Managing
the Outsourcing Risks
1. Understand the project.
Companies that choose to outsource applications must have
a high degree of understanding of the project they are undertaking,
including its requirements, the method of its implementation and the
source of expected economic benefits. This is crucial to providing
reasonable incentives for meaningful measures of performance. On Wall
Street, historically, attention and rewards have been given to those
who produce profits, like successful trading desks; there has been
less interest in managing cost centers like information processing.
Despite the strategic importance of information infrastructure, many
companies on the Street have attempted to squeeze systems, and they
have failed to provide the resources or the guidance needed for long-term
investment in IT. When they realized that they have not always done
a good job managing this area or rewarding performance, some have
outsourced with contracts obligating vendors to "do a better
job"; however, this provides neither the metrics needed to define
a better job nor the incentives for the vendor to steer in the desired
direction. Understanding project objectives also helps to reduce the
risks of poaching, since it is then possible to specify and control
access to elements that may be critical to the client's future competitive
positioning. The risks of outsourcing product distribution-as airlines
did with computer reservation systems in the 1970s, for example-can
clearly shift too much power to the distribution system. Using a third-party
information processor to manage client relationships can allow another
party to have access to your customer history and pick off your best
accounts. The most successful projects we studied were those in which
the client was fully capable of developing the application itself
but chose to outsource simply because of constraints on time or staff
availability.
2. Divide and conquer.
Dividing a large project into smaller, more manageable
pieces will greatly reduce programmatic risk. In principle, completion
of each independent chunk creates the possibility that subsequent
development work will be handed off to a different developer. Each
chunk should have specific objectives and quality metrics, and each
piece should be independent, in the sense that companies would have
to absorb only tolerable increases in development costs should they
choose to switch vendors after one or more chunks has been completed.
Although this will increase development costs, it reduces or eliminates
the risk of vendor holdup. If the vendor attempts to overcharge for
continuation, the self-contained nature of the work completed to date
will permit a more or less painless handoff to another vendor for
continuation of development. Moreover, by assessing checkpoints at
the completion of each chunk, the company can detect quality problems
and reduce the risk of shirking or underperformance. Thus, when deciding
on the milestones for such a project, it is important to have a viable
exit strategy if any chunk fails.
3. Align incentives.
Although the vendor's incentives can never be fully aligned with those
of the client, it is frequently possible to design contractual incentives
that will help enhance performance. If you pay a telephone interviewer
for the number of calls he makes, they will be short; if you pay for
the number of minutes he is on the phone, each call will be long;
if you pay for applications approved, you will have lots of approvals,
and if you pay for applications rejected, you will have lots of rejections.
What you want to do is pay for incremental sales. Unfortunately, such
incentives are not always guaranteed to work. It is difficult to define
incremental sales or determine the basis of compensation for your
call center operators. A similar "law of the wallet" holds
in all software outsourcing, and it suggests that you get what you
pay for: If you pay for lines of code, for example, you will get many
lines of code; if you pay for testing, you will get lengthy test logs.
Incentives can bring vendor behavior in line with a client's expectations,
thereby improving performance, but they can also distort it, causing
performance to drop. It depends on how well individual vendor activities
can be measured and how accurately measurable and rewardable activities
can be correlated with desired performance. In short, for all its
attractiveness, there are a number of potential costs and risks associated
with outsourcing. The above guidelines can help keep those risks under
control. One final tip: When in doubt, hiring an honorable and well-managed
vendor with a reputation to preserve may be your best protection.