A Win-win Contract

should you outsource?

Outsourcing is obviously a means to get non-critical work done by talent
outside your organizational pool. Companies outsource for different reasons–depending
on individual requirements. Some outsource for cost savings, others to gain
skills and resources lacking internally, still others outsource in the hope of
gaining a strategic edge over the competition. We can, therefore, sum up five
specific reasons that companies outsource:

  • Financial;
  • Technical capabilities;
  • Market agility;
  • Operational excellence; and
  • Business expertise.

Factor 1: Financial
The financial area encompasses financial management and cost savings.
Financial management includes economies of scale and IT management abilities
that cannot be achieved internally by end-users attempting to expand their core
competency without adding significant overheads to the IT infrastructure. Key
issues in the decision to outsource also include predictability and cost savings
compared to those that make additional internal investment and talent upgrades.

A case in point is Liberty Mutual Insurance outsourcing its software
application development to DSQ Software. The project is for a period of five
years and is valued at $100 million. Liberty Mutual is looking for a long-term
relationship, as outsourcing would help reduce costs by 50%.

Factor 2: Technical capabilities
Technical capabilities allow a company to enhance existing procedures or
adopt new procedures, formulate strategic direction, and react quickly to
technical evolution.

Transportation.com is an
affiliate of the $3-billion Kansas-based trucking company Yellow.
Transportation.com hired Infosys in 1998 to write logistics management software.
Dan Bentzinger, it’s chief technology officer, says he prefers working with
Infosys over other larger US companies as it helped transportaion.com discover
what it’s customers wanted, with Infosys designing the software accordingly.
He feels Infosys is “good at implementing” ideas.

Factor 3: Market agility
Market agility includes the ability to expand core businesses rapidly and
involves better information management for decision making and expansion to new
geographic markets.

London-based EMI Records outsourced CRM solution and services from Talisma.
EMI wanted to communicate with the fan following of its contracted artists, and
used the package to boost customer database.

Factor 4: Operational excellence
Operational excellence in the form of increased service levels can be
achieved when outsourcers use their asset base and human resources to meet
specified IT objectives. The outsourcer provides access to new skills and
technologies suited to business growth.

The ING Group, the global financial powerhouse headquartered in the
Netherlands, believes in Indian IT expertize. It has signed outsourcing
contracts with three Indian companies, TCS, NIIT and BFL Software, under which
ING companies will outsource projects to these three firms only. ING has
terminated all previously used labor and forwarded all projects to the Indian

Factor 5: Business expertise
Business expertise includes development of effective solutions to end-user
IT problems and knowledge of the end-user’s business.

EveryD.com is a new online community for
Japanese housewives, providing everything from shopping to banking. EveryD paid
it’s outsourcing service provider $9 million to set it all up–from devising
the business plan to designing the portal to writing the software. According to
EveryD.com’s CFO Shibata Iwao, though the provider selected was not the
cheapest, it had expertize in e-banking and e-tailing at both the front and back

Whatever the reason, outsourcing has become an acceptable operational
alternative and is being embraced by companies in the US and Europe, also
gaining in popularity in other parts of the world.

Why shouldn’t you outsource?

Not all companies have outsourced, some never will. There are even companies
that have tried outsourcing, but have brought outsourced operations back
in-house, as difficult and costly as this might have been. Poor outsourcer
performance, loss of control and human resource issues are just some factors
that inhibit outsourcing.

Let’s look at some specific reasons that outsourcers have either chosen not
to or end an outsourcing contract and bring a function back in-house:

Inability to develop unique applications
Outsourcers don’t meet the constant evolutionary cycles provided by the
rapid changes to distributive computing environments. As a result, end-users
become averse to outsourcing applications development without a firm commitment
from the outsourcers of meeting future technological requirements.

Lack of value-added cost measurements
End-users find that service level agreements and funding have to be
constantly modified for additional scope of work effort, while initial
contractual measurements are often ill-defined and require clarification.

Loss of corporate IT infrastructure

End-users are concerned about the loss of valuable skill-sets in the event of
outsourcers not meeting their contractual obligations. In addition, end-users do
not want to find themselves trapped in an outsourcing relationship because of
the dependency on outsourcers created by the original decision to outsource.

Cultural barriers
The most successful relationships are those that have open and honest
communication channels in place to deal with sensitive political and human
resources issues. In addition, transitioned workers should be educated on the
culture of their new environment.

Lack of knowledge of the corporate business
In some cases, end-users have expressed concern that the outsourcer did not
possess significant knowledge of corporate business. This can be a big poser as
IT strategy always needs to be cohesive with the overall business plan.

A case in point

In response to changing client requirements, Computer Science Corporation
completely redesigned it’s renewal contract with Fidelity and Guaranty Life
Insurance in 1999. The new agreement, valid till 2013, is estimated to be valued
at $435 million. Services provided include all aspects of policy administration
and related IT infrastructure.

The original 1995 contract was a traditional arrangement, under which CSC
committed to a service-level-agreement and charged a fixed fee per policy. As
the contract matured, the static pricing arrangement no longer suited F&G’s
changing requirements; it wanted to introduce new products and add new user
technologies not included in the original agreement.

Together, CSC and F&G created a new agreement that abandoned service
level aggrements (SLAs) and fixed fees in favor of pricing based on "value
delivered to F&G" with a guaranteed gross margin paid to CSC. The new
model allows F&G the flexibility to be dynamic and change products to suit
the changing environment without straining its contractual relationship with CSC.

This has led to the evolution of new models, with a view to being a win-win
for both the customer and the provider.

Ishan Ranjan is VP,
projects, CMIL. He has also been founder-editor of Voice & Data.

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