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Carillion not a like-for-like comparison with IT services firms, but an overt reminder

Although Carillion’s problems are unlikely to hit major IT services suppliers, its collapse is a reminder of the need to ensure good governance

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The collapse of construction and business services giant Carillion has brought the outsourcing industry into the public gaze, but enterprises should not associate it too closely with IT outsourcing.

Outsourcing in business is often a dirty word. It is often associated with replacing people’s jobs, sometimes lapses in security, and is often seen as a risk.

The effects of Carillion’s collapse are being felt by customers of its services. Business customers that receive services such as cleaning and maintenance through subcontractors of Carillion are already receiving letters from their suppliers explaining the situation, and that upfront payments may be necessary for them to carry on receiving services.

Clearly, Carillion’s travails should act as a more than a gentle reminder to any business to fully vet its IT suppliers, but does the episode raise doubts over the viability of big IT outsourcing companies? Not really.

Although Carillion had a large business services operation providing what are known as “blue-collar services” such as cleaning and property maintenance, this type of outsourcing is provided by different beasts to those offering IT services.

However, separate news of a profit warning at Capita, whose diverse range of services includes IT to public and private organisations, might hit customer confidence.

Low margins leave little room for error

Mark Lewis, head of outsourcing at law firm Berwin Leighton Paisner, said Carillion’s downfall is a business services problem rather than one for IT outsourcing or business process suppliers and buyers.

“The problem experienced by Carillion is particular to part of the business services sector – the blue-collar end of business services,” said Lewis, who pointed out that IT services company failures have been few and far between, with those that have failed generally being in the mid-market, such as 2e2 a few years ago.

“Normally, large IT and business process outsourcing [BPO] services companies that are struggling are swallowed up, such as Xchanging, which was taken over by IT services giant CSC. Now CSC has merged with the old EDS business, which was acquired a few years ago by HP but has struggled since,” he added.

Nobody wants to buy Carillion, which is why it went into compulsory liquidation.

Lewis said the nature of Carillion’s services and customer base made it vulnerable to events outside its control. “Business services suppliers working for the UK government signed extremely tough contracts, because that’s how government works, with incredibly low margins,” he said. “These are billion-pound contacts with margins of 2-3%. The room for error is small.”

Such contracts push suppliers to cut corners and pay staff as little as possible, said Lewis, which might lead to mistakes, which could in turn give the government reason to hold payments back.

Carillion operated in a labour-intensive industry where many staff are on the minimum wage, so it was hit hard when the minimum wage was raised, he added.

Satyam was saved by cash and customer goodwill

In terms of customers being left high and dry, this is not unlike a major episode in the history of IT outsourcing, when a major supplier with billions of pounds’ worth of contracts faced collapse after an internal fraud brought it to its knees.

Back in 2009, Satyam chairman B Ramalinga Raju admitted he had fixed the company’s books for several years and the company was overvalued by more than $1bn. This triggered panic, which not only threatened Satyam and its customers, but the entire IT services industry in India.

Satyam boasted the biggest global enterprises as its customers, and organisations that had business-critical IT run by Satyam were rightly worried. What happened next was that the enterprise customers and the Indian government backed the supplier.

Satyam needed cash and customer goodwill to survive, and the Indian government and Satyam’s customers had a lot to lose.

Satyam was one of India’s leading IT services players, ranked alongside Tata Consultancy Services, Infosys, Wipro and HCL at the time, so the Indian government was determined to prevent its collapse and the resulting damage that would have been done to India’s huge IT services industry.

Large global enterprises such as General Electric had so much business with Satyam that they quickly committed their business to the company to retain market confidence. It would have been expensive and risky to untangle all their IT contracts from Satyam and move them elsewhere.

Eventually, Satyam re-emerged and is now part of Tech Mahindra. See this timeline for the whole story.

One IT services industry source said: “I don’t know of a single customer that was harmed by Satyam’s demise. Service levels went up across the board immediately following the crisis. Only very few customers dropped them and operationally the company was delivering.”

Carillion different from Satyam

But he added that the case of Carillion was different and far more complex.

“The UK government used Carillion to shift work from the government. A lot of companies that hired Carillion over the years probably paid far too little and this is why it went bankrupt. This company had poor management and was squeezed by hypocritical government procurement officials. Who is to blame?”

However, the whole affair has left its mark on the IT services industry.

Steven Hall, president Emea at IT and BPO services advisory service ISG, said the Satyam case led to a tightening-up of governance associated with IT services contracts. “This case was a significant wake-up call for the IT outsourcing industry,” he said. “We have not had anything nearly as major as this since, and I think the industry has done well putting in the right controls.”

Hall said there was a good level of governance in the large enterprise space, where companies typically have big IT outsourcing contracts in place.

“There are regulatory and compliance issues that the service providers have to go through before contacts are agreed,” he said. “These are fairly rigorous processes that look right down into the supply chain. Large enterprises will check that all subcontractors have the same level of compliance as the main contracted supplier.”

Hall added that the IT industry also used technology to help manage very large contracts: “So we use governance supported by technology to ensure compliance by the suppliers.”

This is not just important to ensure you are getting a good deal, but can also alert a customer to the early indicators if things are going wrong. “If things start to go south early, the customer can step in,” he said.

The Carillion case might have a similar effect on the UK public sector, encouraging organisations to ensure the right controls are in place when outsourcing. “A multi-supplier approach balances the risk but you have to have good governance in place, whether it’s one large supplier or lots of small suppliers,” said Hall.

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