled $US45 billion and should hit $US72 billion by 2001.

Too bad not all of these players will avoid the pitfalls that have already sunk numerous deals.

Some renegotiating is unavoidable, of course. IT outsourcing encompasses tricky areas such as cutting-edge technologies and newly crafted business objectives. Very few contracts forged even four years ago, for example, could have anticipated major shifts like the Internet or global business strategies. Contract terms and conditions must change as new forces dictate, so the rate of renegotiations may even increase.

But that's not to say many outsourcing problems, restructuring, and terminations can't be avoided. Over 10 years experience has taught the industry much about best practices. Likewise, certain universal missteps are now painfully clear. These we call the seven deadly sins of outsourcing:

Ivory-tower goals

The ultimate deal killer is unrealistic goals. And not just client goals; companies on both sides of the outsourcing equation need sensible objectives. "Many deals put together from the late 1980s through 1994 were either made for the wrong reasons or had no clear business goals, period," declares Linda Cohen, research director for The Gartner Group.

Client companies, for instance, harboured the unrealistic belief that outsourcing would save money. At the same time, service providers were busy buying business, building deals without practical profit margins. Neither goal was sustainable, and most contracts built on these premises subsequently disintegrated.

Today, integrators and service providers are more inclined to shun the buy-business tactic, but nevertheless they need a precise understanding of the outsourcer's goals, as well as confidence that those goals make good business sense.

From the client perspective, the presumed payoff of IT outsourcing remains confounding. Cohen says a realistic outsourcing goal is to control costs over time - but that doesn't mean the client saves money on IT. Actually, it's a safe bet the spend rate will grow right along with the cost of technology services.

Half-baked due diligence

A hoary chestnut is that due diligence is crucial to successful outsourcing. But when it comes to doing the work, many companies botch due diligence even as they pledge allegiance.

Due diligence means that both parties fully understand the scope of the environment covered under the contract. For example, enterprise clients often have no idea how many seats or PCs they have, where they are, or whether they're LAN connected.

"We've seen contracts in which clients are 30 and 40 per cent off the actual number of seats," reports Tony Macina, general manager for IBM Global IT Services' managed operations business unit. Because it's so hard to determine the scope of the engagement, the amount of standardisation, and the required service levels, Macina says sometimes his firm sets aside the first year as a due-diligence period.

During this time the provider does the work while learning about the organisation - before the final outsourcing contract is signed. "Doing it this way lets you get your people in and understand the environment," Macina says.

Due diligence also means putting your own company under the microscope. This includes standard practices like checking references and interviewing the team doing the work. And don't forget that subcontractors will be part of that test.

"The prime contractor must be excellent at managing subs and had better have solid relationships with whomever they bring to the deal," cautions Gartner Group's Cohen.

She recommends that client companies drill down, ask about the relationship, ask how the sub is paid, and talk to the subcontractors.

No buy-in from client staff

Achieving full acceptance from the people inside a client company is all part of due diligence. You can't satisfy the client if different groups in the enterprise are defining satisfaction differently. A classic cross-purpose is when one group in the client company expects expertise and another group wants cost savings.

Senior managers may opt to outsource because they think their own IS department is ill-prepared, explains Chuck Jarrow, US-based director of marketing for CSC. These executives want to infuse new talent and techniques, but they don't explain this to IS personnel because they don't want to hurt anyone's feelings.

In this situation, says Jarrow, the IS department is evaluating the vendors and trying to get the price down as much as possible. Meanwhile, they unwittingly price themselves out of the additional skills top management really wants.

Mismatched clients and providers

Outsourcing is an area of IT services where the small-fish/big-pond strategy often fails. Middle-market customers, of course, want large, tier-one companies as service providers - doesn't everybody? But integrators with vast resources and billion-dollar IT contracts simply aren't inclined to devote the same resources to smaller firms that they give big-marquee companies. Deals with the smaller customers tend to sour quickly.

According to Robert Evans, vice president and general manager of outsourcing for Unisys' North America operations, it comes down to selecting a provider that wants the business.

"Our market isn't the billion-dollar deal," says Evans. "A $100 million annual deal is an extremely important one to us. The client will get our best resources. The value proposition for one of the top four outsourcers is far less than for a tier-two player."

Chuck Jarrow of CSC, a tier-one outsourcer, admits there should be differences in the approach to large and small clients. With the former, you need to be very flexible, he says. In the small end of the business, large providers need a set offering.

"It's that replicable nature - standard contracts, standard service levels, actual cookie-cutter products - that make it cost-effective," notes Jarrow.

A standardised approach can provide a fine-tuned but low-cost solution. It may not be flexible. Because of the rigidity, clients are either going to love it or hate it.

Failure to secure staff

With all the hoopla about dollars and technology in IT outsourcing, it's easy to forget the human element. Most deals hinge on the successful transfer of IT staff from the client to the outsourcer.

If the outsourcer has to create a new department, costs rise and productivity often takes a nosedive while new people are recruited.

The problem starts when word spreads that the company is planning to outsource the IT department. Employees see their jobs going away, faced with an uncertain future with a new employer. Today's IT job market suffers negative employment (more IT jobs than qualified people to fill them), so many workers decide it's time to circulate the resume.

There is a need for strong communication from both the client and the outsourcer to IT employees. In most cases, benefits packages are preserved and IT career paths are structured to gain from the transition. Those messages have to be spelled out loud and clear.

Scanty client-side staff

Unfortunately, the term "outsourced" has the sound of finality to it. Goodbye, IT problems. Many companies have followed that siren song straight to disaster.

The client company still must budget for a strong internal staff. This team should meet regularly with the outsourcer to discuss new plans and any changes in requirements, and to generally maintain a high level of contact between the outsourcer and the client company. It's in your own best interest to lobby for this line item. Otherwise you're placed in the perilous position of reactive mode - the only time you'll hear about something is when the client becomes dissatisfied.

No carrots

The last, but certainly not least deadly, sin is the lack of a performance incentive. Performance incentives are crucial because nobody "owns" IT. Like customer loyalty and market position, it's always a moving target.

Most client companies know this and know that the chase is tough, which is a big reason for the popularity of IT outsourcing: let the pros do the running. But how do integrators motivate their people to continue the chase, which is expensive, after the contract is signed? Performance incentives, of course.

Incentives aren't a new idea. In theory, an outsourcer receives part of its compensation based on performance, and the money can go up or down depending on results. In practice, contracts usually end up with too many sticks for under-performance and no carrots for over-performance.

But that's changing. Today it's more common to tie incentives to business objectives than to IT objectives. Using this model, recent alliances have put new spins on the performance incentive concept.

Crafting the contract

Bad contracts can kill an outsourcing deal. These few tips on what needs to be in a successful outsourcing contract can save time, money and endless headaches.

Avoid TBDs like the plague. Many outsourcing contracts leave several issues "to be determined" (TBD) at a later date. These are questions the two parties don't have answers for now but plan to answer 60 or 90 days after signing the contract. The first hitch with TBDs is that they seldom get resolved. The second - and worse - problem is that they open up negotiations all over again.

TBDs can usually be avoided with due diligence. The best policy is to refuse to be driven by an arbitrary contract-signing date. Clear up all TBDs and then sign the contract.

Give clients a way out. Length of engagement is often a stumbling block in negotiations. Some large integrators and IT service providers like 10-year deals because shareholders like them. After all, those 10-year revenue streams float some pretty big numbers.

On the other hand, clients tend to itch at the thought of a commitment lasting more than five years. It's mostly a perception problem. Every outsourcing contract has a termination-for- convenience right that can be exercised after some period. Clients need to understand that clearly. Then, if they can get a better deal by signing a longer-term contract, they should do it.

Give yourself flexibility. Outsourcing contracts are long-term agreements for services that are inherently subject to change. Business models change as new management teams come aboard; technology changes almost overnight. The challenge is to write an agreement that captures the business deal but also is flexible enough to accommodate change.

This includes anticipating a possible end to the deal. Contracts should cover in detail termination or expiration-related activities - for example, the vendor's service obligations during the transition. Termination rights should be keyed to changes in the business or the technology.

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