The shocking revelations of accounting fraud at WorldCom Inc. have left even non-WorldCom users wondering about their service providers. With financial scandals at Enron Corp., Global Crossing Holdings Ltd. and now WorldCom, how can enterprises be certain that their outsourcing providers are being honest about their financial position? The answer is that they can't.
No matter how thorough their due diligence, WorldCom's customers had no way of knowing that the company's financial executives were lying about their costs to boost their image of profitability. Heck, even the auditor that checked WorldCom's books, Arthur Andersen LLP, didn't know. How could WorldCom's customers know?
However, the WorldCom scandal does suggest that potential customers should be aware of some risks associated with the WorldCom business model. In an article in the Washington Post last week, an anonymous source in WorldCom's accounting department stated that, due to more than 60 acquisitions over the past 10 years, the company's financial statements were too complex to be verified. The source estimated that not more than five people at WorldCom truly saw the full picture of the company's finances.
That situation is similar to the one at Enron, in which a small group of people left their fellow employees - and their customers and investors - in the dark about their accounting methods. It stands to reason that if only a few people are in control of financial figures, there will be the temptation for misrepresentation, or at least mistakes. Potential customers should ask lots of questions not only about an outsourcing company's finances, but also about who is responsible for compiling and monitoring them.
Similarly, potential outsourcing customers should ask some questions about how a vendor arrives at its financial figures. WorldCom made a very obvious mistake in counting its leased-line costs as capital expenditures. If someone had spotted the fact that WorldCom had extraordinarily high capital expenditures and surprisingly low operating expenses, perhaps the problem would have been exposed sooner.
Even with the most thorough due diligence, however, IT executives will now have to add financial failure to the list of risks associated with hiring an outside service provider. In less than a week, WorldCom and UUNET went from leading provider to teetering on bankruptcy. Even if the company stays alive, its layoff of 17,000 employees - nearly a quarter of its workforce - will surely affect the quality of its business services.
WorldCom's degradation of performance - or perhaps outright failure - could affect its customer's businesses just as surely as a brownout or a cable cut. Just ask the customers of NorthPoint Communications Group Inc., whose screens went unexpectedly blank when the company went out of business a year ago. In today's uncertain economy - and particularly in the telecommunications sector - financial failure is as big a risk to outsourcing customers as natural disaster or a terrorist attack.
To minimize risk, outsourcing customers should not only step up their efforts to study the finances of their potential vendors, but they should also expand their disaster recovery plans to include contingencies for a provider's financial failure. These contingencies might include back-up staffing sources in the event of provider layoffs, or even back-up outsourcing service providers that could be hired quickly in the event of a major financial disaster.
It is a sad state of affairs, but IT managers must now add " vendor financing " to their lists of risks to IT services. Because while the WorldCom disaster may be the worst to hit the accounting books, it almost certainly won't be the last.