Howdy Partner - Let's Reconstruct the Deal

A large international company signs an IT infrastructure outsourcing deal incorporating the purchase of existing assets by the vendor and transfer of IT staff, in confident expectation of achieving immediate cost reductions.

The contract allows for some changes in usage volumes but requires heavy "financial engineering". The vendor commits to meet service levels and cut costs dramatically, and plans to break even between Year 2 and Year 3 of the seven-year deal.

Sounds like a win/win situation, right? Well it would be, except that one year on in this fictional scenario outlined by Gartner, business units have forgotten the deal and want further cost reduction and higher service levels, despite the fact that Service Level Agreements specified in the contract are being met. Meanwhile, the expected relationship model has changed as the corporation now plans to grow at 30 per cent a year.

Eighteen months on, the position is even less tenable. Changes are overwhelming the skeleton staff left in place to administer the contract. With the contract already outdated the client initiates a benchmark. Meanwhile, the vendor is no longer on track to make a profit.

Not surprisingly, relationships are strained and minor re-negotiations routinely take place to "patch up" the relationship. When a new CIO arrives and re-evaluates IT and all existing contracts he learns the vendor is losing money and key staff members have been replaced, the enterprise now sees the contract as an inhibitor, and business units want to replace the supplier. So in fact, everybody loses, not wins.

Yet the supplier has met all the contract commitments. "What went wrong?" asks Gartner. "The contract was not structured to meet the changing needs of the business."

IT and business executives know that maintaining their organisation's competitiveness in the new millennium will more often than not mean partnering.

Globalisation, the forced march of technology and hitherto unheard of market opportunities are creating a huge void between the aims of the organisation and its ability to achieve those goals without outside assistance.

Research shows that CIOs are increasingly reliant on consultants. For instance, Forrester Research reports 62 per cent of 50 companies interviewed used three different consulting outsourcing services to help with Web development efforts. IDC estimates worldwide expenditures for consulting will grow at almost 16 per cent a year for the next four years.

And analysts are clear outsourcing and partnering will continue to increase dramatically in Australia over the next few years. The trick is to find ways to develop more creative and effective partnership arrangements without losing control or inadvertently setting up situations where neither side can profit.

That's never going to be easy.

Managing alliance relationships is a huge challenge that requires dedication, insight, an excellent understanding of psychology, a clear delineation of responsibilities, a full comprehension of potential pitfalls and continued hard work.

Gartner analyst Richard Matlus says as IT moves from supplier of services to broker, the drivers are increasingly strong for the development of strategic sourcing as a management discipline in the information services organisation.

"Strategic sourcing is a broad approach that covers all IT-related needs and their consequences. It will deal with both the IT skills necessary to develop an accounting application and with the skills necessary to completely outsource it as a business process." Similarly it will handle both with the IT skills necessary to develop a data-mining application and with the skills necessary to, using that data, design an e-business strategy, Matlus said.

Strategic sourcing starts with finding the right partners.

"What makes a good partner? A good partner is one you are able to work with in terms of a business relationship which is going to help each other's business and which meets a common set of objectives," says Deloitte Consulting partner Russell Brewer.

"The first thing you need to know about finding the right partners is that any arrangement has to meet both sides' business objectives. You have to have some common outcomes, you have to have the same sort of focus, and you need mutual respect," Brewer says.

Yet few organisations have even developed integrated evaluation processes for selecting strategic vendors. Gartner says only five per cent of its client enquiries are focused on strategic sourcing as a life-cycle activity.

Once an enterprise has decided to source a service it should immediately assemble a project team to develop a request for information (RFI) or a request for proposal (RFP), based on the business case derived from the strategy phase of the exercise.

Under the guidance of a project leader the team should define - at the highest level - the work to be included in the RFP. At the same time the team develops the criteria used to create a weighted evaluation model.

"Vendor evaluation must include evaluation of the vendors against the model not only in terms of the written proposals, but also oral presentations and possibly site visits. This phase is completed when two finalists, at most, are selected to continue deal-development and negotiation activities," Gartner analyst Rolf Jester says.

Cross check

Jester says organisations must employ a formal competitive-and-review process and develop weighted criteria based on business requirements to select the best vendor available.

He identifies five primary evaluation categories that must be considered in such an evaluation. They are the service provider's process; technical experience; and industry experience, including how these align with the organisation's internal expertise and its engagement requirements; and the provider's track record in performing like kind and quality work.

With a short list of two to work from due diligence is the essential next step, Brewer says.

Do your due diligence at a point of time in the overall assessment process that enables you to find out what the issues are before entering into that partnering arrangement, Brewer advises, but do it well before it's too late to back out of the arrangement.

"The clever people do a due diligence process before they enter into a deal. It's no good learning afterwards that you've entered a long-term relationship with the wrong party, one that has a different set of ideals or objectives and desires different outcomes. You must do it before you sign the agreement, before you actually enter the relationship," Brewer says "in case you find out there are issues coming out of it you might want to get resolved."

The organisation must also decide whether to build its sourcing strategies around a single vendor or around multiple, integrated suppliers.

Jester says a single-vendor (one-stop shop) approach works well for enterprises with protracted procurement methods which are unwilling to undertake constant market tests - at least as long as the vendor has the geographic and service coverage necessary. It can also work well for enterprises that can manage a single complex contract, but don't have the capability to manage and integrate multiple suppliers. But he warns against the trend for inexperienced users, often with a lack of contract management capability, to try to achieve "partnership-style" arrangements with single vendors. "This is often a mistake," he says.

You also need different relationships with different suppliers, according to Peter Hind, manager of user programs and InTEP Forum at IDC Australia.

"The more strategic is the vendor to your business - such as an enterprise resource planning vendor or financial services type organisation - the more you have to think about involving them in your strategic discussions and business strategy. With a PC vendor, you're probably going to have a more take it and leave it attitude," Hind says.

But Hind says while IT execs recognise that it's better to have a co-operative working relationship with their suppliers than an antagonistic one, feedback to InTEP suggests few have vendors sitting on their IT steering committees.

"People pay lip service to the concept, but in reality today vendors don't get much of a look in," he says.

Building SLAs

The Service Level Agreement (SLA) plays a vital role in establishing the baseline for the relationship of the parties. An effective SLA requires a clear and comprehensive description of the required services and performance levels, supported by performance indicators; audits and reviews; reports; user surveys; and benchmarking. But defining an SLA should never involve an overly ambitious reach for the sky.

"People need to understand that the SLA should represent what you're wanting to do in the future: what you're wanting to buy," Brewer says.

"The more they ask for and the higher level of performance, they more they're going to pay. Yet quite often people get carried away in terms of what their shopping list is, versus what their organisation actually needs or is currently delivering. Then they get shocked by the level of pricing that comes back from the potential supplier for the goods people want to buy."

He says balance is achieved by getting business units involved in the determination of the SLA agreement and then checking desired SLAs against what is being currently delivered.

"There needs to be some verification process between what they're asking for now and what they're actually delivering now and whether the business units are prepared to pay a greater price if they wish to raise those service levels. Quite often there is a major disconnect there," Brewer says.

SLAs fail when user requirements are unknown, indirect services are ignored, or services are badly defined.

Service levels are an integral part of a contract document. As such they must contain defined measurable outputs; identified end-to-end responsibility for service delivery; and clear single-point accountability for service management.

Most strategic sourcing deals fail due to a breakdown in the relationship between the parties. In a fast-changing world, companies must focus on managing the relationship, rather than governing the contract.

Gartner says the key to success lies in the managing the relationship, rather than governing the contract, with independent performance assessment an integral component of solutions for managing sourcing relationships.

"Our experience shows that many long-term commercial (out)sourcing arrangements are including a third party to provide 'benchmarking' services," analyst Craig Baty says. "Some benchmarks are included in the contract purely as a mechanism to initiate re-negotiations, others use benchmarking as a mechanism for ongoing price and service-level assessment.

Market pressure

"What is often not properly recognised is that complex, dynamic and fast-moving markets require relationships between buyer and seller that move beyond the tactical status quo, toward a stage where the strategic thinking and development of the two companies are aligned. Best-in-class performance assessments provide an independent, impartial analysis of the total requirements for the relationship, to both customer and supplier, resulting in an agreed-upon set of actions by both parties."

But thought must also be given to retaining skills in-house. When Victorian WorkCover Authority outsourced its environment to CSC as part of the-then Kennett government's downsizing, losing around 100 people in the process, no real thought was given to retaining the appropriate amount of intellectual knowledge and understanding of how the agency's applications worked.

Former VWAinformation services director Ian Rodgers says in both the federal and state public service outsourcers are able to hold the government captive because they, not their client, retain all the skills and intellectual capital.

Rodgers says VWA - along with most other governments, including the commonwealth - has been getting outsourcing badly wrong.

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