Rethinking IT outsourcing: CEOs want a new kind of competition among suppliers

Chief Executive, The, Dec, 2004 by Jerry A. Greenberg

Realizing business value from information technology is a top priority for most CEOs, Forrester Research estimates that the average top 500 company in the U.S. spends close to $400 million, or 3.8 percent of revenue, every year on IT; in 2005, the figure is expected to grow by 6 percent.

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Unfortunately, many companies are dissatisfied with the results from their IT investment. Recent announcements by JP Morgan Chase, UBS Warburg and Britain's J. Sainsbury signify major changes in the way large companies plan to approach IT: J. Sainsbury stated that its IT systems "have failed to deliver the anticipated increase in productivity." At JP Morgan Chase, the company ended a $5 billion outsourcing contract that had failed to produce and brought the work in-house.

At some of the world's largest organizations, CEOs and their senior management teams are thinking about IT in a very different way. They are bucking the old models of IT outsourcing--finding one company to do it all--and pioneering a fundamentally different strategy, seeking substantially better results for their businesses. This new sourcing strategy underscores the difference between a monopoly and a competitive market.

Global industry leaders and some of the world's largest buyers of IT, including JP Morgan Chase and Dow Chemical, are moving away from monopoly agreements with a single IT service provider and introducing the dynamics of competition. An October 2004 statement from Rod Bourgeois of Sanford C. Bernstein supports this point: "Our research shows that IBM has lost signings share in recent periods, and it emphasizes that the Big-3 outsourcers [IBM, EDS and Computer Sciences Corp.] are experiencing increased competition from a growing list of non-Big-3 players."

We believe these events are indications of a major change to the three traditional approaches to IT sourcing that exist today, and they are:

External monopoly. A company out-sources the bulk of its IT to one large external provider. By removing competition, innovation is stifled, control is lost, account-ability is limited and inertia sets in.

Internal monopoly. A company relies on internal staff for the vast majority of its IT. Theoretically, there is a benefit to leveraging people who know the business, but, in practice, most internal IT organizations are not well aligned to the business, not subject to competition and not held to the same standards and expectations as external providers. When asked to describe his IT organization, the CIO of a large financial services firm said succinctly, "We're a monopoly and we act like one. We need to get some competition in here."

Mix and match. This model, used by most companies today, consists of a combination of internal and external approaches. The greatest inefficiencies in this model are found in the way external providers are selected and managed. Most organizations use a "best bid" approach for each engagement. This approach has the benefit of competition, but loses knowledge as companies change providers for projects. This model also fails to foster an environment where providers and internal employees work together to achieve the clients' best interests.

One global energy leader (and a Sapient client) is approaching information technology in an entirely different way. This company has decided to outsource virtually all of its IT, but not by using one of the traditional models above. Instead, it reduced its list of IT providers from several thousand to a few hundred and dropped its list of IT service providers to fewer than 20. By keeping this number of providers in the mix, the client has removed the pitfalls of the "external monopoly" model, which could threaten the success of its IT strategy.

Additionally, the client set standards and metrics upfront and established common dashboards to formally review the providers' performance, which has improved their vendor management approach. As a result, they now have a commitment on all sides for mutual value creation. Each party is willing to make investments to create more value; the client takes the time to ramp up and include the providers in its strategy and the providers are more willing to make investments that may result in innovation and bottom-line improvements. Another benefit: The company receives better service, pricing and ideas as a result of a defined competitive playing field that also allows visibility into provider performance metrics. For example, as a midsize provider of business and technology consulting services to this client, our company acts as a catalyst for higher performance. Every day, we are competing with other providers while helping those same providers succeed, and the client receives the best ideas, lowest pricing and highest quality service.

Taking key aspects of this client's approach with best practices from other companies we work with, we see another model emerging, which we call the "managed competition" model. This strategy is fundamentally different because it has competition at its core. We expect this model to outperform all models in service, business results and innovation. The basis of our belief is simple: Competition at its core will unlock the problems created by all the other models. The managed competition model is characterized by the following: