IT Outsourcing Deals Gone Bad

Scores of articles and studies have highlighted the statistics around unsuccessful IT outsourcing deals – many establishing the failure rate at well above 50 percent. While the concept of IT outsourcing is not inherently flawed, the execution in many cases is – i.e., the classic distinction between “doing the right thing” versus “doing things right.”

Before embarking upon an IT outsourcing transaction, CIOs should recognize an immutable principle – there is a high probability that their IT outsourcing contractual arrangements will not survive the initial term and extension periods. Consequently, CIOs must thoroughly evaluate their contingency options to protect the integrity of outsourced IT initiatives should an engagement come off the tracks.

As a first step, CIOs need to develop a clearly defined exit strategy prior to executing the agreement, which, needless to say, is a challenging endeavor when in the throes of attempting to build a sustainable partnership with that same provider for the future. This goes well beyond standard termination-transition language and gets into tactical provisions such as:

  • requiring the exiting provider to provide incident management and asset data to the succeeding provider
  • retaining the rights to configured tools that have been used in the delivery of services, and
  • minimizing the financial consequences of a termination for convenience event (recognizing that proving “cause” is an incredibly arduous undertaking even under the most dire circumstances).

Identify the Root Cause
of Outsourcing Failure

For engagements already in progress, first ask the question, “What problem are we trying to solve?” The answer generally falls into one or more of the following five categories:

  1. The provider is failing to meet the agreed upon service level agreements (SLAs);
  2. The provider is meeting the SLAs but is failing to meet the non-documented performance requirements;
  3. Provider personnel quality is inadequate;
  4. Provider costs have become misaligned with the market; and
  5. Infrastructure and services have not been maintained at market leading levels.

Despite the notion that customers are generally complicit in each of these scenarios – either through failing to negotiate adequate protection in the underlying contract, enforcing the contract, or implementing appropriate governance – the second question becomes: “What is the best path for addressing the problems?”

Option 1: Restructure or Renegotiate the Existing Vendor Contract

As this strategy clearly has the potential to be the least operationally disruptive, unless the relationship between the provider and customer has become irreconcilably dysfunctional (or the provider has become financially unstable), this option should always be considered first.

That said, CIOs should be vigilant about time-boxing the effort. Allowing negotiations to drag on generally results in problems festering. The contract restructuring or renegotiation process should squarely address the core offending issues identified above.

For example, if the SLAs are being met but there is dissatisfaction with the overall performance, then redesign the SLAs.

If the quality of the personnel is inadequate, then (re)identify the key personnel positions, develop minimum qualifications for replacement personnel, and ensure that market-based key personnel terms (e.g., customers’ approval and dismissal rights, limitations on turnover, and financial consequences for failure to meet personnel requirements) are incorporated into the future contract.

If the rates have become misaligned with the market, give the provider the target rates and negotiate benchmarking or other terms to protect rates from becoming misaligned going forward.

Option 2: Time to Shop Around for IT Outsourcing Services

When deals go bad, the vast majority of customers ultimately decide to at least test the market through the competitive process. But, in the words of George Santayana: “Those who cannot remember the past are condemned to repeat it.” CIOs need to revert back to the underlying current-state issues when approaching the competitive market, but also understand and control the root causes of those problems.

While it’s relatively straightforward to draft an RFP and even negotiate an agreement with a new provider that addresses the problems on paper, a highly disciplined governance framework must be established to ensure that the contract, provider and internal customer stakeholders are tightly managed. For example, the most favorable key personnel language will not result in the delivery of the provider’s “A” team if the customer is reticent about invoking its right to cause the provider to replace underperforming personnel.

Likewise, best-in-class rate benchmarking provisions won’t result in rates being marked to market each year if the customer doesn’t trigger the benchmarking process. Even with a new provider contract and a world-class governance process, transferring services to another outsourcing provider is far from trivial. These types of moves are often transformative in nature (i.e., are done in concert with a major change in the underlying service delivery model), are extremely resource intensive, and often result in a near term degradation of service performance, albeit all with an expectation of sustainable performance improvements in the future.

Option 3: Repatriate Some or All of Your Outsourced Services

Clearly not for the faint of heart, this model presupposes that the only way to control one’s destiny is to own it. While it is unusual for companies to do wholesale insourcing or repatriation of outsourced work, companies are increasingly pursuing more surgical initiatives by carving out components of an outsourced service model and managing those services in-house.

Repatriation initiatives tend to focus on the high-value IT services, e.g., architecture, engineering, and level two and three support, rather than resource-intensive commodity services such as desktop support, level one helpdesk and managed network services. This is often the case as the outsource model for the latter highly routinized services generally offers a more competitive cost structure and absorbs the burden of hiring and retaining resources.

Those contemplating a repatriation model often still issue an RFP for most of the potentially in-sourced services in order to gain market intelligence as well as to create a safety net for an alternative decision.

While many first and even second and third generation IT outsourcing relationships become stale over time, CIOs who take the time to analyze all aspects of a deal before it is signed (or renewed) and keep their hands on the wheel throughout the period of performance can preclude many deals from going bad.

However, if a deal turns sour-due to an underperforming provider or otherwise-companies should be prepared to move swiftly. Setting in place a well-thought-out exit strategy-using powerful alternatives such as renegotiating, recompeting, or repatriating the work-safeguards customers and ultimately protects the IT initiatives at hand.

About the Author

Steve Martin is a partner at Pace Harmon, a third-party outsourcing advisory services firm providing guidance on complex outsourcing and strategic sourcing transactions, process optimization, and supplier program management.

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