What Does It Take to Get IT Outsourcers to Innovate?

IT leaders say they want outsourcing providers to go beyond traditional services. And the providers want to market themselves as partners in innovation. So why isn't it happening?

John Smith had high hopes when Science Applications International Corp. (SAIC) took over Entergy’s IT. Before the New Orleans–based utility signed the five-year, $400 million contract in 2000, SAIC’s sales team described a rosy future in which it would lower Entergy’s IT costs and improve service levels on everything from application development and maintenance to data center management to desktop and infrastructure support. And more than that, SAIC said it could become Entergy’s partner in IT innovation.

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“A partner in innovation”—those were magic words for Smith, then IT director for Entergy’s Southern Nuclear fleet.

“We were looking for a company that would do more than just manage our IT service delivery,” says Smith. “One that would not just provide best practices and run IT like a railroad but could also provide some vision about where IT was going.” Smith, currently in a temporary role assisting in the reorganization of Entergy Nuclear, was particularly interested in SAIC’s nuclear domain experience and its ability to apply that knowledge to the introduction of new business-specific systems.

But as the relationship with SAIC matured, Smith’s disappointment grew. “Innovation was an expectation that wasn’t delivered on,” he says. SAIC met its service-level agreements (SLAs) and kept Entergy’s IT costs under control, but there were no new ideas coming from the outsourcer, no guidance about emerging technologies Entergy should pursue. In short, no partnership in innovation.

The Innovation Promise vs. the Innovation Reality

When it comes to why SAIC failed to meet Smith’s expectations, there’s plenty of blame to go around. Smith suspects SAIC overstated its ability to move beyond the traditional provider’s role of managing IT as a utility. He also admits that Entergy’s leadership was unable to figure out how to manage the relationship with SAIC in a way that would encourage that kind of strategic involvement. Perhaps most important, despite what both sides said, innovation was never officially part of the deal.

“When we were all sitting in the room, there was all kinds of talk about what might be possible,” says Smith. “And what was possible got sold a lot harder than what actually went into the contract.” (SAIC declined comment on its relationship with Entergy.)

Smith is not alone in his frustration. Forrester Research reports that 42 percent of buyers are dissatisfied with the innovation provided by their primary outsourcer. According to a recent CIO survey, 44 percent of respondents were unhappy with the innovation provided by offshore outsourcers. (Twenty-one percent were dissatisfied with the level of innovation provided by domestic providers.) Of course, these numbers don’t take into account IT leaders who are entering their deals with limited expectations or who are looking for more straightforward relationships with providers.

“When you talk to suppliers before the contract is signed, they talk innovation,” says Mark Kobayashi-Hillary, offshoring director of the National Outsourcing Association (NOA), a U.K.-based outsourcing trade organization. “Once it’s signed, they need to service the SLA. So you’ll find outsourcers that hit all the key indicators and still the client is not happy.” CIOs “look at the dashboard and see that everything’s green,” says Ben Trowbridge, CEO of outsourcing adviser Alsbridge, “but they still feel red.”

According to an Alsbridge survey of 300 buyers of IT services, the biggest gap between outsourcing benefits sought and achieved exists around innovation. The same research found that suppliers themselves say that their inability to innovate to client requirements is their biggest challenge.

As was the case at Entergy, both sides, customer and provider, bear responsibility for the failure to deliver on the promise of innovation. Though EDS or IBM may sell the idea of transformation, and offshore providers like Tata Consultancy Services (TCS) or Satyam may say they want to deliver higher value services, the former can’t afford to do so due to decreasing profit margins and the latter built their businesses on commoditizing IT services, not innovating. And while IT leaders may say they want something more than “your mess for less,” for the most part they’re still focused on price, according to outsourcing experts. Most IT shops, says Trowbridge, are unable either to manage the relationship with their outsourcers in a way that yields innovation or are ill-prepared to implement the changes they say they want. Even when buyer and seller think they’re on the same page, a clear definition of what constitutes innovation is rarely built into the deal.

That leaves CIOs with two options if they’re looking for innovation: Make radical changes to the way they establish and manage those relationships, or give up on the idea entirely.

The Innovation Debate

There are two schools of thought about whether IT organizations should look to outsourcers for innovation. “If you’re a big retailer and you’ve outsourced IT to IBM or TCS, those are the guys who are going to understand the way technology is changing, whether it’s SOA or green data centers or using Web 2.0 to reach the customer,” says Kobayashi-Hillary. “If you’re a bank or a utility, you’re not going to be an expert on social networks or how to utilize Second Life in the business. The service providers are.” Outsourcers, after all, have strong partnerships with hardware and software vendors. “They’re looking at the technology space, and their expertise and knowledge is far greater than what exists in our IT organization,” says Robert Taylor, VP of IS for the $14 billion design, engineering and construction company Fluor. “The folks there know where IT is heading and we’re looking to them to bring that expertise to us.”

Others disagree. “I’ve had a few IT executives tell me that they were disappointed that their outsourcing vendor hadn’t done much in the way of innovation. It’s an odd expectation, and a tough one to put into the contract,” says Jeanne Ross, principal research scientist at MIT’s Center for Information Systems Research. “Vendors will innovate to the extent it saves them money or helps them introduce new products or services, but that won’t feel like innovation to the customer.” For an outsourcing provider to offer competitive differentiation for a customer would be contrary to what they’re set up to do, says Barry Rosenberg, a partner with outsourcing adviser Pace Harmon. IT service providers make money when they can standardize processes across their customer base. You’re not buying an innovator, says Rosenberg, “you’re buying a factory.”

Outsourcing sales teams, however, haven’t gotten that memo. “The providers will tell you they’re going to transform your business,” says Gartner Research Director Dane S. Anderson.

“A lot of that is hype.”

Overinflated claims from salespeople? Say it ain’t so. But whether CIOs ought to expect innovative, transformational help from an outsourcer may be a moot point. Could they provide that kind of partnership even if they wanted to?

Perhaps not.

Tips to Get Your IT Services Providers to Innovate

Outsourcing providers are more likely to introduce innovative ideas if they’re hungry. That’s why Ed Hansen, partner in law firm Morgan Lewis’s global outsourcing practice, often advises his clients to take IT services that might be ripe for innovation out of the defined scope of services.

For example, if you’re on the verge of signing a $20 million outsourcing contract, $4 million of which is development work you’d like your provider to approach in a new way, make it a $16 million contract. “Give the outsourcer a position in your organization so that they can understand what’s going on in your business and give them the opportunity to earn that $4 million by coming up with innovative project ideas,” says Hansen. “It puts the economics back where it belongs.”

The idea of actually encouraging your provider to continue to sell new ideas to you after you’ve sealed the deal may be a turnoff to some IT leaders, but Gartner’s Dave Anderson says he’s seen positive results. A customer may hold regular brown-bag sessions, during which his vendor pitches new ideas. The client requires that the vendor bring a third party either to back up the sales pitch or weed out ideas that are purely self-serving.

Some ideas have been approved and turned into additional work for the vendor. “You don’t want to turn them into a bunch of used-car salesmen,” says Hansen. “But if you take them out of that guaranteed revenue position and treat them as a trusted adviser, it encourages them to look for new opportunities.”

They key words are “trusted adviser.” To get innovation you have to “trust the vendor enough to let them under the tent, sharing and getting ideas,” says David Rutchik, partner with outsourcing adviser Pace Harmon.

Not only do you have to give the vendor a seat at the table, you need to make sure you’ve got the right person in that seat. Hansen is currently renegotiating a nine-year outsourcing contract for a customer disappointed with the lack of value-added service provided by the vendor. The customer had stipulated that someone from the vendor sit in on CEO-level meetings, but that someone turned out to be the guy who “kept the lights on,” says Hansen. “You don’t want the data center guy in on those meetings. You want the former analyst-types to be part of that.”

Traditional outsourcing pricing models can also discourage innovation. “[CIOs] are starting to look at more innovative pricing models,” says Ben Trowbridge, CEO of outsourcing adviser Alsbridge. One organization Trowbridge advised chose to go with the one vendor who offered a business metric–based pricing model. The customer would pay the outsourcer $1.15 per claim that was paid. Period.

“The provider had to think of all sorts of innovative technology they could use to make sure that they earned as many claims as possible,” says Trowbridge. “The customer got the full benefit of working with a $20 billion outsourcing provider; the provider has a chance to increase its margins by sharing in the growth of the customer’s business.”

The SLA Trap

“Innovation and operating margins go hand in hand,” says Alsbridge’s Trowbridge. And U.S.-based outsourcers are getting squeezed. If you edit out the short-lived reprieve of Y2K and the dotcom days, outsourcing margins in the U.S. have been declining steadily since the mid-1970s and have flatlined at 6 percent, with just 9 percent annual revenue growth, according to Alsbridge. “When the crunch hits,” says Gartner’s Anderson, “outsourcers do the bare minimum to succeed.”

The financial pressure on domestic providers is the result of offshore competition, primarily Indian vendors who are riding high with double-digit profits. But don’t count on them to fill the innovation gap. “They didn’t get where they are by innovating,” says Kobayashi-Hillary, author of Outsourcing to India: The Offshore Advantage. “They got there by repeating the same processes over and over again.” Plus, they have their hands full managing their own growth.

Thus, outsourcers around the globe are loath to do anything that might affect their ability to meet their service-level obligations and thereby reduce their margins. “Providers are delivering to a contract, and it’s difficult to build any kind of innovation into the language of the contract,” says Kobayashi-Hillary. “There’s a difference between what you sat down and talked about with the outsourcer and what’s written in black and white. It’s just not in the supplier’s interest to proactively change anything.”

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