Avoid outsourcing risks by building flexibility into contracts

This series on outsourcing IT in the financial services industry concludes with a look at the risks involved in long-term deals. Renegotiating a contract is difficult--but it may be your only option. Mark Vernon discusses contract renegotiation and the importance of building flexibility into any new contract.

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In this series on outsourcing contracts in the financial services industry, I've discussed the importance of negotiating the initial outsourcing deal, reported on the benefits of a well-planned Business Process Outsourcing (BPO) partnership, and—last time—explained the rationale behind the decision to outsource. However, what if your organization is already in the middle of an outsourcing deal that isn't providing the services or benefits that you bargained for?

Outsourcing contract woes: What went wrong?

Many outsourcing contracts are now entering middle age—particularly in the financial services sector. A look at these maturing partnerships gives cause for concern. Three to five years into the outsourcing of large, complex, multimillion dollar, front- and back-office functions (including HR, procurement, and accounting), the strain is beginning to show for some of those companies who didn't negotiate flexible deals or skimped on the due diligence of finding the right partner.

"It is a market in turmoil," explains Linda Cohen, Gartner V.P. and Chief of Research in IT Outsourcing. From now until 2008, she estimates that up to 70 percent of deals will be afflicted by some kind of malaise—which she refers to as "offshoritis", "deal paralysis," and "management deficit disorder." And less than 50 percent of these problems will be fixed to anyone's satisfaction.

The difficulty with many contracts is the fact that they have not aged well. For example, outsourcing is reliant for its success on people, as much as technology, and while technology is relatively predictable, people are not. The individuals who set up large outsourcing deals are not the same people who are then responsible for delivering the services.

The entrepreneurial people do the first part, which includes the 6-18 months when tasks are set, staff is reallocated, and benefits are identified. But once the deal is rolled-out, they are off to the next project. Then, a new set of individuals is brought in: They are not entrepreneurial and, to put it bluntly, can lack the skills that lay behind the early success. From this moment, the partnership is under threat.

If a firm wants to make changes over the length of a five- to ten-year contract, which is very likely, the original outsourcing deal may not be flexible enough to accommodate them. For example, consider the way market attitudes are changing in relation to call centers—in particular, the way that off-shore call centers are increasingly beleaguered by complaints. (NatWest recently went so far as to run an advertising campaigning appealing to customers to switch accounts for the very reason that it uses only locally-based call centers.) A bank stuck with an intransigent call center deal, or one in which it is unaware what part of the service is off-shored, may well be unable to respond to these changes in good time, and so lose competitive advantage, if not market share, as a result.

Another outsourcing problem stems from the point in the business cycle at which these older outsourcing deals were signed. For example, in 2002, the IT services industry experienced only around 2 percent growth, according to Gartner—the lowest for 10 years. Vendors offered apparently lucrative long-term outsourcing contracts, and firms that faced tight budgets and pressure to meet short-term cost reduction targets might have been tempted to sign them. However, the "good deal" in 2002-2003 may not be such a good deal in 2004-2005, let alone 2006.

Plan to renegotiate long-term outsourcing deals

Now, if a bank finds itself in such a position, then it really only has one option: to renegotiate the deal (consolation is found, Cohen says, in the fact that an unworkable deal is often as uncomfortable for the provider, and so they are only too glad to make changes).

However, there is more to be learned from these kind of situations, namely in relation to signing up new providers in the future. The key is to recognize that over the lifetime of an outsourcing relationship, commercial variables are bound to change. So, renegotiation should be built into the deal right from the beginning.

It is possible to put together a deal that manages risk and builds in flexibility. A case in point is the recent relationship between Lloyd's of London and Unisys; they are partners in an infrastructure managed services agreement, worth $17 million over five years. "Lloyd's chose to partner with Unisys because of the professionalism and knowledge displayed during the tender process," says Chris Rawson, CIO at Lloyd's. "[But] Unisys also presented an imaginative proposition designed to continually improve the quality of services delivered in line with our organizational change and business objectives." In short, rather than constructing long-term outsourcing deals on the basis of control, companies should base them on flexibility. Perhaps then, fewer outsourcing deals will go sour before the benefits can be reaped.

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