In June 1996, IT services giant EDS issued a triumphant press release announcing a 10-year, £100 million contract to re-engineer and manage UK holiday operator Airtours’ IT systems.
The deal, EDS noted, was revolutionary. Under a so-called ‘risk and reward’ contract, the payments the company received would depend on how Airtours performed as a business. For its part, Airtours said it expected to save around £50 million as a result of the partnership.
Four years into the contract, however, the relationship broke down in acrimony. Airtours claimed EDS had failed to fulfil the terms of its agreement, while EDS said that some of the terms of the contract had changed, and that it hadn’t been happy with the way things progressed.
Getting out of the deal was messy. Airtours had to endure the painful process of bringing its entire IT infrastructure, as well as around 90 employees that had been working at EDS under the terms of the deal, back in-house. A year later it took EDS to court for breach of contract.
While relatively few outsourcing deals end up in court, many organisations find managing relationships with technology services suppliers complex, costly and time-consuming – particularly over the lifetime of a multi-year contract like the one Airtours signed.
According to a recent survey by Giga Information Group, 41% of respondents cited the day-to-day monitoring and management of their outsourcing relationships as the greatest challenge in dealing with third-party suppliers. Just over one-third said that getting suppliers to work together proved most difficult.
Why do so many outsourcing relationships run into trouble? Suppliers upset customers in a variety of ways – from breaches of service level agreements (SLAs) to inflexible pricing structures and contractual lock-ins. And if an implementation is delayed, costs escalate and relationships sour.
“By the third year of a long-term outsourcing relationship, significant tensions often exist between clients and outsourcing vendors,” explains John Kopeck, president of Compass Management Consulting. “Much of this tension can logically be attributed to changes in personnel, technological advances and an evolving external business environment, and shifts in strategic direction for one or both companies.” The upshot: outsourcing consultancy TPI predicts that around half of outsourcing deals in Europe will fail. Analyst group Gartner has also stated that the chances of an outsourcing deal succeeding is “about 50/50”.
But research also shows that the number of companies turning to managed service providers is continuing to escalate and, what is more, the average size of those deals is getting bigger all the time. TPI, for example, witnessed a 56% increase in the number of ‘mega deals’ it advised upon in 2002 compared to the previous year. Effectively managing outsourcing relationships with outsourcers is fast becoming a competitive differentiator.
What that means is that companies are having to accept more responsibility for building a successful relationship and for getting the contract right from the start. Stuart Payne, a director at IT advisory services company Morgan Chambers, says that many organisations sow the seeds of future troubles when they sign the initial contract. Here, says Payne, they make elementary mistakes, such as failing to identify clear business objectives and, consequently, designing weak SLAs to support these fuzzy goals.
But many companies also fail to understand that managing an outsourcer requires a whole new set of skills and working practices. “One of the really big issues is that clients have to learn how to manage the supplier, as opposed to telling their own staff what to do,” says John Hetherington, a managing consultant at Compass Management Consulting.
Rick Bacon, managing director of UK-based IT services company Parity, is well aware of these issues. In December 2002, Bacon was involved in signing off a £15 million outsourcing deal with BT, whereby Parity handed over its entire IT and communications infrastructure to BT. Before it agreed to sign the contract, Parity took around a year to come to a final decision to outsource, and one of the most difficult elements of the contract to agree was the SLAs. That said, Bacon is glad Parity spent so much time ensuring they were happy with every line of the contract. “No matter how long the process takes, [it’s far better to] get it right first time,” he says.
One of the overriding factors in making sure this happens is to have a governance team in place to oversee various aspects of the outsourcing project. According to Compass Management Consulting, poor governance is a major factor in around 70% of outsourcing relationships that fail.
Some types of outsourcing – for example security services, where mission critical information such as network passwords are in the hands of external suppliers – will need to be more frequently and closely monitored than others. On the other hand, an application development contract may require a significant amount of two-way creative input, so will be less formal but more ‘hands-on’. In both cases, performance levels are important, but the consequences of not reaching those service levels are very different.
UK insurer Royal &SunAlliance (R&SA) plans to create an in-house governance team of 150 staff to manage a five-year, £300 million business process outsourcing deal it completed with server and services specialist Unisys in February 2003. Within this team, R&SA will have about 70 finance staff to handle financial activities; 45 to tackle investment pricing and accounting; and the remainder will address contractual issues such as SLAs.
SLAs are, of course, a critical component of the outsourcing relationship. R&SA, for example, has established 60 SLAs relating to specific business processes, such as the time it takes staff at Unisys’ insurance services subsidiary (most of whom will transfer over from R&SA) to process changes in pension policies and telephone response times.
But SLAs are not the only metric organisations should use to manage their relationships with services providers. Payne at Morgan Chambers advises businesses to look for the ways an outsourcer can add value above and beyond the straight technical services it offers. For example, suppliers often commit to providing “technology leadership” in a contract, but they typically offer little, if any, tangible activity towards this goal.
Payne recommends that customers should pin suppliers down as to exactly how they will meet these obligations. Suppliers could give clout to the term “technology leadership” by bringing along Java or web services programming experts to a customer’s executive meetings, for example.
Another issue is skills transference – how existing employees will benefit over the lifetime of the contract by exposure to new technologies and approaches. Jay Gardiner, CIO of systems management software company BMC, spent $50 million on managing internal and external consultants in 2002 alone, and looks for far more than cost efficiencies from his outsourcing relationships. “Aside from the precise cost of the deal, I try and find out what my own employees will get out of the outsourcing deal in terms of skills transfer,” he says.
Ultimately though, any outsourcing relationship has to be mutually financially beneficial for both parties. Outsourcers typically want to make a pre-tax profit margin of between 10% and 12% from an outsourcing deal, according to Morgan Chambers, and it is important that the customer doesn’t seek to completely erode that.
Of course, there are times when the relationship between a customer and a services company breaks down irrevocably. In these circumstances it is vital that customers have clear exit terms and conditions in their contract. Payne at Morgan Chambers says that customers typically build into a contract exit conditions where the supplier helps them to move to another supplier over a period of six to 12 months.
When it comes to getting the contract right, however, it is usually the cultural fit between supplier and customer that is the deciding factor in the success of the relationship. “Outsourcing is a bit like a marriage – customers need to have their pre-nuptials in place before they sign anything,” says Paula Barrett, a partner in the IT and ecommerce group at law firm Eversheds. Getting those ‘pre-nuptials’ right may be a time-consuming and difficult process, but will pay off over time.