Inside Moves

Inside Moves

For some companies, the decision to backsource is all about regaining control.

Turns out you can go home again - at least IT can. Backsourcing is on the increase as more and more outsourcing arrangements fail to meet expectations for savings and service levels.

Suncorp Group Executive, IT, Carmel Gray has nothing against outsourcing per se. Outsourcing works very well for very many firms, she says, and anyway, in this day and age practically every organisation has to outsource something. So when Suncorp decided to bring GIO's IT operations back in-house following its $1.4 billion acquisition from AMP last year, in the process saving $120 million and creating 80 jobs, it was not because of any philosophical or ideological objection to outsourcing.

Rather, Gray says, Suncorp undertook one of the biggest IT backsourcing projects in Australian corporate history because the organisation sees doing the bulk of its IT in-house as the best way to maintain its competitive edge.

"We've got a strong customer focus in Sun and we believe that in an organisation like ours IT is really integral to the quality of the service customers receive from us and every interaction they have with us," Gray says. "It's very difficult to tell where technology ends and products and services begin these days, so our preference is to manage IT in-house on the basis that we can run it at least as well or better than the best outsourcer. That's where we see ourselves."

The decision elevates Gray to membership of a small but growing band of organisations opting to backsource or reinsource. Recent examples of prominent organisations choosing to backsouce include the Bank of Scotland's decision to terminate its outsourcing deal with IBM; and US firm Oxford Health Plans' decision to scrap its IT outsourcing deal with CSC. (See "Bringing IT Back Home", page 56 for insourcing strategies.)

It's a trend researchers Rudy Hirschheim and Mary Lacity first observed in the mid 90s. Their concerns about the overwhelmingly positive press being given to outsourcing decisions prompted them to conduct various IS sourcing studies, eventuating in two books: Information Systems Outsourcing: Myths, Metaphors and Realities (1993) and Beyond the Information Systems Outsourcing Bandwagon: The Insourcing Response (1995).

"It is not uncommon for companies to outsource initially and then to decide on reflection that they should bring IT back in-house," says Hirschheim, the Tenneco/Chase International professor of information systems at the University of Houston. "Whether, in the future, all companies will go to a backsourcing environment is hard to tell but there's an inexorable move toward backsourcing among companies that outsource. I think the trend is unmistakable."

Hirschheim's conclusions are based on a 1999 study that he and Lacity, an associate professor of MIS at the University of Missouri in St Louis, conducted of 14 petroleum, chemicals, energy, rubber, retailing, food, education and banking concerns, each with two to 10 years of IT outsourcing experience.

IT's Mine. Mine, Mine, Mine

For some companies, the decision to backsource is all about regaining control. For instance, in April last year Oxford Health Plans announced it was ending its outsourcing agreement with CSC just 18 months into its five-year $US195 million contract, to bring the functions back in-house.

CSC had been contracted to take responsibility for a variety of the health-care company's information systems, including its data centre operations, help desk, desktop systems and network management, with Oxford retaining many of the IS functions it viewed as important to its core businesses, including application development and maintenance, database administration, quality assurance, program management and architecture. Under the deal CSC took on 150 of Oxford's IT staff.

Announcing the deal in 2001, then COO Charles Schneider said: "This agreement will help us reduce our costs and upgrade our technology capabilities so that we can enhance the quality of services we provide to our members and employee groups." Now, the IS functions and much of the staff have returned to the Oxford fold, in a search for much the same benefits.

In a statement announcing the termination, president and COO Charles Berg said Oxford believed fully integrating the entire function would allow the company to deploy technology solutions in a more flexible, timely and cost-effective manner to meet its business goals.

Oxford public relations director Maria Shydlo says Oxford entered into the relationship with CSC so the company could focus its attention and resources on IT functions that support its core business. However, "Oxford's IT needs changed as our business needs have," Shydlo says. "Controlling the entire IS function will allow us to deploy technology solutions in a more flexible, timely and cost-effective manner to meet our aggressive business goals.

"We will introduce many new products to address the health-care affordability needs of employer groups; develop new applications to simplify the administrative process and improve efficiency; and enhance consumer health programs. By reuniting the development and implementation sides of our business, we can respond more quickly to market dynamics, which is critical to our growth prospects."

Shydlo says Oxford took charges in the second quarter 2002 of $US15.5 million related to the termination of the CSC computer-outsourcing contract.

The story is a little different at Suncorp, where the root of the backsource decision lies with Suncorp's acquisition of GIO from AMP in mid-2001. GIO's infrastructure was outsourced.

"We wanted to bring all of our IT operations together because we saw that there'd be the benefits of platform synergies: GIO and Sun ran very similar platforms through mainframe, midrange and desktop, and obviously we get the benefits of scale," Gray says. "We didn't consider the option of leaving the two operations apart as a viable one. We wanted to bring them together, and Sun already had its operations in-house, and dollar-wise and in fact just in the extent of them, they're larger than the GIO operation."

Gray says benchmarking shows Suncorp has been running its own IT operations very efficiently. The company was keen to maximise that competitive edge. She declines to comment on whether GIO's outsourcing had worked well - except to point out that AMP still outsources to CSC.

Linda Hughes, a managing director for The North Highland Company, an Atlanta-based management and technology consulting firm, has watched numbers of US companies decide to backsource. She says those organisations have had various motivations to bring IT back in-house, ranging from a lack of confidence in the current outsourcing vendor to business changes that make the current agreement no longer viable.

"Many companies today are not happy with their IT outsourcing vendor," Hughes says. "When the companies began outsourcing, many of them were unfamiliar with the complexities involved in outsourcing and assumed that the vendor would have the same attention to detail and concern for the systems that the internal staff exhibited. For this reason the contracts which were negotiated left many items undocumented and therefore open to interpretation. This often causes ongoing frustration with the vendor."

Dissatisfied customers often find they get the same level of attention from the vendor as they experienced with an in-house IT department but at an increased cost, Hughes says, with every little extra item requested of the outsource vendor incurring disproportionate fees. And with so many IT outsourcing contracts failing to include specific and measurable service level agreements (SLAs), they also find it difficult to judge and demonstrate the value received from the IT outsourcing agreement.

Many companies entered into IT outsourcing with the assumption that IT costs would decrease over time, or that they would at least get more value out of the same IT investment. Without the specific SLAs to measure the value of IT, and the lack of control on changes that increase cost, many companies do not believe they received the value they anticipated.

Other organisations have decided to bring IT back in-house in response to business changes. As in the case of Suncorp, Hughes says organisations often question the appropriateness of existing IT outsourcing arrangements when they are undergoing significant acquisitions, divestitures and mergers. New companies arising from such changes can prove to have very different IT needs. The existing contract (or contracts if the original companies were already outsourced when they were independent companies) may not meet the needs of the new company.

In fact Hughes says periods of such evolution can often be the ideal time to readjust the IT spending patterns, and to decide outsourcing may not be the best alternative.

"It is a widely held belief that companies should not outsource until they have 'cleaned house' internally," she says. "The better shape the IT department is in terms of minimising technologies in use, converting to common applications, and so on, the better the outsourcing arrangement will be. After mergers or acquisitions companies often have to adjust and streamline IT systems to gain efficiencies."

Exit Stage Right - or Left?

Companies deciding to bring IT back in-house face significant challenges, starting with the effectiveness of the exit clauses that define how they can untangle their relationship with an outsourcer. It has been clear for years that organisations need to insist on a well-defined exit strategy as part of the contract, yet analysts say even now few organisations pay sufficient attention to exit clauses during the negotiation process.

When the Bank of Scotland merged with the Halifax Building Society to form Halifax Bank of Scotland (HBOS) in 2001 the bank conducted a strategic review which led to last year's cancellation of its outsourcing contract with IBM, as well as Halifax's outsourcing deal with Xansa. The bank says it cancelled because the review showed requirements had changed. IBM reportedly attempted to counter the termination with a managed services insourcing deal. HBOS rejected the offer and gave IBM 12 months notice. Analysts expect much of that time will be spent trying to unpick the contract, as both parties test the effectiveness of the exit clauses in the original agreement to the limit.

Of course the optimum time to negotiate how a relationship will end is before it begins, when vendors are likely to be prepared to pull out all stops to win your business. Smart companies insist on an exit plan in any vendor negotiations, knowing the importance of a trouble-free transition in the face of any decision to alter the arrangement, from normal contract termination, to termination for cause or termination for convenience.

"A well-scripted transition should describe the conditions under which the exit plan is to be implemented, along with each party's duties, roles and responsibilities," says Joe Auer, president of International Computer Negotiations Incorporated, writing in US Computerworld. "All costs that are to be shouldered by either party should be clearly identified and quantified in as much detail as possible. Ownership of everything should be clearly delineated. Some of the ownership issues are obvious, but some, like data, system modifications and improvements, subcontractor relationships and magnetic storage media, often get overlooked."

Hughes says the pitfalls encountered when bringing IT back in-house depend very much upon the original agreement with the outsourcer. She cites some common pitfalls as:

  • the financial and legal aspects of asset ownership (hardware and software);
  • procuring appropriate transition services from the outsourcer;
  • financial and intellectual property terms within the termination section of the agreements;
  • the need to re-establish relationships with vendors, which the outsourcer previously maintained on behalf of the company;
  • having the appropriate facilities available for the data centre and IT asset management;
  • acquiring appropriate and current IT skill sets; and
  • readjusting executive management's view of IT spending.

Thread by Thread

The complexity of untangling the outsourcing relationship makes maintaining an excellent relationship with your outsource supplier absolutely critical.

Gray says Suncorp struck an agreement with AMP that let it continue to receive outsourcing services via AMP for 12 months after the sale. That left it free to focus on the project to bring everything in-house. The major project, completed within months at a total cost of around $32 million, involved a huge effort, which included upgrading Suncorp's own mainframes and moving all applications and data from the mainframes at CSC; then progressively moving midrange systems, NT servers and desktops.

"It was logistically a very, very complex operation and we had very detailed plans for the moves. We had equally detailed plans to back out of the moves - every one of those moves - if in fact things started to not go to plan during each weekend that we were making a move," Gray says. "So there was a heck of a lot of planning, a great deal of discovery in the early stages of the project. We knew broadly of course what we were going to move; but you never know the nitty gritty detail until you get in there and start talking with CSC and AMP. So it was very much a team effort and we had [consulting firm] DMR helping us to manage the program."

She says none of the numerous technical issues encountered during the project proved unresolvable. The organisation also had strong support from both Suncorp and GIO staff, who were very happy with the decision, but found it had to recruit between 50 and 60 new people to the Brisbane-based operation. Although some key personnel did also move over from CSC, she says the organisation did have to pay special attention to the issue of knowledge transfer.

It also engaged CSC for a good month to six weeks after each transition so that it could rely on the outsourcer's knowledge in the event of any hitches. Gray says the project could never have come in on time and budget, and may even never have worked, without the teamwork displayed by the people from DMR, Sun and CSC, and the "very significant" contribution from CSC.

"The way that team came together, and from the outset the commitment from senior management in each company to say: 'Look, this is something we all want to have happen. We're committed to the timeframe. We're all committed to the success of the project', was a really key factor in making this project work," she says. "It could so easily have turned out that there had been hidden agendas. CSC behaved very professionally, because after all we were taking away some of their business, but they understood that it was a sensible decision for us and was not a reflection on them as outsourcers at all - it made sense for us as an individual firm."

Avoiding Brain Drain

The corporate memory lost to an outsourcer remains a critical issue. Oxford hired all CSC technology staff dedicated to the Oxford business, many of whom were formerly Oxford employees who remained working with Oxford under CSC. Shydlo says because many were already affiliated with Oxford, it did not have significant issues surrounding change management or HR. Oxford offered technology staff dedicated to the Oxford business positions within the company with comparable pay and benefits packages. The vast majority accepted. About 300 employees make up its IT function today.

Hughes says since most companies do an incomplete job of maintaining corporate knowledge when they outsource, they are also often at a loss as to how to maintain the corporate memory that has now been built up within the outsourcer.

She says companies should identify the corporate knowledge needed to maintain or improve the companies' competitive advantage and then procure that expertise. Focus on core business knowledge and plan to replace "commodity knowledge" - that is, skills in great abundance and not specific to your company or industry, for example PC repair skills - as needed or through selective sourcing alternatives.

"Once you are clear what your core corporate knowledge is, identify where this knowledge resides and how easily it can be obtained," Hughes says. "Identify whether the knowledge can be obtained through a targeted training program with others in the company, obtained via a knowledge transfer program from the outsourcer, or whether this knowledge is so specialised that it must be obtained from specific individuals."

Looking at how the outsourcer obtained the knowledge initially and how they have maintained the knowledge as resources have transferred on or off your account within the outsourcer's organisation (through training, documentation and so on) may help to make this determination. Next, develop a transition plan to obtain the knowledge. The transition plan should focus on the most cost-effective mechanism for obtaining the specific knowledge that is needed. Alternatives may include: standard training on basic skills, customised training for configurable software packages, hiring vendor staff for very specialised application knowledge, training of IT resources on business processes by business resources within the company and so on.

These decisions will form the basis for the transition assistance services for which you may contract with the IT outsourcer.

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