About to outsource your IT? Read this first
Some of you just might be changing suppliers soon
Posted in Management, 8th February 2013 11:48 GMT
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Whenever a major service provider runs into financial difficulties it is undoubtedly an extremely unsettling period, not least for the workforce, customers and management.
Tough decisions need to be made in very tight timeframes which often don't allow much time for strategic planning. Financial distress is one of the ever-present risks in outsourcing. Much like geopolitical risks, data breaches and service failures, it is impossible to contract against them.
A customer needs to assess the best procurement strategy to manage these inherent risks and should plan (and price) for some of the risks to materialise.
Outsourcing, by its very nature, involves a transfer of functions from a customer to a supplier. This can lead the customer to lose detailed knowledge relating to the processes involved in delivering those services, particularly in long-term contracts.
For example, UK government spending statistics show a remarkable concentration on a relatively small number of major suppliers: about 80 per cent of central government’s ICT work is undertaken by 18 suppliers.
Many of the contracts are for a government body’s entire infrastructure. Public-sector staff, together with their knowledge and skills, physical networks and infrastructure, are all transferred to a supplier, effectively locking the government customer into a relatively small number of long-term contracts.
There is nothing inherently wrong with this - concentration of resources can produce economies of scale, although they inevitably carry increasing risks in the post-credit crunch world. When a financially distressed supplier effectively disappears, there is unlikely to be anyone in-house to take up the reins.
How can customers protect themselves?
There are a number of contractual protections that customers can include to try to mitigate (if not eliminate) risks of supplier distress. At the simplest level, these include rights to terminate on the occurrence of events ranging from the appointment of an administrator or other insolvency practitioner through to a failure by the supplier to pay any of its debts when they are due. The customer's protections always need to be balanced with supplier's need to be able to run its business without excessive interference.
Know your supplier
Detailed contract terms dealing with the supplier’s financial health should be included where a contract is particularly high-value and/or business critical for the customer, or where it represents a significant proportion of the supplier’s annual turnover, particularly when the supplier is new in the market or taking on contracts that are larger than it might normally do. Typically, increasing levels of supplier financial distress result in more extensive remedies being available to the customer.
For example, a first level of financial distress (measured by a fall in credit rating or pre-agreed financial ratios) might result in more stringent reporting requirements and a requirement to provide a service continuity plan. Further deterioration might require the supplier to establish a financial distress escrow account into which sums owed by the customer to the supplier are paid. Payment out of the account is then prioritised – usually to subcontractors and other parties that have a direct impact on the performance of the contract first, followed by the supplier.
These measures often apply to other members of the supplier’s group, particularly where the group structure is large or complex. The contractual provisions rely on the customer, or its financial advisers, undertaking adequate financial due diligence at the outset. Any deterioration in the supplier's financial position should be monitored closely throughout the term, although there will inevitably be some degree of time lag in any reporting mechanism. Customers should look out for the typical early warning signs, which often include a sustained drop in service levels, the supplier failing to pay subcontractors on time (or at all), or an unusual delay in publication of the supplier’s annual accounts. Significant obligations should also be backed up by financial and/or performance guarantees from a financially sound parent company.
Examine the supply chain
Outsourcing often involves a complex supply chain of sub-contracts. Customers should ensure that any sizeable contracts with third parties can be transferred to the customer or a replacement supplier. It is also helpful where the outsourcing agreement gives the customer a right to enter into direct agreements with (key) sub-contractors. This can be useful where there is a risk that a sub-contractor will walk away due to non-payment by the supplier, particularly where that subcontractor delivers a sizeable proportion of the services.
Know your rights
Outsourced services may be delivered using a range of tangible and intangible assets. A common customer concern is the danger of being locked in to a supplier’s proprietary solution. The customer should ensure that the agreement clearly identifies the types of intellectual property being used. If new software is being written specifically for the customer, the source code should be placed in escrow to be released on the occurrence of insolvency-related events.
This should be accompanied by rights to use the supplier's software for at least as long as it takes to transition to an alternative technology platform – whether provided in-house or by a replacement supplier. Similarly, the rights to any software provided by third-party vendors should be capable of being transferred to the customer or a replacement supplier.
If the services have been outsourced for the first time, a supplier may take on existing assets used by the customer to deliver the services in-house. These may be supplemented by the supplier’s own assets. The customer should ensure that it has an option to purchase the hardware on termination – at a fair market value to reduce the risk that a liquidator might be able to disclaim that right – and should restrict the extent to which the supplier can give security interests or other rights in that hardware to anyone else.
These provisions should be negotiated at the outset of any outsourcing deal - by the time an insolvency practitioner is appointed the customer will be in a weak position to negotiate rights to assets which may need to be retained in order to sell the business as a going concern. Where the supplier is using the infrastructure to provide services to other customers, things can become more complicated and it is not simply a matter of buying back and removing the assets from the supplier's premises.
Start (and manage the contract) with the end in mind
A planned exit, managed over a reasonably long period of time towards the end of the term, is much easier to manage than an emergency exit triggered by a particularly serious breach of contract or insolvency.
When a supplier is in financial difficulties and insolvency practitioners are involved, this adds yet further layers of complexity. Exit from a supplier should therefore never be an isolated exercise in its own right. It should be looked at in parallel with day-to-day contract management and information requirements (for example, reports on service levels, assets, IPR and work in progress) and (continuous) knowledge transfer provisions, which apply throughout the term.
More fundamentally, the potential for supplier distress should be one of the key factors to bear in mind when formulating a coherent procurement strategy. Is there over-reliance on one supplier, what are the alternatives, and how long would it take to procure replacement services? ®
Huw Beverley-Smith is a Director in the Technology and Outsourcing Law Group at Field Fisher Waterhouse LLP in London, where he advises customers and suppliers on major technology procurements, outsourcing projects and the protection and exploitation of intellectual property rights.
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COMMENTS
"Many of the contracts are for a government body’s entire infrastructure. Public-sector staff, together with their knowledge and skills, physical networks and infrastructure, are all transferred to a supplier, effectively locking the government customer into a relatively small number of long-term contracts.
There is nothing inherently wrong with this.."
"Outsourcing, by its very nature, involves a transfer of functions from a customer to a supplier. This can lead the customer to lose detailed knowledge relating to the processes involved in delivering those services, particularly in long-term contracts."
You don't see an inherent contradiction between those two statements at all then?
Re: Don't do it for the money
> duff outsourcing projects where the main reason is money
The problem with such projects is that they invariably cost less because they don't provide the same service.
So the headline cost falls, but the customer ends up spending engineering time - which is likely to have a higher hourly rate - doing the job that he expected the outsourced contract to do. And because the engineers aren't the experts in that task, it frequently takes longer to boot.
The net result is a large *increase* in costs - but because the headline figure has fallen, this seems[1] to be a Good Thing(tm), and there only remains to be a witchhunt to find out why Engineering has become less productive this quarter...
Vic.
[1] To seagull-management, at any rate...
Re: Err, no
There is a difference though - 'IT isn't a department of a company, it is the company'. I seem to remember that was a quote from a long time back from a certain Bill Gates.
In other words, a company needs to own it's own operational systems; data, workflows, reporting etc etc. As a contractor myself I can fully recommend bringing in contractors to improve systems or carry out specific projects etc - but - what they do must be part of the company's systems and fully integrated via documentation, sharing, training etc.
To continue your analogy, if you change your electricity/gas supplier then it makes no difference to your operations - identical electricity and gas comes in. Similarly, if you change your catering you shouldn't have problems; food was supplied before, food was supplied after.
But, change your IT provider and the way every single member of your workforce could be affected.
The problem with outsourcing IT is this.
You either specify in minute detail what you want; Win 7, Exchange, Sharepoint etc etc - and ask for tenders. But what's the point? Same stuff, no chance for providers to differentiate on how to provide desktops, email, collaboration. You pick the cheapest supplier who hasn't thought it through properly - they then struggle as you're not paying them enough. They then provide poor service until they go bust.
So what do you get? Years of poor service and major problems when the supplier goes under.
Or - you say to suppliers - we need Desktop, Email, document sharing, collaboration - knock yourself out with different ways of supplying this and send in your tender.
So you choose between say Win 7/Exchange/Sharepoint or SAP or Oracle or ADempier or PlanGuru . Good luck with picking which would be the best fit for your company. Normally the contract will go to the best presentation - i.e. not a technical choice but one based on a sales pitch. If you could carry out some live trials this would be best - but this rarely seems to happen.
Now you have the battle to get this huge solution implemented and used at your company. Of course, none of them are a good fit - so SAP consulatants at a K a day are need to modifiy SAP to fit how your company works.
If you're really lucky you may be able to get one of these solutions to work well enough - but - and here is an important point - you are now over a barrel. Not happy with the ever expanding cost of SAP - want to tender out and change - say change from SAP to Planguru because you've worked out it looks much cheaper. Well good luck with the switch - changing all your systems and all your technology and all your workflows and how every single member of your workforce works. The cost of the change is so huge that you will stick with the expensive, rubbish service for way too long.
So - DO NOT OUTSOURCE.
Work with your own guys - get some more staff in if you need to. So they can evaluate solutions, carry out some tests, carry out some trials. This way you can even use best of breed and not use a single solution.
An important point is this - things are always changing - new technologies, new ways of selling, dealing with customers, new platforms etc. You need to have a max and match approach - and IT staff need to be able to check out all the options. No huge, overarching do-it-all system is going to fit everything forever - or even for a few years.
For example, say you have Groupwise on Windows server, Android on phones, Win 7 desktops, MS Office, Accufund for ERP/Payroll/CRM and IIS/.NET for the company website (supplied by an outside company).
Then you decide to have better messaging. You could change Android phones to Blackberrys - and put BES on top of your Groupwise. Of course this could be trialled with a small number of users first.
Or say you realise that many users could happily use LibreOffice - again carry out some trials. Brilliant! Works fine. Massive savings on license costs.
Accufund starts playing up or starts getting expensive - look at Sage for your payroll and other solutions. That should shake Accufund up - get you a better deal etc.
See the picture - you are not over a barrel.
You could even bring currently outsourced stuff back in. Company website running slow? External supplier charging the earth for always delayed changes? Then you want a new fangled responsive (works on pads, smart phones etc) site - quote from current suppliers has way too many zeros.
Bring in a couple of contractors, Nginx proxy, Apache, Debian, Drupal and voila - much faster, much better, much cheaper. Get your own web guys to work with the contractors and learn the site. Future changes are carried out by your own in-house staff for a cheaper cost and much faster - no time wasting over contract and quotes etc.
Of course, this comes up against a big problem - changing how management works. They now have to be more hands on and to be able to work with their own staff. No more management by watching sales guys PP presentations and signing huge cheques.
Also, staff need to be valued - paid well, looked after, cared for.
And that, I think, is why we have this madness of outsourcing the fundamentals of a company - it's much easier for management. I know many senior managers are very busy and have to look any many projects, budgets, systems etc - but if they start out with the principle of doing stuff in-house they will retain control of their companies. I suggest they start by having big 'say anything' meetings - look at what existing staff are suggesting - don't get stuck with a one-size-fits-all solution. It might be harder initially to identify staff who can be trusted to run the various parts you need - but once you have them in place should be able to rely on them. Again, if any part is proving problematic, and that particular staff member is struggling they can be helped or re-allocated to something which suits them better - without it affecting/breaking all the company processes.
Generally, as well - look to moving to open source solutions - again, it's about ownership. Want to install a training copy, testing copy etc etc - no extra license costs. Weird bug which is specific to the way you use a solution - you will be able to get someone to fix it. That is the beauty of open source - not cost, ownership.
As an example of what is possible. We've just supplied a document storage and collaboration platform based on Drupal - and the cost was almost a tenth of a Sharepoint cost estimate.
"About to outsource your IT?"
Then shouldn't you be reading the FT instead of the Register?
In charge of an outsourcing decision?
Then the chances of this person reading something on a website written by and for the type of technical, hard working and experienced staff you want to replace with someone from overseas, are few limited.
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