Outsourcers Should Hope for Best, Plan for Worst

At a time when outsourcing deals draw comparisons to failed marriages, perhaps it’s not surprising that one consultant recommends that parties moving toward a contract pursue a prenuptial agreement.

Jeff Kaplan, senior consultant with the Cutter Consortium, said end-user companies should evaluate how they would be able to take back their IT operations—or other outsourced business functions—before outsourcing them in the first place.

That’s not a one-sided concern, considering how complex and fragile outsourcing arrangements can be. At contract time, both vendor and customer need to agree on a process through which they can extract themselves from a deal, Kaplan advised.

It sounds like common sense. But the notion of preparing for a breakup was lacking from the original outsourcing deals some 15 years ago.

“The practice of outsourcing was rather unsophisticated,” Kaplan said. “There hadn’t been enough experience to develop best practices, and the idea of ‘backsourcing’ wasn’t on the minds of people at that point.”

Backsourcing—the process of retaking formerly outsourced functions—continues to be overlooked today, according to Kaplan. The “competitive urge” to follow offshoring and business process outsourcing trends has “led many corporations to go down the path without thinking about the consequences,” he said.

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Enterprises and their vendor partners would be well-advised to think through the backsourcing scenario. A recent Deloitte Consulting LLP study reported widespread disenchantment with outsourcing deals among the 25 large enterprises surveyed.

Twenty-five percent of the survey participants have already brought outsourced functions back in-house. Ken Landis, a senior strategy principal at Deloitte Consulting, compared outsourcing breakups to the divorce rate, noting that 50 percent of outsourcing projects go bust within a few years.

The potential for developing irreconcilable differences isn’t the only reason to hash out a separation plan. A change in business philosophy or a merger, for example, may make an outsourcing deal suddenly out-of-step with the customer’s direction.

Last year, J.P. Morgan Chase axed a multibillion-dollar outsourcing pact with IBM, a move that followed the merger of J.P. Morgan Chase and Bank One. The merger, according to the company, “created a new firm with significantly greater capacity to manage its own technology and infrastructure.”

To prepare for such occasions, Kaplan suggested that outsourcing vendors and customers explore and reach consensus on the following questions:

• What specific situations will be considered the catalyst for terminating a relationship?
• What sorts of consequences or penalties will the parties incur for termination?
• Through what specific processes will the companies handle the return of the once-outsourced operations?

“The steps for executing backsourcing should be all spelled out so it’s clearly stated from the beginning,” Kaplan said. He also recommends that a steering committee of vendor and customer representatives be appointed to coordinate the backsourcing effort.

But even before the prenuptial is negotiated, the parties should establish reasonable expectations and objectives for the outsourcing arrangement.

For starters, a baseline study should be conducted to evaluate the current level of performance so appropriate service-level targets can be set for the outsourcing firm. The next step is to benchmark how other companies have set standards and objectives for outsourcing projects. Once the outsourcing parties agree on standards, they can be used to determine whether the outsourcing pact is working or foundering. If that happens and either vendor or customer decides to terminate the contract, that’s when the pre-negotiated extraction plan would come into play.

No one wants to dwell on the worst-case scenario at the onset of an outsourcing deal. But contingency planning can help companies deal with an unpleasant situation as gracefully as possible.