Five Steps to Take If Your Outsourcing Service Provider Is Sold

Merger activity is on the uptick among IT service providers and experts say the industry is ripe for more consolidation. Here's how to protect your company if your outsourcing provider is sold.

Future sale plans for outsourcing provider Affiliated Computer Services may be up in the air, but one thing is certain. More mergers and acquisitions are definitely in the cards in the IT services field.

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“The industry is ripe for another round of consolidation,” says Gartner research director Dane Anderson. “IBM is going around scooping up things left and right. It’s all part of the next iteration of M&A activity that’s going to continue to go on.”

The activity is not new. IBM has been buying up companies for years: more than 40 software and services companies since 2000. El Segundo, Calif.-based Computer Sciences Corp. announced a few weeks ago that it will buy First Consulting for $365 million. Last spring, EDS paid $380 million to acquire a 52 percent stake in Bangalore-based IT and business process outsourcer Mphasis .

And then there are the offshore outsourcers—cash rich, with high market valuations, and an eagerness to expand their footprint in the U.S., Europe, Latin America and Asia. “I expect to see more deals like Wipro’s purchase of Infocrossing a few months ago,” says Chris Pattacini, vice president for outsourcing consultancy Nautilus Advisors , referring to the India-based outsourcing giant’s acquisition of an U.S.-based infrastructure provider. “And I expect many clients will be looking for help dealing with these issues.”

Given what experts expect to be a consolidating market for outsourcing service providers, it pays for customers to be prepared. Here’s what to do when your IT services provider is sold.

1. Keep an eye on service levels and delivery.

Once a merger transaction is complete, it means change for companies delivering services. Delivery and account management staff may get reassigned, removed or replaced, and retained knowledge of the client’s environment—that is, familiarity with your operations—can get lost. This can lead to service delivery problems.

“Once a deal is announced, clients need to provide clear expectations and more actively manage vendor performance—both delivery and change management,” says Pattacini of Nautilus Advisors. Post-merger layoffs and turnover resulting from uncertainty can disrupt front-end service teams and compromise back-office support.

Outsourcing customers should make sure you have meaningful service-level agreements (SLAs) in place now, including penalties for services not delivered according to the agreement. Also make sure your contract gives you the ability to terminate the agreement upon a change in control of the vendor or at least be able to terminate for convenience at a reasonable fee, says Pattacini.

2. Look out for a change in stature with the vendor.

This often happens when a smaller IT service provider is snapped up by a larger company. Former big fish, meet much bigger pond.

“The customer may have been a large client at the original firm, but after the acquisition, they become a 'small' client of the larger firm,” says Pattacini. “This often translates to less attention from the vendor’s account management team.” It may not lead to any missed SLAs, but it can affect other key aspects of the relationship like change management and innovation.

3. Think long term.

You’re likely on solid ground for a time just before and after a deal is announced. The last thing a provider is going to do is ax an existing delivery model that’s bringing in profit or revenue, says Gartner’s Anderson.

Long term, however, is a different story. Find out as soon as you can where your business falls in terms of the new company’s strategic value proposition. “It’s rare that strategy changes that drastically,” says Eugene Kublanov, CEO of outsourcing consultancy neoIT. But if what you were paying your outsourcer to provide is not longer critical to the success of the new organization, that’s a cause for concern. It’s not a dire issue, says Anderson, but “you might choose to ride your contract out, and as it nears the end of its term, bring another provider into the fold. Most buyer organizations are constantly looking at their alternatives.”

4. Use your contract for leverage.

A good change-of-control termination clause gives a client leverage with the new supplier.

Customers can use it to negotiate for assurances of continuity among key outsourcing staff regardless of reductions in force or expanding service levels and related performance credits, says Randall Parks, cochair of the global technology and outsourcing practice at law firm Hunton and Williams. A change of control can also provide an opportunity to engage in a more comprehensive review of the contract and exit rights going forward.

5. Survey the new landscape in its entirety.

Don’t just investigate the obvious issues, like whether or not you’ll keep your account manager or the buying organization is planning to continue supporting mainframe services. Look out for potential problems around competitive issues, IP protection and the like.

“I had one client working with a vendor who went through an M&A and the company they bought was a service company with a software component as well,” recalls Kublanov. “And the software component was actually a competitor of the customer.” So the new outsourcer was actually in competition with its own customer. “They had to put up Chinese walls, get the lawyers involved, it got pretty hairy,” says Kublanov. “But the onus is on the new service provider to do that in order to convince the customer not to leave.”

In the end, it’s rare that an outsourcing customer up and leaves after its service provider is sold. The costs, risks to service levels, and disruption involved in transitioning from one vendor to another midcontract are usually deemed too high. The best plan is to stay engaged throughout the M&A process. “Not just through your account manager—because that individual could get reassigned or let go—but also further up the chain,” says Pattacini of Nautilus Advisors. “Clients should use this opportunity to expand their network within the larger vendor organization.”

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Copyright © 2007 IDG Communications, Inc.

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