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Darwin Magazine, August, 2001

Classic Outsourcing Blunders

by Lauren Gibbons Paul

It's been nearly 25 years since the first corporation had the bright idea of farming out part of its IT department to somebody else. They called it time-sharing, and it was supposed to cut costs dramatically. These days, the hot money-saver is off-loading Internet-related functions to application service providers (ASPs) that rent out software applications. Between the two, businesses experimented with giant agreements that saw entire technology operations shift to outside companies.

No matter what the current term, the basic concept is outsourcing. And seeing as we've had a quarter century to work out the kinks, you'd think that by now it would be a trouble-free, fill-in-the-blanks process.

But you'd be wrong. Outsourcing, it seems, is one place where it's a snap for history to repeat itself—with some calamitous results. While many companies have undoubtedly saved money, several others have seen costs spiral, quality plummet or, worst of all, IT operations crash. Why is it that this seemingly simple idea has spawned so many disaster stories?

The plain truth is that outsourcers commonly repeat a painful learning cycle every time a new technology gets outsourced. Because it can take years for both outsourcers and their customers to learn a technology and understand how best to manage it within the scope of the outsourcing agreement, they often make mistakes that have long-term effects. For example, when technology is new—such as customer relationship management and supply chain management—outsourcers often underprice their offerings to such a degree that they either go out of business or are forced to cut back on service. Customers, who mistakenly think that outsourcers are the experts in any technology, often do not know how to protect themselves from bad deals.

Doug Plotkin, director of sourcing strategies for the Meta Group in Stamford, Conn., sees a parallel between the proliferation of outsourcers handling the desktop more than 10 years ago and what's happening today with ASPs. When outsourcers began to offer the maintenance of desktop PCs for the first time, a multitude of outsourcing companies sprang up to meet this demand. Eager for customers, they priced their services too low. A shakeout followed, leaving only a handful of companies and a host of dissatisfied customers. But as both customers and vendors gained experience with how to best structure desktop deals, satisfaction levels rose.

Plotkin believes that so far, the ASP phenomenon is following the same trajectory. A year or two ago, new ASPs were appearing overnight. Today, he says, the ASP consolidation is well under way as both businesses and customers get smart about how to handle these new projects. In the meantime, mistakes happen.

Given the high margin for error, why would anyone outsource a new technology? Simply put, you may have no other choice. Cycle times are shorter than ever, money is tight and skilled personnel are hard to find. For many companies, outsourcing offers an attractive path around these constraints. (According to the Meta Group, the overall outsourcing market in 2000 was $100 billion and is growing each year at an impressive 20 percent.) But regardless of why you outsource, mistakes happen and often enough for us to compile a list of five classic outsourcing blunders. Here's hoping that you can learn from a host of others' missteps.

Don't Get Entangled in a Long-Term Contract

Traditional outsourcers often try to persuade companies that only a long-duration agreement justifies the high up-front investment needed to provide great service, says Peter Bendor-Samuel, CEO of the Everest Group, a Dallas-based outsourcing consultancy. "The suppliers are always looking for five- and 10-year contracts, but do we have any idea where e-commerce will be in five years' time? How can we contract for it if we have no idea where it's going?" he asks. Don't be swayed, he warns. Because both business and technology change so rapidly, it does not make sense to have an agreement longer than one or two years.

Long-term contracts can also act as a disincentive for good service, because outsourcers may grow complacent without the hovering threat of a canceled contract. For example, Blue Cross Blue Shield of Massachusetts discovered that a decades-long relationship with Plano, Texas-based EDS was a recipe for lost money and internal dissatisfaction. The company had signed its first deal in the 1970s, when it outsourced its mainframes. Throughout the years, the contract grew to encompass the installation, maintenance and support of its desktop PCs. In the end, EDS had 450 IT people working onsite, while Blue Cross had 150.

When Mark Caron came on board as CIO, he discovered that his new employer was actually losing money on the outsourcing deal—all because it just re-upped the same contract every five or 10 years without reviewing what had changed through the years. The result? "IT was our largest budget area in the company," says Caron, who has since left Blue Cross. In fact, because the outsourcing agreement failed to tie PC maintenance pricing to current market rates, the insurer's IT costs were two-and-a-half times what the rest of the industry was paying—and there was no end to the cost increases in sight. Hog-tied by the contract, the insurer had to charge higher rates for its policies just to keep afloat.

After a protracted battle with the outsourcer, as well as with internal management, Caron managed to restructure the contract. There would be no more automatic renewals of 10-year contracts, and he made sure to build in items, such as benchmarking provisions and credits for unused bandwidth, that tied the outsourcer's fortunes more closely to those of the insurer.

Many of the ills that befell Blue Cross could have been avoided if its contract period had been shorter. Bendor-Samuel says that in most cases, newer technologies—such as an e-commerce website or a virtual private network for remote access—should merit short agreements. That way, if the provider's technology becomes out-of-date, if pricing drops much more rapidly than anticipated or if your needs change radically, you won't be stuck. Things are simply changing too fast to be able to strike an intelligent deal that far in advance.

Don't Let Your Responsibilities Collide with Those of the Outsourcer

Surprisingly, contracts are frequently vague about exactly what the outsourcer's responsibility is versus the customer's. Without a patrollable boundary, neither side knows with certainty what it should be doing. The result: Each side blames the other when things inevitably don't get done. The big problem seems to occur when businesses think that outsourcing obviates the need for any kind of corporate technology strategy. Blue Cross's Caron discovered that very thing when he walked into the contract from hell. "People here thought [the outsourcer] was going to do everything, but it could only do so much and had only so many resources," he says. "Without an internal IT strategy to drive it, [the outsourcer] was faced with a no-win situation." Because nobody took charge of strategy, the result was a sluggish operation operated with minimal oversight. The outsourced IT operation was unresponsive to business needs to the point that it eventually threatened the company's ability to compete.

Don't Neglect to Measure Success (or Failure)

Parties to an outsourcing agreement often fail to set the parameters for measuring performance simply because it's a difficult and time-consuming task. The results can be disastrous, says Alison Smith, vice president of infrastructure at the now-defunct dotcom Myspace (previously known as in San Francisco. She speaks from bitter experience. Her company formed a relationship with Andover, Mass.-based NaviSite to manage the day-to-day operations of its website. At first, Smith says, the relationship was practically a love fest. "Everyone was pals and friends and everyone just wanted the relationship to work," she relates.

But things grew difficult as Myspace took off. The dotcom started with two servers and 10 megabits of bandwidth but quickly needed eight servers and 100 megabits of bandwidth, and was adding 10 gigabytes to 12 gigabytes of storage per day. NaviSite found it increasingly difficult to handle the growth, and Smith grew dissatisfied with NaviSite's performance.

That's when it became painfully clear to Smith and her colleagues that they had been operating without a contract that spelled out performance measurements. Everyone had been moving so quickly at the beginning of the deal and there was so much goodwill on both sides, it was hard to believe a stodgy legal document would be required. Consequently, when things started to break down, there were no guidelines to help define performance and satisfaction levels.

"The contract is the most important part of the outsourcing relationship," says Smith. "If it's not in the contract, you'll find it hard to do." When she and her cohorts signed with their next outsourcer, which turned out to be Intira of Pleasanton, Calif., they insisted on an ironclad contract, complete with service level agreements that link financial penalties to subpar performance, and with detailed security and capacity provisions. Smith suggests that customers define acceptable levels of performance in terms of business relevance. For an e-commerce site, for example, a good metric would be the online customer conversion rate—the rate at which online browsers become online buyers.

Don't Be a Control Freak

Companies often go into outsourcing expecting to retain control of how the particulars are carried out. Tempting, yes. But it's a big mistake. Forcing the outsourcer to do it your way prevents your hired gun from doing what it does best—leveraging its own experience and hard-earned best practices. "Outsourcing is the transfer of ownership of a process to a supplier," Everet Group's Bendor-Samuel says. "It's different from consulting, where you own the problem but pay people to try to help you fix it."

One company that Bendor-Samuel knows of outsourced management for all of its desktop computers to EDS. Rather than letting EDS own the process, company executives insisted on retaining control of details such as exactly how many people should be on the project and which equipment they should have. "It was a very unhappy situation, because EDS was prevented from using its best practices," and the customer was frustrated by EDS's attempts to take more control of the situation, Bendor-Samuel explains. Both sides ended up wanting out, which was an expensive proposition for the customer.

Don't Bet on a Dark Horse

It's tempting to choose an outsourcer with an alluringly low price. But remember: Many of the new outsourcers have unproven track records and aren't as stable as the companies that have been around for years rather than months.

And picking a loser can have excruciating consequences. Just ask Fred Eisenberg, director of information security for Mount Sinai New York University Health, in New York City.

Two years ago, Eisenberg elected to outsource remote Internet access for the group's 4,000 physicians and other personnel. The provider he chose was new to using remote Internet access in the health-care industry but said all the right things about capacity and reliability.

Talk turned out to be cheap. The outsourcer, whom Eisenberg declines to name, stumbled badly in its performance. The service was frequently down, and the doctors, who had never had remote Internet access before, became frustrated with the long connection times.

Not surprisingly, new subscribers to the service stalled at 420 out of a target audience of 4,000. When the provider abruptly decided to leave the business, Eisenberg had just 11 weeks to find a new provider. The biggest mistake they made, Eisenberg says, was initially going with a provider that did not have an established track record in his industry. "[Next] time around, we knew to look for a company that had some history in the field," he says. After an introduction via another business partner, Mount Sinai settled on Aventail of Seattle.

The take-away message from these tales of woe: When it comes to outsourcing new technology, proceed with caution. You may think the outsourcers have all the answers, but too often they don't. You'll need to weigh for yourself the risks of outsourcing a new technology versus holding off on implementing that technology. But when outsourcing is your only choice, avoiding those common mistakes will save you from a painful learning cycle.

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Read comments on this article posted by Intelligence-Soft web site visitors:

Date: 10/5/01 Posted by: Nidhi Saxena Country/City: -
Excellent article... perhaps a name of few recommended vendors or sites would make a lot of difference.
Date: 9/8/01 Posted by: William Country/City: -
An excellent article. Having been involved in outsourcing for the past 10yrs I have seen may companies around the world treat the outsourcer as a vendor who can solve all rather than a partner working to improve service and reduce costs. One of the key mistakes is too many retained staff. This leads to the difficult governance models you briefly mention in your article. Companies that outsource without really "letting go" are primed for failure.
Date: 8/9/01 Posted by: Jose' E. V. Cunningham Country/City: -
Darwin does its readers a service by pointing out that outsourcing can, and sometimes does, have a downside. The fact of the matter is that outsourcing is not a good business strategy for every enterprise. But rather than promote the idea that the sky is falling, it's important to realize that many outsourcing buyers and sellers are applying the lessons learned from and best practices of their engagements. In a recent user survey co-sponsored by The Outsourcing Institute and The Conference Board, in nearly all areas of IT outsourcing the respondents indicated they were satisfied with outsourcing. Interestingly, not a single respondent indicated they would bring outsourcing back in-house when their existing contract expired. Some enterprises are, as you demonstrate, "still doing it wrong," but many more are learning from their mistakes. They are mitigating their risks and exposure by
1) Paying more attention to service levels;
2) Ensuring flexibility in the contract to meet changing business needs;
3) Using a competitive bidding process; and
4) Paying more attention to the contract and contract governance.
Date: 8/5/01 Posted by: Lee Dews Country/City: -
Outsourcing, whether it be long-term or short-term has core cause and affect symptoms that currently aren't being remedied. There are six basic business and technical rules that need to be addressed by both the oursourcing firms and the client companies.
1. Hire competant teams that understand both the business and technical needs and how to fill them. This includes recruiters, HR personnel, sales people, client specific knowledge based teams, and management.
2. Ensure communication between the outsourcing company and the client company is clear and ongoing.
3. Set and document all expectations before sign formal agreements. This should include a Letter of Intent, Statement of Work, Deliverables, Timeframes, Risk Mitigation Plan and Assumptions. These expectations are dynamic and shouldn't be treated as a one-time static commitment. All changes to these agreements should be documented, communicated and tracked.
4. Both outsourcing and client companies absolutely have to assume that turnover is part of the package. Therefore any work done by an outsourcing company and client has to be documented and continually transferred to the client to prevent a "single-point-of-failure". Another benefit is that the client ends up owning the deliverables, not the outsourcing company.
5. Communication and management between the outsourcing companies and the client company have to start during negotiations and be ongoing and clear. The mindset of completely turning any type of technical operation over to a consulting company because "they're the experts" and not managing the progress, costs and risks will ensure failure more often than not.
6. Communicate and document both business and technical changes immediately. Then plan incorporation into any outsourcing efforts in progress.
This is a very high level list of success criteria that most outsourcing firms have not succeeded in putting in place. Therefore, client companies haven't been educated as to how they will be impacted when dealing with these firms.
Date: 8/2/01 Posted by: Ron Leckrone Country/City: -
You could summarize the article in two sentences. Don't outsource if you don't know what you're outsourcing. And, Don't outsource to people you don't know. The big double-whammy mistake is not knowing what you're outsourcing and then giving the unknowns away to a vendor that you really don't know.

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