Outsourcing: Bringing IT Back Home

Cecilia Claudio is an IT outsourcing veteran. With 31 years of IT experience, she was one of the architects behind the 1994 landmark $3.2 billion outsourcing deal between Xerox and EDS. As one of the first megadeals in the world of IT outsourcing, it infected countless CIOs with outsourcing fever. Back then, Claudio says, there were “real reasons why Xerox needed to do that” — the most important being the need to control IT costs on a global scale.

Nine years later, having watched numerous peers sign mega-outsourcing deals that have turned into major disappointments, she is wary about farming out IT. “I’ve never been a major proponent of outsourcing,” says Claudio. “Sometimes people jump into it without really understanding what it means and why they’re doing it. Then two, three years into it, they’re very disappointed and they don’t know how to get out of it.”

It’s no secret that IT outsourcing has a high failure rate. A whopping 78 percent of executives who have outsourced an IT function have had to terminate that agreement early, according to a November 2002 study from DiamondCluster International, a Chicago management consultancy. The top reasons for CIO dissatisfaction: poor service, a change in strategic direction and costs.

“IT outsourcing has been around long enough now that we are starting to see the second phase of it — CIOs are renegotiating terms, contracts are expiring. Some deals just aren’t working out at all,” says Michael Murphy, who has been doing and undoing outsourcing deals for the past decade as a partner in the technology group at the Los Angeles offices of law firm Shaw Pittman.

But rather than renegotiate disappointing deals or contract with other vendors, CIOs are finding that if they want something done right — or at a lower cost or in a more strategic fashion — they’ve got to do it themselves. “Reinsourcing is becoming more common,” says Rudolf Hirschheim, the Tenneco/Chase International professor of information systems at the University of Houston, who is conducting a study of the trend. “Many companies are finding that outsourcing simply doesn’t provide the cost savings they had hoped for. Or they find themselves burdened by the contract, which doesn’t allow them the flexibility they need.”

The profiles below show how three CIOs brought outsourced work back into the fold — and how reinsourcing saved money.

Walk Like An Outsourcer

A few years after leaving Xerox, Cecilia Claudio got burned by a big-name outsourcer. When she took over as CIO of Anthem Blue Cross and Blue Shield in 1996, she inherited a five-year, $30 million data center deal with Unisys. Claudio was dissatisfied with service levels and increasing costs, so she got out of the contract and rebid the work, ultimately going with Affiliated Computer Services.

Since then, Claudio has proved that she knows not only how to get out of a bad situation but also how to bring outsourced IT back in. As senior vice president and CIO of Farmers Group, which she joined in 1998, Claudio did just that after the company acquired Foremost Insurance for $812 million in 2000. The Caledonia, Mich.-based provider of insurance for mobile homes and RVs was outsourcing all of its mainframe IT support, application development and maintenance. The company was eight years into a 10-year, $150 million arrangement with Integrated Systems Solutions (a division of IBM that eventually became the core of IBM Global Services). Foremost Insurance had originally outsourced the work for financial reasons but, according to Claudio, savings never materialized. In fact, costs were escalating. “They didn’t have a strong contract that allowed the customer to reap the benefits of total cost of ownership going down over time,” explains Claudio.

So after Farmers brought Foremost into the fold, Claudio and her team chose to bring all the work in-house rather than offer it to another outsourcer. By doing that, she believed she would have better control over the work being done and the costs involved.

Although Farmers would have to pay $4 million in cancellation fees and early termination penalties, Claudio’s financial analysis showed that the company could recoup those initial costs within a year and then begin to save money.

First she had to break the news to the service provider, which was difficult. “I pride myself on having excellent relationships with partners and vendors, and I don’t do things lightly,” explains Claudio. “It’s hard to go to a big partner and say, ’This is no longer working for us. We’re not seeing the benefits.’”

Then there was the process of bringing outsourced staff aboard at Farmers. Those employees effectively had been boomeranged. Originally Foremost employees, they lost their job when the IT work was outsourced. Then they had to be convinced to join up with the outsourcer. Now they were being asked to come back as Farmers employees. Claudio knew that having their knowledge of the company and its systems would be critical, particularly during the transition. So she had to “make it appealing not only on a professional level but on an emotional level.” Although she could not offer them the variety of tasks and access to new technologies that the outsourcer provided, she could promise stable positions at a company that cared for its employees. Ultimately she was able to bring back 90 percent of the original IT staff.

The entire reinsourcing process took six months and was completed in September 2000. Claudio says the move paid off. “Within the first year, we began saving about $6 million a year.”

The key has been running in-house IT like an outsourcer. “[We’re] a very lean organization capable of achieving the best value for our money,” Claudio explains. In fact, some say Claudio’s IT shop is even more efficient than that of most outsourcers, with information technology costs coming in at 1.9 percent of revenue. William N. Pieroni, general manager of IBM’s global insurance industry group, can attest to that fact: “Farmers’ IT spending levels are less than half that of the major competitors, and that is nothing less than incredible given the scale and scope of the enterprise.”

“It all starts with pride of ownership,” Claudio says. “I believe I can do as good a job if not better in the major aspects of running an IT shop than an outsourcer.”

The Vendor Strikes Back

Things didn’t go smoothly for Ellen Barry when she reinsourced network and Internet services. As the CIO of the Metropolitan Pier and Exposition Authority (MPEA) in Chicago, she was up against an outsourcer that fought dirty.

In 2000, Barry joined the MPEA, which owns and manages the McCormick Place convention complex and popular tourist attraction Navy Pier. At the time, the municipal agency was in the second year of a three-year revenue-sharing arrangement with RedSky Technologies for all show-floor network services. The relationship started in 1995, and then the MPEA signed a deal with RedSky in January 1998. At the outset, the arrangement made sense: The MPEA didn’t see technical services as its business, the capabilities of its IS department were limited, and its clients weren’t interested in Internet and network-related services.

In the late ’90s, however, demand for such offerings at McCormick Place — the largest convention center in the country — exploded. With those services outsourced, the MPEA couldn’t effectively respond to new demands from customers for things like private virtual LANs, firewall implementations and high-speed bandwidth. It became evident to Barry that perhaps offering such value-added IT services to its customers should be part of the MPEA’s core competencies. “Some people might say that your business isn’t support. But if it touches your customers, it is your business,” says Ivy Meadors, CEO of High Tech High Touch Solutions, a Woodinville, Wash.-based IT consultancy.

RedSky, which had no plans to expand the outsourcing side of its business, invested little in network hardware and thus had to design a network for each show, leaving the MPEA to build and tear down the physical network each time a show rolled into the 2.2 million square-foot center. Barry knew there had to be a better way. So in September 2000, she began exploring what other centers were doing and evaluating the pros and cons of insourcing those IT services. What she learned convinced her to bring Internet and network services under the MPEA roof. With a year left on the contract, insourcing was worth pursuing.

However, desperate to keep MPEA’s business, RedSky did everything it could to hold on. The vendor went behind Barry’s back and approached members of the board, other MPEA IT vendors and even Mayor Richard M. Daley’s office to argue that the agency couldn’t handle the job. (RedSky declined to comment for this story.) One board member, the vendors and a fellow IT executive in the mayor’s office tipped Barry off to the bad-mouthing. “Some doubters at the MPEA didn’t trust the IS organization to manage this type of delivery,” Barry recalls. “It’s that age-old belief that government employees can’t handle that kind of service work.”

So Barry went about proving that it could be done — and that it would be a boon for the MPEA. “We had to make sure that whatever we designed was flawless,” Barry explains. With the help of Cisco Systems, the networking vendor and partner on the project, she drew up plans for the transition. Although a basic fiber infrastructure already connected the three buildings that make up McCormick Place, the MPEA would need to add 400 miles of fiber runs to create a permanent and redundant network backbone. She also saw an opportunity to connect the facilities at Navy Pier as well as the Hyatt Regency McCormick Place (owned by the MPEA and operated by Hyatt). She made the presentation to the board, who told her to pursue the insourcing alternative.

In September 2001, the MPEA prepared a proof of concept for insourcing network services at one of the biggest shows McCormick Place hosts, the Radiological Society of North America, which descends upon the Windy City every Thanksgiving. During the six-day gathering two months later, MPEA IT staff connected 40 rooms on a private network and provided uninterrupted Internet access. “It gave the organization the confidence that we could do what we needed to do,” Barry says. “And do it well.”

The MPEA spent $1.5 million to build the infrastructure, and Barry informed RedSky that the MPEA would be going through a 90-day transition period to bring network services in-house permanently. And during that transition, she told RedSky, the MPEA would provide all Internet and network services using the Cisco backbone. The outsourcer’s network would serve as backup.

Barry eventually hired four RedSky employees and brought over two from the MPEA’s IT staff. And since late March 2002, that team has been delivering all Internet and network services to the show floor. In addition, the MPEA now provides high-speed Internet access to all 800 hotel rooms at the Hyatt McCormick Place, has installed 802.11 wireless cafes to customers who request them and has implemented a connection to Internet2.

“We saw insourcing as a strategic opportunity for us,” Barry says. Expanding IT services, she believes, will attract more customers to the MPEA and ultimately lead to a stronger local economy.

When the Mission Changes, IT Does Too

When Jerry Gross came aboard as executive vice president and CIO of Washington Mutual in June 2001, he had an open mind about outsourcing. The Seattle-based bank’s 10-year, $533 million outsourcing deal with IBM Global Services (IGS) dated back to 1996. As part of that deal, IGS provided desktop support, network services, help desk, network management, architecture and strategy for the $17.7 billion company. Having just inked a deal with IGS himself in his previous position as the group executive of technology, operations and e-commerce of Sydney, Australia-based Westpac Banking, Gross wasn’t averse to the idea.

To learn the lay of the land, Gross conducted focus groups with employees inside and outside IT, reviewed customer satisfaction data and compared notes with his peers. “I went through a fairly exhaustive process to find out what people’s perceptions were of the services we were providing to them as customers, both internal and external,” Gross says.

He found that IT’s service levels were less than satisfying. For instance, it took up to a month to deploy a new computer for an employee. Another red flag: Calls to the help desk weren’t getting answered in acceptable time. As a result, IT was getting a bad name.

Gross determined that the IGS deal, which made sense in 1996 when WaMu was in rapid growth mode (the company has acquired 32 companies in the past 20 years), was no longer serving the bank well. During the late ’90s, WaMu relied on outsourcing just to keep the business running. But once the acquisitions slowed, the CEO made operational excellence and customer service top corporate goals. Outsourcing was negatively affecting those two new priorities. “It occurred to me that in some cases it would be better to reinsource back into the WaMu IT group because the functions involved such close interaction with customers,” Gross explains.

But first, Gross says, he needed to get his house in order. Most technology development and strategy had been distributed to the business units, which had in turn further outsourced some of their IT to yet more providers, including IBM and Accenture. In effect, Gross says, there were a number of players internally and externally providing strategy and architecture advice to the company, ultimately fragmenting the IT department and the company.

So Gross restructured the IT department in an attempt to get everyone “rowing in the same direction.” Gross also wanted to begin running the technology department like a business. “We forced ourselves to be price-competitive with external service providers,” he says. “We began to model ourselves after an IGS or other service provider.” Gross implemented the Balanced Scorecard method of creating specific, quantifiable goals and monitoring performance as a way to stay on top of service levels.

The restructuring was key to proving to the business that WaMu’s IT division could reinsource further activities. “We were able to raise the quality of service levels and build trust and credibility with the business units,” Gross explains.

At that point, Gross decided to take back the help desk, network management, architecture and strategy work — “all of the resources that directly affected our customers,” he says. Although Gross would not reveal the costs, a business case analysis indicated that the company would see a return on the initial costs of insourcing within nine to 12 months. But Gross points out, “Reinsourcing wasn’t just about the cost. It was about the service levels and the value proposition to your customers. The benefits that one can get when service levels are improved are immeasurable.”

So he simply picked up the phone and called IGS. “They weren’t surprised when I contacted them,” Gross recalls. “When you’re in the IT services business, negotiation is a fact of life.” Armed with a lawyer on his IT team and the knowledge that WaMu’s size gave it great power in the negotiations, Gross worked through the legal issues and penalties involved in restructuring the contract and terminating some services. (IGS now provides only desktop support and hosting services.) To ease the negotiations, Gross made it clear that he “wasn’t just picking on them.” It was part of a larger strategy to extract greater value from all of WaMu’s vendors.

“When the writing is on the wall that the restructuring is going to take place, [outsourcers] are reasonable,” Gross says. It’s a sign of the times for service providers. “They’re feeling the slowdown,” agrees Shaw Pittman’s Murphy. “There’s more pressure on them to be accommodating.”

The biggest chunk of the reinsourcing — the help desk — took most of 2002. It was completely reabsorbed by December. Gross has staffed it with former IGS contractors and new hires. New strategic work, such as creating a single enterprise customer view, has already begun. And service levels are heading north. Now employees needing PCs wait days rather than weeks.

Gross says he would never again sign a long-term outsourcing contract. “It’s too difficult to maintain accountability and maintain passion,” he says.