Success and Failure in Outsourcing

IT executives entering into IT and business process outsourcing arrangements seek various benefits, including cost reductions, variable capacity and reduced management time spent on IT. But outsourcing succeeds only if both the vendor and the client achieve expected benefits. How can clients and vendors settle into a “sweet spot” where their interests coincide? New research from MIT’s Center for Information Systems Research (CISR) and CIO examined 90 outsourcing deals in 84 companies to help executives recognize opportunities for long-term benefits from outsourcing relationships.

We found that the outsourcing sweet spot depends on the nature of the client-vendor relationship. Our first two articles in this three-part series (Simple Successful Outsourcing and Working with Offshore Partners Requires CIO Oversight) explored transaction relationships and co-sourcing alliances. This article accompanies Outsourcing Can Mean Big Deals, Big Savings and Big Problems, which focuses on strategic partnerships.

How to Be in the Half of Strategic Partnerships That Succeed

In a strategic partnership, vendors provide an integrated set of operational services. For example, a single IT outsourcing deal might encompass mainframe operations, WAN and LAN management, telephony and help desk services—some of which are commodity services. By integrating its service offerings, the vendor adds value beyond the value of the individual services.

In a strategic partnership, the client expects to be able to focus on core competencies after handing off major operational responsibilities to the vendor. Clients also usually expect to realize cost savings and have access to variable capacity. To meet these expectations, vendors rely on economies of scale and scope, shared resources and best practices. Despite the potential for mutual benefit, these deals are risky. Only 50 percent of strategic partnerships in our study were successful.

Metrics are part of the problem. While vendors expect to earn a margin on the integrated set of services, client assessments of their partners often rely on a set of service-level agreements for the individual services. We believe the value of a strategic partnership is better assessed by its impact on the client’s bottom line. For example, one CIO noted that when he needed to reduce his IT budget by $10 million, his vendor partner identified several million in outsourced services that could be cut with minimal pain to the client. Recognizing that this reduction would be painful to the vendor, the client and vendor identified new outsourcing services that reduced the clients IT budget, and the client awarded the vendor a number of new projects, which restored and in fact increased the vendor’s revenue.

Strategic partnerships work best when they are treated by both client and vendor as long-term interdependencies with shared risk. Clients need vendors to adapt their offerings and processes to changing business conditions; vendors need clients to adapt their expectations and behaviors to permit appropriate process innovations and service changes. Successful strategic partnerships often apply a first-choice provider principle, meaning that the strategic partner is favored when new activities are to be outsourced. This reduces search costs for the client and sales costs for the vendor.

Understand the Three Types of Outsourcing Deals

The three types of outsourcing relationships are so different that learning gained in one type of relationship does not transfer to another. We believe companies can become competent in all three types of relationships. Thus it is important to match specific outsourcing needs with the appropriate type of relationship.

Clients managing transaction relationships, like strategic partnerships, incur expensive and unnecessary overhead. Co-sourcing that is treated like anything but a team environment is sure to suboptimize outcomes. And clients and vendors in strategic partnerships who refuse to regularly renegotiate and adapt to the changing needs of their partners will become embroiled in bitter contract battles. In all outsourcing, both client and vendor should target the sweet spot to maximize benefits to both parties.

Jeanne Ross is principal research scientist at MITs Center for Information Systems Research. Cynthia Beath is a professor emerita in the Department of Management Science and Information Systems at the University of Texas at Austin.