In a marriage, it’s referred to as the seven-year itch – the time when partners may start to consider the long-term viability of their relationship. In the IT outsourcing world it takes about half that time for a client and vendor to start looking at each other with a suspicious eye.
often when the initial promises of reduced costs and efficiencies are realized, but now the client is wondering if the benefits will continue to flow in their favour.
“”As in marriage, when one party enters into a relationship with only financial gain in mind, the end result is typically disaster,”” says John Kopeck, president of Compass Management Consulting, speaking in Toronto recently.
“”A lot of these big contracts, from the vendor side, don’t make any money until about the third year; the break-even point is on average, three to four years,”” Kopeck said. “”From the client CFO’s standpoint, it looks great upfront because ‘You take some assets off my balance sheet, you take a bunch of people away. What’s not to like about this?””
But three years down the line when the vendor starts talking about their costs improving and IT per unit costs going down, client starts to get nervous.
“”Now all of a sudden it doesn’t feel so good,”” says Kopeck. “”There’s a fundamental disconnect that has to be worked out and the price of not working it out is to have these things fail.””
And while he says few deals are actually broken, many are threatened. That’s when the equivalent of marriage counselling comes into play. Kopeck says vendors are often keen to make the deals work out with a long-standing customer and avoid public scrutiny in the business press.
When Compass is asked to assist, Kopeck says the first thing they ask a client to consider is, What would the scenario be if it hadn’t outsourced or if it brought IT back inside the organization? What would the cost have been? Then compare it to average, best in class or some other target.
“”We tell them to ask themselves, ‘What is the reasonable expectation of what it should cost me?’ Then we say ‘Look at the price and see if it’s a fair markup?'””
Kopeck says some large organizations have decided to bring IT operations back in house after an initial period of outsourcing.
“”Usually it’s just dissatisfaction, couched in terms of ‘They never understood what we were trying to do.’ If you really ask them they will say, ‘We weren’t getting the cost benefits we expected or they never really understood us, they were a vendor, they weren’t really a partner.’ But you could throw that back at them and say, ‘Did you let them be a partner?'””
Compass executive consultant Dawn Willis says companies considering long-term outsourcing deals are doing more extensive work on the front end, making sure there is a structure in place to monitor what they want to see achieved.
“”Outsourcing governance is one of the key contributors to success. It’s knowing how to set up your deal, how work towards that goal over time,”” said Willis.
She said stewardship is required to make sure there is continuous improvement to quality as well as cost reductions and advises developing a flexible plan that ensures the client and service provider are on the same page in terms of relationship expectations.
At Ontario Power Generation (OPG) a 10-year outsourcing deal worth $1 billion is 18 months old. And while the relationship is still in its infancy, the organization is getting what it was looking for, says Stephen Shields, director of service management for the CIO organization.
“”What we asked for, we are getting and more. We have an aggressive service level agreement – higher than what we were able to give ourselves,”” said Shields, who agrees outsourcing governance is important to avoid any hiccups along the way.
“”Governance is like having a board of directors and senior management. The board sets targets but doesn’t get into the day to day management,”” he said.
OPG also entered into a gain-sharing agreement where Cap Gemini receives a portion of any additional savings generated from reduced costs or implementing new solutions.
“”The method we have with Cap Gemini is we want to drive down costs, so they gain more by saving us money,”” says Shields.
However, Kopeck says clients must be wary of vendors who might end up providing a basic, commodity service to customers only interested in driving down costs.
“”There is an inherent risk built into gain-sharing which is you’ve now incented your vendor to continuously find room for cost reductions. Be careful you don’t work your way into a trap where they are reducing service each year in order to find margins in that long term relationship,”” he said.
At this stage of the agreement, Shields doesn’t see it being a problem, but acknowledges that OPG is watching the relationship with Cap Gemini carefully.
“”John’s point doesn’t concern me, but it is something we do need to be sensitive to. In a strategic agreement, you need to keep your finger on the pulse and keep checking,”” he said.
“”A very large percentage of outsourcing deals fail because people are trying to extract every penny of profit. There are no long-term win- lose outsourcing agreements. You typically have win-win or lose-lose,”” said Shields.
When drafting objectives or service level agreements some organizations are going through a checklist that asks ‘If I do this, am I going to be motivating the right behaviour?’ Willis pointed out.
“”If putting some kind of pricing structure in place is going to cause people to do weird kinds of things to be able to capitalize on the pricing structure that’s not the kind of business you want to be in,”” she said.