INFORMATION TECHNOLOGY SOURCING

Managing Customer/Supplier Relationships

• Current IT Outsourcing Practices & Definitions
• Three Models of Customer-Supplier Relationships
• Sourcing Decision Framework
• Best Practices
• Applying Best Practices to a Case Example

RESEARCH METHODS

Over 80 case studies in US, UK, and Australia

• British Aerospace
• DuPont
• System One
• Enron
• IRS
• South Australia Government
• Occidental Petroleum
• Ralston Purina
• Rigg's Bank
• Texaco
• Vista Chemicals
• Westchester County

OUTSOURCING MARKET

• 1990 -- $9 billion Dataquest
• 1994 -- $28 billion Dataquest; $50 billion The Yankee Group (global revenues)
• 1995 -- $76 billion International Data Corporation (global revenues)
• 2000-- $121 billion International Data Corporation (global revenues)

TOP OUTSOURCING SUPPLIERS

Rated by % growth in revenue, formal practices, number of regional operations, centers of expertise, etc.

55 EDS
55 IBM
40 Andersen Consulting
40 CSC
37 MCI Systemhouse
35 AT&T
35 Cap Gemini
35 Perot Systems

CURRENT U.S. OUTSOURCING PRACTICES: OUR SURVEY

MOST COMMONLY OUTSOURCED ACTIVITIES: OUR U.S. SURVEY

• Personal Computer Operations 61 %
• Disaster Recovery 61 %
• Help Desk 53 %
• Mainframe Operations 50 %
• Education and Training 50 %
• Network/Lan Operations 45 %
• Client/Server Operations 37 %

• Project Management 32%
• Systems Analysis 21%
• Systems Architecture 21%
• Systems Design 18%
• IT Strategy 5%

SINGLE VERSES MULTIPLE SUPPLIERS

Advantages of using multiple suppliers:

• Companies can select "best-of-breed" vendors for each outsourced IT activity.
• Companies mediate risk because no one supplier has sole monopoly power.
• Companies can motivate supplier performance through environment of competition.

• Companies incur higher transaction costs because they conduct multiple evaluations and negotiate multiple contracts.
• Companies have to coordinate multiple suppliers, particularly when outsourced IT activities are integrated.

DEFINING TERMS

The attitudes and behaviors of parties responsible for executing a customer-supplier contract.

Partnership:

"A specific type of contract entered into by two or more parties in which each agrees to furnish a part of the capital and labor for a business enterprise, and by which each shares in some fixed proportion in profits and losses." -- American Heritage Dictionary

3 TYPES OF CUSTOMER - SUPPLIER RELATIONSHIPS

• Buy-In Relationships: Not considered true outsourcing
• Strategic Partnerships: 11% of IT outsourcing contracts
• Exchange-based Relationships: 89% of IT outsourcing contracts

BUY-IN RELATIONSHIPS

Key Features:

• Supplier performs work at customer site
• Transfer of learning from supplier to customer
• Contract usually based on $ per resource per time period

• Hire technical experts to participate on in-house applications development teams
• Hire management consultants to help develop a strategic IT plan
• Hire contractors for database administration

BUY-IN RELATIONSHIPS

• Requirements are uncertain
• Customer's technical maturity is low
• Customer cannot afford to miss a learning opportunity

STRATEGIC PARTNERSHIPS

Strategic Alliances
Joint Ventures

Key Features:

• With most IT outsourcing, the strategic partnership is only a small portion of the deal.
• The deal first focuses on transition from in-house to suppliers
• Considerable time to establish internal work practices before considering external sales
• Strategic Partnership is long-term goal
• Very few successes; most revert back to exchange-based relationship

Announcement in 1996: Swiss Bank signed a 25-year outsourcing deal with Perot Systems worth $6.25 billion. The partners will sell client/server solutions to the banking industry (Schmerken and Goldman, 1996).

Outcome in 1997: Swiss Bank reduced scope and value of contract to 10 years, $2.5 billion.

Example: Delta Airlines/AT&T

Announcement in 1996: Delta Airlines and AT&T form Transquest to provide IT solutions to airline/travel industry. Deal is worth $2.8 billion. 10 year contract.

Outcome in 1997: Venture terminated; Delta brought IT back in-house

Example: Xerox/EDS

Announced in 1996: The Xerox-EDS contract provides for future shared revenues for the development and sale of a global electronic document distribution service. Contract worth $3.8 billion, 10 years. At the time of the contract signing, the President of EDS and CEO of Xerox announced:

"We realized that each of our companies brought to the table specific best-in-class capabilities that enabled a level of performance that neither could achieve independently. This is a case of two technology companies enabling one another to achieve a shared vision for adding value for their customers." (reported on October 10, 1996 on WWW at http://www.xerox.com /PR/NR950321-EDS.html)

Outcome in 1998: Contract completely renegotiated; reject strategic partnership model and enacted exchange-based relationship.

Example: Kodak/IBM

Kodak and IBM formed Technology Service Solutions to provide multivendor PC maintenance and support services to the manufacturing industry.

EXCHANGE-BASED RELATIONSHIPS

Key Features should include:

• Detailed contracts that fully specify requirements, service levels, performance metrics, penalties for non-performance, and price.
• Short-term contracts that last only for the duration for which requirements are known.

• Requirements are known and stable
• Customer's technical maturity is high
• Customer's IT activity is not highly integrated with other business processes

• Cost reduction and better quality service were the most important outsourcing expectations.
• All but one respondent cited a well-defined contract as critical to realizing expectations.

"[Have] specific service levels, define the baseline, and have an out clause." -- CIO

"Clearly define objectives and detailed contractual arrangements." -- Corporate Manager of Corporate Systems

"Ensure performance measures are clear and calculable" -- Manager of IS Administration

"Plan for change" -- MIS Manager

"Don't assume anything." -- CIO

"Get good detailed help--legal, metrics, and consultants. Keep senior management out of all but the final negotiations." -- Project Manager

"You need measurable milestones, performance incentives and penalties, and a good contract manager.-- Project Manager

"Contract performance specs" -- VP of Information Services

"Contracts must be customer focused with rewards and penalties linked to customer satisfaction" -- Director of IT Services

"You can destroy a relationship putting a contract together. Use experienced professionals to help pull it all together. P.S. I don't ever want to be a lawyer." -- Director of Information Systems

"Understand what you want to accomplish with the contract. Move slowly to start with --pilot first before you give away the keys." -- CIO

Excange-based Contracts: Emerging Practices: Can flexibility be built into the contract?

ASSESSMENT:
Competition does not always protect the customer.

"Our contract says we can go elsewhere. When [the vendor] wanted to charge us $2500 to upgrade each of our HP workstations to 2 gigabyte harddrives, we went elsewhere and bought them for $1,000. Now [the vendor] won't support our machines because we put somebody else's hardware in them" -- User, Aerospace Company (Year two into a ten-year contract)

PRACTICE: Flexible Pricing.

• Vendor-cost-plus pricing via open-book accounting
• Market pricing via benchmarks
• Fixed-fee-adjustment pricing based on volume fluctuation
• Preferred-customer pricing based on supplier maintained list
• Performance-based pricing based on supplier performance

See, Shepard, A. (1997)

Business Factors Matrix

Economic Factors Matrix

Technical Factors Matrix

SELECTIVE OUTSOURCING

Sourcing Decision	Percent "Successful"
Total Outsourcing	29%
Total Insourcing	67%
Selective Sourcing	85%

BEST PRACTICES ON DECISION PROCESS

Joint senior management & IT management decision

Decision Sponsor	Percent "Successful"
Senior Executives Only	50%
Senior Level IT Managers Only	74%
Joint Decision	87%

Rationale: Sourcing decisions required senior management's larger business perspective and power to enforce decisions and IT managers' understanding of technical requirements for their organizations.

Invite both internal and external bids

Sourcing Decision Process	Percent Successful
No Formal Bid Process	50%
Compare bids to current IT costs	72%
Compared bids to a newly-prepared internal bid	89%

Rationale: In the past, IT managers were not empowered to institute change. When senior executives empowered internal IT managers through the threat of outsourcing, internal IT managers often competed with external vendors by proposing to replicate their managerial practices.

In case of outsourcing, negotiate a tailored, detailed contract

Contract Type	Percent Successful
Vendor off-the-shelf contract	50%
Detailed Contracts	91%
"Relational" Contracts	33%

Rationale:

Strategic partnerships did not have contractual obligations for shared risks and rewards.

Detailed contracts specify costs, service levels, performance measures, penalties for non-performance.

Shorter Contracts were more successful than longer contracts:

Contract Duration	Percent Successful
Less than 4 years	83%
Between 4 and 7 years	70%
Greater than 7 years	40%

Rationale:

As older contracts matured, they became obsolete as technology and business conditions changed.

Fixed price, long-term contracts did not adapt prices to technology's high price/performance improvements.

Short term contracts motivated vendor performance to ensure contract renewal.

"It's no surprise to me that the closer we get towards contract renewal, it's amazing what service we can get"--IS Director of an Aviation Authority

Create post-contract management infrastructure

• Contract Facilitation
• Contract Monitoring
• Vendor Development

Global Outsourcing: DuPont/CSC/AC

Company Background

• Founded in 1902 in Wilmington, Delaware
• 1996 Annual Revenues: $44 billion
• Percentage of sales outside US: 48%
• 1996 Employees: 97,000
• 20 strategic business units operate in 70 countries
• >120 Joint ventures

Business Strategy

• Core capabilities:Petroleum (Conoco), Chemicals, Fibers (nylon, lycra, dacron Note: all products are
• registered trademarks)
• Divest: Medical products, Photomasks, Electronic Imaging

DuPont's IS Department Prior to Outsourcing:

"He didn't ask what value, only that the number was too big". -- IS Global Planning Manager

Scope of Information Systems

• Mainframe and Midrange Computers 800
• Personal Computers 65,000
• Local Area Networks >500
• Telephones 120,000
• Data Exchange Customer Links >2500
• Internet Access per Day 1,700,000
• Business Information Systems >3,000
• Customer Invoices per year 5,000,000
• E-mail messages per month 17,000,000

IS Organizational Structure Prior to Outsourcing:

• CIO
• Business Information Board, select group of senior VPs.
• 3,000 people provided to the 20 SBUs: data and applications, planning and security,data center operations, telecommunications

Asia, Canada, Europe, Mexico, South America, and the US.

Decentralized:

1,000 IS staff worked on SBU specific systems Reported to the VP of IS within the SBU.

Major IS Cost Reduction Effort: 1991-1996

• Consolidated data centers (100 to 3 mega centers)
• Reduced redundancies -- multiple systems performing same function
• Standardized products -- package software verses building, purchase software only if it runs on current architecture
• Standardized methods -- reusing code, development methodologies from AC

1996 Reduced IS costs by 45%
$650 million spent per year on IT
The users were forced to accept cost reduction measures.

Consequences of IS Cost Cuts

• No disruption in service
• SBU managers applauded the IS group on their continuous cost reduction performance:

• IT assets and skills were not being renewed
• IS infrastructure needed several hundred million dollars worth of investments.
• The IS group was operating on borrowed time, and any data center disasters would potentially cripple DuPont.

Objectives of Outsourcing Evaluation:

• Avoid cost of renewal
• Move from 90% fixed costs to variable
• Further reduce costs (7% savings estimated)
• Faster flexible service
• Improved IS careers

RFP PROCESS

• In February of 1996, DuPont created a "three foot" RFP.
• The RFP contained no cost data, but provided details on every IS job and the services provided.
• April of 1996, twelve companies were invited to respond
• Four companies responded: IBM, Phillips, CSC and AC.
• In June of 1996, CSC and AC were selected as partners.

DUE DILIGENCE

• From August until December of 1996
• 100% of the infrastructure would be given to CSC
• Applications would be divided based on competency.

CONTRACT NEGOTIATIONS

• December of 1996 until the 2nd quarter of 1997
• Negotiated 22 global contracts
• All the RFPs requirements had to be translated into legal requirements.
• "The transformation was frustrating" -- Global Alliance Manager
• Legal experts
• Technical experts for service level agreements

CSC -- 2600 people (64%) provide global infrastructure & applications
AC -- 400 people (10%) provide chemical applications
DuPont -- 60 people ( 1%) manage contract
-- 1000 people (25%) provide business IT leadership
4060

Overall master service agreement, no billing occurs at this level

CONTRACT OVERVIEW

• 22 country contracts
• Pricing schedule that reflects cost of living
• Local currency
• 20 different billing units:
  • stand-alone desktops
  • desktops connected to a LAN
  • mainframe MIPS
  • gigabytes of storage
  • tape mounts
  • UNIX boxes
  • IS staff charges by job category.

CONTRACT OVERVIEW

• Document current service levels as the baseline
• Set goals of long-term service improvement, especially in the area of desktop computing.
• 600 services defined at different locations world-wide.
• For each location, determine standard, differentiated, or no service.
• Ranked services by criticality
• Escalation procedures, cash penalties for non-performance
• Procedures defined for root cause analysis
• In the spirit of a partnership, no cash penalties in the first year

Contract Volumes

• DPont has a 10 year forecast demand for baseline services
• Volumes are expected to increase
• "take or pay" : DuPont wanted complete variable costing of IS; DuPont is obligated to pay at least 50% of baseline volumes

• CSC and AC have separate contracts
• Competitive bidding for additional services: CSC, AC or other parties
• Structure of the deal requires the suppliers to cooperate.
• AC is developing some SAP applications that will have to run on the CSC infrastructure.
• Users call one help desk run by CSC, but their calls are seamlessly forwarded to either a CSC or an AA person, depending on the question.

Transition Challenges:

"The lawyers delivered 10 boxes to the office and said, 'that's the contract'. The contract is 30,000 lines long. It's impossible to execute the relationships from this contract." --Global Alliance Manager A 2 inch summary document was made of the contract

18 months worth of work to translate the contract into daily work practices.

Global Alliance Manager called experts and asked, "why didn't you tell us we weren't even close to done?"

Transition Challenges: Demand Management (volume):

Demand used to be constrained by central IS

"What we found is that everyone is using more IT than baseline." -- Global Alliance Manager

"In old times, each SBU bought from global leverage (i.e., centralized IS group). There was lots of negotiating pressure to keep costs down." -- Global Planning Manager · Difficult to forecast demand, which means lost discounts

Transition Challenges: Service Management (quality):

Monitoring Service Levels

In actuality, 90% of the service lapses within the first 8 months were inherited from DuPont.

Transition Challenges: Financial Management (Price):

Work on 150 major projects was halted due to lack of project pricing.

Bills have been incorrect by millions of dollars

Primarily cause: services have not been fully defined:

• What should be included in mainframe billable units?
• What should be included in a standard PBX upgrade cost?
• Analyst time? Installation? Wiring? Shipping and handling?

Partnering in Practice:

• Act on the intent of the contract, rather than the exact content of the contract
• Rely on continuity of experience
• Additional negotiations not officially amended to contract
• Implemented Problem Resolution Process
• Joint DuPont-supplier teams are assigned responsibility for major areas.
• Each management team told lower level IS employees to do the work, we'll worry about price.
• The operating principle of each team is to be fair, not to exploit any contract inefficiencies.