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?

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Indeed, most outsourcing SLAs and pricing models deter innovation. Take data center management. It’s the outsourcer’s responsibility to ensure 99.99 percent uptime or provide backup services. “The value add would be when the service provider looks at the environment and says, Now I understand how you support your business and I see that by leveraging this new technology or different hardware, we can improve the quality of the service or your costs,” says Taylor of Fluor, which is on its fourth major outsourcing contract since the mid-1990s. “But you’re paying the vendor X dollars per server so there’s no motivation for them to reduce that number.”

“There’s so much change management embedded in outsourcing processes to prevent them from missing an SLA, their ability to innovate to support our business is very limited,” agrees Robert Fecteau, CIO of BAE Systems Information Technology, a line of business within the U.K.-based BAE Systems. Fecteau was hired in 2005 to oversee the backsourcing of U.S. IT services previously outsourced by its parent company in a $2.2 billion, six-year IT contract with CSC. (The rest of BAE Systems will continue to work with CSC as “a trusted partner critical to our success,” says Fecteau.) According to Fecteau, BAE’s outsourcing had been driven by a desire to cut costs. (In addition to the design, manufacture and maintenance of military vehicles and equipment, BAE Systems provides IT services.) But there were trade-offs.

“It’s very difficult to write a contract with an outsourcer that says, ‘Give me more innovative IT processes,’” says Fecteau, who will complete the backsourcing process during 2008. “They’re not there to transform your organization,” he continues. “They’re there to deliver IT as a commodity.” Fecteau should know since BAE Systems is itself in the outsourcing business. “The very nature of outsourcing naturally restricts innovation,” he says.

Processes further inhibit the kind of client-vendor interaction that would yield innovative solutions. “I don’t think the big outsourcers do well with customer intimacy,” says Fecteau. “They’re huge, matrixed organizations with revolving doors. You never know who’s coming in on a given day.”

“We would clearly disagree with any assertions that large outsourcers such as CSC can’t bring innovation to outsourcing engagements,” says CSC spokesman Mike Dickerson. “In this case, BAE Systems’ decision to insource certain operations was based on a long-term strategic objective to grow its computer services business in the federal IT services market, an area in which we obviously compete, and is not a reflection of the services provided by CSC.”

If you really want innovation, you can get it, says Fecteau, “but you’ll pay for it.” Dearly.

You Get What You Pay For

That gets at another impediment to innovation and one that’s squarely in the customer’s control: price tolerance.

“U.S. providers may be able to come up with new offerings that provide innovation, but at what price?” says Trowbridge. “They may come up with great ideas but if the price point is off, CIOs won’t buy it.”

CIOs may not start off looking for the lowest price; they may have big ideas about transformation and innovation. But somehow, as they move from RFP to final selection, price almost always becomes paramount.

“First there’s talk about how we’ll be partnered forever,” says NOA’s Kobayashi-Hillary. “But once you get to the final stages of the RFP and the only people left in the room are those competent enough to handle the job, it comes down to price.”

Trowbridge ascribes this process to human nature: “People like watching the vendor grovel and getting them to come down in price. The client deal team comes back and everyone congratulates them on how they kicked the vendor’s butt.” But negotiating the vendor out of a profit helps no one. Says Trowbridge, “You get what you pay for.”

In 2003, Fluor signed a $351 million, seven-year contract with IBM Global Services, one of Big Blue’s hallmark On Demand deals that year. In a press release, IBM said the deal would result in “substantial cost savings to Fluor…the streamlining of numerous core work processes…and flexible usage-based pricing that enables Fluor to access computing resources as needed to support growing businesses.”

How’d that work out?

It didn’t.

“They were not innovating; they were not working as a partner for innovation,” says VP of IS Taylor. But he doesn’t blame IBM alone (which declined to comment on its relationship with Fluor). “We were putting the entire relationship in a place that’s just commodity-based,” admits Taylor. “If you want to say, ‘Give me some value add,’ there was no way for [IBM] to get compensated for that under the contract.” Once price becomes the primary focus, you’re locked in. “If you approached outsourcing as a price play, but now you want innovation, it’s hard to move the provider around to that way of thinking,” says Ed Hansen, partner in law firm Morgan, Lewis & Bockius’s global outsourcing practice.

“You can’t change the business model on them in the middle of the deal.” The provider didn’t build in any governance dollars for innovation, and chances are the buyer didn’t either.

It’s no wonder that the IT leaders who are reportedly most disappointed with the level of innovation provided by their IT service providers originally engaged in outsourcing to cut costs or because of competitive or business pressure, according to CIO’s survey. That was certainly true for Fluor. “We had gotten too big in terms of cost, and we wanted to improve efficiency and consistency globally,” says Taylor. And when measured against those objectives, he says, “outsourcing was the best thing we did.” But it hardly lent itself to outside-the-box thinking.

“You put the vendor in a narrow box when you say we want you to do this well and less expensively,” says David Rutchik, a partner with Pace Harmon. CIOs may have more of a shot at innovation on marquee deals, Rutchik says, “but [innovation] still has to be a function of the customer’s knowledge of his own business and processes, what he really wants, and his ability to articulate that.”

What Happens After the Ink Dries

According to CIO’s survey, impediments to innovation include cultural and communications issues, the lack of skills within the supplier, internal resistance and internal budget restraints. But the simplest reason is that innovation was probably never written into the contract in a meaningful and effective way. Once the vendor’s sales team and the buyer’s procurement group part ways and day-to-day management begins, what the outsourcer is and isn’t legally obligated to do suddenly becomes crystal clear. “That person with the strategic vision no longer influences the behavior of the vendor. The people responsible for the P&L take over and all that great stuff never happens,” says outsourcing attorney Hansen.

“Everyone is in such a rush to get these deals done, they end up disappointed because [they] haven’t had the right conversations,” says Gartner’s Anderson. Even if they have had discussions about “innovation” or “transformation,” definitions remain fuzzy. “[A vendor] telling you they can provide ‘innovative solutions to your business needs’ is the same as them telling you they will ‘implement your system based on proven methodologies,’” says Hansen. “Everyone says it, but it means nothing.”

Even if the two sides do come to a consensus about what’s meant by innovation, building a contract around those definitions is difficult. At Entergy Nuclear, Smith realized that his hopes for input and innovation from SAIC were never going to happen because they weren’t in the contract. “I had a kind of a selfish view of it,” says Smith. “Contract be damned, you know, we brought you in here for a reason and that had to do with what else you could bring to the table.” The excitement he had about SAIC using its nuclear domain expertise to come up with new ideas for IT faded. “All the talk about how they could show us how to do new things better…it never happened,” says Smith. “Everyone turned back to the pure utility view.”

An architectural council set up as part of the outsourcing deal and led by an Entergy CTO and technical leads provided by SAIC did a good job of setting standards but, according to Smith, it never played a role in bringing viable emerging trends to the business. On the occasions that SAIC did present Smith with ideas, “they’d say, Here’s something new, what do you think about it?” says Smith. “The next question was, How much are you willing to pay? That’s not want I want to hear from my value-add buddy. They didn’t understand my business.

“I didn’t expect them to live at the nuclear plant,” he says, “but they could spend a week there.” Smith included SAIC employees in all his own meetings, but the further he went up SAIC’s chain of command, the less they knew. The one innovation for which the business was most hungry—wireless capability—“turned into discussion of SLAs and how to restructure them,” says Smith. “They wanted to set it up so each wireless point was treated the same as a server or router.” (Entergy implemented the wireless project with limited help from SAIC.)

“The further we got downstream from the deal, the more we got over our illusions about what the relationship with SAIC might be in the area of innovation,” says Smith. “We couldn’t figure out how to measure innovation and ultimately we had to decide whether we wanted them to manage the IT utility or innovate, because we weren’t hitting either.”

Willingness to innovate only decreases over time, says BAE’s Fecteau. It’s an open secret that the beginning of the outsourcing relationship is a money-losing proposition for outsourcers; they make it up on the back end. If you try to renegotiate to improve or expand services, the provider puts in a less experienced and cheaper team, says Fecteau. “They can still deliver exactly to the SLA, but there is no thought about improving or innovating,” he says. To get that, “you have to build a new kind of contract.”

Why Small Companies Have an Edge

Sure, companies like GM and American Express may have a lot of clout when it comes to getting their IT service providers to innovate, but CIOs at small to midsize companies shouldn’t despair.

“You may not have the negotiating leverage that a GM does,” says Ed Hansen, partner in law firm Morgan, Lewis & Bockius’s global outsourcing practice, “but you might have the ability to help the vendor break into a new market or build a new business model or become more global.” As a bonus, small organizations may be more capable of working with providers to incorporate new ideas or systems—innovation. “[SMBs] may not have all the built-in procedural barriers to innovation that a lot of bigger companies do,” says Hansen.

One trick Hansen uses to help small-business customers realize their own power is to turn the tables during the getting-to-know-you stage of negotiations. “During the RFP process, customers always ask, ‘Why should I do business with you?’ Instead, they should ask, ‘What is it about us that makes this deal worth it to you?’” says Hansen.

If you’re afraid you’re too small to get the vendor’s attention, say so and see how it responds. “The vendor may say, Let’s be realistic. The money we make on this deal is less than a week’s worth of revenue from GM but it’s valuable to us because of X,” says Hansen. Then, at least, “you know you’re worth more to them than the fees laid out in the contract,” Hansen says. And knowledge is power.

Separate Innovation from Service

That new kind of contract is easier to imagine than write. “I was in one meeting where the vendor sat for what seemed like centuries trying to put an SLA around innovation, saying we’ll provide X number of ideas per month, creating this really detailed governance process in place for how ideas get vetted,” Morgan, Lewis’s Hansen recalls. “It didn’t work.”

“The process that produces [the vendors’] 6 percent margins is well understood and providers are quite happy with it,” says Trowbridge. “They don’t have to think too much. They don’t have to meet with the customer. If they have to show up and engage and innovate, that’s risky.”

Customers will have to break the cycle, and that begins with figuring out what they actually want from the vendor. “It’s ultimately up to the buyer to define what is meant by innovation,” says Gartner’s Anderson. “If you can’t define it, you can’t expect it.” IT leaders at Fluor attempted that with their IBM deal in 2003. “We tried to bake innovation into the contract, from a responsibility point of view,” says Taylor. But the pricing remained inflexible and transaction-based so “it was very difficult to reconcile their invoices with what we thought was their contractual obligation to innovate,” Taylor says. If he wanted IBM to do some R&D work or explore a new technology, there was no efficient way to fund it.

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