The Dangers of Outsourcing (and What to Do About Them)

The last thing most CIOs want to think about as they embark on a major outsourcing deal is what will happen when it ends. After all, reaching the decision to outsource some or all of an organization’s IT services requires a great deal of business case analysis, transition planning and soul-searching about the best way to handle the many human issues involved. Assuming that the organization views the pending transaction as positive, or at least acceptable, this is a time of high excitement and tension, and it may not seem like the ideal time to plan how to get out of this arrangement in a few years. But you ignore the end game at your peril. Sourcing deals are risky, and some of the biggest risks are not visible in the rose-colored days leading up to deal consummation.

Fortunately, these risks will come to light not at the very end of the deal, but somewhere midstream, as they did a few years ago for me and my colleagues at General Motors. GM manages one of the industry’s largest IT outsourcing agreements with EDS. Many factors make this arrangement unique, including the fact that it was created in 1996 when GM divested EDS with the proviso that EDS would maintain a more or less exclusive lock on GM’s IT business for the next decade. Ralph Szygenda was hired as CIO for GM’s newly formed Information Systems & Services organization, and he hired a couple hundred IT executives and managers, including yours truly, to drive GM’s technology strategy and manage the EDS outsourcing deal. I led three organizations in my time there, including the operations portion of GM North America’s multibillion-dollar agreement with EDS, which is set to expire in 2006. In 2001 (the midpoint of the contract), we began to analyze the opportunities and risks involved in the expiration of that arrangement. While that story has yet to play out, the risks we identified are relevant to any sourcing deal, as I have since discovered in other contracts I have worked on, including here at the American Red Cross.

The first lesson from my GM days is that long-term exclusive outsourcing isolates the organization from the market. You still have widespread access, of course, to technologies and solutions, but you have granted one vendor the exclusive right to understand your business in depth. The more this outsourcer learns about you, the harder it will be to change your sourcing choice once the contract is up. This dynamic exists not only because this vendor understands your business well, but because others have not had the opportunity to do so. There is simply no knowledge base in the vendor community about your needs and, therefore, only limited ability to respond to downstream sourcing opportunities.

The way to mitigate this risk is to create competitive events in your sourcing arrangement. Even in its exclusive deal with EDS, GM had the ability to competitively bid some services?long-distance telephony and voice mail, for instance. We also rebid all of the IT services in GM’s locomotive division. That gave other vendors the opportunity to learn about GM’s needs. Many contracts contain provisions to rebid some services to keep pricing and terms competitive, but the chief benefit of these competitive events is to educate other vendors about your business. Keep such competition reasonably modest in scope so that it doesn’t undermine your deal, but use it strategically to build competence in the vendor community.

Keep Employee Skills Au Courant

The second lesson is that the skills you need to provide IT services internally are different from those you need to govern outsourcing agreements. Just as you have to build contract and vendor management skills to govern a new deal, you may also have to bring on hordes of project managers, programmers and system administrators if you decide to bring services back inside at the end of the deal. In the meantime, any technical employees you retained while services were outsourced have likely experienced some deterioration of their skills since the vendor did most of the digging into new technology. Even if you decide to continue to outsource, you will need to recharge your employees’ skills to adapt to changes in the business climate since you last wrote a deal some years ago. That requires a commitment to training internal staffers both in the skills they need to manage outsourcing arrangements and in the latest and greatest technologies. Training programs like this yield two benefits: You will have a staff that is capable of bringing the work back inside if that is the right choice, and in the meantime, your team will be knowledgeable enough about technology to effectively manage the outsourcer. If it appears that insourcing is your best option, plan early to begin hiring the workers you will need. Finally, stay active in the technology sphere. Your participation in training and in technology decisions signals to your workers that this is important for them too.

Maintaining Leadership

The third lesson I learned at GM is that while vendors are busy running the IT services you have contracted to them, they are also busy building relationships with your business peers that they hope will lead to future business. While this is not all bad and can lead to better execution of projects, it does pose a significant risk for the CIO. If you and your leadership team fail to engage actively with your business partners, the vendor becomes a surrogate for you or, worse yet, a rival. You may be left with no other choice at the end of the contract than to bring the vendor back in, whether or not you want to continue with that company. Business partners may even feel that the IT function provides little value beyond managing a contract.

You can assuage this risk by maintaining close ties with key business partners and asserting your leadership over the outsourcing relationship. Make sure the vendor understands what interactions with business partners you find acceptable. Recruit your business peers to help keep the IT team clearly in charge of technology choices. My relationship with my business peers at GM was strong enough that they routinely redirected vendors to me and my team to select products and services, satisfied that their requirements would be faithfully represented. Finally, implement robust metrics that will give your company objective information about the vendor’s performance and help you reinforce a proper business relationship with the vendor. This strategy should prevent any unwelcome “cozying up” to the business.

Outsourcing is a risky proposition, but one that offers potential benefits to the organization in terms of cost, service levels and access to talent. Managing an outsourcing deal well is not just a matter of negotiating effectively or implementing a strong governance model. Effective outsourcing management requires a life cycle approach that includes a robust sunset strategy. Whether you are contemplating an outsourcing arrangement or are well into one now, it’s never too soon to start looking for the exit.