IT Sourcing Reflections: Lessons for Customers and Suppliers

1 Introduction

The size of the global information technol-ogy (IT) outsourcing market is estimatedto be between $200 and $500 billion.Clearly, customers no longer question ifthey should outsource IT, but rather ques-tion how they can best exploit this im-mense market. Customers now expectmany business advantages from IT out-sourcing, including lower costs, better ser-vice, infusion of new technology, transfor-mation of fixed IT budgets to variable ITbudgets, improved business processes, andeven increased revenues [LaWi01]. Inshort, customers expect IT outsourcing totransform IT functions into lean, dynamicgroups that respond quickly to businessneeds and opportunties. But how do custo-mers actually achieve such business advan-tage? Based on over a decade of research,we found that customers must becomeadept at managing four continual processesto successfully exploit IToutsourcing:

& Assess the in-house IT portfolio to de-termine which activities are best out-sourced

& Evaluate market options for the bestsourcing models and best suppliers toachieve customer objectives

& Craft contracts to align customer andsupplier expectations and incentives

& Continually manage supplier relation-ships

Although many people view these activitiesas sequential, we found that these are con-tinual and concurrent processes. Evenwithin the same customer-supplier rela-tionship, customers frequently revisit the

scope of the deal and re-craft contracts sev-eral times. This iterative learning process isreflected in Figure 1.

In this paper, we extracted 14 customer les-sons most frequently associated with suc-cess for these fours processes. We identifiedtwo additional lessons to help customersstay abreast of evolving IT sourcing prac-tices. Furthermore, we identified four les-sons aimed at suppliers to help them edu-cate, inform, and attract good customers1.Our overall message is that customers cansuccessfully exploit the IT outsourcingmarket, but that it requires a tremendousamount of in-house management. Some ofour research participants expressed thissentiment as follows:

“[Outsourcing] requires a massive hands-on effort every day. You must manage sup-pliers daily or outsourcing will either fail,or the customer will incur higher costs.” –Global Alliance Manager for DuPont’s $4billion IT contracts

“I think mega-deals can work, but theytake a lot of hard work.” – BAE SYS-TEMS IT outsourcing report on a £900million contract

“How do we manage the relationship atthe operational level? . . . We’ve got a rela-tionship where there’s interfaces takingplace between our business and the supplieraccount managers, every hour, every day.And any one of those can be taking awrong turn.” – Inland Revenue AccountManager for a £1 billion contract

WIRTSCHAFTSINFORMATIK 45 (2003) 2, S. 115–125

The authors

Mary LacityLeslie Willcocks

Dr. Mary Lacity,College of Business,University of Missouri-St. Louis,8001 Natural Bridge Road,St. Louis, MO 63121-4499, USAE-Mail: [email protected];Dr. Leslie Willcocks,Warwick Business School,University of Warwick,Coventry CV4 7AL, United Kingdom,E-Mail: [email protected]

ITsourcing reflectionsLessons for customers and suppliers

WI – Schwerpunktaufsatz

2 Research method

We and our coauthors (David Feeny ofOxford University, Thomas Kern of Eras-mus University, and Rudy Hirschheim ofthe University of Houston) have studiedIT sourcing practices in 543 organizationsworld-wide (See Table 1). We have donein-depth case studies based on interviewswith over 300 senior executives, IT man-agers, supplier account managers, businessusers, and outsourcing advisors in the Uni-ted States, United Kingdom, Australia,Europe, and Japan. We have surveyed over400 CIOs in the United States, UnitedKingdom, and Europe.

One key feature of our case studies andsamples is that we measured actual out-comes compared to expected outcomes.For the surveys, this included perceptualassessments of expected and actual out-comes for costs, service levels, access toscarce IT skills, infusion of new IT, IT flex-

ibility, financial restructuring, control of ITresources, and ability to refocus in-housestaff [LaWi00; KLWZ01]. For the case stu-dies, we used the triangulation of stake-holders’ perceptions as well as secondarydocumentation to compare expected andactual outcomes [LaWi01]. We then createdan indicator of success with four possibleoutcomes:

& YES, customers achieved most of theirexpectations

& NO, customers did not achieve most oftheir expectations

& MIXED results – customers achievedsome major expectations but other ma-jor expectations were not achieved

& TOO EARLY TO TELL whether ex-pectations were achieved

By correlating these outcomes againstsourcing practices, we were able to assessthe practices which were most frequentlyassociated with success2.

3 Assessing the IT portfolio

Lesson 1: Treat IT as a portfolio. Soundsourcing strategies begin with the assump-tion that IT should be treated as a portfolioof activities and capabilities. Some of theseactivities must be insourced to ensure cur-rent and future business advantage andflexibility, while others may be safely out-sourced. This portfolio perspective is em-pirically supported by our case study find-ings that selective outsourcing decisionshad a higher relative frequency of successthan total outsourcing decisions (See Ta-ble 2).

We defined the scope of sourcing optionsas:

Total Outsourcing: the decision to transferthe equivalent of more than 80% of the IToperating budget for IT assets, leases, staff,and management responsibility to an exter-nal IT provider.

Total Insourcing: the decision to retain themanagement and provision of more than80% of the IT operating budget internallyafter evaluating the IT services market.

Selective Outsourcing: the decision tosource selected IT functions from externalprovider(s) while still providing between20% and 80% of the IT operating budgetinternally. This strategy may include singleor multiple suppliers.

Selective outsourcing decisions have beengenerally successful during the past tenyears, with a 77% success rate. This isgood news given that selective outsourcingis also the most common sourcing practiceaccording to sample surveys [ASHS97;GrCT96]. With selective outsourcing, or-ganizations select the most capable and ef-ficient source – a practice some partici-pants referred to as “best-of-breed”sourcing. The most commonly outsourcedfunctions were mainframe data centers,software development and support ser-vices, telecommunications/networks, andsupport of existing systems. In most cases,suppliers were judged to have an ability todeliver these IT products and services lessexpensively than internal IT managers. Theability to focus in-house resources to high-er-value work also justified selective out-sourcing.

In general, total outsourcing decisionsachieved their expectations less frequentlythan selective outsourcing decisions or to-tal insourcing decisions. With total out-sourcing, only 11 of 29 companies achievedexpectations. An example of a total out-sourcing success was the South AustralianGovernment’s economic developmentpackage with EDS. The supplier (EDS) hasexceeded yearly targets for delivering $200million in economic development duringthe nine-year contract. Note, however, thatother aspects of the deal were less success-ful (See Chapter 3 in [LaWi01] for a fullcase on the South Australian Governmentand [CrES97] for an example of successfuloutsourcing at British Petroleum).

Ten of the 29 total outsourcing cases(35%) with discernible outcomes, expecta-tions were not realized. Participants en-


Figure 1 Learning and feedback ineffective IT sourcing processes

Table 1 Major IT sourcing research projects

Research Method Sample Size Data CollectionDates

Exchange-based, traditional IT outsourcingand insourcing case studies [LaHi95;LaWi01]

111 in US,Europe, Australia

1989 to 2001

Exchange-based, traditional IT outsourcingand insourcing survey [LaWi00]

141 in US, UK,Scandinavia

1998

Joint venture case studies [FeWL02abcd] 7 in US, Australia & Europe 1994 to 2002

Netsourcing case studies [KeLW02] 10 in US and Europe 2001 to 2002

Netsourcing survey [KLWZ01] 274 in 28 countries 2001

116 Mary Lacity, Leslie Willcocks

countered one or more of the followingproblems:

& excess fees for services beyond the con-tract due to increase in user demand,

& excess fees for services participants as-sumed were in the contract,

& “hidden costs” such as software licensetransfer fees,

& fixed-prices that exceeded market pricestwo to three years into the contract,

& inability to adapt the contract to evenminor changes in business or technologywithout triggering additional costs,

& lack of innovation from the supplier,and

& deteriorating service in the face of pat-chy supplier staffing of the contract.

For total outsourcing, about 27% of totaloutsourcing decisions achieved such mixedresults. The biggest difficulty was notachieving expected cost savings. Other ex-pectations were more readily achieved suchas Year 2000 compliance, switch to theEuro, and accessing enterprise resourceplanning expertise from suppliers’ globalworkforce.

Exclusive sourcing by an internal IT de-partment has remained generally successful(76%). We found, however, that such suc-cess stems from a potential threat of out-sourcing (Lesson 9 explores this further).

Given that IT should be treated as a portfo-lio, the next question is how to assesswhich parts of the portfolio should be out-sourced or insourced? While common wis-dom tells customers to insource core cap-abilities and to outsource non-corecapabilities [SaGH97], the distinction isnot very useful. More thorough assessmenttools are needed to identify exactly what iscore and non-core. The following two les-sons therefore explore the theoretical andpractitioner tools to make core/non-coreassessments.

Lesson 2: Identify core capabilities for in-sourcing. There is a rich theoretical foun-dation for make-or-buy decisions that havebeen applied to IT outsourcing, includingresource dependency theory, agency theo-ry, auction theory, game theory, institu-tional theory, and, by far the two dominanttheories: transaction cost economics (TCE)and the resource-based view (RBV).

In many ways, TCE is the ideal theoreticalfoundation because it specifically addressesmake-or-buy decisions based on generic at-tributes of assets and describes appropriateways to govern customer-supplier relation-ships. Transaction cost economics positsthat transactions with high asset specificity(the degree to which assets can be rede-ployed elsewhere without losing value),high uncertainty, and/or occur frequentlyare managed less expensively in-house,while the rest should be more efficientlyoutsourced [Will91a; Will91b]. Specifically,the theory posits that when asset specificityis high, the activities are so idiosyncraticand customized, that insourcing is less

costly than outsourcing. When uncertaintyis high, contracts cannot be clearly definedfor effective outsourcing, thus increasingthe threat of supplier opportunism. Anumber of IToutsourcing empirical studieshave found that asset specificity has been asignificant factor [AnSt98; LaWi96;NRRC96; PoZe98], although uncertaintyhas not been a significant factor. The TCEview guides customers to focus on themost cost efficient sourcing option.

The resource-based view (RBV) has beenthe second most widely-applied theory toIT outsourcing context [DiBR02; StWS02;TeCG95]. RBV suggests that managerskeep valuable, rare, non-imitable, and non-substitutable resources in-house becausethey contribute to a firm’s competitive po-sitioning and profitability [Barn91]. Otherresources may be outsourced. Valuable re-sources can be used to exploit strategic op-portunities or ward off threats, allow thecustomer to charge premium prices, attracttop human resource talent, and attract in-vestors. Resources are rare if few competi-tors have them. Non-imitable resources aredifficult or costly for competitors to imi-tate. Non-substitutable resources have noimmediate equivalents. RBV guides custo-mers to focus on the strategic potential ofresources when making sourcing decisions.

TCE and RBV are both valuable perspec-tives because they guide managers to treatthe entire IT function as a portfolio oftransactions/capabilities – some whichmust be insourced, some which may beoutsourced.


Management summary

The authors have studied the sourcing practices in 543 organizations world-wide. In thispaper, they present the major lessons customers have learned to successfully exploit the glo-bal IT outsourcing market.These lessons focus on four processes:

& Assessing the in-house IT portfolio& Evaluating market options for the best sourcing models and best suppliers& Crafting contracts to align customer and supplier expectations and incentives, and& Managing supplier relationships.

Major supplier lessons call for superior supplier integrity in selling, negotiating, and deli-vering IT services.

Keywords: technology sourcing, outsourcing, supplier management, core IT capabilities

Table 2 Sourcing decision scope (n¼ 102 sourcing decisions with discernible outcomes)

Sourcing decision YES, mostexpectationsmet

NO, mostexpectationsnot met

MIXEDresults

Total

Total outsourcing 11 (38%) 10 (35%) 8 (27%) 29

Total insourcing 13 (76%) 4 (24%) 0 (0%) 17

Selective outsourcing 43 (77%) 11 (20%) 2 (4%) 56

TOTAL NUMBER OF DECISIONS 67 25 10 102

IT sourcing reflections: Lessons for customers and suppliers 117

The most direct assessment of IT as a port-folio was first articulated by Feeny andWillcocks [FeWi98]. They defined fourbroad core IT categories (CITC) whichcustomers must keep in-house, even if theyintend to outsource nearly all of IT:

& IT governance: IT strategy, mission, andcoordination.

& Business requirements: understandingbusiness needs as they relate to IT, andrelationship building among manage-ment, users, and IT .

& Technical ability: The architecture op-eration may be outsourced, but the cus-tomer maintains control over architec-ture design and keeps some in-housetechnical workers to help assess supplierclaims and performance.

& External supplier management: Custo-mers must make informed buying deci-sions, monitor and facilitate contacts,and seek added-value opportunitiesfrom suppliers.

To illustrate how these three different as-sessment perspectives might yield differentprescriptions, consider the example of anenterprise resource planning (ERP) imple-mentation in a global manufacturing com-pany. Based on the resource based view,the ERP project would not likely pass anyof the core capability tests as ERP systemsare widely used by competitors, thus out-sourcing would be prescribed. But transac-tion cost economics suggests insourcingthe ERP project if:

(a) The ERP system had to be highly cus-tomized to meet a specific business context(high asset specificity) or

(b) The customer’s unique requirementscould not be fully articulated in a soundcontract (high uncertainty).

The Feeny and Willcocks model wouldsuggest a mixed model. Their model wouldinsource parts of the ERP project asso-ciated with governing the project, articulat-ing business requirements, and managingthe political terrain among users. But theirmodel would suggest outsourcing certainaspects of the project, such as program-ming, testing, and systems integration toaccess market expertise.

Lesson 3: Best source non-core capabil-ities. Once core IT assets or capabilities areidentified, it does not automatically meanthat the remaining non-core capabilitiesshould be outsourced. We found that cus-

tomers who considered additional busi-ness, economic, and technical factors ofnon-core capabilities were most frequentlysatisfied with their sourcing decisions[LaWF96].

From a business perspective, some IT cap-abilities which are non-core today, couldbecome core in the future. Outsourcingthis non-core function now may impedestrategic exploitation in the future. For ex-ample, one of our case studies outsourcedtheir web site design and hosting in 1995,which initially served as a marketing tool.As the web became increasingly importantto their strategy, including online sales andcustomer service, the customer found theiroutsourcing relationship impeded the stra-tegic exploitation of the web. It subse-quently terminated the supplier at a signifi-cant switching cost and brought thefunction back in-house.

From an economic perspective, some non-core IT activities can be more efficiently in-sourced. For example, several of our casestudy participants were willing to out-source their large data centers but couldnot find suppliers who could do it cheaper.

From a technical perspective, some non-core IT capabilities are highly integratedwith other core activities. This makes out-sourcing extremely difficult. For example,one case study participant outsourced fac-tory automation but found the suppliercould not adapt to the rapid redirectionsfrom the sales department, let alone man-age the supply chain implications. The sys-tem was eventually brought back in-houseafter paying a significant early terminationfee.

Assuming non-core capabilities pass theseLitmus tests, the customer must still evalu-ate the market options to further validatean outsourcing model and to identify vi-able suppliers, as discussed in the next sec-tion.

4 Evaluatingmarket options

An important and ongoing IT sourcingprocess is to keep abreast of market op-tions, even if the organization is exclusivelyinsourcing at present. At a high level, man-agers should track current supplier capabil-ities and practices in four general IT out-

sourcing models: time and materials,exchange-based or traditional IT outsour-cing, netsourcing, and joint ventures (seeTable 3.) Keep in mind that these modelsare often blended, such as having a jointventure component to structure a sharedrisk and reward and a traditional IT out-sourcing component for operational deliv-ery. In general, these models are most sui-ted for particular types of IT activities, asexpressed in the following lessons.

Lesson 4: Consider time and materialscontracts when business or technical re-quirements are uncertain. In the time andmaterials model, supplier capabilities arebought-in to supplement in-house capabi-lies under in-house management. Typicalexamples include project work, such as hir-ing consultants to help in-house teams im-plement customer relationship manage-ment (CRM) systems. In these cases,customers are able to learn from suppliersduring project development, such as learn-ing to support the CRM system after im-plementation. Because requirements areuncertain, the customer cannot negotiate adetailed contract, and thus the variableprice based on time and materials is appro-priate.

The time and materials model is the mostcommon, and indeed poses the least risk tocustomers. Because the scope of such workis often short-term, many people do notconsider this true outsourcing. The mostcommon model that is considered trulyoutsourcing, is the exchange-based – ortraditional – IToutsourcing.

Lesson 5: Consider exchange-based con-tracts for stable, non-core activities re-quiring some customization. In theexchange-based, or traditional IT outsour-cing model, the customer pays a fee to thesupplier in exchange for a customized pro-duct or service. In this model, the customertypically transfers its IT assets, leases, li-censes, and personnel to the external sup-plier. The supplier manages the resourcesand provides back to the customer a set ofproducts and services governed by a one-to-one contract.

In our early studies of IT outsourcing, wefound that customers often had naive ex-pectations about this model. For example,many customers expected to save 25% onIT costs by signing ten-year, fixed-pricecontracts for a set of baseline services theyassumed would remain stable for the dura-



tion of the contract. Many customers sub-sequently re-negotiated, terminated, orswitched suppliers mid-stream. For exam-ple, our survey found that 32% of respon-dents had terminated at least one IT out-sourcing contract. Of those, 51% switchedsuppliers, 34% brought the function backin-house, and the remainder eventually re-instated their initial suppliers due to prohi-bitively high switching costs [LaWi00].

But the good news is that customers havelearned to effectively use the exchange-based model by better identifying whichactivities, suppliers, and contracts suit thismodel. Examples of successful outsourcingof stable, non-core activities requiringsome customization include:

& Data center operations,& Telecommunications management,& Network monitoring,& Application hosting, and& Application support.

Lesson 6: Consider netsourcing forhighly standardized, non-core activities.In the netsourcing model, the customerpays a fee to the supplier in exchange for astandard product or service delivered overthe Internet or other networks. Netsour-cing promises to deliver best-of-breed,scalable, and flexible business applicationsto customer desktops for a low monthlyfee based on number of users or number oftransactions at the customer site. Custo-mers can rent nearly all popular indepen-dent software vendor (ISV) products from

netsourcing providers, including ERPpackages from SAP, Oracle, Peoplesoft,Great Plains, and JD Edwards; CRMpackages from Siebel and Convergys; per-sonal productivity and communicationspackages from Microsoft, Netscape, andLotus; and all types of e-commerce and e-business software from CommerceOne,E.Piphany, Requistite Technology, andmany others. This model is suited for cus-tomers wanting lower costs at the expenseof accepting standardized solutions.

“Through our (netsourcing) relationship,we have been able to gain the maximumlevel of services from the hosting model andthus ensuring a high return on invest-ment.” – Operations Director, InsuranceCompany

The revenues generated in this space – de-pending on which research firm’s reportyou read – are still modest, between $1and $2 billion. Our preliminary researchon this space found that early adopters areprimarily small to mid-sized enterprises.Most worrying, these early adopters arenot following proven sourcing practices.For example, contracts in the netsourcingspace are flimsy and leave the customercompletely vulnerable. Thus there is an im-mense opportunity for netsourcing adop-ters to learn proven practices from moreexperienced outsourcing customers.

Lesson 7: Consider customer-supplierjoint ventures only if there is a proven

market for the partners’ complementarycapabilities. In the joint venture model,the supplier and customer create a newcompany. Deals are typically structured sothat the customer investor provides per-sonnel, becomes the venture’s first majorcustomer, and shares in future profits if theventure can attract external customers.

Customer-supplier joint ventures, althoughnot a very common model in IT, receivesignifant attention [McNo95; Kant94;KlJo97]. Most recently, joint ventures forbusiness process outsourcing (BPO) aremaking headlines. For example, the UK-based IT start-up company Xchanging hasa joint venture with British Aerospace Sys-tems (BAE SYSTEMS) called XchangingHR Services for BPO of human resourcemanagement [FeWL02c]. Becoming theventure’s first customer, BAE SYSTEMSsigned a 10 year contract worth £250 mil-lion and transferred 430 HR employees tothe venture. Ultimate success will depend,in part, on the venture’s ability to attractcustomers besides BAE SYSTEMS. In theUS, Exult ’s equity relationship’s with Brit-ish Petroleum and Bank of America havewarranted significant attention. These ma-jor investors have transferred over 1,000employees to Exult in exchange for signing10-year contracts in excess of $2 billion,guaranteed costs savings, and a share in Ex-ult’s profits. Thus far, Exult has won signif-icant contracts beyond British Petroleumand Bank of America, including a $700million contract with Prudential Financial


Table 3 Four outsourcing models

Model Resource ownership(infrastructure& people)

Resourcemanagement

Customer/supplierrelationship

Typical locationof supplier staff

Typical customer/supplier contract

IT activities most suitedfor this model

Time & materials Supplier Customer one-to-one Supplier staffon customer site

Time & materials Core or non-core capabilities;Customized products & services;Uncertain business or technicalrequirements

Exchange-based(traditionalIT outsourcing)

Supplier Supplier one-to-oneor one-to-some

Mixed (some supplierstaff on customer site,some staff centralizedat supplier site)

Highly customizedcontract defining costsand service levelsfor that particularcustomer

Non-core capabilities;Customized products or services;Stable business & technicalrequirements

Netsourcing Supplier Varies one-to-many Supplier staffnot on customer site

Generic contractspecifying rental costsand very minimalservice guarantees

Non-core capabilities;Standard products or services;Stable business & technicalrequirements

Joint ventures Venture SupplierInvestor

one-to-one:Customer is bothinvestor and firstmajor customer

Mixed (some supplierstaff on customer site,some staff centralizedat venture)

Highly customizedfor operationsdelivery; broadlydefined for revenuesharing

Customer non-core,supplier core capabilities;Significant market forventure’s product & services


and a $600 million contract with Interna-tional Paper.

In the past, joint ventures between custo-mers and IT suppliers often failed to attractexternal customers and the relationshipswere redefined as exchange-based. Exam-ples include Delta Airlines and AT&T,Xerox and EDS, and Swiss Bank and PerotSystems. Problems arose among such dealsbecause the parties thought they could sellhome-grown customer IT assets and cap-abilities to external customers. But the rea-lity of delivering daily IT services devouredresources and customer IT assets and cap-abilities turned out to be too idiosyncraticfor commercial delivery in highly-competi-tive markets like ERP [LaWi01].

What is new with Xchanging and Exult isthat the web-enabled software is designedfor one-to-many delivery and there is aclear demand in the market for BPO. Forexample, Gartner estimates that the BPOwas $119 billion in 2000 and will swell to$234 billion by 2005.

Lesson 8: Ensure all layers of the servicestack are adequately provided. As pre-viously noted, the sourcing options in Ta-ble 3 are actually simplified archetypes.Even the characteristic one-to-many busi-ness model of the initial netsourcing con-cept is becoming blended with one-to-onecustomization of some aspects of the sup-plier’s products and services.

In reality, the business models are oftenblended and customer-supplier relation-ships can be quite complex. A supplier

may have primary accountability to a cus-tomer, but the customer may not be awarethat their hardware, monitoring, billing,help desk, and support services may actu-ally be subcontracted to many players.

A good way for customers to manage thecomplexity is to consider outsourcing as astack of services (See Table 4). At the bot-tom of the stack is IT connectivity, pro-gressing through increasing levels of func-tionality. Suppose for example a customerselects traditional outsourcing for a busi-ness process such as accounting (level 7 inthe service stack). The customer needs tounderstand how the supplier will managethemselves or alternatively, subcontract,the other six layers of the model. Such a di-agnosis might even lead the customer to adifferent decision, such as outsourcing di-rectly with the subcontractor to maintainmore accountability and control or to re-duce costs by eliminating the prime con-tractor’s margin [KeWL02].

Merely identifying a sourcing model doesnot mean that there are suppliers worthyor willing to engage in a relationship. Thereare many ways to woo suppliers, but themost proven method is:

Lesson 9: Compare request-for-proposalto internal bids. During the last ten years,organizations that invited both internaland external bids had a higher relative fre-quency of success than organizations thatmerely compared a few external bids tocurrent IT performance. Based on 85 casestudies, we found that when customers al-lowed internal IT bid teams to compete

with external suppliers, 83% of those deci-sions were successful. When no in-housebid was invited and existing costs werecompared with 1 or 2 supplier bids, only42% of those decisions were successful.

We believe that this was because formal ex-ternal supplier bids were often based on ef-ficient managerial practices that could bereplicated by internal IT managers. Thequestion was: If IT managers could reducecosts, why didn’t they? In some cases, ITmanagers could not implement cost reduc-tion tactics because the internal politics ofuser departments often resisted cost reduc-tion tactics such as consolidating datacenters, standardizing software packages,and implementing full-cost chargebackschemes. For example, users in two divi-sions at a US food manufacturer did notwant to consolidate their data centers intothe corporate data center:

“[The two divisions] didn’t want to come tocorporate IS in the first place. They didn’twant to close their data centers, a controlthing, ’my car is faster than your car’thing.” – Data Center Director

Senior executives at this company felt thatIT costs had become too expensive anddecided to outsource its large corporatedata center. The Data Center Director lob-bied to submit an internal bid.Oncegranted permission, he prepared an internalbid that beat an external bid on cost. With-in three years, the internal IT departmentcut costs by 45% by consolidating andstandardizing (See [HiLa00] for more in-depth examples of the empowermentfueled by internal bids).

Internal bids, however, might be infeasiblein some circumstances. For example, ratherthan use its own capital to invest in muchneeded IT renewal, DuPont wanted a sup-plier(s) to make the investment upfront inexchange for variable fees based on usage.Clearly an internal bid team could not com-pete with the $4 billion deal DuPont subse-quently signed with CSC and Accenture.

Lesson 10: Involve senior managementand IT management in sourcing deci-sions. Concerning who should be makingthese assessments, our case study and sur-vey data both suggest that multiple stake-holders need to be involved. In our surveydata, 68% of respondents had at least twostakeholders driving the decision, most fre-quently the IT Director and lawyers or the


Table 4 The service stack

Stack level: Service provided:

7. Business process delivery Complete end-to-end business process delivery for functionssuch as human resources, accounting, or finance.

6. Customized applications Access and support of customers’ home-grown applications

5. Standard applications Access and support of Independent Software Vendor appli-cations

4. Application operatinginfrastructure

Middleware layer for accessing applications on remote ser-vers, such as MS Terminal or Citrix products.

3. Hosting infrastructure Data center facilities, leasing of servers, server performancemanagement.

2. Network services Monitoring and security services

1. Network connectivity Internet service providers and telecom companies offer anextensive array of connectivity options which are matched tocustomers’ bandwidth and data throughput rates.


IT director and senior executives. Our casestudy data shows that joint senior execu-tive/IT manager decisions or IT managersacting alone had higher relative frequenciesof success than senior executives actingalone (See Table 5).

We defined decision sponsor as the personwho initiated or championed the sourcingdecision and who made or authorized thefinal decision [Beat96]. In our study, sour-cing decisions made jointly with both se-nior executive and IT input had the highestsuccess rate (76%). It appears that success-ful sourcing decisions – like most large-scale IT endeavors – require a mix of poli-tical power and technical skills.Politicalpower helped to enforce the larger businessperspective – such as the need for organi-zation-wide cost cuts – as well as the“muscle” to implement such business in-itiatives. Technical expertise on IT services,service levels, measures of performance,rates of technical obsolescence, rates of ser-vice growth, price/performance improve-ments, and a host of other technical topicswere needed to develop requests-for-pro-posals, evaluate supplier bids, and negotiateand manage sound contracts. In somecases, this mix of political power and tech-nical knowledge was encompassed in onestakeholder group, as evident by 12 suc-cessful decisions sponsored solely by se-nior executives and 20 successful decisionssponsored solely by senior IT managers.

5 Crafting deals

Assuming an appropriate sourcing modeland viable supplier has been identified, theparties must still negotiate a contract. Thetwo most important proven practices forcrafting contracts are discussed below:

Lesson 11: Detail contracts, including re-sponsibilities of both parties and mechan-

isms of change. Many different types ofcontracts are used to govern exchange-based relationships:

Standard Contracts: the customer signed thesupplier’s standard, off-the-shelf contract.

Detailed Contracts: the contract includedspecial contractual clauses for servicescope, service levels, measures of perfor-mance, and penalties for non-performance.

Loose Contracts: the contract did not pro-vide comprehensive performance measuresor contingencies but specified that the sup-pliers perform “whatever the customer wasdoing in the baseline year” for the durationof the contract at 10–30% less than thecustomer’s baseline budget.

Mixed Contracts: For the first few years ofthe contract, requirements were fully speci-fied, connoting a “detailed” contract.However, participants could not definetechnology and business requirements inthe long run, and subsequent requirementswere only loosely defined, connoting a“loose” contract.

Detailed contracts achieved expectationswith greater relative frequency than othertypes of contracts (75%) (See Table 6).These organizations understood their ownIT functions very well, and could thereforedefine their precise requirements in a con-tract. They also spent significant time ne-gotiating the details of contracts (up to 18months in some cases), often with the helpof outside experts. For example, the Finan-cial Manager at a US bank spent threemonths negotiating the data center con-tract, assisted by the VP of IS, internal at-torneys, and two hired experts:

“And that’s when [the VP of IS] and I andthe attorneys sat down everyday for threesolid months of drafting up the agreement,

negotiating the terms, conditions, and ser-vices.” – Financial Manager

From our survey, customers included thefollowing clauses in their detailed con-tracts:

& costs (100%),& confidentiality (95%),& service level agreements (88%),& early termination (84%),& liability & indemnity (82%),& change contingency (65%), and& supplier non-performance penalty

(62%).

Increasingly, contracts also include respon-sibility matrices, which outline the respon-sibilities for both customers and suppliers.This innovation recognizes that supplierssometimes missed service levels because oftheir customers. For example, in one of ourcases, the supplier did not connect newcustomer employees to the network withinthe contractual time limit because the cus-tomer systematically failed to properlyauthorize new accounts.

No matter how detailed contracts become,changes in requirements will occur. Manydetailed contracts now have mechanisms ofchange, including:

& planned contract realignment points toadapt the contract every few years,

& contingency prices for fluctuation in vo-lume of demand,

& negotiated price and service level im-provements over time, or even

& external benchmarking of best-of-breedsuppliers to reset prices and service le-vels.

In contrast to the success of the detailedcontract, all seven of the loose contractswere disasters in terms of costs and ser-vices. Two of these companies, actually ter-minated their outsourcing contracts earlyand rebuilt their internal IT departments.Another company threatened to sue thesupplier. Senior executives in these compa-nies had signed flimsy contracts under therhetoric of a “strategic alliance.” However,the essential elements of a strategic alliancewere absent from these deals. There wereno shared risks, no shared rewards, and nosynergies from complementary competen-cies nor any other of the critical successfactors identified by researchers [Kant94].Instead, these loose contracts created con-flicting goals. Specifically, the customerswere motivated to demand as many IT ser-vices as possible for the fixed-fee price by


Table 5 Decision sponsor for sourcing decisions (n ¼ 102 sourcing decisions with discernibleoutcomes)

Decision sponsor YES, mostexpectationsmet


MIXED results Total

Senior executive 12 (43%) 10 (36%) 6 (21%) 28

IT manager 20 (71%) 6 (21%) 2 (7%) 28

Joint executive/IT 35 (76%) 9 (20%) 2 (4%) 46



arguing “you are our partners”. Supplieraccount managers countered that theirfixed-fee price only included services out-lined in the contract. The additional ser-vices triggered supplier costs which werepassed to the customer in terms of excessfees. Because the customers failed to fullyspecify baseline services in the contract, thecustomers were charged excess fees foritems they assumed were included in thefixed-price.

Six of the 11 “mixed” contracts with dis-cernible outcomes achieved expectations.The contracts contained either shared risksand rewards or significant performance in-centives. A Dutch electronics companyspun-off of the IT department to a wholly-owned subsidiary in 1991. Because thenewly-formed company’s only source ofrevenue was from the electronics company,the venture was highly motivated to satisfytheir only client’s needs.

Lesson 12: Keep contracts short enoughto retain relevancy and control, but longenough for suppliers to generate a profitmargin. From the customer perspective,there is clear evidence that short-term con-tracts have higher frequencies of successthan long-term contracts (see Table 7).From our 85 case studies, 87% of outsour-

cing decisions with contracts of three yearsor less were successful, compared to a 38%success rate for contracts eight years orlonger.

Short-term contracts involved less uncer-tainty, motivated supplier performance, al-lowed participants to recover from mis-takes quicker, and helped to ensure thatparticipants were getting a fair marketprice. Another reason for the success ofshort-term contracts is that participantsonly outsourced for the duration in whichrequirements were stable, thus participantscould articulate adequately their cost andservice needs. Some participants noted thatshort-term contracts motivated supplierperformance because suppliers realizedcustomers could opt to switch supplierswhen the contract expired. As the IS direc-tor of a UK aviation authority commented,“It’s no surprise to me that the closer we gettowards contract renewal, it’s amazingwhat service we can get.”

In contrast, long-term contracts have re-mained troublesome, with failure toachieve cost savings as the primary reason.Few total IT outsourcing mega-deals reachmaturity without a major stumbling block.Conflicts are increasingly being resolvedthrough contract re-negotiations. In 1997,

the Gartner Group, based on a survey of250 CIOs, estimated that 75% of all IToutsourcing customers would renegotiatetheir deals [Cald97; CaMc97].

The suppliers, however, have a clear prefer-ence for long-term relationships to recoupexcessive transition and investment costs.Returning to DuPont’s 10 year deal, thetransition activities lasted over 18 monthsas the contract was operationalized in 22countries to a population of nearly 100,000users. The transition also included massiveinvestments by one supplier in IT infra-structure, which the supplier could onlyrecoup in a long-term deal. Clearly, thecustomer’s incentives for short-term dealsmust be balanced with the supplier’s incen-tives for long-term deals.

6 Managing externalsuppliers

For all the sourcing models, there is an in-herent adversarial nature in the contracts inthat a dollar out of the customer’s pocket isa dollar in the supplier’s pocket. (This iseven true for joint ventures because thecustomer investor is also the venture’s pri-mary or even sole paying customer.) If thecustomer followed best practices up to thepoint of signing the contract, they shouldbe sufficiently protected from the devastat-ingly negative consequences experienced inthe early days. If the supplier negotiated afavorable deal, they should be able to deli-ver on the contract and still earn a profitmargin. But even under the most favorablecircumstances, relationship management isdifficult:

“Really our challenge is relationship man-agement . . . I know, I certainly haven’tfound the answer yet, but not too manyother people have found the answereither,” – Customer of a $AU600 millioncontract

Lesson 13: Put core customer capabilitiesin place to protect the customer interestsas well as to foster supplier success. Thesecapabilities, as defined by Feeny & Will-cocks are:

Contract monitoring capability to ensurethat the supplier delivers on the contract.This capabilities also monitors best-of-breed cost and services emerging in the


Table 6 Types of exchange-based contracts (n ¼ 82 outsourcing decisions with discernibleoutcomes)

Contract type YES, mostexpectationsmet


MIXED results Total

Detailed 45 (75%) 9 (15%) 6 (10%) 60

Loose 0 (0%) 7 (100%) 0 (0%) 7

Mixed 6 (55%) 1 (9%) 4 (36%) 11

Standard 2 (50%) 2 (50%) 0 (0%) 4


Table 7 Contract duration (n ¼ 85 outsourcing decisions with discernible outcomes)

Contract duration YES, mostexpectationsmet


MIXED results Total

0 to 3 year contracts 28 (87.5%) 4 (12.5%) 0 (0%) 32

4 to 7 year contracts 19 (59%) 10 (31%) 3 (9%) 32

8 to 25 year contracts 8 (38%) 6 (29%) 7 (33%) 21



market to motivate and negotiate improvedsupplier performance over time.

Contract facilitation capability to provide avital liaison role between the supplier andthe customer’s user and business commu-nities to ensure supplier success. For exam-ple, the contract facilitator role makes surethe user community understands what thesupplier is contractually obligated to deliverto prevent unrealistic expectations of thesupplier. Contract facilitation helps suppli-ers implement vast change programs such asconsolidation, standardization, and rationa-lizion. The role also evaluates user demandto harness spending beyond baseline.

Supplier development capability exploresways the customers and suppliers can en-gage in win-win activities beyond the legalrequirements of a contract. The partiesmay question: Can the supplier sell any ofthe customers assets externally? Can thecustomer serve as a test site for a new sup-plier offering? This capability is usuallynot evident until the transition period isover and operations are stabilized.

Lesson 14: Embrace the dynamics of therelationship. Even with these capabilitiesin place, customer and supplier relation-ships will sometimes be adversarial. For ex-ample it is quite natural that customers andsuppliers will fight over a monthly bill oran interpretation of the contract, but stillhave a good relationship overall. Ratherthan seek to extinguish such fights, the bestrelationships embrace the dynamics. Weidentified three other common types ofcustomer-supplier interactions besides ad-versarial: tentative, cooperative, and colla-borative. These are based on the extent ofgoal alignment for the task at hand:

& Tentative interactions occur when goalalignments are unknown, such as duringthe bidding process. At such times, eachside tends to exaggerate their strengthsand hide their weaknesses.

& Cooperative interactions occur whengoals are complementary, such as thecustomer wants the service, the supplierwants the payment.

& Collaborative interactions occur whenboth sides have shared goals, such aseducating the user community on whatthey can expect from the contract orpresenting a positive face to the press.

The important lesson here is that each sidemust have equal power so that they canachieve equitable outcomes. The aims of

each party should be fairness, not domina-tion or exploitation. Again, this commonplaying field can only occur if the customerhas successfully executed the IT assess-ment, supplier evaluation, and contractingprocesses.

7 Other sourcesfor customer learning

Customers have learned many lessonsabout evaluating their IT portfolios, evalu-ating market options, crafting contracts,and managing suppliers. But learning isnever stagnant, and customers must findways to keep abreast of emerging sourcingpractices. Two proven ways are discussedbelow.

Lesson 15: Consider incremental out-sourcing to develop experience with out-sourcing. Just as someone cannot learn todrive from reading a manual, someone can-not learn to successfully outsource merelyby reading about other people’s experi-ences. We found that the best way to accu-mulate learning is through incrementaloutsourcing, in which customers adopt thisoutsourcing strategy precisely to developan in-house knowledge about outsourcing.With incremental outsourcing, organiza-tions outsourced a small and discrete partof its IT activities, such as third-partymaintenance or shared processing services.The experience gained from this first incre-mental approach was then fed back intofurther outsourcing. In two cases, a petro-chemical company and an electric utility,organizations found themselves ultimatelyengaging in total outsourcing.

Lesson 16: Hire help. Another very im-portant factor in customer learning is thewide spread-use of key IT outsourcingconsultants and IT outsourcing legal firms.We are witnessing an institutional iso-morphic effect where outside experts, suchas Technology Partners International(TPI), Gartner Group, Corbett & Associ-ates, Shaw Pittman, Millbank Tweed, theEverest Group and many others seed clientorganizations with similar standards andmethods. The overall effect of these exter-nal constituents is the dissemination of bestpractices. In particular, mega-deal contractsare now templated, with all the customercosts, service levels, performance measures,mechanisms of change, and other clausesnearly identical. Although each organiza-

tion participating in the research regardsthese practices as “competitive secrets”,practices are nearly identical across mega-contracts. A typical mega-deal contractnow contains 30,000 lines, over 600 servicelevel agreements, and over 50 different pri-cing mechanisms.

Outside experts have also standardizedmany post-contract management practices,such external benchmarking of data cen-ters, networks, desktops, and applications;color-coded problem resolution systems,joint supplier/customer teams to resolvedisputes; and responsibility matrices toclearly define customer responsibilities andsupplier responsibilities. For example,BAE SYSTEMS, DuPont, Inland Revenue,Government of South Australia use thesepractices.

In addition to hiring external experts, cus-tomers may also access external expertisethrough outsourcing interest groups, suchas ITTUG or the Sourcing Interest Group.Groups provide an opportunity for bothcustomers and suppliers to share and disse-minate data. For example, the OutsourcingWorld Summit draws over 500 outsourcingcustomers and suppliers each year and fea-tures prominent speakers, panels, Q&Asessions and many opportunities for infor-mal exchanges.

8 Lessons for suppliers

Nearly all of our exchange-based cases stu-dies in which the deals were worth in ex-cess of $500 million or more, the supplierswere EDS, IBM, CSC, and/or Accenture.These suppliers are among the few organi-zations which have a significant global pre-sence to service such large deals. We foundsignificant variability in the success of suchdeals. Given the suppliers are the same, it islogical to assume the differentiating factoris the customer. Put simply from the sup-plier perspective: good customers make forgood relationships. The ideal customer hassignificant experience with outsourcing theright activities, crafting the right types ofcontracts, and ensuring supplier successthrough the previously discussed roles andpractices. The following lessons stand outas viable ways to educate, inform, and at-tract good customers, primarily throughsuperior supplier integrity.

Lesson 17: Educate your customer dur-ing earliest possible phase. Increasingly,



we advise suppliers to help educate naivecustomers on the issues discussed in thispaper. For example, after presenting thecore IT capabilities framework to one sup-plier bidding on a significant US govern-ment contract, the supplier went back tothe US government agency and told themto reduce the scope of their RFP and to re-tain more supplier management capability.The agency was quite taken back with thisapproach, revised its RFP, and subse-quently selected the aforementioned sup-plier because they trusted them.

Lesson 18: Briddle your public relationsstaff, unbriddle your account managers.Increasingly, we talk to outsourcing shop-pers who are shying away from some sup-pliers because they simply don’t believethem. The potential customers complainthat the supplier oversells with polishedPR and salespeople. Legitimate concernsabout possible escalating costs and servicelapses are readily dismissed with appeals totheir “world class expertise.” Client refer-ence lists often include only new custo-mers, where expectations are still high andsupplier delivery is still unproven. Custo-mers are not naive – they know that out-sourcing relationships will encounter road-blocks and problems. They want to hearstories of past disasters and how the sup-plier responded to them, what the supplierlearned from them.

Consider one of our case study from amulti-billion dollar company. Senior man-agers rejected bids from big suppliers andinstead signed a 10-year, $1 billion dollarcontract with a small start-up company.The big players sent their slickest salespeo-ple to present. The start-up sent the unpol-ished, but enthusiastic team of people whowould actually be doing the work:

“The early presentations were really quitecrap, lots of feeling, lots of passion, lots ofdrive, lots of enthusiasm. There is a certainpleasure in the naivety . . . it’s like lookingat a Lowry painting, it’s still beautiful butis naı̈ve, rather than a Gauguin or some-thing like that. I would hate to lose thetouch that’s in here for the sake of beingslick.” – Practice Director from the win-ning supplier

Lesson 19: Submit realistic, open bids.Some suppliers underbid in order the se-cure the contract. Such a strategy was oftenfruitful in the past because suppliers knewthat the customer’s needs would change,

and opportunties for upsell would morethan compensate for the loss on the base-line contract. But customers are increas-ingly aware of such strategies and inten-tionally select other suppliers for add-onsto keep a competitive playing field. Itserves the supplier far better to offer a rea-listic bid and to disclose how they can deli-ver on the bid and still earn a profit. Suchdisclosure might entail their non-imitiablecosts in IT infrastructure and capabilitiesdue to econonomies of scope and scale.For example, Xchanging can boast that oneof their process experts previously imple-mented General Electric’s Six Sigma pro-gram which saved GE $54 million (Disclo-sures also makes customers question theunrealistic bids of competitors).

Lesson 20: Propose and price value-added options. Once transition periods arecomplete, customers generally find thatsuppliers can deliver on operational objec-tives of IT contracts. But customers in-creasingly expect more innovations andopportunties for generating revenues, evenif the deals are essentially exchange-based.Customers express continued dissapointon this front:

“Sure, the supplier delivers the contract . . .but trying to get them to identify theadded-value we both talked about at thebeginning, let alone deliver on it, is verydifficult.” – IT Contract Manager, USBank

“Yes, the supplier can achieve all the thingsthat were proposed – but where is this fa-mous added-value service? We are not get-ting anything over and above what any oldoutsourcer could provide.” – IT ServicesDirector, Aerospace Company

The value-added supplier proposes andprices options which significantly benefitthe customer. Examples from our case stu-dies include significant cost savings andservice improvement by web-enabling hu-man resource management, creating wire-less connections for sales force support,and helping customers use online auctionsto reduce procurement costs.

9 Conclusion

Once dominated by a few big players(EDS, IBM, CSC), the IT outsourcing mar-ket has fragmented into many niche ser-

vices. From the customer perspective, thisincreased competition affords them morepower to bargain for shorter contracts,more select services, and better financialpackages. But to harness this market op-portunity, customers need to learn how tocontinually monitor market options, assessthe contribution of their IT portfolio forcurrent and future business value, decidewhat type of relationships suite their needs,craft optimal contracts, and successfullymanage supplier relationships. The overallmessage for customers is clear: all outsour-cing requires continual and significantin-house management.

For suppliers, they must be able to selecteducated customers with clear goals, andhave the ability to execute such deals whilestill generating a profit. At the end of theday, success is measured by the operationaldelivery of the contract, ability to fairlyadapt to change, and the ability to identifyadded-value services.

Remarks

1 A shorter version based on 12 customerlessons was initially published in [Laci02].2 Further details on the research methodsmay be found online at www.umsl.edu/~lacity/guide.html and www.umsl.edu/~lacity/cases.htm.

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Abstract

For more than a decade, the authors have studied the best, worst, and emerging informationtechnology sourcing practices in 543 large and small organizations world-wide. From aninitial focus on cost reduction in the early 1990s, the authors found that customers now ex-pect many business advantages from IT outsourcing, including better service, infusion of newtechnology, transformation of fixed IT budgets to variable IT budgets, improved businessprocesses, and even increased revenues. In short, customers expect IT outsourcing to trans-form IT functions into lean, dynamic groups that respond quickly to business needs and op-portunities. But how do customers actually achieve such business advantage? Customersmust become adept at managing four continual processes to successfully exploit IT outsour-cing:

& Assess the in-house IT portfolio to determine which activities are best outsourced;& Evaluate market options for the best sourcing models and best suppliers to achieve custo-

mer objectives, ranging from simple ASP provision to the creation of customer-supplierjoint ventures;

& Craft contracts to align customer and supplier expectations and incentives; and& Continually manage supplier relationships.

Major supplier lessons are also identified, which call for superior supplier integrity in selling,negotiating, and delivering IT services. The overall lesson is that outsourcing can achievesignificant results, but it requires new management capabilities.

Keywords: technology sourcing, outsourcing, supplier management, core IT capabilities


IT Sourcing Reflections: Lessons for Customers and Suppliers

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