Long-term sustained management of a strategic alliance is turning out to be the dominant challenge of effective IT outsourcing. From a relatively unusual entrepreneurial activity, IT outsourcing has recently exploded across the global corporate landscape.1 Xerox, Delta Airlines, AMP Insurance (Australia), British Aerospace, and the Inland Revenue Service are the latest of these mega-alliances. Several years ago, Shell Oil out-sourced its Brazilian IT activities. Like marriage, however, these arrangements are much easier to enter than to sustain or dissolve. The special economic technology issues surrounding outsourcing agreements necessarily make them more complex and fluid than an ordinary contract. Both parties need to make special efforts for outsourcing to be successful. In addition to clear successes, we have identified troublesome relationships and several that had to be terminated.
Our purpose in this article is to provide a concrete framework to help senior managers think about IT out-sourcing and focus on how to manage the alliance to ensure its success.
Why Outsourcing Alliances Are Difficult
Outsourcing contracts are structured for very long periods of time in a world of fast-moving technical and business change. Ten years is the normal length of a contract in an environment in which computer chip performance is shifting by 20 percent to 30 percent per year. (This standard contract length has emerged to deal with switching cost issues and to make the economics work for the outsourcer.) Consequently, a rigid deal that made sense at the beginning may make less economic sense three years later and require adjustments to function effectively.
Exacerbating the situation is the timing of benefits. For the customer, the first-year benefits are clear; usually the customer receives a one-time capital payment. Next, the customer feels relieved to shift its problems and issues to another organization. Finally, the tangible payments in the first year occur in an environment in which the outputs most closely resemble those anticipated in the contract. In each subsequent year, the contract payment stream becomes less and less tied to the initial set of planned outputs (as the world changes) and, thus, more subject to negotiation and misunderstanding.
The situation from the outsourcer’s perspective is just the reverse. During the first year, there is a heavy capital payment followed by the extraordinary costs for switching responsibility and executing the appropriate cost-reduction initiatives. All this is done in anticipation of a back-loaded profit flow.