It's a common scenario: the IT service provider meets all its SLAs and holds to all the pricing models... but the customer still isn't happy. Something just isn't right. As one outsourcing advisor describes it, "You look at the dashboard and everything is green. But you still feel red."

What's the problem? In a word: innovation. Or lack thereof.

Many IT leaders enter into outsourcing arrangements with an expectation that the outsourcing provider will not only live up to the letter of the contract, but by virtue of being a Big Outsourcer, will bring something more to the table.

Is that so wrong?

Some say, yes. It's an unreasonable expectation. IBM, EDS, Wipro, Satyam -- they're IT factories, not innovators. Sure, they'll innovate internally to the extent that it advances their business. But if you're expecting them to bring ideas to the table that might somehow provide you with competitive differentiation, you're nuts.

Others say, if you can't get IT innovation from billion-dollar service providers, who can you get it from? They've got partnerships with the Oracles and Microsofts of the world. They know where technology is heading. They should be your innovation sherpa.

Philosophical arguments aside, are the big outsourcers even capable of providing innovation right now? Economics are against them.

U.S. providers are getting squeezed. If you edit out the recession of the early 90s and the short-lived reprieve of Y2K and dotcom days, outsourcing profit margins in the U.S. have been steadily declining since the mid-70s and have flat-lined at 6 percent, with just 9 percent annual revenue growth, according to research by outsourcing advisor Alsbridge.

The financial pressure on domestic vendors is the result of offshore competition, namely Indian vendors who are riding high by comparison with double-digit profits. But don't count on them to fill the perceived innovation gap. They've always been laser-focused on repeatable processes. Some of them have set up R&D centers, but they're loss leaders intended to reel in new clients for the commoditized stuff. Besides, they have their hands full managing their own growth.

So it's safe to say that outsourcers around the globe are loathe to offer added value that might affect their ability to meet the service level obligations, and thus, their margins. Providing more value-add could have a huge upside for them, but it's risky. Alsbridge goes so far as to call the situation an innovation crisis. One CIO (who's now backsourcing due to "failures of innovation") tells me: If you really want innovation from an outsourcer, you can get it. But you'll pay for it. Extensively.

Meantime, there's a good deal of dissatisfaction in the market right now. The biggest gap between outsourcing benefits sought and achieved exists around innovation, according to an Alsbridge survey of 300 buyers of IT services. The same company found that suppliers themselves indicated that the inability to fund and apply innovation to client requirements is their number one challenge by a four to one margin. (Not surprisingly, Alsbridge uses this data to persuade IT buyers that they need to hire an experienced outsourcing advisor to help them out. But hey, everybody's got a dog in this fight.)

Here at CIO, we conducted our own survey. Nearly a quarter of respondents were dissatisfied with the level of innovation provided by their domestic services provider and almost half were unhappy with the innovation provided byoffshore outsourcers. And neither number takes into account IT leaders who, despite outsourcing marketing materials that advertise innovation, already have limited expectations.

So, who's to blame? Outsourcers for selling themselves as potential partners in innovation, knowing they won't deliver? Customers, for having expectations that the know doesn't line up with the traditional outsourcing business model?

Better question: what's the solution? I've got respected IT leaders and experts whispering in one of my ears that the most you should expect from an outsourcer is for them to truly commoditize the services they're providing and someday be able to do it so well that you don't have to worry about those things anymore. Then you can focus on innovating. In the other ear, I've got respected IT leaders and experts saying that there's a better way. If you move outside the box of the traditional outsourcing RFP process and ongoing governance, you can work with an outsourcer in a way that yields more innovation.

Who's got it right? I'm leaning toward the latter. If you want innovation from your outsourcing, innovate around the outsourcing process. It's risky, but maybe it's worth a shot.

Stephanie Overby
Senior Editor
CIO magazine US and CIO.com