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Is It Time To Revisit Your IT Outsourcing Agreements?

CIOs who entered into long term agreements prior to 2010 will be faced with a critical decision in 2012. CIOs will need to determine if their current provider contracts are still competitive and, if not, should they re-source the work or renegotiate their agreements.

The problem stems from most ITO deals prior to 2010 being primarily focused on labor arbitrage, often to the exclusion of innovation and continuous process improvement. This is exasperated by vendor account managers who don't fully understand that their clients are now looking for savings and improvements beyond cheap resources. Today's IT leaders are looking for savings stemming through opportunities such as cloud computing, virtualization, self-service for traditional "help desk" activities, application rationalization, improved operating processes and agile development. In addition, clients need their suppliers to be more innovative rather than reactive, which typically isn't built into labor arbitrage based deals.

Based on a number of contract reviews conducted by Archstone Consulting in 2011, it won't be an easy decision for any CIO. Most "legacy" agreements were written in terms of dedicated resources (hardware and people), where the new model suggests a significant portion of the contract should have consumption-based pricing. Because this drives a high probability of a complete renegotiation and lower revenue, vendor account managers are likely to instead offer up a reduced resource rate, propose fewer "administrative" resources or shift a volume of work to a lower cost region. In no situation we assisted with in the past year did the vendor respond with a proposal to revisit the entire contract and, when challenged to do so, the client-vendor relationship soured.

In the case where the vendor does not meet the client's expectations for renegotiating their agreement, it may not be a simple decision to walk away and find a new partner. As anyone who has re-sourced work from one vendor to another can attest, doing so comes at a premium of cost and risk. In the current economy, it is very possible that the one-time cost and subsequent risk may not be worth breaking the contract, requiring the client to live within their agreed upon terms and pricing, or find more creative ways of sourcing. For example, there may be non-critical applications and/or data that can be moved to the cloud with another provider, which allows the client to test the market and move a portion of services away from the provider (if the contract allows it).

We suggest CIOs take a four step approach when reviewing these long term agreements...

  1. Analyze the contracts and determine where there are opportunities, such as:
    • Benchmark clauses that would allow costs to be reviewed by a neutral 3rd party
    • Termination for convenience clauses
    • Services that are not guaranteed to the vendor moved to a lower cost provider
  2. Conduct a review session with the incumbent supplier that allows them to provide innovative solutions (i.e. ask them "what could we do differently together to drive down cost / improve performance?")
  3. Hold informal meetings with competitors to understand how they may approach services within scope to see if there are more innovative models than what your provider is proposing
  4. Determine as an IT leadership team how you might approach the services within scope differently if you were performing them in-house, and share that data with your incumbent

By following these steps, it allows the client to have an intelligent, fact based discussion around the vendor's service delivery approach and challenge them based on industry practices. Should the vendor still not be willing to renegotiate, the informal meetings in step 3 makes it easier to send out an RFI to capture pricing and determine if there is a business case for exiting the agreement or piloting services with a new provider (vendors typically don't like to respond to RFIs where they don't have an existing relationship with the client as they feel it's nothing more than an exercise to renegotiate with the conducting the informal sessions to understand their offerings, they will likely feel that it's a more qualified opportunity).

In addition, as IT departments move to more consumption-based agreements, there will likely be a need to revisit their supplier governance model. In a resource based agreement, it is common for IT leaders to act as though the supplier is an extension of their staff, managing the vendor resources as though they were their own. In a consumption based model, IT leaders need to focus on managing the outcome, not the process / people. This shift in governance may also help lower internal labor costs, as there is less effort required from IT leaders.

A Case Study

The CIO of a large consumer packaged goods company was feeling pressure to cut costs and evaluated his outsourcing agreement with a Tier-1 vendor, which was centered around dedicated labor and other fixed resources. His IT team would constantly be involved in hardware and software upgrades, staying abreast of capacity trends and resource utilization, and in general spent more time managing vendor resources than helping their business take advantage of technology investment.

He was in year five of a ten year agreement when he approached his vendor, asking them to think about creative ways to reduce costs. The vendor response was typical, still centered on dedicated labor and resources - e.g. move some of the staff to lower cost countries, eliminate a couple of administrative people, migrate all servers to Linux, etc.

Rather than accept minor savings (which would come with risk), he invited several vendors to come in and meet with his team. Prior to the discussions, he gave each vendor an overview of their environment - the number of applications and servers, volume of storage, etc. He asked them to come in and describe their model for supporting that type of environment, and didn't constrain them with any pre-conceived ideas.

The majority of vendors pitched solutions based on commodity models, where they would provide support with pricing based on volume (number of users, volume of data, etc.). When discussing high level cost, it was not a dramatic savings for servers and storage over what they were paying, but models being offered would eliminate any need for IT to continually be involved in managing capacity, upgrades, procurement of new hardware, etc. In addition, it would allow them more flexibility in scaling up or down. For example, they were considering reducing their data retention requirements, though in their current agreement, they had already paid for a dedicated amount of storage and wouldn't see any savings. In the commodity model, the decrease in storage would drive lower monthly costs.

The CIO decided to test out the commodity based model using the launch of a new system (not in scope of the existing agreement) as a pilot. This is allowing the IT organization to test out service levels where they are not actively involved in managing the day-to-day activities of their vendor. The strategy is that after a successful pilot, they will add more to this model and over time migrate away from the dedicated resource approach, where appropriate. It will also provide them an opportunity to define areas where the commodity model works better yet retain a dedicated resource model where they feel there is more risk.

In conclusion, given the economic challenges most businesses will face in 2012, reviewing these legacy contracts is not something a CIO should overlook. Coming up with the right strategy will be critical and will require much thought and effort from the IT leadership team.

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