Forward thinking and a regular review of contracts can help prevent spiralling costs if relationships sour, writes Ian Fraser
When Her Majesty’s Revenue & Customs switched a massive information technology outsourcing contract from EDS to Capgemini in 2004, the UK tax men appeared to leave their negotiating skills at home.
In a hard-hitting report in June, the Public Accounts Committee accused HMRC of letting the cost of a 10-year contract more than double, from £2.83bn in 2004 to £8.5bn in 2007. Capgemini’s profits on the deal quadrupled from £300m to £1.1bn.
Vince Cable, the Liberal Democrat shadow chancellor, said: “It is disgraceful that only four years after this project was tendered for, costs are spiralling out of control. The contractor appears to be running rings round the government at the expense of the taxpayer.”
IT provides some classic tales of muddled managerial thinking and outsourcing contracts gone awry. But there are many ways to avoid obvious gaffes.
One is to make outsourcing contracts last less than a decade. Three years on from the HMRC debacle, 10-year contracts are almost unheard-of; lengths of five years are common and many contracts in the private sector run for as little as three.
A more Machiavellian solution is to play suppliers off against each other through “multi-sourcing” contracts. In these, portions of work are farmed out to separate service providers. They may be harder to manage but the results can be better service and less risk.
Roger De Montfort, a partner at PricewaterhouseCoopers, believes any company entering a long-term outsourcing arrangement should incorporate termination clauses in case the relationship sours.
“Prospective partners should think ahead with a detailed exit plan, which they should constantly review so it remains up to date for the lifecycle of the contract,” he says.
Yet only 5 per cent of respondents to a recent PwC survey on public sector outsourcing said they had such an exit plan.
In talks with an outsourcing provider, managers should address the big issues at the outset, says Wendy Colquhoun, a partner at law firm Dundas & Wilson. The things that need to be spelt out, she says, are: service quality and price; flexibility, or the ability of the contract to cope with change; allocation of financial and reputational risk; and cultural fit. Ms Colquhoun says: “If you do this, it can transform the economics of the deal.”
The upfront approach will also quickly reveal if the relationship is unlikely to work, and that can leave time to find alternatives. Ms Colquhoun recommends assessing at least three potential partners. “That enables the board to compare apples with apples and makes it easier for them to reach an informed decision.”
She also urges client companies to pin down prospective providers on costs as early as possible. Apart from anything else, this saves negotiators the embarrassment of having to return to their boards to seek more funds mid-way through talks.
Vague specifications about the service to be delivered and an obsession with price were two factors behind the failure of many contracts in the 1990s, according to D&W’s Allan Wardhaugh. Companies need to be clear about the services they are looking for, he says – for example specifying the size of a data centre for an IT contract – before they go out to tender.
Given the controversy over offshoring – and the antipathy of some organisations towards it – a company should also specify which, if any, tasks it would be happy for its chosen partner to “offshore” during the contract negotiation phase.
“That offshoring, sub-contracting piece should be agreed right at the outset,” Ms Colquhoun says, “because it has an economic impact on the deal as well as a regulatory impact, reputational risk and data protection issues.”
Once a company has an outsourcing deal in place, it cannot just sit back and enjoy the ride. The contract needs to be monitored and updated where necessary and the client company must retain a team of staff to handle that. If not, it can be easy for the outsourcing partner to run rings round the customer, raising their charges whenever the slightest change is introduced.
In the case of “lift-outs” – where companies transfer a whole in-house department – the company should hold back some employees to manage the contract as it progresses.
“Effective governance is essential,” says Phil Morris, chief executive of specialist advisory firm Morgan Chambers. “Working without a proper decision frameworkto define policies, procedures and resources can lead to disaster.”
In the event that relations between the company and its service provider break down, Mr Wardhaugh says it is essential that the contract is revisited as soon as possible.
“If you see it going wrong, don’t just ignore it – deal with it as early as possible. If it does fall apart, it’s going to cost you a hell of a lot of money
This article was published in the Financial Times on 3 August 2007. Read it on ft.com