From: www.itworld.com

When the outsourcing honeymoon ends

by David Raths

April 30, 2001 —

DO YOU CONSIDER outsourcing a major IT function? If so, bear this in mind: Like an eager suitor, the vendor will promise the moon. But the courtship period is often the best part of the relationship. IT leaders should look at working with outsourcers more like a marriage with the potential for divorce, says Peter Vogel, a Dallas attorney. "If you know you're going to get divorced -- and I use this analogy -- you should start thinking about who's going to get the record collection and who gets the furniture," he says.

Some IT managers don't plan for problems, because they don't want to envision failure of the relationship. With the economy pinching both IT departments and outsourcers, flexibility and solid agreements are key to surviving tough times in the IT/outsourcer marriage. Deciding whether to seek a new vendor, renegotiate, or bring a function back in house is daunting. The following case studies illustrate paths that IT executives have followed when a relationship with an outsourcing vendor has soured.

Reworking the marriage contract

In 1999, Robert Nelson overhauled his company's outsourcing agreement with IBM Global Services for functions from help desk to distributed network management to application development. Because of mergers and QoS (quality of service) issues, the former director of IT services for New Century Energy (NCE) of Denver (now part of Minneapolis-based Xcel) determined that the agreement had to be renegotiated. "We were pretty dissatisfied with the services and the contract," he recalls.

Signed in 1995 and worth about $500 million over 10 years, the original contract lacked flexibility. Because NCE was among the first in the energy industry to craft such an arrangement, there were few examples to follow. The decision to outsource to IBM Global Services (then called ISSC) was made at the executive level and without competitive bidding. At the time, IBM was one of NCE's largest customers for electricity, so the deal was seen as part of a broader strategic relationship.

The catch point, Nelson says, was that different NCE business units wanted varying service levels from IBM; but the initial service agreement was "one size fits all." That wouldn't work going forward. "We wanted to create a more competitive situation where the onus was on [the outsourcer] to demonstrate that they were a world-class IT provider," Nelson says.

But reworking the contract failed. "We worked to make incremental changes all along, but it was like pulling teeth to get the type of changes we wanted out of the [IBM] account team," Nelson says. "Typically, the account team is a world unto itself, and they have the freedom to run the account as they see fit ... [So] we created and sent a detailed statement of restructuring requirements to senior IBM execs outside of the account team. It was at that point that IBM seriously took on the challenge of restructuring the agreement."

It's still not clear how successful the reworked contract has been, Nelson says. The assessment has been complicated by a merger in 2000 that doubled the size of the original agreement to $1 billion. "The new agreement hadn't been in place three months ... I hadn't even had a chance to take the pulse of the agreement when it had to be amended again," says Nelson, who now consults at Xcel.

But Nelson is convinced that, with changes in the utility industry, outsourcing IT has been a benefit. For example, with the 2000 agreement IBM has consolidated datacenter operations and the help desk. In addition, Xcel is seeing a much greater emphasis from IBM on strategic IT.

Time for a new relationship

When health insurer Anthem wasn't getting the expected service or prices from its datacenter outsourcing arrangement, Rick Molland recommended switching vendors.

Anthem had outsourced operation of its three Midwest datacenters to Unisys, in January 1996, with a five-year facility-and consumption-based contract. After the first year, Anthem was somewhat dissatisfied with service levels and some "runaway costs," recalls Molland, a senior e-business advisor for Anthem, in Indianapolis.

The original agreement had not clearly articulated service levels. It also lacked repercussions for failure to meet service goals, Molland says. "With consumption-based fees, we were paying considerably more than what we had projected. [But] we were not getting any improvement in the kind of service [from] when we ran the datacenters internally," Molland says.

Anthem hired Compass America, a third-party benchmarking consultancy, in Reston, Va., to do a cost-comparison study. It also brought on outsourcing consultant Peter Bendor-Samuel of the Dallas-based Everest Group to review market conditions and provide an estimate of current reasonable outsourcing pricing.

Pricing is where negotiations can get nasty, Bendor-Samuel warns. "The vendor feels entitled, and the buyer feels like a hostage," he says. From the vendor's perspective, it's difficult to renegotiate on pricing because they have already told the analyst community what revenue they are generating. "It helps to come up with some value-added service they can provide to earn some or all of that revenue so they can save face," he suggests.

Anthem's Molland also conducted a cost projection of returning the service in house. The answers that came back suggested that the company could do better with either a new vendor or in-house operations.

"We decided not to insource, because the underlying premise behind the outsourcing decision was still valid," Molland explains. "This is not a core competency of an insurance company. We want to devote our energies to more strategic technologies."

Involved in these discussions were the CIO, the vice president of IT administration, and Molland, who was director of contract management at the time. The group kept higher-level execs updated on their progress. The decision was made in April 1997 to develop an RFP (request for proposals) and seek bids. By July, Anthem had issued the RFP and invited eight firms, including Unisys, to bid.

Although one might expect this to have led to hostility from Unisys personnel, Molland was very impressed with how well the management team cooperated. "They were totally professional about it, and I believe we maintained a good working relationship with management on the ground. They were very gentlemanly throughout the whole process."

By fall of 1997 Anthem had narrowed the field to two companies and was negotiating terms with both of them. "We had a great desire to have the whole thing completed by Dec. 31, 1997," Molland says. The vendor Anthem chose, Affiliated Computer Services, in Dallas, is still providing that service. In fact, Anthem has grown considerably since that time, acquiring Blue Cross and Blue Shield insurance plans in several new states. "They have taken on all that mainframe processing, and we wouldn't have given it to them if we weren't happy with their service," Molland says.

Anthem included clauses in the contract with Affiliated Computer that it hadn't considered with Unisys. "In addition to tightly defined service levels, we felt that it was important to have in the contract a governance process that mandated that executive management -- not just datacenter managers -- get together at least once a quarter," Molland says. Once the deal makers disappear, so can the essence of the arrangement and the spirit of cooperation, he says.

"If it gets reduced to, 'But the contract says this,' you're in trouble. If you know where your contract is and feel the need to reach for it often, the relationship is probably not in good shape," Molland adds.

Suddenly a widower

Dieter Schoenegger, CTO of adidas America, will never forget the day last July when he received a letter from his ASPs (application service providers), Pandesic and U.S. Interactive, advising that they were going out of business.

When Schoenegger took the post of CTO of adidas America in January 2000, he found a three-part infrastructure already in place based on SAP-Intel joint venture Pandesic (Web-enabled back office), U.S. Interactive (front-end, navigation logic, and image management), and Digex (data hosting). Seven months later, after working to improve the U.S. Interactive front-end and attempting to deal with the shortcomings of Pandesic's hierarchical SAP R3 ERP (enterprise resource planning) system and its manually intensive logistics capabilities, Schoenegger was faced with the collapse of Pandesic and U.S. Interactive.

Schoenegger and his staff began to weigh options. Via e-mail, Schoenegger contacted some 80 Pandesic customers who were also searching for fall-back strategies and formed an informal consortium. One option was to get a "life extension" of Pandesic run by another entity, Osprey, in Charlotte, N.C. But the process was taking too long -- September passed, then October, without signatures. "I thought it was getting too risky," Schoenegger recalls. "I wanted a soft landing."

Before working with another vendor, Schoenegger created a requirement analysis for major functions, including e-commerce features (shopping cart, search, gift certificates), back-end ERP, and warehouse integration. Schoenegger rejected several large players and decided to work with a smaller, more nimble company. "We found someone who could mirror our product structure," Schoenegger says of Cutsey Business Solutions of North Bay, Ontario.

The process of building a prototype took from mid-September until the end of October. The new contract was signed before Christmas 2000. Migration for thestore.adidas.com and teamsoccer.adidas.com were completed on Jan. 19 without any business interruption, says CTO Schoenegger.

What lesson does Shoenegger draw from this experience? "Keep looking for alternatives as they evolve. Never let the vendor feel they are the only one."

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