July 19, 2013, 4:36 PM — Almost as soon as the outsourcing deal was inked, it was an $800 million disaster.
The Fortune 500 company's seven-year, $120 million-a-year IT services deal had all sorts of problems from the beginning, according to an IT director whom we'll call Skip Currier (not his real name), who had a front-row seat to the debacle. "From the beginning, the project was understaffed and overambitious. They didn't fulfill certain parts of the contract, and our executives didn't force them to," he says with a sigh of exasperation. All told, the deal was badly executed and badly managed, with plenty of blame to go around.
It's no wonder, then, that this organization chose not to renew the deal and is bringing responsibility for deploying and managing technology back in-house. It's not alone, of course. The most famous recent example: CIO Randy Mott brought a broom into General Motors last year and swept 90% of its outsourcing deals out the door.
Other high-profile companies turning to insourcing over the past few years include the Sainsbury's grocery chain and financial services firm Santander (both of whom, along with GM, turned down interview requests, as did most of the outsourcing firms involved).
While it would be misleading to say that insourcing is a new phenomenon -- companies have been cancelling major outsourcing deals as long as there have been major outsourcing deals -- indications are there is a shift in thinking underway. Charles Green, a Forrester Research analyst focusing on sourcing and vendor management, sees "an ongoing level of dissatisfaction with outsourcing," citing Forrester's 2012 services survey of some 1,000 IT services professionals, where nearly half the respondents listed "poor service quality" as a challenge and 32% stated they were looking to bring work back in-house.
What's also changing, according to several sourcing consultants and IT executives who did agree to talk, are the deals themselves: their duration (shorter), their focus (narrower) and how they're managed (more closely). Other issues -- changing economic conditions, new technology and even the competency/incompetency of outsourcers -- are also feeding the insourcing trend.
Whether they're ready to cut the cord or not, companies should take heed of these converging forces as their outsourcing deals come up for renewal. (For more about how to rein in an outsourcing contract, see Three tips for intelligent insourcing.)
The problem(s) with outsourcing
As the saying goes, when you're up to your butt in alligators, it's hard to remember that your original objective was to drain the swamp. Business executives who followed the admonition to "stick to your core competency" determined that IT was not their companies' core competency and so waded into the outsourcing swamp unawares.
Problems that are roiling those waters include:
Lopsided decision-making. Kevin Chase, CIO of Energy Future Holdings (EFH), is in the process of what he calls "rightsourcing" (details below) one of the biggest outsourcing deals ever, which dates back to 2004, when EFH was known as TXU Corp. The goal of such outsourcing agreements at the time, Chase explains, "was to hold a single outsourcer accountable for delivering all IT services -- as well as many business functions -- while achieving cost reductions through operating efficiencies and economies of scale."
The problem with this approach was "the amount of control and decision-making power that was put in the hands of the outsourcer," Chase says. "That makes it difficult to effectively manage risk and strategic opportunities over the long term."
Poor service quality. Steve Martin, founder and partner of Pace Harmon, a McLean, Va.-based outsourcing consultancy, has certainly heard the stories IT executives like Currier and others tell. While he prefaces his comments by saying he "hates to bash outsourcers" (not surprisingly, given that many of them are his firm's clients), Martin frankly admits that some outsourcers are "not doing a great job. If you talk to enterprises about their outsourcing providers, there's a high level of dissatisfaction."
Pace Harmon recently released a report on insourcing that echoes that observation: "Many outsourcing deals are failing to meet expectations from an overall service delivery value perspective," the report says, specifically citing "escalating cost-of-quality issues" and "inconsistent quality during service transition and delivery" as concerns.
A lag in technology. Shouldn't companies that set themselves up as technology experts be able to deliver that technology? Sure, in theory. But as every CIO knows, it's hard to keep up with the pace of technology. Outsourcing firms have been ensnared by changes in technology just as other firms have.
Just one example: "Some managed service agreements have a pricing structure based on the number of physical servers," says Scott Stewart, research director for ITNewcom, a Brisbane, Australia-based consulting firm. "That means that outsourcing provider has no incentive to deploy virtualization and consolidate infrastructure. That's a problem." The increasing capabilities and multiplying permutations of cloud computing confuse the outsourcing issue even further.
These technology changes have driven some companies to insource and others to compress outsourcing deals from covering seven to ten years to covering three to five years, with one-year renewal options. Technology simply moves too fast for ten-year contracts, sources agree.
Staffing and other woes. As Martin notes, when many outsourcing deals were first inked a decade ago, there was a huge gap between what companies could pay workers in India or the Philippines versus those same costs in the U.S., so there was a significant financial incentive to do business overseas. But now wage inflation in the U.S. hovers in single digits, while it's in double digits in India. "There's still a significant differential between what you pay a database administrator here and there, but it's compressing," Martin observes.
Those rising costs, coupled with some customer complains about language difficulties while talking to offshore service representatives, have also spurred some companies to bring call centers back onshore.
Three tips for intelligent insourcing
Sourcing experts -- both IT executives and consultants -- advise that companies may not be able to transition to insourcing quickly or painlessly. "If outsourcing is difficult on a scale of one to ten," says Steve Martin, a partner at outsourcing consultancy Pace Harmon, "insourcing is a 12." Here are their suggestions for successful transitions from outsourcing inward.
Watch the calendar. Outsourcers require notice for cessation of agreements, even if it's being done for cause. You'll need anywhere from 12 to 24 months to get ready to make the transition, suggests Martin.
Check your resources. Insourcing requires having both the staff resources to manage activities you haven't been doing and to purchase software you haven't had to own. Not everyone has the resources that GM's Kevin Mott had when he began bringing several thousand employees back onboard.
Prepare for change. As Energy Future Holdings' CIO Kevin Chase notes, insourcing requires configuring a new model of IT structure. That requires that everyone involved to change, which isn't always easy with a global IT organization. It is, however, necessary, he says. "Don't let your current situation stop you from creating a more flexible organization for the future."
A shift in mindset. Recently, a light has gone on over the heads of many business leaders regarding the importance of technology: It is a core competency. The last few years have convinced what were once considered non-tech companies in fields like automobile manufacturing, retail, hospitality and consumer packaged goods that technology plays a central role not only in what they build, but in how they interact with customers.
"As the economy starts to thaw, companies are moving out of maintenance mode," observes Pace Harmon's Martin. As that happens, IT "is becoming more critical to business operations, and that puts a higher premium on gaining control through insourcing," he says.
At the same time, the business side is more involved in technology decisions, and "with the business side driving more of the discussion around technology investments, companies are forced to reevaluate their outsourcing deals," says Forrester's Green. Specifically, business executives are quite interested in any value to be gained by moving from a traditional outsourced model to a cloud service model, where the company manages and has control over its data but doesn't necessarily own the software or hardware it uses.
How to re-grab the reins
EFH's Kevin Chase epitomizes the trend of companies taking back control over their systems, as he has reconfigured his internal IT organization, increasing its numbers to 25% of the total IT staff (internal and external) and "giving it responsibility for strategy, governance, and operational and project leadership, architecture design and subject matter expertise," Chase ticks off.
While shifting those capabilities back in-house, Chase at the same time brought in or maintained relationships with firms such as HCL, Accenture and PwC and Capgemini. HCL manages infrastructure, Accenture and PwC are currently leading strategic projects across the enterprise and Capgemini manages applications."This helps us get an optimal balance of cost, quality and control," explains Chase.
Chase likens the new strategy to a hub-and-spoke system, where EFH is the hub and the spokes connect to multiple outsourcing vendors that then implement strategies developed under EFH's control. "This model enables EFH to own all key decisions and drive the priorities most important to the business, while we leverage the strengths and scale of several global IT delivery organizations."
So far, no one can argue with his results. "As a result of rightsourcing to this 'best-of-breed' model, we've reduced our IT costs by 30% over the past four years. We've eliminated more than $50 million of recurring costs because we've taken more direct control over strategy and optimized day-to-day operations," Chase explains.
Because internal people know better than outsourcers what the company really needs, they can "focus on gaining new efficiencies, automation and leveraging innovation for each business unit's benefit," Chase elaborates. What's more, because IT has been able to gain more productivity from fewer people, "we have been able to reduce total staffing across IT by 25%," he says.
Pace Harmon's Martin says this strategy makes sense. "You can still outsource routine functions. There's nothing sacred about having someone monitor your network devices or do tech support," he points out, reasoning that repeatable, routine activities are not central to a company's strategy.
Consultant Stewart concurs that he's seeing Chase's strategy becoming more popular. Companies have greater control, he says, by doing what he calls specialized "striping" of vertical business processes -- that is, outsourcing specific activities, rather than wholesale responsibilities.
Key metric: Understanding IT costs
There's one more piece to the insourcing puzzle that companies need to nail down, practitioners agree, something that's always been difficult: understanding IT costs. One good thing that came out of Currier's disaster is that "it exposed the real cost of IT. Originally, from the business perspective, IT didn't 'cost' anything, because it was buried." As the company begins to insource again, it has a better understanding of what IT costs.
ITNewcom's Stewart agrees that understanding costs is important, because it helps you determine what you're getting from an outsourcing agreement. "Ten million dollars a month sounds like a lot of money," he says, "but it's not the invoice that comes in every month, but understanding the true cost of IT and what level of IT you're getting."
Companies need to benchmark their costs and make an informed decision about the rightsourcing model. "By going through that process, they can go to the market and ask outsourcers what they would charge, and compare [prices]."
Besides understanding what IT costs, the most important key to remember when considering insourcing is that the world has changed. IT is no longer something that can be surgically excised and transplanted to an outside firm. It is strategic, something that needs to be managed and even nurtured.
"It's not always about the cost. It's also about getting the business back to its core competency, retaining their agility in business processes, without owning the assets or managing the capital expenditures," says Stewart.
Silicon Valley-based freelancer Howard Baldwin wrote most recently for Computerworld about CIOs in emerging economies.
This article, Outsourcing, adieu: Companies retake the reins on IT services, was originally published at Computerworld.com.