A few years ago the CEO of a leading IT Services company told me that all CEO are alcoholics. I asked him why he says so and he responded, “We all live by the quarter.” A very profound statement that talked of the CEOs’ inability to focus on the long term but look for how best to meet and exceed the next quarter’s market expectations.
A few years ago the CEO of a leading IT Services company told me that all CEO are alcoholics. I asked him why he says so and he responded, “We all live by the quarter.” A very profound statement that talked of the CEOs’ inability to focus on the long term but look for how best to meet and exceed the next quarter’s market expectations.
The results announced during the last week by Infosys, TCS and Wipro reminded me of this living by the quarter and also clearly showed a few trends – slower growth (mostly in single digits), lower profitability and worse still, lower guidance. Hidden away in the numbers are – slower hiring plans, automation and most importantly lower revenue per employee (also called revenue productivity).
I had visited some engineering colleges a few months ago in the 2nd and 3rd tier locations of Tamil Nadu. Hiring was extremely slow there. The IT majors were, at best, dishing out Letters of Intent (LOI). What these letters would say is that if the market conditions were good, they would consider hiring. Basically, these were not offers. Most colleges show as though they have 100% placements when in reality it is not even 10% and the rest are LOIs.
Hiring for all the major IT companies (Wipro, Infosys, TCS, Cognizant and HCL) was 24% lower in 2015 as compared to 2014. NASSCOM has said that in 2016 it will be a further 20% lower. All companies claimed that they were automating jobs. For example, Wipro talked of its Artificial Intelligence Platform Holmes that will take out 3,300 jobs from its services workforce of 30,000 who are on fixed price contracts. The fact is that if these companies do not automate, someone else will and will force automation to happen. Robots will take these jobs. After manufacturing, the IT/ITES sector will see the largest displacement of jobs as more and more roles get robotized. This is happening as the space of Artificial Intelligence, Machine Learning and the world of Data Sciences are getting better and better. However, this is not the major cause of dipping profitability as of today. This is only the tip of the iceberg and most companies talk more and deliver less on this aspect.
The biggest reason for dropping profitability is pricing. Companies are giving up margins for market share. The revenue per employee for most of these companies is dropping year on year. It is ranging at 1% – 5% currently but I believe will go down further till these companies change the product/ service mix.
The quantum of exposure of different companies to troubled verticals has also resulted in dropping revenues. For example, the banking industry in Europe is causing sleepless nights for some of our IT Majors. Further, currency fluctuations are not helping.
TCS, Wipro and Infosys average around $46,000 per employee per year. Cognizant seems to have bucked this trend because of their acquisition of Trizetto and also the fact that their split of work is more towards consulting and technology than outsourcing.
Vishal Sikka of Infosys talks of reaching around $80,000 per employee by 2020. So, what needs to be done to make this a reality not just for Infosys but also for the industry as a whole?
Build Consulting and Technology Practices – As businesses globally struggle with technology and the impact of Digital to their businesses, the IT Majors need to shift more to consulting and pure technology and start reducing their reliance on outsourcing using headcount. I had a European friend who would say “Is there a problem? Why don’t we throw more labour at it?” Those days seem to be fast disappearing as smaller and nimbler companies are throwing robots at problems or people with higher skill sets who build robots to be thrown at these problems.
Learn to shop and actually shop effectively to build capability – This shift to consulting and technology means a different kind of capability build in products, platforms and services that the IT Majors currently don’t have. Such a capability build will take years. So, an approach would be to acquire. Like what Cognizant has done with Trizetto or Infosys with Edgeverve. Most acquisitions are small but the Trizetto one was not only huge but catapulted Cognizant in to a vertical that is hot and got them off to a flying start. It also improved their revenue per head and margins. So, the IT majors should start a shopping spree. If the Government of India can be so pro-active and invest $500m to build a port in Iran so that it can protect its energy interests, I am sure our IT Majors can do better.
Build Data Sciences and Analytics Practices at a very large scale The data sciences practice should replace the fast commoditizing IT Outsourcing practice with really high end artificial intelligence and robotic capabilities that will help customers not only to scale faster but also move out of old technologies.
More data scientists than just coders – Push universities to bring out more employable engineers – strong in maths, computing, machine learning and artificial intelligence.
Balance the long term and short term – The stocks may take a beating in the short term as speculators leave your counter on the stock exchange. But the long term investors will invest for your strategy. Of course the speculators will return to your counter – they cannot stay out of “ups and downs” forever.
As I walked past a liquor shop I couldn’t help notice a few people buying a quarter liter bottle and smiled as I wondered which CEO was going to down that bottle that night.
Operating level agreements (OLA) aren’t exactly new to IT. Unlike service level agreements (SLA) between an IT organization and its service provider, OLAs state how particular parties involved in the process of delivering IT services will interact with each other in order to maintain performance.
“By establishing OLAs between these groups, the IT function can provide the appearance of seamless service to the business,” says Edward Hansen, partner with law firm Baker & McKenzie.
Until recently, OLAs were most often internal to an IT organization or a single large service provider, ensuring that the groups within the organization were working together to deliver IT services. But with the rise of multisourcing, OLAs are back in the spotlight.
“In this context an OLA becomes a record of shared assumptions and interdependencies at the level of processes shared and intersecting between each of the multiple parties engaged in the delivery of services,” says Les Druitt, founding principal of outsourcing consultancy Sourcing Advisory Services. “It is where the rubber meets the road in a multi-party outsourcing.”
“It has become more and more important for the ultimate customer to know that the relationships and interactions among these multiple parties are well-known, documented in clear and precise language, and reflected in binding agreements that can be enforced-if necessary-by the customer,” says partner Robert Zahler, partner in global sourcing group at law firm Pillsbury.
How to Use OLAs in a Multi-Sourced Setting
Establishing OLAs in the multi-sourced environment, however, is inherently more difficult than instituting them within a single organization.
“There is limited understanding of this new role, what level of description is sufficient, the role the OLAs play in validating both pricing and solution assumptions, and in facilitating continuous improvement,” Druitt says. “Creating OLAs for the purposes of documenting and confirming how solutions will play in harmony requires a collaborative process to arrive at a set of documents that all parties respect and support.”
Here are nine dos and don’ts for establishing OLAs in the multi-sourced IT environment.
1. Do expect bumps in the road. “Establishing OLAs requires a service provider to clearly understand their own processes and [to be in] harmonious agreement with peer providers about the role each is to play within those processes,” says Druit. OLAs for mature processes, such as incident management, will be easier to establish than for other areas. “It can be a struggle when process maturity levels differ significantly between providers,” adds Druitt.
2. Don’t let service providers hijack the process. “Often the service providers are most interested in those OLAs that are necessary to support the performance of their delivery against a client’s SLA,” says Druitt.
One provider may not be able to meet an SLA commitment for incident management unless another provider commits to certain hand-offs and time frames. “OLAs are a powerful tool because they document a powerful process. But that process is not talking to your service providers to see how they’re going to behave with each other,” says Hansen.
“The really powerful process involves the internal discussion between the IT groups and the business to determine how the service needs to be provided in a sourcing-agnostic manner,” Hansen says.
3. Do address OLAs before RFPs. “Customers often fall into the process by first executing multiple outsourcing contracts, and only then recognizing that they need to coordinate and integrate activities across these various outsourcing contracts,” says Zahler. “OLAs should not be used after-the-fact to document relationships that have just developed over time. Rather, OLAs should provide the roadmap for how those relationships should be established in the first instance.”
An OLA can be useful in helping to draft an RFP for services, says Hansen of Baker & McKenzie.
4. Don’t outsource accountability. Establishing OLAs between service providers does not absolve IT of responsibility. “The CIO’s organization must be responsible for the service across the board,” says Hansen. “Failing to do this results in finger-pointing and business users who feel at the mercy of outside service providers regardless of the OLAs.”
It’s a good idea to establish internal OLAs first, advises Hansen. “This has nothing to do with how hard or easy you will be on your vendors. It only has to do with making sure that the IT organization and the business realize and internalize that outsourcing does not mean they are off the hook.”
5. Do be clear and concise. It can be tempting to overthink OLAs and litter them with legalese and IT jargon. Resist. “There’s usually no reason to get too bogged down in the formality,” says Hansen. “The most important thing about OLAs is that they have to be readable and understandable by both business and techie readers.”
6. Don’t accept business OLAs. A service provider may push for a customer to accept OLAs against end-user performance, such as requiring a business unit to give full project requirements to the service provider within a certain time frame. Don’t agree to them, advises Druitt.
“While the dependency is certainly there, the underlying agreement is not there,” Druitt says. “The business unit is the customer and should not be treated like a partner in the delivery of service.”
7. Do include all key interactions. “Customers often do not know what to include in an OLA,” Zahler says. “At a minimum, the OLA should identify the particular services covered by the OLA and specify how key interactions will be handled.”
The most important interactions include work planning; provision of operational data, information and reports; integration of activities with the service desk; coordination of changes; handling of the cross-functional services; and governance and dispute resolution.
It also is important that the OLA expressly state that the customer, while not a party to the OLA, is what lawyers call a “third-party beneficiary” of the agreement. “This allows-but does not require-the customer to enforce the OLA in its own name if it desires to,” says Zahler.
8. Don’t manage by OLA. It’s a mistake to “use these additional metrics that come from establishing OLAs as a means to manage the delivery in a whole new way,” says Druitt. “The measures should support the delivery of service and are really for the providers to manage against.” Step in only when providers fail to address underperformance.
9. Do track your OLAs. “OLAs can often provide the metrics that provide the basis for good decision making-if they’re tracked, which they often aren’t,” says Hansen. These metrics are helpful not only in improving service delivery, but they can also provide a solid foundation for future sourcing decisions.
“If you have OLAs that are current and actually tracked, the decision to outsource or not has more integrity,” says Hansen. “If the decision is made to outsource, then documenting legacy SLAs is a snap, which makes the discussion around transition and transformation much easier to have.”
Learn how to draw IT innovation from your IT outsourcing vendors and structure your contracts to cover new technology models like cloud and SaaS.
Enterprise CIOs seeking IT innovation from their IT outsourcing providers must be prepared to give a bit, too.
Specifically, CIOs must be willing to share their problems with IT vendors, get comfortable with emerging, innovative technologies like cloud computing and Software as a Service (SaaS), and structure their IT outsourcing contracts in a way that rewards vendors for their IT innovation efforts.
This advice, stemming from Forrester Research Inc.’s recent Services & Sourcing Forum in Chicago, is especially pertinent in the current economy, in which many CIOs are looking to innovate IT and restructure long-term outsourcing deals with an eye toward both cost savings and future growth.
Speakers advised that CIOs beware of locking themselves into long-term IT outsourcing contracts that do not provide the wiggle room to take advantage of new, more efficient and less expensive technologies — particularly if they want vendors working on their behalf to stir up more IT innovation.
But doing so isn’t easy. A Forrester survey of 710 enterprise IT decision makers in the second quarter of 2009 found that 38% complained of a lack of IT innovation or continuous service-level improvements by their IT vendors.
According to Sudin Apte, a senior analyst at Cambridge, Mass.-based Forrester, as IT sourcing professionals struggle to cut costs in a down economy, they are also determined to extract the maximum value possible from their service providers. However, many are unsure how to justify change requests and demand flexibility in their contracts.
Share your organization’s problems with your IT outsourcing provider
Conference speakers said while IT shops sometimes expect their service providers to go the extra mile and solve their problems for them, vendors aren’t mind readers. An organization that wants to draw IT innovation from its providers must be willing to undergo a transformation of its own, pushing the business to take bigger risks and transform its approach to IT outsourcing, said Dev Mukherjee, senior vice president and president of toys and seasonal items at Sears Holdings Corp. This includes getting over any mental roadblocks that prevent IT from openly discussing problems with an IT vendor — or even several IT vendors at once.
“I would rather have an innovative organization than just a risk management IT organization,” Mukherjee said, adding, “I appreciate how much work it takes to get the lights on, but you’re not getting credit for it.”
Mukherjee advises making a list of the five biggest problems in not only IT, but also your entire organization. Then, go to your vendor management team members and ask them to address these problems with IT sourcing partners. It’s important to ask your service providers not only what they can do for you, but what you should stop doing, he said.
To achieve IT innovation, you will have to recast the IT dialogue so the business side can understand it. “Talk the language the business wants you to talk,” Mukherjee said. (See sidebar for buzzwords to avoid.)
Eric Cohan, director of IT procurement at Dell Inc., agreed, saying it’s important to speak openly with your vendors about your organization’s IT problems. In other words, “take the mystique out,” he said.
Structure your outsourcing contract with an IT innovation margin for cloud, SaaS
It’s unrealistic to expect service providers to provide IT innovation on your organization’s behalf for free, so be prepared to structure your IT outsourcing contracts to pay for this progress, speakers and attendees said.
NASA, for example, is revamping its IT sourcing strategy spanning 100 contracts and 10 NASA locations. As part of the process, IT has implemented fixed-price contracts for stable, utility-based services and implemented a cost-incentive model for larger, transformative work that rewards maximum vendor flexibility, said Jonathan Pettus, director of NASA Marshall Space Flight Center’s Office of the CIO.
NASA is also including emerging delivery models such as cloud in the requests for proposals it sends out for services for its five IT towers — desktop services, enterprise applications, Web services, network services and data center services.
“It’s given vendors the opportunity to share other innovations they’d propose,” Pettus said.
Stephanie Moore, chief marketing officer at UST Global Inc., an outsourcing services firm, said one of the key challenges customers face is fear of being “hoodwinked” when paying for innovative services like cloud or SaaS.
Paying for managed or outcome-based services is difficult, Moore said, as it’s hard to know what qualifies as a good deal, how to validate what you’ve spent and what metrics to use in validating and payment. Thus, she stressed the importance of trust in a managed service relationship.
Still, opinions among attendees differed on the best payment model for extracting IT innovation from providers.
Courtney McCoy, manager of worldwide preferred vendors at Cummins Inc., a 37,000-employee company that designs, manufactures, distributes and services engines and related technologies, said he believes a lack of innovation can cost a company in the long run.
At the moment, McCoy is looking to improve IT innovation while also procuring a good price by moving to a fixed-bid model for some IT services.
“Now we can say [to the vendor],’You’re in here, be creative and bring something to the table,'” he said.
But Miguel Medina, manager of global procurement at Mattel Inc., a toy company with 25,000 employees worldwide, said he believes focusing on a set price could lead to problems.
“If you’re concentrating on cost, there’s only a small amount of margin,” he said. “They’re not going to come back with the dashboards that are going to allow you to sell to your business.”
IT often faces a problem when the CFO or others on the business side want to see more savings. However, “if we push [vendors] to the edge, we’ll sacrifice innovation,” he said. “The CFO is saying, ‘I don’t need innovation. I need [to cut] cost.’ But I think that premise is flawed.”
In managing relationships, it’s important to understand costs on both sides, look toward future gains and reward vendors appropriately for those gains, Medina said.
“If you improve, that’s the whole point,” he said.
What are the warning signs that outsourcing contracts are going bad? How can you mitigate the risks? Experts offer advice in this second of two articles.
Companies did not sit on their hands and watch their outsourcing agreements sail by in 2009. As reported in part one of our series, on outsourcing contracts’ danger signs, nearly 50% of companies told Stamford, Conn.-based Gartner Inc. that the economic crisis caused a sharp increase in contract renegotiations to save money. But paradoxically, such renegotiations leave a lot of room for costly mistakes.
“A recession causes [outsourcing] providers to sign bad deals that are not sustainable and do not give them the profits they need to stay in business, ultimately putting the CIO’s company at risk,” said Allie Young, research vice president and distinguished analyst in Gartner’s technology and service provider group.
And CIOs intent on cutting costs introduce risks when they agree to more lenient service-level agreements, which could result, for example, in lower-quality workers being assigned to their contract. This also is not an arrangement the business can tolerate over the long term, Young said.
In part one of this series, TPI’s Thomas Young dissected the ways in which outsourcing relationships can fail to meet expectations, from poorly documented contracts to lapses in governance after the deal is signed. In part two, Young and Forrester Research Inc. Vice President and Research Director Christina Ferrusi Ross focus on outsourcing contract risks: the overlooked danger signs that can torpedo a CIO, the deal and even the company; and, on a brighter note, the risks that with insight can be used to your company’s benefit.
Imbalances in outsourcing contracts
Imbalances between costs and control of the deal are a sure sign that an outsourcing contract is in trouble, Gartner’s Young said. An obvious imbalance is when the CEO is saying the provider is the “greatest thing since sliced bread” because the contract has lowered IT costs by 10%, while the company’s employees are complaining that IT is no longer supporting their needs.
Other imbalances, however, are more subtle and often reflect a defect in the CIO, rather than the provider. “Before you find the speck in another’s eye, look for the log in your own,” Young advised. To wit: If the organization is having cultural miscommunications with their offshore provider, that means the CIO does not have the right process or methodology in place to manage cultural differences and should consider reducing the number of offshore workers, she said.
Another danger sign is when the outsourcing vendor comes armed with “all kinds of ideas about innovation,” Young said. CIOs can partner with external providers on innovation and bat ideas about. But to cede a vision for the future, or not to have a point of view about architecture, means the CIO’s operations are not aligned with the business, she said “There are certain things you don’t want to lose control of — innovation and architectural standards,” she added.
Another imbalance: too many vendors. Gartner has long been a proponent of multivendor sourcing — choosing the right vendor for the job at hand rather than doing one-stop shopping: “It’s one thing to have two or three different providers helping with applications versus a provider list of 50 different application providers, which does happen,” Young said.
‘Operationalizing’ vendor risk
One of the biggest complaints auditors have with IT departments is their lack of governance of third-party providers, said Ferrusi Ross, who leads Cambridge, Mass.-based Forrester’s vendor sourcing team. Clients often tell her that they don’t have the resources to track every business change at a provider company, much less interpret what these changes mean. “The recession has stretched them so that the due diligence that is done is done upfront, and they can’t keep up with all the ins and outs at their providers,” she said.
For example, an outsourcing vendor that is experiencing financial trouble poses a risk to the deal. But should the alarm bells go off when the provider experiences one bad quarter, or a single- or double-digit loss, or a loss for the year? Ferrusi Ross asked. “The question is, how do you operationalize that?” she said. One bad quarter of revenue in an otherwise stable company might put the outsourcing contract into yellow mode, for example, until the next quarter, and perhaps warrant a conversation at the next steering committee meeting, she added.
Even when you know what to look for, red flags can come with many nuances. Take employee turnover: “If the vendor is in line with the industry standard for turnover, but your turnover is higher than the standard, that is a red flag that your deal is going bad,” Ferrusi Ross said. If your account manager is taken off the job without your approval, that is another red flag that needs to be addressed. On the other hand, if the turnover is high for all customers, the problem is with the vendor, and might be sign enough to take your contract elsewhere, she said.
Mapping the outsourcing contract to enterprise risk
But vendor losses can also be exploited for gain. Ferrusi Ross cited a CIO whose outsourcing vendor had lost business in the wake of the Wall Street meltdown. Rather than scurry to find a new vendor, the CIO picked up the phone and told the outsourcer to move its A-list talent, who had been working on Wall Street financial services contracts, to her account. “She basically said, ‘You have a lot of people on the bench. Swap mine out for them,'” Ferrusi Ross said. The CIO was able to do that because she was a huge client of the outsourcer, and she knew the outsourcer was not going to go out of business. The risk was well worth the upside for this CIO.
CIOs tend to see their outsourcing contracts through the lens of IT operations, Ferrusi Ross said. “One of the biggest red flags is a risk that can damage a company brand without the vendor ever breaching any part of the contract,” she said. Consumers associate lead paint in toys with Mattel, not the outsourcing vendor who used the paint. “The biggest risk is not that the deal fails, but the red flags you didn’t know were there,” she added.
CIOs should start with their company’s enterprise risk portfolios, Ferrusi Ross advised. That might require going to the chief risk officer or CFO or whoever has an enterprise-wide view of risk. For each enterprise risk, ask where the outsourcing vendor helps or hurts. One company she worked with had an outsourcing provider who did background checks on workers going seven years back. The company, however, had a 10-year policy. “My client made the provider do a 10-year check on employees; sure enough, in year nine, one of the employees had been arrested for money laundering,” she said.
Outsourcing contract renegotiations were up sharply last year. Most of that activity focused on cost cuts, which spells trouble. Experts offer advice, in the first of two articles.
During the past year, 50% of 1,073 organizations worldwide saw a sharp uptick in outsourcing contract renegotiations, according to recent research from Gartner Inc. in Stamford, Conn. Many of those contracts were renegotiated in a bid to cut costs, due to the recession.
“The recession causes bad behavior on both sides of the coin, the client and the supplier,” said analyst Allie Young, research vice president and distinguished analyst in Gartner’s technology and service provider group.
This seemed like a good time to look for the warning signs of an outsourcing deal gone bad. We spoke with three experts on the misconceptions, missteps and mistakes that spell trouble. In this first article of a two-part series, TPI’s Thomas Young, explains how lack of innovation and productivity gains, as well as culture miscommunications, can break down an outsourcing contract. Be prepared for self-examination. Many of the telltale signs have more to do with your organization than the provider.
Thomas Young is a partner and managing director with the CIO Services-Infrastructure at TPI, an IT consulting firm based in The Woodlands, Texas. Prior to joining TPI, Young was financial director at AT&T Labs, another TPI client. “When it comes to outsourcing deals, I’ve seen every bad movie you can imagine,” he said.
Innovation vs. continuous improvement in outsourcing contracts
Young said one of the biggest complaints he hears from CIOs is they aren’t getting innovation out of their deals. “My question is, ‘What did you think you were going to get?’ There is no provision in the contract for innovation,” he said. The CIO will mumble something about the sales meeting where promises were made, Young said.
The key to a successful outsourcing contract is documentation, he explained.
Innovation is difficult to document in an outsourcing agreement, and real innovation in any case is quite rare in mature industries. “That is why everyone is mesmerized by Apple,” Young said. CIOs tend to think that because they’re doing $100 million worth of business with a major outsourcing provider, they are going to get special access to some cool new technology. But that is not the case.
“About the best we have been able to do is dedicate a pool of resources from the supplier side, whose job is to sit in the client’s business and look for new opportunities to bring new projects to bear,” Young said. But that solution may be no better and worse than seeding one’s own research and development.
“Is the IBM guy better than what you could buy in the open market? That’s mixed,” he said, adding that in his view, innovation is better bred into the company culture.
Continuous improvement is another matter. Normal (and nominal) productivity is about 3%, maybe 4% in IT, Young said. Productivity gains greater than that usually require investment on both the client and provider side, and both kinds should be explicitly articulated in the contract. Providers that can bring 5% to 10% productivity gains are investing in the tools, automation and methods that bring continuous improvement. An application development outsourcing project with code that’s undocumented, buggy and expensive to maintain, for example, will require the client to invest in retooling the software to achieve meaningful productivity gains. “Over time, the defects go from 1,000 per million to low single digits, because the software is retooled, and we put that into the contract,” he said.
Company culture and outsourcing contracts
Beware the productivity gains that will not happen at any cost because of company culture. Young gave the recent example of a very large outsourcing firm brought in to consolidate the IT environment as part of a business transformation project. The environment in play: 3,500 servers, running at a 15% utilization rate. “The provider comes in and says we can virtualize the environment, stack it up and get them down to 20:1 on big boxes. We said, ‘[There’s] no way are you are going to do it,'” he said. The provider guaranteed the work.
Technically, the supplier could absolutely do it, but Young said he knew the political environment jeopardized, if not precluded, success. The CIO did not have control of his app dev teams and could not get them to consent to any changes for recompiling or adjusting the code, or freezing the code so it could be tested. “It was a dynamic environment where they were constantly making changes to applications, so they would not agree, right or wrong,” he said. Plus, the CIO did not have application performance metrics, so any change in response time was attributed to the virtualization efforts, and there was no documentation to prove otherwise.
The job was not done. The supplier did not, as promised “eat the costs,” choosing instead to be the “bad partner.” The contract was readjusted, but the experience was “not good,” he said.
Optimizing price but ignoring quantity in outsourcing contracts
CIOs focused on cutting costs do a good job of optimizing price by using outsourcing, but they tend to ignore consumption of services by users. They need to do both, or what Young calls “minding your p’s and q’s” — price and quantity.
The recession causes bad behavior on both sides of the coin, the client and the supplier.
When Young was at AT&T in the late 1990s, chairman Mike Armstrong wanted to reduce the $3.2 billion IT spend by half, in two years. The CFO’s answer was more outsourcing. “That will get you 15% to 20% and you are done, because you are locked into a contract and can’t go much further,” he said. Outsourcing providers are not incentivized to reduce costs when you sign a contract. Young’s team launched a parallel effort to reduce consumption by introducing a rigorous chargeback methodology so people could see the cost of what they were asking for — and pay the bill.
“We never made it to 50%, but we reduced costs a lot,” he said. “When I tell clients to take costs out, I tell them to focus on the Qs.”
The cost of writing out the terms of an outsourcing contract can come out to about 1% to 2% of the total contract value, counting attorney fees. The bigger the deal, the lower the cost — but not low enough to renegotiate annually. Good contracts are written to be as flexible as possible, to accommodate changes in the business and technology and the provider’s business. The trend for a while has been toward five-year deals, but many companies don’t make it that long, and cloud computing could lead to even shorter agreements.
Young said a big mistake people make is that after doing a yeoman’s job on the initial contract, they neglect governance and contract “maintenance” that will keep the contract fresh. Even CIOs with $200 million of external spend on 20 outsourcing contracts will put their “C” students on invoice verification. A $12 million per year contract that the CIO agonized over will creep to $18 million because managing the invoice and the contract was the employees’ “night job,” an afterthought, Young said. “Vendors love the afterthought mode,” he said.
IT outsourcing contracts are only as strong as the negotiations surrounding them. In this FAQ, learn how to establish service-level agreements, set contract lengths and maintain flexibility.
IT outsourcing is playing a larger role in enterprise IT organizations as they attempt to gain efficiencies and cut costs on a global scale. As enterprises develop their IT outsourcing and offshoring strategies, it’s critical that they craft IT outsourcing contracts that drive IT outcomes and deliver business value. In this FAQ, learn where to start when you draw up IT outsourcing contracts, how to prepare service-level agreements (SLA),which terms typical IT outsourcing contracts should have and how to make your contracts flexible documents that deliver the benefits your organization seeks. Also, consult our FAQ about getting started with IT outsourcing and offshoring.
How do you begin drawing up an IT outsourcing contract?
Never use a vendor template when you draw up an IT outsourcing contract. “They’re inherently slanted toward the vendor, and it’s going to take a lot to modify it,” said Helen Huntley, a research vice president and IT outsourcing analyst at Gartner Inc., a Stamford, Conn.-based consultancy. Instead, look to your own legal team, and don’t be afraid to turn to a third-party firm for direction. “[IT organizations] are going head to head with masters of negotiation,” she said. “If they don’t have a team with the same capability [in] understanding maturity about negotiations, they are not going to be as strong at the table.”
Take a hard look at your own procurement department before you entrust them with your IT outsourcing negotiations. Some procurement departments are very focused on cost, but that’s not necessarily the most important aspect of an IT outsourcing deal. “In outsourcing, you could be buying something more service-related and relationship-driven — it’s different than buying printers,” Huntley said.
Enterprises should consider a few main factors from the get-go, said Tom Lang, a partner and managing director at TPI, a global sourcing advisory firm based in Houston.
“We always say, there are three legs on a stool: price, productivity factor and SLAs,” Lang said, calling pricing “the most complicated area of these deals.” Pricing algorithms, for example, are quite complex, and can be based on the number of quality, full-time employees devoted to a deal; the workload output; or other factors. As for productivity, it’s important to measure your own organization’s productivity levels before both parties can agree on the service levels the outsourcer is expected to maintain.
How do you craft SLAs in an IT outsourcing contract?
Every contract should have performance metrics that prove the vendor is living up to the terms of the agreement. “Never sign a deal without SLAs, or with to-be-determined metrics,” Huntley said. “If you don’t have penalties associated with the SLAs, then they’re just objectives. How will you hold [the vendor’s] feet to the fire?”
However, Christine Ferrusi Ross, a vice president and research director at Forrester Research Inc., a Cambridge, Mass., technology and market research company, said you shouldn’t have too many SLAs.
“It’s like a pilot’s dashboard — if there are too many blinking lights at once, you’re not sure where you should be looking,” Ferrusi Ross said. Perhaps an enterprise must accept that it doesn’t need 24-hour response times from its helpdesk, for instance.
Clients often get frustrated when their outsourcer is meeting their SLA but they’re still not happy with the service levels delivered, Ferrusi Ross said. As such, clients need to understand what the SLA actually accomplishes. “It keeps you from paying for higher SLAs than you actually need,” she said. “A lot of clients struggle in this sense. Everyone thinks higher SLAs are better, but they don’t quite understand the financial implications of what it means in dollars and cents.”
As a general rule, SLAs should include some numerical objectives and a clear statement of the end results expected. It’s also important that the people responsible for the performance being measured are the ones involved in the development of the metric. “It’s easy to get lost in the nitty-gritty details” of performance management, Ferrusi Ross said.
In all cases, start by establishing business goals, then outsourcing goals and last, the terms of the SLA. “Make sure everything rolls up to an operational benefit,” Ferrusi Ross said.
Interestingly, Ferrusi Ross said she has one client who doesn’t believe in penalties for missing SLAs, but offers bonuses for exceeding them. “It’s a fascinating idea that changes the provider mind-set,” she said.
SLAs should not be about trying to get money back from suppliers, TPI’s Lang said. If a supplier has a problem, it should have a certain time frame — perhaps several months — to get back in the client’s good graces, he said. That encourages both sides to work toward achievable SLAs that benefit the business, he added.
“Most of the contract is kind of like a prenuptial agreement before a marriage,” Lang said. “You spend all the time working on how it’s going to work if it’s not working.”
One of the most critical terms a client should seek is the outsourcer’s demonstration of progress, which can then cycle back to clients. “As we set the baseline for SLAs that are critical, we’ll ask that the contract include continuous improvement,” Lang said.
How long are the terms of a typical IT outsourcing contract?
“When I first got involved, you never saw a deal of less than 10 years. Now the average is less than five,” Lang said. For a major asset, however, such as outsourcing a data center, he recommends a five-year deal at the minimum.
For application deals, Gartner is seeing shorter IT outsourcing terms, usually two- to three-year contracts, Huntley said. Infrastructure deals are tending to run longer, between three and five years, with the length of the term being somewhat dictated by the work being provided. Data center services are longer term, because they tend to represent more mature service delivery. In signing longer-term deals, it’s extremely important to establish a benchmarking process that will make sure cost rates continue to match changing market values. Organizations “need to give themselves cost-change provisions so rates come within the market bands,” she said.
How can an IT outsourcing contract be flexible?
“Flexibility means different things to different people,” Huntley said. The definition depends on what your organization is looking for. Flexibility can mean shorter terms, or having your service levels reviewed on a more timely basis. It can mean crafting provisions so that your baseline can be adjusted at certain intervals, or changing your service delivery model to incorporate emerging technologies, such as cloud computing.
Flexibility also includes crafting proper out-clauses. “Termination language has to be very clear,” Huntley said, and it should include three provisions: one for cause, if the outsourcer materially breaches the contract; one for convenience, if your own business needs change (you may have to pay some early termination fees); and one for change of control to another provider.
“We see a lot of consolidation in the market, so if your vendor were to be acquired, you would have the right to renegotiate with that vendor if they have a controlling interest you no longer want,” Huntley said.
This goes for bankruptcies as well, or improper financial reporting, which would allow you to sever ties, such as was the case with Satyam Computer Services Ltd., Huntley said.