Outward Bound

IT outsourcing is set to get cheaper and more popular. But as recent events show, hazards remain.
Tim BurkeApril 2, 2009

Few CIOs will be surprised to find their budgets slashed today. As Bill Floydd, CFO of IT group Logica UK, points out, finance chiefs are taking a much closer interest in their companies’ IT strategy during the downturn, pushing their CIOs “to deliver a savings plan and to do this quickly.” In fact, almost half of the global IT managers recently surveyed by consultancy TNS said they were working with less money than in 2008.

Expect outsourcing to play a central part in their plans. In late 2008, adviser EquaTerra studied more than 400 outsourcing contracts held by 125 of the top IT-spending companies in the UK. It found that 63% of respondents expected to increase the amount of activities they outsourced, compared with 54% in a similar study in 2007. Most respondents in 2008 said the main motivation was cost savings. Indeed, the downturn should mean companies face lower costs from outsourcing as vendors clamour for a share of companies’ dwindling budgets.

But companies looking to increase IT-outsourcing commitments were given a stark reminder of the risks earlier this year as news broke of the accounting scandal at Indian outsourcing company Satyam. Seen by many as an isolated incident, the news nonetheless cast a shadow over the outsourcing industry, right at a time when it should be booming.

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Buying Some Options

The benefits of IT outsourcing should become even more pronounced during a downturn. During the current volatility, “everybody’s crystal ball is laid slightly smashed on the ground,” says Rob Thomson, a director at IT group SunGard. “So for any CFO trying to work out where his business is going to be in 12 months, it’s even more difficult than ever. By outsourcing some part of that lumpy IT infrastructure, they can buy themselves some scalability and some options—both up and down—as the business changes over the next 12 months.”

That benefit wasn’t lost on directors at De Agostini UK, a €600m publisher in Europe and Asia. Two years ago, the company—part of Italy’s De Agostini Group—decided to replace a range of 12-year-old bespoke legacy systems it was using for work such as sales forecasting and financial reporting.

Furthermore, the directors wanted to replace its IT outsourcing provider. The outsourcer “was quite a small company,” recalls Nick Mison, the publisher’s IT director. “Because of its size, it wasn’t scalable. In effect, it was like having a fixed-cost IT department. It was fine when we had work, but when we didn’t, because we represented such a high percentage of their revenue, [the outsourcer] was a big risk and an overhead for us.”

De Agostini UK signed a new contract with NIIT Technologies, an Indian IT outsourcer, which rewrote and now runs its applications. Mison points to several benefits, not only financial (he says the company saved about £2m, or around €2.2m, compared with the cost of using a UK outsourcing provider), but also flexibility, since the contract with NIIT allows the company to scale down the services it uses in quieter periods.

“It’s quite do-able to shrink and not have the cost, and then when we’re looking at new projects, we can ramp the team back up again,” Mison says. That kind of flexibility is especially important during the current uncertainty, he adds. “I have a few projects running that I think are going to go, but they could change in the next couple of months. It was helpful before [to be able to scale back], but it’s even more relevant now.”

Ravi Pandey, senior vice president and managing director in the UK at NIIT, agrees and adds that pricing models have also had to become more flexible. “We used to charge for a number of people to provide a service,” he says. “Now we just provide that transaction on a per-service basis. And we will bring down the cost further by not keeping a dedicated resource for [the customer]. We’ll run it on a shared services model.”

Now for the bad news. The challenges of outsourcing haven’t disappeared. TPI, a sourcing adviser, highlights a number of common problems companies face when outsourcing, ranging from misunderstanding contracts to culture clashes between the client and the vendor. At De Agostini, Mison says even the relationship with NIIT, which he’s happy with, calls for close management and he concedes that hidden costs remain a bugbear.

And although prices are expected to fall, companies may find that they pay more upfront during the downturn. Mike McCormac, a director at Procertis, an IT consultancy, says outsourcers would once have structured contracts to show lower costs at the start of the agreement and higher costs at the end, in order to woo new customers. But now many outsourcers themselves could use the extra cash, while others might be concerned about the creditworthiness of new customers. So McCormac reckons companies are likely to pay more at the start of a contract than they previously might have been.

All these, however, seem like quibbles ever since the Satyam scandal broke in January. It was at the start of the year that founder and chairman B. Ramalinga Raju admitted that the company had been filing false accounts for several years, claiming at one point to have $1 billion in cash that didn’t exist. CIOs of companies around the world who had outsourced infrastructure or process to not only Satyam but also other providers began wondering what happens if the company running their IT infrastructure takes a dive.

In a paper on the topic, consultants at Booz & Company noted that any CIO working with an outsourcing vendor should use the Satyam situation as a wake-up call to start gathering more information on their providers. “To maintain trust in any outsourcing vendor, customers will no doubt expect much higher standards of financial transparency and due diligence,” they wrote. “Every company needs to set up a systematic way to analyse its current outsourcing relationships and develop workable risk mitigation against short-term service disruptions.”

Experts agree that although it’s impossible to predict every risk, CIOs can at least make sure they’re as close to their vendor as possible. Due diligence is critical—companies should check customer references, make on-site visits and get acquainted with a vendor’s management team. They should also talk to competing vendors to understand the different ways a project can be managed and to gain pricing leverage. Contracts should be reviewed at least twice a year, and companies should pay particular attention to how their corporate data would be retrieved if a problem occurs. Finally, in the wake of Satyam, management teams should consider worst-case scenarios, whether it be a vendor going out of business or confidential information being stolen.

During such economic uncertainty, IT outsourcing is a balancing act between risk and reward. 

Tim Burke is a senior editor at CFO Europe. Additional reporting by Sarah Johnson.

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