IT's still a risky business.

FDs who think that outsourcing their IT is an easy option may be in for a rude awakening. In the past, outsourcing has seemed like a relatively painless way to shift responsibility for mundane IT tasks, even if the cost savings promised in the original contracts never quite fully materialised. But the signs are that outsourcing itself is becoming a more risky activity – fraught with almost as many problems as managing an in-house IT department. Consider, for a start, these disturbing findings by the Gartner Group, the prestigious IT research and analysis organisation. By 2003, outsourcing “project disasters” (defined as projects that miss quality, time or cost objectives sufficiently to be considered a failure by the client) will double from one in 20 to one in 10. In the same time-frame, one in five of all outsourcing projects will end in dispute over the benefits achieved or the benefit-linked payments. A third of these disputes will end up in court. Furthermore, FDs who imagine they can strike a hard bargain in a burgeoning outsourcing market are in for an unpleasant surprise. The external service provider (ESP) will out-negotiate its clients to get the better end of the deal in nine cases out of 10, says Gartner. And the bad news does not end there. Companies will make the wrong choice of ESP in 13 cases out of 20. Why then, in the light of all this, is IT outsourcing set to grow at high rates (figures of 20% annual growth are regularly bandied about in the industry)? The answer is a huge shortage of IT skills. As Gerry Dube, president of integrated business services for Computer Sciences Corporation (CSC), says, executives are using outsourcing “expressly to gain access to scarce skills”. The Gartner Group puts the skills shortage down to “unprecedented levels of demand driven by once-in-a-generation issues, such as year 2000 compliance and the introduction of the euro”. It adds: “Many enterprises are choosing to replace existing systems, rather than spend money patching systems that are nearing the end of their life-cycle.” That means a substantial growth in the demand for the most up-to-date skills. The bottom-line for FDs is this: far from removing risk, outsourcing IT introduces a whole new raft of risks, which must be carefully managed if the whole operation is to deliver business benefit. The key question: how can those risks be minimised? The first point is that the FD has a critical role to play in any outsourcing decision. Bryan Brady, vice-president, finance, for CSC UK, has seen scores of outsourcing deals from the supplier’s side of the table. But he also understands the user’s point of view. “FDs ought to be part of the team that sets out the objectives of the proposed deal,” he says. “They should be very interested in reducing risk – in fact, outsourcing that risk to an external provider.” But, given the problems identified by Gartner, is it really possible to outsource the risk? There are three issues here. The first is choosing the most appropriate outsourcer. The choice is made more difficult because of high demand for outsourcing services. There are big name outsourcers with best-of-breed skills in critical areas such as Andersen Consulting in business process, PricewaterhouseCoopers and Siemens Business Services in package implementation, and Wang Global in desktop systems. Suppliers such as EDS, CSC and IBM Global Services are solid across-the-board service providers. But Gartner says “it’s a sellers’ market and the reality is that ESPs are very selective about which bids they pursue”. One solution might be to bundle some high margin work, such as application development, with a commodity-type service such as running a data centre. The danger is bundling too many disparate services with conflicting objectives, although firms are aware of this problem. “Buyers are choosing from a smorgasbord of different outsourcing contracts to achieve different objectives rather than opting for a big bang approach,” says Martin Brampton, a senior analyst at Bloor Research. This also allows them to access best-of-breed practice in specialist areas such as call centre management or application development. In the present climate, the reality for most companies is that they will need to choose top-level suppliers for the truly strategic parts of their IT, while settling for smaller players for niche activities. But, whichever they choose, FDs need to have a clear idea why they are choosing specific suppliers. Too many companies award contracts on price and the ESP’s selling skills – then wonder why the relationship fails, Gartner warns. Gartner suggests the key differentiators between outsourcers are their commitment to the business and the quality of relationship they establish with clients. Gartner classifies these differentiators under five main headings: service line viability, technical quality, ease of doing business, customer satisfaction, and contract terms and conditions. It warns: “No single ESP delivers best-of-breed performance in each of these areas.” Its advice is to decide criteria for evaluating potential suppliers that focus on the “tangible components” of the deal and the “intangible aspects” of the relationship. The second key aspect of outsourcing risk is defining and operating a service level agreement (SLA). In the past, some outsourcing deals have fallen apart as inadequately defined SLAs lead to trench warfare between an aggressive client, unhappy with service, and a defensive supplier, which wants a larger fee for extra work. CSC’s Brady points out that it is important to spend enough time upfront to define the terms of the contract and the SLA in detail. “We try to agree in a contract what each party’s obligations are,” he says. “It becomes a very detailed exercise. But at the end both parties feel they have tackled a very big problem. There is a contractual arrangement that both are comfortable with.” The problem with early outsourcing contracts was that they defined a baseline and not much else. The client soon found out, often at great expense, that anything above that baseline cost much more. Now, clients and outsourcers are moving towards more flexible arrangements, although baseline deals are still common in the public sector. The SLA needs to be precise and flexible. “It has to be an on-going change document,” says Brady. He points out that many companies new to outsourcing do not actually have an SLA with their in-house IT departments. They may be unaware of the level of service they require. The first task, therefore, is to define it. And it is important that SLAs are not set in concrete because needs change, says Brady. “There needs to be a willingness to agree to review it on a regular basis.” The third critical area of risk is all about management. This is an area which stirs up strong passions. Some pundits suggest IT is now so central to a company that it should not be outsourced. Mike Mager, an analyst at the Butler Group, says: “IT is so inextricably linked with success that it puts firms at a disadvantage to hand over this strategic resource. IT is the core of a business.” Yet leading outsourcers say more companies are turning to them precisely because IT is strategic. “Rather than simply off-load distracting non-strategic tasks, CIOs are outsourcing the development of their most strategic systems, including Web-based applications and ERP,” says CSC’s Dube. Managing risk for strategic systems is then critically important, and it raises the spectre of the future outsourcing problems identified by the Gartner Group. For example, what can be done to minimise “project disasters”? A key reason for failure is that the skills shortage often means outsourcers reduce the attention they pay to activities such as platform sizing, data cleansing and acceptance testing. “Hot-shot consultants consider these activities boring. But they are too technical for business executives to understand.” Gartner’s solution is to “break the project into separate work steps defined in terms of staffing, deliverables, time-frame and budget.” It suggest companies should “set aside up to 10% of the project costs for a third-party audit at each project phase”. One of the most effective ways of minimising risk is to persuade the outsourcer to share it. In a large deal that has an attractive upside, this is increasingly possible. Brady says: “Increasingly companies want us to take on more risk. We are becoming more comfortable with that because, naturally, we are becoming more competent at it.” He adds: “In fact, just about every new business activity we are involved with at the moment is about risk and reward.” In the longer term, risk sharing could lead towards true partnerships or even joint venture agreements, such as those between Swiss Bank and Perot Systems or Ernst & Young and Shell. But true partnership requires a culture shift among both the buyers and sellers of IT outsourcing. And with the euro, Y2K and other urgent IT issues on the agenda, that may have to wait a while. THE LOGIC BEHIND OUTSOURCING Major surveys by CSC and KPMG have uncovered the reasons for choosing to outsource IT.

 CSC survey cost reduction                  26.5% company strategy                18.4% service improvement             16.3% skills enhancement              14.3% re-engineering effort            8.2% technology renewal               6.1% legacy migration                 4.1%  KPMG survey more cost effective               24% greater expertise                 21% reduces IT costs                  15% focus on core business            15% resource constraints              11% skills shortage                   10% future flexibility                 6% Sources: CSC: Critical Issues of Information Systems Management. KPMG: The Maturing of Outsourcing.

Industry Perspective: Outsourcing Experts Have Their Say ROB WIRSZYZC, STRATEGY DIRECTOR FOR EDS UK. What trends do you see in corporate IT outsourcing spend in the next three years? A move towards outsourcing specific activities, such as transaction processing and desktop systems management, instead of wholesale IT outsourcing. The next few years are also likely to see the return of the ‘bureau’ approach to supplying a flexible volume of processing against a modular pricing structure. Which parts of IT will be particularly ripe candidates for outsourcing in the next three years? Communications networks, including local and wide area networks supporting voice and data services, and the underlying infrastructure of electronic trade. Desktop computing, together with its management, could also routinely be outsourced, offering flexibility and cost control. What impact do you think the growth of e-business will have on outsourcing? It’s likely to impact on every aspect of business, including outsourcing. It’s essentially a new infrastructure for trading but it needs to be more robust. Investment could be from groups of shared users or even from outsourcing companies. What impact do you think fall-out from the Y2K issue will have on outsourcing? Contractually, it is focusing attention on the loading of liability on to suppliers. Some organisations have outsourced their Y2K work while their internal departments implement new systems. Another approach has been to overcome the Y2K problem by installing Y2K compliant systems. Which benefits do FDs most commonly look to from outsourcing? FDs clearly look for cost control and value for money. But outsourcing can also deliver greater efficiency, better customer relationships, business development opportunities and other “value propositions” that support the business rather than just delivering the same work for less. Which barriers are preventing FDs doing more IT outsourcing? The ability to define outsourcing requirements is a major barrier. And volatile markets, increasing the potential for mergers and acquisitions, mean that FDs may be unsure of the future direction of their organisation and so find it difficult to define their IT needs clearly. KEITH BURGESS, GLOBAL MANAGING PARTNER, BUSINESS PROCESS MANAGEMENT & ENTERPRISES, ANDERSEN CONSULTING. What trends do you see in corporate IT outsourcing spend in the next three years? Companies will increasingly recognise the benefits of business process outsourcing for complete business functions such as finance and administration, logistics or customer care. As they climb the outsourcing sophistication ladder, companies will tie outsourcing decisions to their business strategy. Which parts of IT will be particularly ripe candidates for outsourcing in the next three years? It is feasible that major corporations will outsource their entire IT operation. Alternatively, companies may organise by critical business process and include the associated IT. As pan-European competition intensifies, look for corporations outsourcing their back office and supply chain functions. What impact do you think the growth of e-business will have on outsourcing? No question, e-business will drive some of the growth. Change is coming so quickly, creating a real shortage of capability and skilled talent. E-business will change the rules of the game. Many companies simply will not have the capacity to manage a change programme of this magnitude on their own. What impact do you think fall-out from the Y2K issue will have on outsourcing? Near term, very little. Certainly companies are focused on Y2K compliance today, as one would expect; the clock is ticking. Longer term, this could set the stage for explosive growth as companies accelerate outsourcing to reduce the crushing backlog of work generated while their focus was on Y2K. Which benefits do FDs most commonly look to from outsourcing? Feedback from our clients, particularly financial directors, is about increased focus on process performance, service levels and, of course, greater cost control and responsiveness. Which barriers are preventing FDs doing more IT outsourcing? They believe they must own the capability, little realising that a good contract can get them much better and more responsive control. ROGER COX, RESEARCH DIRECTOR, OUTSOURCING AND MANAGEMENT ISSUES, EUROPE, GARTNER GROUP. What trends do you see in corporate IT outsourcing spend in the next three years? IT outsourcing growth will continue. We will see alliances among outsourcing suppliers as they move to provide integrated business and IT service solutions. Business process outsourcing will emerge as the new growth area. Which parts of IT will be particularly ripe candidates for outsourcing in the next three years? The demand for on-going assistance to manage new technology areas (such as enterprise resource planning) will provide new outsourcing opportunities. The networked desktop area will continue to grow. What impact do you think the growth of e-business will have on outsourcing? Once deployed, the demand from FDs to ensure the business value of these highly complex and costly implementations will open new outsourcing opportunities. What impact do you think fall-out from the Y2K issue will have on outsourcing? Y2K will cause some drop-off in near-term demand. Organisations will not have the spare capability to embark on outsourcing and suppliers will not want to have deals in transition at the turn of the year. Which benefits do FDs most commonly look to from outsourcing? In big corporates, the FD tends to be the business process leader. In that role, his objectives are quality improvement, control and realising value. Which barriers are preventing FDs doing more IT outsourcing? Major outsourcers have as much business as they can handle and it’s a complex business. TOM GORMLEY, SENIOR ANALYST, FORRESTER RESEARCH. What trends do you see in corporate IT outsourcing spend in the next three years? An increase in outsourcing of legacy systems to enable companies to focus more on new technology. This lets the company’s internal resources focus on strategic capabilities. Which parts of IT will be particularly ripe candidates for outsourcing in the next three years? Big mainframes and the networks that connect them, as companies invest in new technology. Also enterprise resource planning – it is still very complex to manage and keeps changing with the business. What impact do you think the growth of e-business will have on outsourcing? It will put more pressure on companies to outsource legacy systems in order to enable them to have the bandwidth to work on the new projects. Over the next few years, it looks as though this is going to be a problem for a lot of companies. What impact do you think fall-out from the Y2K issue will have on outsourcing? Companies will still have work to do. They need to work on the backlog of things that they put on the back burner. Most critical work is finished, but not everything, so it will continue to suck away at some resources both internal and external. The net impact will be a greater demand for outsourcing. Which benefits do FDs most commonly look to from outsourcing? Cost savings for the most part, which come from using a supplier more expert in a particular area with greater economies of scale. Also it’s important to look at outsourcing as a way to focus on new business opportunities. Which barriers are preventing FDs doing more IT outsourcing? The biggest is service level agreements and having confidence in defining the service levels correctly. Then being able to manage that without service providers wriggling around.