Applied Materials: Looking to Flexible Offshoring Deals to Survive

This year could be one of the toughest in Applied Materials’ 42-year history. The provider of nanomanufacturing technology solutions posted a $133 million loss in the first quarter; new orders fell 64 percent from last year’s first quarter. Even the brightest spot on the horizon—its new business to produce equipment for solar photovoltaics and energy efficient glass—has seen a temporary demand slump due to the recession.

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“We were facing the worst semiconductor downturn in history, and then the global recession hit,” says Applied Materials CIO Ron Kifer. “Those things are beyond our control, so we are focused on what we can control. And 80 percent of that is costs.” Kifer knows: He was hired in 2006 to transform IT, reduce costs, improve service levels, and drive business transformation. He took a workforce of 580 full-timers and 1,000 consultants at 40 service providers and whittled it to 300 full-time workers and contracts with three providers to handle offshore IT services at prearranged prices, instead of by the man-hours. He cut IT costs by 35 percent over two years.

“We didn’t want internal resources focused on commodity activities. We wanted to refocus them on core competencies that drive value,” he says. He inked deals with IBM Global Services, Tata Consultancy Services and Wipro, which compete to provide services including application development, maintenance, desktop and database support. His own staff focused on strategy, architecture, cost management and program, portfolio, security, risk and vendor management. The plan eliminated expenses and improved services, making more IT budget reductions a delicate balancing act.

Still, when things got tough six months ago, Kifer asked his big three for more price concessions. “You don’t want to reduce their margins to where they’re hurting to make a profit,” says Kifer, whose benchmarking showed that his prices were 15 percent to 20 percent below best practice price points. “But there was room.” He noted that his Indian providers benefitted from international exchange rates in the past. The talk worked. “Our ability to move work between service providers creates an atmosphere in which they’re quite keen to find win-win opportunities,” he says.

Renegotiating reduced costs by 6 percent to 8 percent. But it wasn’t enough.

One reason Kifer adopted a managed services model for offshoring was flexibility. IT had maintained high service-level agreements (SLAs) with providers. When Applied began to lose money, Kifer’s team eased requirements. A service that required a two-hour recovery period may be relaxed to three or four hours with a drop in the service cost. Each SLA shift was prenegotiated with the business. But since IT costs are allocated to the appropriate unit (each with cost targets), it hasn’t been a hard sell. IT still reexamines SLAs, but the bulk of the adjustments have netted an incremental 18 percent to 20 percent savings.

Many CIOs are seeking such savings. “We are seeing a surge in clients working with their vendors to reduce costs from 15 [percent] to 25 percent,” says Atul Vashistha, chairman of offshore outsourcing consultancy neoIT. “The timing is key because both sides recognize the impact of this economy and so are open to working together to make changes.”

Options for slashing costs include weeding out low-performing partners, moving to a managed services model, driving more volume to the vendor or benchmarking to ensure competitive pricing. The key is to find opportunities that don’t punish the provider, says Vashistha.

Stephanie Overby is a freelance writer based in Boston.