Business responds to recession by tying outsourcing agreements to outcomes

News Analysis

Business responds to recession by tying outsourcing agreements to outcomes

Karl Flinders

Business outcomes are increasingly being written into outsourcing agreements, as companies respond to the recession.

The IT services market declined last year as a result of businesses changing strategies amid recession. Customers retrenched and so did suppliers, according to Gartner.

The analyst firm said worldwide spending on IT services declined 5.3% to $763bn in 2009 compared to $805bn the previous year. In the wake of economic turmoil, suppliers and end-customers are increasingly drafting outsourcing agreements with a defined business outcome. According to the Gartner research, suppliers that focused on the business outcome did better than average last year.

"The economic uncertainties and the crisis in industry have had negative implications on the worldwide consulting market in 2009, and many providers' revenue growth rates were negatively impacted. However, business outcome-focused providers of consulting services with established business relationships were often successful in growing their market share better than the market average," says Gartner.

Lee Ayling, managing director at sourcing consultancy Equaterra, says "outcome based" is a term that can mean many things to many people and is as a result difficult to define. "But I do think that suppliers have done better if they have a more outcome-based ideology," he says.

During the downturn, many contracts were based on cost-cutting targets, which were easier to measure and therefore lent themselves to outcome-based agreements. "This can be easily understood by the wider business," says Ayling.

Robert Morgan, director at consultancy Burntoak Partners, says the trend has been initiated by suppliers and their customers. "This is the way the market has decided it needs to go. It is more risky for the providers and provides some surety to the end customers."

This is because these contracts can benefit both the suppliers and customers, according to Douglas Hayward, research manager European services at IDC.

He says 2009 was a bad year for BPO and IT services and outcome-based models meant the suppliers and customers have shared the pain. He adds that when things pick up they will share the gain.

An example, he says, would be businesses only paying in relation to the volume of services consumed. "A lot of end users are looking to pay per transaction or click. This is crude and simple, but it works."

But tying payment with outcomes can be risky if it is done without careful consideration. Nigel Hughes, director at business and IT consultancy Compass, says the outcome must be related to what the IT is there to provide.

He gave as a bad example an oil and gas company linking the outcome of a contract with EDS to its share price. "The price of oil went up and it ended up paying out more and more money for nothing."

He says a good example is part of a deal between Scandinavian airline SAS and CSC, which segmented a business process. It saw the supplier run all the systems involved in putting passengers on board aircraft. CSC was paid a fixed price per passenger. "This left CSC to drive more efficiency," adds Hughes.

The telecommunications sector, which overlaps IT, is also seeing this trend, says Harry McDermott CEO at consultancy Hudson & Yorke. "This is a definite market trend, especially in deals that have a transformation programme embedded." He says these deals can incentivise suppliers and customers.

Increasing numbers of suppliers are introducing models where customers can tie payment with outcomes.

Morgan at Burntoak Partners says there are three groups of suppliers that are succeeding in providing outcome-based services.

He says Indian suppliers are happy to take on more risk and he even describes them as pioneers in this area. Then there are highly specialized suppliers doing well out of it, such as Fujitsu in infrastructure. The third group is the tier-two suppliers such as Steria, Logica and Atos Origin says Morgan.

But businesses must take care when agreeing contracts because those with a business outcome will have to be tightly written, says Mark Lewis, partner and head of outsourcing at law firm Berwin Leighton Paisner. "They have to be much more carefully drafted because while you are not being prescriptive in how services are provided you have to be very clear concerning the outcome."

"There is extra management time and attention required and you need more business involvement than normal," adds Lewis.

He warns that if contracts are not tightly defined, customers will not be able to redress some grievances if they occur. "If there is any doubt, the supplier can get off the hook."

The recent global recession has left its mark on every industry. The IT outsourcing sector is no exception. Suppliers cannot expect to continue to charge top dollar while customers are struggling. Internal IT departments have to change to better serve the company, so why can't service providers. After all they often pride themselves as being extensions of the customers' business.


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