The Bank of Scotland, which last year merged with Halifax bank to form HBos, is to terminate its 10-year £700m outsourcing contract with IBM after less than two years and bring its IT back in-house.
The move is likely to cost the bank a substantial amount in one-off transition costs. It will also be forced to pay penalties to IBM for terminating the contract early without sufficient cause.
The collapse of the deal raises serious doubts over whether long-term "mega" outsourcing deals can ever survive business change.
"The actual costs to HBos will potentially run into the tens of millions," said Robert Morgan, chief executive of outsourcing consultancy Morgan Chambers. "A 'without cause' termination [no blame on the supplier] brings with it huge client cost and risk," he said.
Costs normally amortised over the life of the contract, will now fall due and the bank will be hit with a bill from IBM for its estimated profit for the period, Morgan added. There are also legal fees, software licences and recruitment and contractor costs as the bank faces the prospect of staff who transfered to IBM in the deal not returning.
"Rebuilding the management team will be a huge task," said Morgan. "This is a brave decision, not taken lightly. There must have been a lot more behind the scenes we're not being told about," he added.
Yet last week the trend for mega outsourcing in financial services continued, as ABN Amro signed a £1bn deal with EDS.
Legal experts said that although corporate IT users could minimise the cost of exiting a long-term outsourcing deal early by writing special "get-out" clauses into the contract, this enhanced flexibility would come at a cost.
According to Robert Courtneidge, head of the outsourcing team at law firm Osborne Clarke, you can only insert get-out clauses if the weight of the contract is balanced differently to allow the supplier to make its money within three years rather than the latter half of the contract, as in most contracts. "The greater the flexibility the higher the cost for the user," he said.
When signing the deal with IBM in 2000, Bank of Scotland claimed the deal would save £150m in IT costs over 10 years. Now, it appears that these figures proved unrealistic. One explanation is that HBos underestimated hidden costs such as training and redundancies, industry watchers suggested.
However, an IBM spokesman said the decision was a natural result of last year's merger with Halifax and was to be expected. "At the time of the merger they said they would be looking to create cost efficiencies and IT was one of the key areas they identified," he said.
The spokesman said IBM had tried to hold on to the contract, offering HBos an "insourced" alternative, involving some form of managed service.
He said the split was amicable and confirmed that IBM would receive a one-off termination payment from the bank but refused to disclose the amount.
A spokesman for HBos said the move was "all about cost savings" and was part of a wider review of IT systems across the organisation, adding that HBos was very satisfied with the quality of IBM's service. "This move offers great opportunities for growth," he said.
Despite the costs it will incur through the early termination, the bank's spokesman said HBos was still on track to deliver the £690m of cost savings in three years it promised the City on the day of the merger last September.
The bank's main union, Unifi, was informed of the plan last week.
"Based on the information we've had from HBos so far, everyone who is now attached to the HBos contract will transfer back to the company on transfer of undertaking terms," said Mary Alexander, Unifi's national secretary for Scotland with responsibility for negotiating with HBos.