A recently-published Holway Ovum report forecasts that outsourcers will control the IT market in the next 10 years, but that does not mean that clients should be tied into unsatisfactory contracts.
Outsourcing has many attractions: it gets IT "off the books", while users take advantage of outsourcer's economies of scale, access scarce skills and exploit the outsourcer's best-practice experience.
Such are the attractions that already about 20% of FTSE companies have set up major outsourcing contracts and the market is set to be worth more than £11.5bn by 2004, and account for half of the UK IT services market.
One of the key benefits for both clients and outsourcers is flexibility - but this can be a double-edged sword.
Users look to outsourcers to deliver major change in IT infrastructure and architecture, but change is risky even when anticipated, and far more so when it cannot be foreseen. Having IT delivered via an outsourcer does not alter the fact that flexibility - preparedness for change - costs money.
However, users should ensure that, when the time comes to change, whatever the outsourcer develops and delivers, they only pay the true cost of that development and delivery.
Companies need to guard against artificially high costs generated by over-the-barrel contracts that do not allow for flexibility and future change. Though neither user nor outsourcer can predict what changes the future will require, that it will require changes of some kind is predictable, and must be built into the original contract.
"The user's option to realign the contract is an essential requirement of the initial contract," says Robert Morgan, chief executive of outsourcing consultancy Morgan Chambers. "The key to success is to understand how to build flexibility without undue penalty in order to cater for significant change. Understanding applied here virtually guarantees a successful relationship."
Morgan advocates that all companies outsourcing IT should include a continuous improvement programme in the contract from the outset, as a means of future-proofing the user and containing risk.
A continuous improvement programme, says Morgan, "allows the user company to be assured that the outsourcing contract will adapt to new business and new technology regimes as and when they are deemed commercially necessary and advisable".
This warning may seem ironic when all too often it is the outsourcer that is desperate to change a client's IT.
"Outsourcing deals don't work well when expectations are different," warns Adrian Quayle of the Gartner Group. Problems can arise, he says, when the client just wants a utility-style outsourcing agreement to decrease cost while the outsourcer wants to initiate a wide-sweeping programme of improving IT effectiveness - for which the outsourcer will, of course, charge considerably more.
Outsourcers can present tempting reasons to undertake ambitious changes such as business transformation programmes which tend to be put on hold when recession hits.
"Outsourcing is a legitimate and underutilised tool in an uncertain environment," says Les Mara of analyst Cap Gemini Ernst & Young, arguing that outsourcing can free sufficient financial resources to finance such transformation programmes, which the outsourcer will run for you.
To their credit, increasingly these days outsourcers are prepared to put their money where their marketing is and enter into shared risk-and-reward relationships with their users, to convince them of the benefits of business transformation programmes - though just how much risk is shared is, again, something the user must hammer out. The principle has to be, says Mara, "If things go wrong both parties need to feel it, and if things go right both parties need to feel it."
An outsourcing relationship can and should be a strategic partnership - from a legal point of view it is a contract - and every contract must be finite. Because the business environment is uncertain, premature termination - if the user merges or demerges, for example - will cost money. But although the outsourcer should be compensated for the loss of an anticipated revenue stream, it is up to the user to ensure that early closure charges are not punitive.
Whichever way a user cuts the outsourcing cake, one truth is paramount - change costs money.
Guest editor's comment: flexible contracts
Where should the balance of flexibility fall in an outsourcing contract? Here are my golden rules:
- Build a mutually profitable relationship. Customer and supplier both need to benefit. You have to ensure there's a win-win. If a supplier does not make a profit he will go under, which will not benefit you, his customer
- Limit the term of the contract. In buying development skills from India, for example, I made it a two-year contract, and then negotiated an extension. In that time-frame costs of skills may change, as may business and market conditions
- Recognise that any outsourcing contract results in a degree of risk, both for the customer and the supplier
- Look for ways of minimising your risk. For example, my outsourcing contract guaranteed a daily rate for an agreed number of man days over a two-year period. Each item of work within those two years was subject to a separate negotiation where the supplier accepted a fixed-price contract within the terms of the overall contract. Failure to complete the work within that time-frame did not then result in extra cost to me, the customer
- Negotiate the contract before signing it - and be clear what you want. Don't take the supplier's standard contract. Work through all the clauses, such as service level agreements, especially the exit point and flex points, to allow for events like mergers. Suppliers may not be keen to do this but I've managed to do this on two outsourcing contracts despite initial suppler resistance
- Accept that you must invest resources in contract negotiation - it is essentially a walk-through of the management processes you will use during the life-time of the contract. If you do not do this you will find situations arising which had not been thought through and will be potential conflict areas. Take legal advice from a specialist lawyer - expensive but very cost-effective
- Accept that you must invest resources in contract management. For a major contract meet with the supplier monthly. The first meetings will be crucial to ensure that minor problems do not escalate to crisis proportions
- Convince business management that change will always cost money. If you enter into a contract worth millions of pounds change will be expensive. Would your business expect that flexibility from other suppliers? It's important to treat IT suppliers as any other corporate suppliers.