How often do IT outsourcing deals fail? The numbers vary depending on which study is cited and what definition of failure is used. But executives initiating or tending to an IT outsourcing relationship must be constantly sobered by the fact that, from a purely statistical viewpoint, their deal stands about as much chance of failing as of succeeding.
Millions of dollars are often in play in an IT outsourcing deal, along with the hopes of management and investors in the business transformation that outsourcing can deliver. So it is to everyone’s benefit to have the means in place to deal with the problems which, perhaps inevitably, will occur.
However, what IT decision makers really need is not just better triage but better preventive medicine along the entire lifecycle of their outsourcing deals. Issues and challenges can appear quite different depending on where they occur in the course of a relationship. What might be a catastrophic problem in year two or three of a deal might have been only a small issue when the seeds of the problem were sown at the contract or transition stage.
Based on our experience and research, we recommend that IT outsourcing buyers take a three-part approach to maximizing the value of their IT outsourcing deal:
- Prevention. Focus on the risk mitigation capabilities and governance structures that anticipate problems before they occur and that keep an outsourcing relationship on track.
- Quick response. Develop the diagnostics and “early warning systems” that identify problems quickly and then address them before they mushroom into deal-killing catastrophes.
- Retooling. If things go badly wrong, have the mechanisms at the ready to bring the parties together, reexamine the original deal intent and retool or refresh the relationship where possible.
Contracting Phase Issues
When we conduct our realignment and remediation services for IT outsourcing relationships, our diagnostics frequently find that the root cause of the problem goes back to the deal itself. Outsourcing selection processes tend to focus both the company and the service provider primarily on financial terms, obscuring the fact that the real work comes only after the signatures on the contract are dry.
And the contract itself may be the root cause of the problem. If getting to the signature stage is a battle, forcing a provider to negotiate away its margin and reasonable operational assumptions, outsourcing buyers may win the pricing battle only to lose the delivery war. Under water from day one, the service provider may have little choice but to focus on margin recovery behaviors—trying to get back to a break-even point on the deal, rather than focusing on generating value from the outsourcing relationship. Performance, quality and flexibility inevitably suffer. More intangibly, the outsourcing buyer loses out on important opportunities for innovation and continuous improvement, as the provider pulls back from any activities beyond the bare essentials. When we evaluate the situation of companies that are either vaguely or overtly dissatisfied with the collegiality and quality of their outsourcing relationship, we often find that the buyer engaged in aggressive deal-making behavior that created the problem.
What’s the better way? Some basic principles that can help mitigate overall deal risk at the contract stage include the following:
- Create winners on both sides. Remember that everyone needs to make or save money. Ultimately, ensuring high service quality is paramount. Overreaching does not create value; it breeds trouble and value leakage. The engagement process must enable all of the parties involved to converge on an appropriate solution that takes into account the various economic, technical, political, operational and geographic stresses that might apply to the arrangement.
- Establish a foundation for good governance early in the relationship. At the contract stage, we work to create contract structures that reflect the operating reality of a long-term relationship. You want a type of governance that is self-regenerative as much as possible, and that has effective change management mechanisms embedded within it, including the ability to change the terms using a mechanism built into the contract.
- Be aware of cultural differences. The misalignments that derail an outsourcing deal can be as much cultural as financial. The contract stage is the best time to align the respective cultures around the deal’s intent and to develop the operating mechanisms that will enable all parties to succeed. Culture diagnostic tools are worth the investment.
The transition period is critical to the success of the overall outsourcing relationship. In our experience with outsourcing remediation, at least two-thirds of the cases we encounter can be traced to problems at the transfer or transition stage. Some high-profile outsourcing divorces—such as Sears’ 2005 termination of a $1.6 billion IT outsourcing deal with Computer Sciences Corporation less than a year after signing the contract—suggests that the relationship went sour even before transition could take place.
What kinds of problems can affect an IT outsourcing deal at the transition stage? Often, buyers who are attentive to service issues in the run phase of a relationship may be less attentive to issues in transition. So there may be no mechanisms in place even to identify problems, much less to drive corrective action. This means some deals can end up in a kind of a failure loop right at the outset, with no means in place to correct problems.
Another reason for early-stage failure is that transition management involves specialized skills and experience. Currently, there are far more outsourcing deals in the marketplace than there are people experienced enough to perform effective transition management.
Transition is also a time when loyalties are changing as personnel move from the buyer to the service provider. Regardless of who is signing the paycheck of key personnel, an outsourcing buyer will want to watch carefully that everyone remains focused on serving their best interests. We worked with a manufacturing company recently where the application development and maintenance lead on the buyer’s side began to transition into a similar role on the service provider’s side. Up until that point, the client had been appropriately focused on negotiating the mechanisms for scaling and managing workflow from the client to the service provider, including SLAs and targets. But as soon as the client lead began to transition, those issues suddenly became less important than considerations of who would be filling what roles for the provider. By surfacing this issue, we were able to help the buyer refocus the service provider team, improving the performance commitment and the pricing metrics.
Here are some factors to consider in anticipating and fixing issues at the transition stage:
- Refocus and retraining of the retained organization is critical. In most cases, the retained staff consists of IT professionals who have been “doers,” with strong technology management roles in service delivery. Now they must shift gears and reconstitute themselves as managers and liaisons between their organization and the service provider. Special training may be necessary so that members of the retained organization understand and can operate effectively in their new roles.
- Use acceptance criteria. Tactically, a key success factor at the transition stage is the use of acceptance criteria: What are the marks that the service provider needs to hit, by what dates? Unrealistic transition timetables are a frequent source of trouble. Both buyers and providers should look with a skeptical eye at the viability of their transition timeframes.
- Choose the right transition economic model. A milestone-based, achievement-based economic model is a better approach than a time-based economic model.
The paradox of IT outsourcing management is that an overly aggressive approach to negotiations may be followed by an overly passive approach to managing and governing the relationship in the long term. Service providers historically have worked to create the perception that they will be watching out for their clients’ best interests. That has caused some outsourcing buyers to pull back from the ongoing work they still need to do to understand the temperature, quality and status of the ongoing relationship and to identify drift when it occurs.
Because of the complexity of the IT marketplace and the pressure placed on IT executives, governance tools can be a boon to avoiding costly performance failures. New online management tools that leverage and automate outsourcing management best practices and decisions can give IT decision makers visibility into relationships with multiple service providers and can verify service performance algorithms.
Other actions to consider in putting in place the right governance structures to manage ongoing outsourcing operations include:
- Commit to an ongoing investment in governance. Analysis of failed deals such as that between IBM Global Services and JP Morgan point to a failure to invest in project management and governance. Governance includes not only the reporting structures and decision making mechanisms, but also the means to diagnose the health of the relationship, put in place early warning signals and revisit and refresh the relationship where necessary.
- Don’t let up. Yes, the contract stage was long and arduous. But the finish line of delivering value from the outsourcing relationship is still a long way off. Keep everyone’s eyes on the prize through continued attentiveness to staffing, training and the process discipline of governance through transition and steady state.
- Use third parties. The use of advisory third parties can help in the operations phase at least as much as during the contract phase, because such counsel lets both parties see the relationship through the eyes of an independent and objective observer. Often, we find that simply focusing both parties on the original intent of the deal and the relationship is the most constructive route to putting things back on course.
A Focus on Value Creation
At the highest-level, the most important factor in avoiding IT outsourcing failure is ensuring that both the organization and its service provider maintain a steady focus on the value creation opportunity rather than exclusively on price and cost. The value of an outsourcing relationship isn’t measured by the contract, anymore than the value of a marriage is measured by the wedding.
Keep in mind that:
- Attentiveness to milestones and not just timetables is essential to moving successfully through the transition period.
- Governance of IT outsourcing is hard. It doesn’t pay to pretend otherwise. Take advantage of whatever tools and best practices you can to gain visibility into how the relationship is performing.
- Cost is one side of the coin of an outsourcing strategy. Optimal performance of IT processes is the other. If you focus on one side and ignore the other, you’ll have trouble on your hands sooner rather than later.
And, speaking of coins: IT outsourcing success does not have to have the same odds for turning up as heads or tails. Companies can significantly improve their chances of successful outsourcing by being attentive to the distinctive challenges at all points along the outsourcing lifecycle.
Mark Robinson is executive director, Advisory Services (Mark.Robinson@equaterra.com), and Peter Iannone is executive director, IT Advisory Services (Peter.Iannone@equaterra.com), at EquaTerra, a leading outsourcing advisor.