Rapid Growth, Widespread Dissatisfaction

According to Gartner Group’s
Dataquest, the total user spending in Europe on outsourcing services will experience a 20%
cumulative average growth rate (CAGR) in the period between 1997 to 2002. All segments of
the outsourcing market are enjoying healthy growth rates. The desktop market segment is
growing most rapidly, as represented by a 32% CAGR from 1997 to 2002. Even spending for
the relatively mature data center and network outsourcing segments will grow at a CAGR of
17% and 18% respectively. Though strong revenue growth and buyer dissatisfaction logically
may not seem to fit together, it is exactly the situation in the outsourcing market in
Europe.

Some level of dissatisfaction after outsourcing is typical, especially during the first
year of a new relationship. In fact, if some level of dissatisfaction is not evident early
in the deal, the chances are the enterprise is not paying close enough attention to the
outsourced function. The transfer of IT functions, and in many cases people, from the
enterprise to the external services provider (ESP) rarely goes as smoothly as expected.
Service levels may worsen until the ESP has had the time to stabilize systems and strike
the right balance between workload and resources. The vendor may find that some of the
transferred staff members are poor performers and need to be replaced with qualified
people, or at least be nurtured through the transition so that they recover their
motivation. Individuals from the enterprise and ESP need to become comfortable with each
others’ personal idiosyncrasies and communications styles. However, if dissatisfaction
continues after this start-up period, it is likely that significant problems exist with
the structure of the deal itself.

A recent survey of IT managers by Dataquest Inc shows evidence of widespread
dissatisfaction with outsourcing in Europe. A key conclusion from the survey was that
satisfaction with outsourcing is generally low-and lowest of all in the most mature market
segments. The unhappiest of all were enterprises in the United Kingdom that had outsourced
their data center. On a worldwide basis, outsourcing of data center services has the
longest history. The United Kingdom adopted IT outsourcing earlier than the rest of
Europe. In fact, it is the relatively longer history of outsourcing that may be the reason
why UK enterprises are most dissatisfied. A second factor may be that many large deals in
the UK are public sector deals. These were primarily aimed at reducing the cost of
computing for government departments. Such deals are a delicate balance between cost
reduction and service quality, usually a tough challenge for the outsourcing vendor.

Until recently, most data center outsourcing deals carried long contract terms, typically
10 or more years. Consequently, many of these same deals are still active today. Because
the data center is most often the first function an enterprise outsources, the level of
buyer experience when these deals were negotiated was extremely low. Enterprises agreed to
prices that were fixed for the length of the contract. No provisions were made for
adjusting the costing basis to reflect price/performance improvements in technology.
Neither were provisions made (either in pricing or for early contract termination) for
unforeseen changes in capacity requirements by the enterprise (e.g., the early retirement
of applications running in the outsourced data center). Finally, over the years, the
individuals who negotiated the deal moved on to other areas of the business or outside the
enterprise entirely. Financing of non-workload-related items, such as the acquisition by
the vendor of the enterprise’s facilities or equipment, was often bundled into data center
unit pricing. The longer a deal lasts, the greater the likelihood is that no one will be
left on either side who understands the financing structure and can evaluate it properly
against the current market. All these factors contribute to widespread dissatisfaction
with data center agreements-as our survey indicates. In some cases, outsourcing users have
benchmarked the services and this has highlighted the unsatisfactory nature of the deals.
In the face of prices that are significantly out of line with the market, the majority of
vendors are willing to renegotiate. For any type of outsourcing deal, do not rely on
renegotiation to compensate for all the errors and omissions that were made when the deal
was originally constructed. Outsourcing deals are back-end weighted, meaning the ESP makes
the majority of its profits in the later years of the contract term. The ESP may, for
example, be willing to decrease prices if its own costs have declined faster or more
deeply than forecast. However, it will not erode its expected margin, nor will it take a
loss on the deal because, through the benefit of hindsight, the structure of the deal was
weighted in its own favor. Naive users may believe that they can simply beat the vendor’s
prices down by tough negotiation, and they may appear to succeed. But in reality, the
vendor will be forced to reduce the resources to keep margins up, with a resultant threat
to service levels. Users who understand the motivation of the vendor stand a far better
chance of a successful renegotiation. The basic ingredients of a mutually satisfactory
renegotiation are simple-the vendor will trade off immediate revenue against higher profit
margins or a longer contract. Enterprises should negotiate hard on commodity-like services
such as operations, technical support and the like. Enterprises should sweeten the deal
for the vendor by offering additional higher-value business such as consulting or systems
development work.

Given widespread dissatisfaction with outsourcing, why then does demand continue to grow?
Our survey clearly indicates that outsourcing is increasing year over year. However, the
willingness of IT managers to outsource is relatively unchanged. Simply said, this means
that a significant percentage of outsourcing is done out of necessity, not out of choice.
The skills shortage in Europe is so severe that for many enterprises outsourcing is the
only sourcing option available.

Learning from the mistakes made in one outsourcing deal can make for a better constructed
relationship in subsequent deals assuming, that is, that key members of the team that were
involved with the initial deal participate in subsequent outsourcing activities. The
latter is the fundamental stumbling block that we see to improving enterprises’
satisfaction with outsourcing. For most enterprises, internal legal counsel, internal
finance, and internal IS staffs do not have the requisite expertise to successfully
execute and manage outsourcing agreements. The ESP’s team is staffed with professionals
well-seasoned in negotiations, contract development and account management. Typically, the
enterprise’s team is staffed with whoever happens to be in the appropriate job titles at
the time-with no regard to their ability or experience.

Bottomline
If the in-house skills are not available, it is imperative that enterprises bring in
outside expertise either on a consulting or a permanent basis. Look to the user community
for individuals that have had years of experience throughout the life cycle of a major
deal. Recruit from the ESP community deal makers and account managers who understand
contracts, costing and account management. Further, be prepared to pay handsomely for the
right people. Top-performing ESP account managers can earn 100,000 pounds sterling or more
a year. Satisfaction will not improve until enterprises match the ESP’s skills at each
stage of the relationship: evaluating, negotiating and managing the outsourcing deal.

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