CIOs warned against long outsourcing contracts

Gartner has advised CIOs against signing outsourcing deals with base terms of longer than five years.

Mike Lafford, group vice president at Gartner told an audience of CIOs in Sydney that today's best practice is a base term three to five year deal, with extension clauses of one to two years.

"Please, please, please, don't sign ten year deals," Lafford urged attendees. "I can't believe I still see people doing this."

Many large Australian private sector organisations and Federal Government agencies have - particularly in the late 1990s - signed outsourcing deals for periods of up to ten years - including the Australian Tax Office, the South Australian Government, the Commonwealth Bank, Qantas and Westpac.

Many are again considering ten year deals as the current ones expire.

"[Outsourcing] vendors will offer these deals, looking for continuity of revenue," Lafford said. "They will give you very exciting advantages around price and terms and conditions.

"But without the right performance management constructs in place... the arguments for shorter deals are far more compelling," he said.

"Please, please, please, don't sign ten year deals."
- Mike Lafford, Gartner

Lafford said most organisations were attracted to offers of reduced prices in return for signing ten year deals.

Indeed, in the Federal Government's latest procurement guidelines, released yesterday, agencies were told that the public interest was best served "when government agencies achieve value for money for their purchasing activities."

Lafford said another major driver of long-term deals was the perceived "cost of transition" and long periods of evaluation that comes with negotiating an outsourcing agreement.

"The contract process in Government is notoriously protracted and complicated," Lafford said.

"When I was meeting with CIOs in Canberra last week, they were telling me that they weren't going to go through all of that for a two or three year contract. My argument to them is that the real problem is the contracting process."

Problems with long deals

Lafford outlined a few of the major problems with long term outsourcing agreements.

One is the pace of technology change.

"Does anybody in this room have a ten year deal on their mobile phone?" Lafford asked, to illustrate.

Second, business requirements change.

The recent economic downturn, for example, may have reduced the baseline of IT services required for many customers. But under inflexible long-term outsourcing agreements, they may still be paying, for example, for an outsourcer to support desktops that are no longer in use due to downsizing of staff.

Similarly, Gartner analyst Jim Longwood said many Australian resources companies signed up for a level of services that didn't anticipate the mining boom that followed, and found themselves paying too much for the additional services required during the term of the contract.

What happens when your outsourcing partner runs into financial hardship or goes bust? Read on to page 2 for more.

SOS

Lafford said organisations also need to consider a "plan for transition and termination" of an outsourcing agreement, which could have the potential to occur at short notice.

"What if the vendor goes bust? What if there is an acquisition?"

Organisations have usually assumed that if the vendor was healthy the day they signed, and if the deal was profitable for both parties, there need not be concern about the vendor failing.

"Those assumptions have been blown away in this landscape," Lafford said.

"All of a sudden at the end of last year, things start happening. We didn't see Satyam coming. We didn't see BearingPoint or Nortel coming. And yes, the Americans in the room will say it's Chapter 11. In Australia we say you're bankrupt, that the business failed."

The problem in many organisations, Lafford said, was that once the deal was signed, nobody was assigned the job of 'managing' the deal over the life of the contract.

Lafford recommended ongoing due diligence and not to assume the contract "will manage itself."

He also recommended using multiple sources when checking on the health of outsourcing suppliers.

"The lessons [from Satyam] would be, don't just rely on the annual reports," he said. "Look at whether or not they are winning new deals and announcing them in the press, look at service disruptions and look at new investments.

"I would start getting worried if you can't get time with their executives any more or if their best people are being pulled away from customer facing roles to win new deals or fix things in the back end."

Caveats

Lafford said organisations "can get away" with longer deals, as long as they include benchmarking and flexibility clauses in the contract.

"That way, if there are huge sparks or drop-offs in the workload, you aren't penalised in the contract," he said.

But he maintained a shorter deal has better outcomes.

"I have spoken to legal teams that specialise in outsourcing agreements, and they confirm that all the deals done in the last few months were for three to five year terms with extensions," he said.

"For the last three years, I've never spoken to any organisation that was satisfied with a ten year deal they'd signed."