Outsourcing Can Mean Big Deals, Big Savings and Big Problems

Large-scale outsourcing deals promise big savings, but they fail half the time. Here’s how to make them work for you.

When Campbell Soup CIO Doreen Wright was trying to cut costs to fund a multimillion-dollar global investment in SAP, she found help from what many might view as an unlikely ally—her outsourcing vendor. Without being asked, IBM reexamined the outsourcing contract and identified several million in services it was providing that could be cut with minimal pain to Campbell. Recognizing the financial hurt that move might cause her partner, Wright took the sting out of it by working with IBM to identify new outsourcing services (which, by the way, would also further reduce her IT operating budget) and awarded the vendor several other projects in the following months. "They were very forward-thinking, and there was a tremendous amount of teamwork involved," says Wright. Bottom line: Campbell cut its IT costs and was able to go ahead with the SAP project, while IBM actually saw its revenue increase.

A CISR-CIO Study

This is Part 3 of a three-part series about outsourcing strategies and success models, defined in original research by MIT's Center for Information Systems Research and CIO magazine.

Part 1: Simple Successful Outsourcing

Part 2: Working with Offshore Partners Requires CIO Oversight  

The Campbell-IBM relationship is an example of what Jeanne W. Ross, principal research scientist at MIT’s Center for Information Systems Research (CISR), calls "strategic partnership" outsourcing, in which a single outsourcer takes on responsibilities for a big bundle of IT services. These contracts include everything from mainframe operations and network management to application support and help desk services. The success of strategic partnerships depends on mutual benefit. CIOs set up these large, long-term deals to cut costs, access variable capacity and focus on their own core competencies. Vendors sign on not only to make money by taking advantage of their internal best practices and economies of scale but also in the hopes of becoming a first-choice provider for the client and moving up the value chain of IT services.

When strategic relationships are good, they’re very good. Client and vendor work together, and the benefits accrue to both parties’ bottom lines. But when they are bad, they’re awful. Client and vendor can develop an adversarial relationship and become embroiled in bitter contract battles. In fact, half of all strategic partnerships fail, according to a study by CISR and CIO.

The two other outsourcing models identified in the research have higher success rates because they’re simpler for both parties. Transaction relationships, in which an outsourcer performs a well-defined process that has clear business rules, work out for CIOs 90 percent of the time, while co-sourcing alliances, in which client and vendor jointly manage projects, are successful for the client in 63 percent of cases, according to the CISR-CIO research. (See Success and Failure in Outsourcing for a summary of the research findings.)

Evidence of the difficulties inherent in strategic partnerships has been seemingly everywhere lately. JPMorgan Chase pulled the plug early on its $5 billion outsourcing contract with IBM in September 2004 and brought the work back in-house (read Outsourcing—and Backsourcing—at JPMorgan Chase). Dow Chemical prematurely canceled its $1.4 billion deal with EDS in July 2004 and brought in IBM to start over. Even GM, which had the most long-lasting of any outsourcing relationship—its involvement with EDS dates back to 1986—is backing off its strategic partnership and introducing more vendors into the mix, in a multisourced model.

The difficulty with strategic partnerships lies in their complexity. "Making these deals work is very difficult because the magnitude of the challenge is far greater," says Jeff Kaplan, senior consultant with the Cutter Consortium’s Sourcing and Vendor Relationships Advisory Service and the managing director of ThinkStrategies. "The outsourcer is assuming a broader scope of responsibilities across the enterprise and IT operation. There are far more people and process issues to be addressed and migrated. And there are more enterprise and outsourcer business needs to be met." Overcoming these issues takes time—usually two to three years with the biggest deals, says Geoff Smith, president of IT consultancy LP Enterprises and former deputy CIO at Procter & Gamble. "Beyond that point, only the truly committed strategic partners survive," he says.

Report from MIT CISR

For mid-market CIOs, setting up and managing a strategic partnership has its own challenges. Read Strategic Partnerships in the Mid-Market.

For a strategic partnership to be mutually rewarding, vendors need to be flexible and willing to adapt to their clients’ changing business conditions. And CIOs must bend their expectations and behaviors to allow the vendor to perform optimally. Success in strategic partnerships has less to do with contract negotiations than with the day-to-day interactions down the line. Ross says that CIOs who sign the same kind of big outsourcing deal with the same vendor can end up having completely different outcomes. "When you talk to [CIOs] about it, what you find is that they didn’t have terribly different experiences in the beginning. But in one case, the situation is deteriorating and in the other case it’s getting better," she says. "The ones who are happy are the clients who say, ’Change is to be expected and we’ll work this out.’ And those that aren’t are the clients who dig in and resist change."

But getting to that state of healthy interdependency takes time, trust and more management overhead than any other kind of outsourcing effort.

Getting Off on the Right Foot

The relationship between Campbell Soup and IBM wasn’t always a good one. The $7.5 billion food manufacturer’s 10-year deal with IBM for IT infrastructure and operational support dates back to 1995, when the existing management signed the contract in an attempt to reduce IT costs. By the time Wright arrived as CIO in 2001, though, the relationship was on the rocks. Campbell’s CIO position had turned over three times since the signing of the contract, with each new IT leader leaving his own imprint on the partnership. One was as opposed to the outsourcing as the next was gung ho about it. One of the CIOs was so disillusioned with IBM that he duplicated the entire infrastructure group internally to oversee what the outsourcer was doing, Wright says, adding, "There was obviously a level of mistrust."

Wright began to remedy the situation by eliminating the duplicate functions, drawing a clear line between what IBM was responsible for and what Campbell owned. Then she began the longer-term rehabilitation of the badly broken partnership. "We just took a clean sheet of paper and looked at every single thing each of us performed and asked who should perform it, both today and in our future state," says Wright. With Gartner mediating, Campbell and IBM spent a year reorganizing the outsourcing arrangement. In the end, although Campbell took its help desk back in-house, the company ended up outsourcing even more to IBM. That year of planning was critical in setting the tone of the relationship and setting the stage for a true partnership. "After that, we knew about how to work together and what our roles were," Wright says.

Ontario Power Generation (OPG) also took its time in laying the groundwork for a successful strategic partnership. When OPG decided to outsource 80 percent of its IT functions and services to a single vendor in late 1999, it was a huge leap for the Toronto-based energy provider. "It was our first jump into the IT outsourcing world," says CIO Dietmar Reiner. "And it was the only large-scale outsourcing deal ever done in our company."

The driving factor behind the outsourcing plan was deregulation of the electricity market in Ontario, which would force OPG to reduce its market share in the province from 90 percent to 30 percent. OPG’s centralized IT structure, which had provided internal economies of scale, would be impossible to sustain as the company sold itself off in chunks. An external services provider could provide that centralized IT resource without unit costs going through the roof. In addition, Reiner recognized that he would have to pare down his IT staff as the company divested itself of assets. Partnering with an outsourcer could provide those IT employees with a safe place to land.

Still, Reiner knew the nine-year, $1 billion deal with Cap Gemini Ernst & Young (CGEY, now known as Capgemini) was a big step for a first-timer. So he took extra precautions to make sure the relationship started off on solid footing. Rather than jumping into a traditional outsourcing arrangement, in which the client contracts with an independently owned vendor, OPG launched its strategic partnership with CGEY as a joint venture. OPG retained a 49 percent share of the CGEY subsidiary that would supply the IT services, and OPG executives (including its CIO, CFO and COO) made up half of the board of directors. "Jumping into what was largely the unknown, this [joint venture] gave us a vehicle to mitigate the risks," Reiner explains. The joint venture also provided some safety for CGEY.

The original plan was to sell OPG’s interest in the entity to CGEY after two years and move to a traditional outsourcing arrangement. The joint venture period gave OPG and CGEY time to put in place new processes for running IT, as the entire organization learned how to operate under the new model. "We were coming from an organization with an internal IT shop that didn’t have any service levels in place. Everything was done on a best-effort basis," says Reiner. "The move from that into the service-level world was a big one."

The joint venture launched in February 2001, and 550 of OPG’s original army of 700 IT staff became its first employees. In April of the following year, CGEY bought the company in full. Still cautious, OPG introduced a unique element: a "gain-share phase," as a bridge from joint venture to fixed-price deal.

Common outsourcing wisdom holds that CIOs should try to squeeze all the efficiencies they can out of their internal IT shops before entering into a large outsourcing deal. OPG had not done that. The gain-share phase was a two-year contract that encouraged the elimination of inefficiencies by giving OPG and CGEY an equal share in any IT cost savings. "We knew that Cap Gemini needed to make some kind of profit margin on this business. But we didn’t want to leave money on the table. So we introduced an incentive that would encourage them to cut our costs," says Reiner. "We came up with the idea jointly. It comforted us, and they shared in the financial benefit." OPG and CGEY finally moved to a more traditional strategic partnership model last spring.

With an outsourcing deal as complicated and risky as a strategic partnership, CIOs should take time to learn how best to work with an outsourcer and to assess what each party can—and more importantly, can’t—do. "Part of what goes on when these things fail is that the client’s expectations of what the vendor can accomplish for them are just not realistic," says MIT’s Ross. "And part of what goes on in a successful strategic partnership is a learning process. You can’t just say, ’Here are my demands.’ You have to figure out what works for both parties."

The Demand for Hands-On Management

The root cause of many a dysfunctional strategic partnership is the misguided notion that by outsourcing a sizable portion of the IT pie, a CIO is outsourcing a whole hunk of IT management responsibilities as well. In fact, it’s quite the opposite. As Ross explains, "Any good partnership has enormous overhead."

That came as a surprise to Reiner at OPG. "One thing we didn’t recognize initially was that it takes significantly more work to manage a relationship like this," he says. Rigorous management is required to strike a balance between the competing interests of client and vendor. "The service provider is motivated by profit, and we’re looking at cutting costs and extracting value. So there’s a natural tension," says Reiner. At each phase of the relationship—from joint venture to gain share to strategic partnership—the two parties learned more about the middle ground between what the outsourcer needed and the business required.

Yet keeping the relationship on an even keel remains difficult. "It’s taking a lot more effort than we thought," Reiner says. "You have to have the proper processes in place, the proper governance, the proper escalation when things go wrong. And, you have to be on top of all of that all of the time."

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