Software Development Outsourcing
Research Paper
Long term
contracts or short term contracts, which are more successful in offshore IT
outsourcing?
-
T.A. Pai Management
Institute, Manipal.
With the Information Technology Outsourcing industry looming large over most economies in the Asian continent, the success or failure of various IT outsourcing projects depend upon a few crucial decisions which can make or break the deal. One of the most such crucial decisions is that of whether to outsource the information technology of the firm for a long term or a short term.
The
nature of the duration of the contract in term will influence other components
of the contract like pricing, platform dependency, relationship building, IP
transfer, technology sharing, human resource sharing etc. So one of the first
decisions which are taken when deciding on an IT outsourcing contract is
whether the contract will be a long term or a short term one, and based on this
decision the other components of the contract are decided upon and negotiated
upon. It is interesting to note that at times a medium size long term IT
outsourcing contract is deemed to be more valuable to the vendor than a short
term big size multi million dollar contract. On the other hand, the reason for
the failure of a lot of IT outsourcing projects have been said to be the long
term nature of the contract. To understand the mystery behind the dilemma of
the decision between long term and short term, let us explore what has been
cited in literature available on the topic, considering both the sides of the
coin.
Long term
contracts have taken place since the inception of IT outsourcing, and the
latest £100m 9 year outsourcing contract of Welsh Water in September 2006 (Web
reference 1.1 “Utility signs £100m
outsourcing contract”) proves that long term outsourcing deals are
happening and are here to stay. The Welsh Water 
too
was not an exceptional contract; lots of long term contracts are still being
executed by prestigious firms all around the
world. Some examples are the £486m 12-year outsourcing 
firm
signs £486m outsourcing deal”) which happened as recently as April
2006. In a more recent example of long term contracts, BAE Systems renewed its
IT outsourcing agreement with CSC in a deal worth $1.9bn (£1bn) over the next
five years Services (Web reference 1.3 “BAE renews IT outsourcing contract ”).
What is the reason
behind such big organizations outsourcing their IT for such long 
terms?
The answer is best described by National Outsourcing Association chairman
Martyn Hart who says that big organizations go to big contracts because they
can do the whole thing for the company – it is the simplest solution and the
client only has one entity to go to if things go awry. Hence the major reason
does seem to be that long term contracts seem to bring simplicity for the
client and makes the ownership issues for the project more clearly defined and
less cumbersome. (Web reference 1.4 “Long-term
outsourcing deals maintain lead”).
However the other reason as quoted by Hart is that when the deal is split into smaller sub parts for shorter durations of time, they may have to be re-negotiated multiple number of times with multiple companies and the cost overhead for doing this can sometimes outweigh the savings and this is one other reason why a lot of big firms are going in for big long term IT outsourcing deals.
The other views in favor of long term contracts come from Welsh Water’s head of IT Fraser Nairn, who says that a 9 year contract like the one which his company has undertaken are usually part of the company’s overall management strategy, which says that the company outsource between 80 and 90 per cent of all their business activities such that their business model relies on a number of partners doing what would normally be done in-house. This perhaps makes it very simple for the company to handle and keep tabs on all their IT activities, considering that at present it is planned that IT Alliance will supply technology services to the rest of the contractors who manage Welsh Water’s physical assets, and having one vendor do this is obviously much less complicated than multiple vendors do the same thing. (Web reference 1.4 “Long-term outsourcing deals maintain lead”).
However a lot
depends on the definition of what we term as long term and what we term as
short term. If we say that long term is anything above 5 years then a 
startling
statistics from a Forrester Research September 2006 report which would perhaps
silence all pro short-term contract advocates is that in the UK, the average
contract length was 5.5 years, and most deals had a value of between €20 and
€100 million. (Web reference 1.5 “
It is also
interesting to know that the term of contract might depend on the type of
contract being executed apart from the geographic location. In this regard it
is interesting to note that even in the public sector there are a number of
incidents of long term contracts being
signed. In April 2006, Capita signed an initial ICT contract worth £475
million, (originally valued at £424 million) to the joint venture over a 10
year partnership. (Web reference 1.6 “Capita signs
contract with 
Agilysis in March. (Web reference 1.7 “
Till now we have
only been talking in favor of the long-term contracts. In the process we have
shown numerous recent examples where long term contracts have been signed.
However there is a recent emerging school of thought which strongly believes
that IT outsourcing contracts should strictly be short term, and attributes
most of the failures of IT outsourcing contracts to its long term nature. There
are strong arguments that challenge the traditional outsourcing logic that a
long term agreement is imperative to justify the high initial investment being
made. However the argument against this is that as “both business and
technology change so rapidly, it does not make sense to have an agreement
longer than one or two years”. (Web reference 1.8 “Don't Get Entangled in a
Long-Term Contract”). 
Other reasons which have been quoted by anti long term believers is that because the contract is long term, the vendors will start having a complacent attitude because they feel secure in the long term nature of the deal and know that whatever the case, the deal is still going to remain with them. This results in a situation where the vendor does not take proactive steps to better the quality of service and does not have the motivation of a renewal of a contract as is the case with a short term contract.
The article “Don't Get Entangled in a Long-Term Contract” (Web reference 1.8) quotes the example of Blue Cross Blue Shield of Massachusetts. The following excerpt from the website of web reference 1.8 clearly shows the consequences of being caught up in an unproductive long term contract:
“Blue Cross Blue Shield of 
Cross had 150.
When Mark Caron came on board as CIO, he
discovered that his new "The contract is the most important part of the
outsourcing relationship. If it's not in the contract, you'll find it hard to
do."-Alison Smith, former VP of infrastructure, Myspace
employer was actually losing money on the outsourcing deal—all because it just
re-upped the same contract every five or 10 years without reviewing what had
changed through the years. The result? "IT was our largest budget area in
the company," says Caron, who has since left Blue Cross. In fact, because
the outsourcing agreement failed to tie PC maintenance pricing to current
market rates, the insurer's IT costs were two-and-a-half times what the rest of
the industry was paying—and there was no end to the cost increases in sight.
Hog-tied by the contract, the insurer had to charge higher rates for its
policies just to keep afloat.
After a protracted battle with the
outsourcer, as well as with internal management, Caron managed to restructure
the contract. There would be no more automatic renewals of 10-year contracts,
and he made sure to build in items, such as benchmarking provisions and credits
for unused bandwidth, that tied the outsourcer's fortunes more closely to those
of the insurer. Many of the ills that befell Blue Cross could have been avoided
if its contract period had been shorter.”
Most advocates of the short term contract say that short term contracts are absolutely necessary when dealing with technologies that are changing fast. This makes sure that after the client signs the contract, if situations arise where the vendors technology becomes outdated, the prices of similar services become much cheaper, or the clients requirements change, then the client is not in a false situation where he is bound by a long term contract and hence unable to bag a better deal elsewhere.
Dr Leslie P. Willcocks, in his article, “When it comes to that all-important IT outsourcing decision, make sure it’s a matter of fact, not fiction” (Web reference 1.9) states that one of the greatest myths of the outsourcing industry is that long-term, single-supplier deals secure partnering relationships, lower transaction costs and greater business advantage. He gives us the statistics from a recent study which looked at 29 such deals and found 38 per cent met expectations, 35 per cent were unsuccessful and 27 per cent had mixed results. It was very clear that initially in 1990s long term deals would not go through properly because of financial reasons like restructuring the balance sheets of organizations. Dr. Willcocks says that even the better set-up, long-term, single-supplier deals rarely report innovation, significant risk-sharing and real business advantage flowing from their IT deal. This view perhaps echo the general opinion about the vendor becoming more laid back and less proactive when he has the assurance of a long term contract, and this reason has been stated in this paper above as one of the strongest points against long term IT outsourcing contracts. In the opinion of Dr. Willcocks, long term contracts for IT outsourcing should only be undertaken by organizations that have become extremely mature in the process of outsourcing. The basic point to note here is that organizations should initially try implementing short term 2-3 year contracts, and only after they have become adept at handling outsourcing contract and outsourced processes should they venture out to sort out the risks for a long term contract and implement the same.
Mark Vernon in his article “Avoid outsourcing risks by building flexibility into contracts” (Web reference 1.10) says that “three to five years into the outsourcing of large, complex, multimillion dollar, functions the strain is beginning to show for some of those companies who didn't negotiate flexible deals or skimped on the due diligence of finding the right partner.” Linda Cohen, Gartner V.P. and Chief of Research in IT Outsourcing defines the outsourcing industry as a market which is in turmoil. She estimates that till 2008 a minimum of 70 percent of outsourcing contacts will be affected by some kind of a disease, which she interestingly has termed as "offshoritis", "deal paralysis," and "management deficit disorder." She also estimates that less than 50 percent of these problems stemming from the disease will be fixed to the satisfaction of the stake holders. Another point highlighted in the article is the failure of long term contracts also depends at the time when the contract was initiated. The reason why long term contracts are today becoming a cause of major concern is because these contracts were signed during 2002 when the vendors had stronger bargaining power than the clients and hence firms went into contracts which are today not profitable considering a market where there is intense competition amongst outsourcing vendors and hence better priced options at better quality. Hence contracts which might have seemed a lucrative deal in 2002 might have been completely unattractive in 2003, and would have become a complete liability in 2006, when the market is extremely agile and so many options are available.
Mark Vernon also clearly states in his article “If a firm wants to make changes over the length of a five- to ten-year contract, which is very likely, the original outsourcing deal may not be flexible enough to accommodate them. For example, consider the way market attitudes are changing in relation to call centers—in particular, the way that off-shore call centers are increasingly beleaguered by complaints. (NatWest recently went so far as to run an advertising campaigning appealing to customers to switch accounts for the very reason that it uses only locally-based call centers.) A bank stuck with an intransigent call center deal, or one in which it is unaware what part of the service is off-shored, may well be unable to respond to these changes in good time, and so lose competitive advantage, if not market share, as a result.”
The only
solution in such a stage, as stated by
A case that can be cited to understand the above concept of “flexibility” in the contracts is the $17 million 5 years deal between Lloyd's of London and Unisys. It is interesting to note the flexibility in the deal which has replaced the traditional nature of long term deals. "Lloyd's chose to partner with Unisys because of the professionalism and knowledge displayed during the tender process," says Chris Rawson, CIO at Lloyd's. "[But] Unisys also presented an imaginative proposition designed to continually improve the quality of services delivered in line with our organizational change and business objectives." (Web reference 1.11 “Unisys wins five-year, $17m Lloyd's IT transformation contract”).
Hence we see after exploring both sides of the coin of long term and short term contracts, that the success or the failure does not simply depend on the short or long term nature of the contract, but also on a lot of other factors, like the nature in which the contract has been crafted, the flexibility of the contract and the renegotiation clause. Long term contracts as well as short term contracts have both advantages and disadvantages, however most reports indicate that the recent international trend has been towards short term contracts which are flexible.
Web References:
1.1 Utility signs £100m outsourcing contract (http://www.computing.co.uk/computing/news/2165170/utility-signs-100m-outsourcing)
1.2 Insurance firm signs £486m outsourcing deal (http://www.computing.co.uk/computing/news/2154706/insurance-firm-signs-486m)
1.3 BAE renews IT outsourcing contract (http://www.computing.co.uk/computing/news/2155772/bae-renews-outsourcing-contract)
1.4 Long-term outsourcing deals maintain lead (http://www.managementconsultancy.co.uk/computing/analysis/2165673/long-term-outsourcing-deals)
1.5 UK IT Outsourcing Deals Overview: 2004 To 2006 (http://www.forrester.com/Research/Document/Excerpt/0,7211,39837,00.html)
1.6 Capita signs contract with Birmingham City Council to create ‘Service Birmingham’ partnership (http://www.capita-lgs.co.uk/MediaCentre/Service+Birmingham.htm)
1.7
1.8 Don't Get Entangled in a Long-Term Contract (http://offshoreitoutsourcing.com/documents/outsourcing_contracts.asp)
1.9 When it comes to that all-important IT outsourcing decision, make sure it’s a matter of fact, not fiction (http://www.outsourcing.com/content.asp?page=01b/other/oe/q405/mythunderst.html&nonav=false)
1.10 Avoid outsourcing risks by building flexibility into contracts (http://articles.techrepublic.com.com/5100-10878_11-5708950.html)
1.11 Unisys wins five-year, $17m Lloyd's IT transformation contract (http://www.unisys.co.za/about__unisys/news_a_events/04080301.htm)
Image References:
2.1 http://www.trowbridgegroup.net/it_outsourcing.htm
2.2 http://www.pearl.co.uk/pearl/pearl.nsf/Content/home
2.3 http://www.sfe.org.uk/sectors/organisation/Tata_Consultancy_Services
2.5 http://www.forrester.com/my/1,,1-0,FF.html
2.6 http://www.agilysys.com/agilysys
2.7 http://www.ericksonwebdesigns.com/benefits.htm
2.8 http://www.capecodbaseball.org/sponsors.htm