IT outsourcing – walking a financial and relational tightrope

Regardless of the type of service being purchased, outsourcing by definition represents a certain loss of control by the client, as opposed to doing everything in-house. Contractual agreements exist for very obvious reasons, including costing of the project in question and delivery times. IT, however, is a notoriously difficult service to estimate from the client’s side as so many potential reasons for late delivery exist and are often justifiably the case for purely technical reasons. One need only look at the high-profile case of JP Morgan, who ended a 7-year, $5 billion dollar agreement with IBM after just 2 years to appreciate the potential pitfalls.

Looking on the more positive side, outsourcing IT can also raise the overall quality of service and tools offered by a firm and enable the firm to make better, more cost-effective use of its internal resources. However, it’s when the cost of an outsourced IT project starts to escalate that the firm can find itself in not only a financial but also diplomatic nightmare.

You can’t always get what you want, but….

By cost escalation, we are talking about the estimated cost versus the final, actual cost of a project. Whilst firms cannot be reasonably expected to assess the value of an external supplier’s services down to the last cent of a euro, what they can do is to better protect themselves in the event of late delivery and extra costs being generated. To do this, they must ensure that they are equipped with tools to measure cost and performance in the first place, before signing a contractual agreement. Accusing a subcontractor of over-charging or delivering late is one thing, but if you have no barometer by which to gauge this then on what grounds are you questioning the service being provided?

Getting the fine print right

Disputes over cost and delivery at the action end of the project can potentially lead to what is known as a “hold-up”, a form of lock-in situation where the client is hostage to the terms of the initially agreed contract, thereby increasing the bargaining power of the supplier. It is for this reason that getting the terms, conditions and fine print of the original agreement is key. The client can potentially look elsewhere to get the job done but re-deploying assets can also be an expensive business, plus the client may already have become so dependent upon the sub-contractor’s knowledge and expertise and the project so far advanced that this may not make sense from either a financial or project management perspective.

Devising a contract and a project set-up that protect both parties is a time-consuming business. Firms need to set in place measuring tools in order to judge performance whist the supplier will need to dedicate time to reporting during the project in order to justify the time and money being spent. Loose agreements are always open to abuse. However, two “smoother” approaches to outsourcing agreements are worth considering.

Keep suppliers on their toes and build up trust

Although potentially difficult to manage internally, “multi-sourcing” is a viable option, where the client outsources to a number of suppliers for the same overall project, making sure each one involved is aware of the fact. Knowing that a potential competitor is working on part of the same project is likely to apply some gentle pressure on suppliers, increasing the chances of on-time delivery and fair costing. Even better still is a phenomenon known as a “clan mechanism”, where clients call upon suppliers with whom they have already worked, had positive experiences with and want to establish a long-term partnership with. The chances of disputes are reduced even further still. These two approaches should logically make clients less complacent and presumptuous about the abilities of their suppliers and also keep the suppliers on their toes, resulting in a far healthier climate for the project as a whole.

The (re)search goes on

If firms are starting out in the IT outsourcing process, then the above model is more difficult to apply and they will have to begin their search for sub-contractors from scratch. However, what they absolutely must try to do is equip themselves with the measurement tools in the first place in order to cover their back in the event of disputes further down the line. A smoother governance of sub-contracts is desirable for all parties involved but this should not mean a lack of formality and clarity in the initial agreement.

This is a rich area of study for academics and practitioners alike. The capabilities of both client and supplier need to be taken into account, as well as the management and governance of relations between them, and not just the nitty-gritty of the job in hand. One thing is clear, though – disputes need to be avoided by all means necessary. Not only is the client in danger of paying over the odds for a project due to the woolly nature of the original agreement, but time is money for both the client and the supplier, so disputes are costly in all senses of the word. Creating a clearer but also healthier contract-based working relationship has to be the way forward for all parties.

This article was inspired by the paper Cost escalation in information technology outsourcing: A moderated mediation study, written by Bouchaib Bahli and Suzanne Rivard and published in Decision Support Systems – 2013 (volume 56).

Bouchaib Bahli is Professor of Information Technology (IT) at ESC Rennes School of Business, France. His research areas are: IT outsourcing, risk management of software development projects and, IT adoption modelling. His publications appeared in Information and Management, Journal of Information Technology, OMEGA, Communications of AIS, and Requirement Engineering Journal.

Suzanne Rivard is a Professor of Information Technology (IT) at HEC Montreal. Her research focuses on outsourcing, strategic alignment of IT and software project risk management. Her work has been published in such journals as Journal of Information Technology, Journal of Management Information Systems, MIS Quarterly, and Organization Science.