Labeled the winner’s curse, the conclusion is the main finding of new research carried out by Leslie Willcocks, professor of technology, work, and globalization at the London School of Economics, and sponsored by LogicaCMG. According to Willcocks, not only do winner’s curse contracts force suppliers to accept minimal returns from outsourcing deals, they also fail to meet the needs of clients in the long term.
Willcocks said that many clients make the mistake of choosing the supplier offering the lowest price, rather than the firm best equipped to do the job. He said that suppliers often deliberately lower their prices in order to secure high-profile business, or undercut other business in the hope that, once the contract has been won, it can make a profit by selling additional services to the client.
The deal between UK-based IT services provider ITNet, now owned by Serco Group, and global fuel company Esso was used by Willcocks to illustrate his point. ITNet was desperate to get Esso as a client, he said, so they signed an unreasonable contract and, as a result, made no profit on the deal.
The problem is further fuelled by discrepancies between the goals of a vendor’s sales team and those of the delivery department charged with fulfilling the contract. The sales people are simply interested in winning deals and can often leave technicians to work within an unrealistic framework, resulting in the client experiencing service issues.
So how can both clients and vendors avoid the winner’s curse? First, Willcocks said that clients should not automatically go for the least expensive option. Rather, they should set price against quality of service in order to achieve the best value for money. Not only that, but customers should make sure that suppliers are making a reasonable profit. He said failure to do this will impact the supplier’s performance and the client”s experience of the outsourcing deal.
Yet what actually constitutes a reasonable profit is difficult to quantify. Naturally, both client and vendor will have their own views on what is ‘reasonable,’ and the margins available can also differ depending on the services being provided.
John Blain, managing director of outsourcing at LogicaCMG’s Portuguese subsidiary Edinfor, told Global Computing Services: If a supplier is getting between 7% and 12%, that”s about average, although obviously that depends on the service lines. In general, suppliers aim for 10%. If they get above 5% net over the life of the contract, doing IT outsourcing, then they’re doing well.
As well as the winner’s curse, Willcocks research identified other errors which often scupper deals before they even start. Clients very often select a supplier by looking at a checklist of resources, said Willcocks. This is a mistake; they should instead look at how these resources are translated into capabilities. Only then will the client know if the supplier has the ability to provide the contracted services.
Willcocks identified 12 key supplier capabilities that clients should be on the look out for, including leadership, domain expertise, sourcing, program management, customer development, planning and contracting and governance. In turn, these 12 capabilities form part of three core competencies, covering delivery, transformation and relationships.
This research into the potential pitfalls of outsourcing comes just a week after Jean-Marc Lazzari, head of Unisys’ operations in continental Europe, told us that he knew of up to 10 deals worth between 700m euros ($890m) and 1.5bn euros ($1.9bn) that were already back on the market despite having been signed less than two years ago. These deals were based on the ‘your mess for less’ principle, said Lazzari, and they are in danger as the supplier often did not get the volume of work expected from the client, and the client didn’t get the expected cost savings.
Willcocks’ recommendations to clients on the best way to pick an outsourcing partner are not revolutionary, but reflect the slow pace at which it market is maturing. Learning is painfully slow in outsourcing, Willcocks told us. It often takes until the third generation of an outsourcing deal before the lessons are learned.
According to Willcocks, there is a sourcing learning curve which can be split into four distinct stages. Phase one is fear and hype and is characterized by scare stories surrounding the loss of jobs and other perceived perils of outsourcing. Willcocks said that, currently, the fear and hype is mainly centered on BPO and offshoring. The second phase involves the early adopters of outsourcing making mistakes, through with best and worst practices emerge. In phases three and four, the curve is less steep, as the markets mature. Willcocks believes that this is the stage the IT outsourcing market is currently at.
