Is IT outsourcing still the answer?

Business may be booming for the providers of corporate services, but some of their clients are finding that the contracts are beginning to feel like straitjackets, says Mark Vernon. Business process and IT services outsourcing is booming: 30% of leading European businesses will include onshore or offshore outsourcing in their business and IT plans for 2005, according to research consultancy Gartner. 'Outsourcing is becoming the dominant way that enterprises buy IT services,' says Allie Young, research vice-president for the company's sourcing group. 'The outsourcing industry continues to evolve, but the imperatives for enterprises that are considering outsourcing are constant: focus on core business, access to critical technical expertise and optimised IT operations.'

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Last Updated: 31 Aug 2010

But look at the more mature partnerships: three or four years into the outsourcing of large, complex, multimillion-dollar front and back office functions, including HR, procurement and accounting, the strain is beginning to show. The problem often lies with the contracts that govern such deals and the fear that they may not be aging well.

For example, according to specialist outsourcing consultancy Orbys, only 29% of com- panies believe that outsourcing contracts do more than they were expected to - which suggests that most do far less. What's more, the evidence is that contracts are taking longer to bed in as they become more complex. In fact, contracts let after 2000 achieve lower satisfaction ratings than those let before the millennium. In other words, it could be that many deals will have to be renegotiated if they are to last the course.

If the critical issue is the long-term success of outsourcing, which is a relative unknown, the nub of the problem is likely to be familiar: outsourcing success relies on people as much as technology, and whereas technology is relatively reliable and predictable, people are not.

One way of looking at it is to point out that the kind of individuals who set up these deals are different from those who run the services.

Entrepreneurial types do the first, thoroughly enjoying the six to 18 months when tasks are set, staff are reallocated and benefits are identified.

But once projects are rolled out, they want to be off to the next new job, so a new set of individuals are brought in to manage the outsourced service. These people can lack the skills that lay behind the early success.

From this moment, the outsourcing project is under threat. If the company wants to make changes - which is very likely over a five to 10-year contract - those now in charge may well not be up to implementing it. If adequate management structures are not in place, outputs blur with inputs and then performance suffers.

A related problem that can arise stems from trying to change or get out of long outsourcing contracts. For example, a company may become involved in M&A activity or some kind of consolidation, necessitating a fundamental renegotiation of existing deals. Or, as companies outsource more business functions - perhaps adding HR to a successful first experiment in finance - renegotiation becomes vital to prevent two or more service providers pointing the finger at each other when these business functions overlap.

Lloyds TSB, for example, is in a contractual dispute with its existing voice and data networks supplier, BT, and this has delayed handover to IBM, the new supplier. Although the move was announced in April 2004, six months was not long enough to conclude the contractual negotiations, and the bank missed its handover date of 1 October as a result.

A different kind of concern stems from the point in the business cycle at which the outsourcing deal is signed. For example, according to Gartner, the IT services industry experienced only about 2% growth in 2002, the lowest for 10 years. Companies with tighter budgets and increasing pressures to meet short-term cost-reduction targets might then have been tempted to sign the lucrative long-term outsourcing contracts that were on offer.

However, the deal that was good in 2002/3 may not be such a good deal when the business cycle moved on into 2004. What can also happen is that the individuals who signed the deal achieved their cost-cutting objectives on paper and then moved on; 18 months later they feel no responsibility for the difficulties that emerge after the bedding-down period.

Alternatively, consider a recent trend in call-centre outsourcing. Outsourced call centres are increasingly beleaguered by complaints when located offshore.

NatWest's advertising campaign appeals to customers to switch accounts because it uses only UK-based call centres. Polls regularly show that customers are concerned about communications problems and the loss of jobs. Little wonder then that some call-centre companies are moving away from the commodity approach to providing the service - which has fired the growth of call centres in Bangalore and elsewhere - and are offering more sophisticated options.

Frank Foy, deputy head of Capgemini's UK outsourcing division, believes that companies will increasingly take a portfolio view of their global delivery, moving from simple offshore to the concept of 'Rightshore', a blend of onshore, near-shore and far-shore locations. 'More emphasis will be placed on transformation and innovation during the life cycle of a contract,' he says.

When it comes to outsourcing accounting software, Dennis Keeling, chief executive of the Business Application Software Developers' Association, believes that the trend to outsourcing some functions may be in reverse.

'We spoke to 600 accountants in industry and although 30% of them said they outsource payroll now, fewer than 10% of them said they would in the future,' he says. He suspects the reason is that payroll has become a lot easier to handle; being locked into an old outsourcing deal may therefore be expensive.

One way of dealing with the problem focuses on ways of sharing the long-term risk. Consider, for example, work done by the outsourcing services company Xchanging at Lloyd's of London. The insurer, operating in a highly competitive market, is working hard to improve services to its customers, both in terms of efficiency and effectiveness. As part of that, Xchanging formed a claims-processing joint venture with Lloyd's that commercialises the Lloyd's Claims Office. This new enterprise offers a range of comprehensive claims management services back to Lloyd's - hence the risk-sharing.

The challenge for such approaches is to ensure that the joint-ownership project does not stymie some of the benefits that outsourcing offers.

For example, companies want to get into outsourcing arrangements with a minimum of fuss and, perhaps even more importantly, want an easy means of exit too, which joint ventures may complicate.

Xchanging says that the answer is to realise that joint-owned companies will not suit all scenarios. Horses for courses is the mantra. It is generally the case that time spent upfront before any deal is signed is time that reaps rewards later, particularly in relation to large corporate business functions.

If things were to go wrong, exit strategies are relatively straightforward to devise from the outset.

However, Orbys believes, the fundamental problem is that organisations are too focused on initial contract procurement. Angela Wyatt, managing director, argues that this is to the detriment of longer-term business benefits, which include the general satisfaction levels of the service users and the management of their expectations. It is for this reason that the market is increasingly using outsourcing advisers - consultants who specialise in setting up contracts. Benchmark Research says that satisfaction levels can rise as high as 42% if such services are brought in at the early stage.

Wyatt's belief is that they should also be used to solve the pressing problem of post-contract disconnect. 'This is not to say that contracts written two or three years ago need to be ripped up and rewritten from scratch, though some may require substantial reworking if that is the only way to avert a crisis,' she notes. 'Rather, renegotiation needs to be built into the deal. It should be a continuous process.'

Gartner also believes that contracts need to be managed and maintained as much as any other commercial asset. Says managing vice-president Linda Cohen: 'The outsourcing deal must be flexible so that as business goals change, the deal will also change. Successful outsourcing depends on a perfect balance of trust and control between both parties. Long-term outsourcing deals are usually constructed to rely on control rather than trust.

'However,' she adds, 'organisational agility and the ability to create value require flexible thinking and creativity that goes beyond process excellence.'

WHEN OUTSOURCING GOES WRONG

For evidence that industry opinions on the wisdom of outsourcing are split, look no further than the October announcement by US finance giant JP Morgan Chase that it was taking its IT infrastructure programme back in-house. 'We believe managing our own technology infrastructure is best for long-term growth and success,' said CIO Austin Adams. The whopping $5 billion contract was awarded to IBM Global Services in 2003, but is to end next year, almost five years before its expiry date.

In an effort to find out what goes wrong with outsourcing, Leslie Willcocks of Warwick Business School, David Feeny of Templeton College Oxford and Mary Lacity of the University of Missouri at St Louis looked at hundreds of deals. Their work revealed that outsourcing can fail on three fronts:-

- Divergent expectations within the partnership

- Unsustainable levels of innovation over time

- Inappropriate application of an outsourcing model borrowed from another business function

HOW TO CUT A BETTER DEAL

Make sure your chosen provider has sufficient knowledge of your organisation on the ground.

Consider the human element. Highly commoditised models tend to underestimate the fact that staff who are not happy work at lower performance levels and, over time, offer less and less.

When outsourcing make sure that you don't lose the feedback between staff at the front line of the service and management. If you do, you risk developing a serious gap between what management think is happening and what is actually going on.

Don't rely on the headline numbers. Management transfer, travel costs and loss of productivity during transition, and subsequent developments can dramatically eat into savings.

Source: Orbys Outsourcing White Paper, 2004.

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