September 29, 1997

Outsourcing Backlash Many companies aren't getting what they wanted from their outsourcing deals. Some are so disillusioned that they're bringing IT back in-house. Discuss this story in InformationWeek Online Shop Talk By Bruce Caldwell with Marianne Kolbasuk McGee fter years of big promises and even bigger deals, the IT outsourcing backlash has arrived. Many users say wholesale outsourcing hasn't lived up to its promise. Some are so frustrated that they're canceling long-term deals and going through the painful process of rebuilding their in-house IT operations. "I don't think we would ever, in the foreseeable future, entertain any ideas of large-scale outsourcing again," says E.P. Rogers, CIO at MONY. The New York insurer this month finished rebuilding its in-house IS structure after terminating a $210 million contract with Computer Sciences Corp. in May, less than halfway through its seven-year term. Other organizations apparently feel the same way. LSI Logic, which late last month cut short a five-year outsourcing contract with IBM Global Services, is rehiring IS staff and implementing core business applications itself. "The linkage between technology and business processes is so tight that when you outsource, somehow you get dysfunctional," says Lam Truong, CIO at the Milpitas, Calif., chipmaker. Companies bring IT back in-house for any number of reasons. Among them: to regain control and to react more quickly to rapid business change. "Outsourcing didn't work for us, a Silicon Valley company, because we change our mind all the time," says Truong. Acr oss-the-board outsourcing promised to cut costs, improve service, and help organizations move to new technology more quickly by tapping outsourcers' skilled staff. But those benefits often haven't materialized. A study released last week by Deloitte & Touche Consulting Group shows that outsourcing falls short of user expectations in key areas such as vendor expertise and transitions to new technology (see chart, right). In fact, more than half the companies recently surveyed by consulting firm Dataquest Inc. have renegotiated their outsourcing contracts; 16% of those switched vendors, and 8% pulled IT back in-house. "I don't think we've gotten what the marketing brochures sold," said George Orlov, CIO of utility holding company Unicom Corp., during a session on outsourcing at last week's InformationWeek 500 conference in Laguna Niguel, Calif. IS costs and complexity are rising for Unicom, he said, following an outsourcing agreement with IBM Global Services; talks are under way to resolve those pro blems. Indeed, "it seems like every big deal more than two years old is being renegotiated or ended," says one CIO who rebuilt his company's IS operation after terminating an outsourcing contract this year. He says he was deluged with calls for advice from other dissatisfied CIOs. Rebuilding an IS operation is difficult. Many companies outsourced because they had trouble finding IS talent. After discovering that outsourcers face the same problem, they are back trying to rebuild their IS organizations-and back to square one on the hiring front. Yet the IT outsourcing market is still booming, largely because many companies continue to rely on outside vendors to find those elusive skilled staffers. Dataquest estimates the worldwide market will reach $54.1 billion by 1998 and $76.7 billion by 2000. Dataquest analyst Allie Young says, though, that the current annual growth rate of 19.5% may slow because of market maturity and an increasingly cautious approach to large deals. The IT skills shorta ge is one reason many users switch outsourcers rather than rebuild. Moore Corp., a business-forms company in Toronto, is abandoning custom enterprise apps in favor of SAP R/3. That decision led to the restructuring of a 10-year, $400 million outsourcing contract Moore awarded to EDS in 1994 and to the awarding-expected to be announced this week-of $175 million in outsourcing business to MCI Systemhouse. "It is extremely difficult for a nontechnical company to compete for skills," says Robert McNulty, CIO at Moore. "Young kids are tied more to technology than the company, and we can't hire or keep or train skills." Companies that opt to bring IT back in-house face more than skills problems, though. "You have a real morale issue," says MONY's Rogers. Since ending the CSC deal, MONY has rehired 225 of nearly 400 staff originally transferred to CSC. "Some people had been with the company for 10 to 20 years," Rogers says. "You come in one day and say they now work for CSC-then turn around and say, `Now you wor k for MONY again.' We needed to reestablish trust." Says Bob Chapman, author of Insourcing After The Outsource: An MIS Survival Guide (American Management Association, 1997): "It's incredibly difficult and expensive to change providers, but it's a thousand times more difficult to bring operations in-house." Typically, six months after an outsourcing deal is signed, only a fraction of the user's original staff is still working for the outsourcer on the user's systems. "There's no one around who understands the business," Chapman says. But some companies think bringing operations back in-house is the only way to go. At Southern New England Telecommunications Corp., a three-year contract to outsource 10,000 desktops awarded to I-Net last year was canceled earlier this year. The negative "cultural impact" on end users of calling a toll-free number for support outweighed the savings, says Richard LeFave, CIO at SNET, in New Haven, Conn. Care And Feeding LeFave has since brought back the 50 outsourced employees and put site managers at each location "with the responsibility for the care and feeding of their environment." A new contract, for PC procurement only, will be awarded in weeks, he adds. A data center contract with Computer Sciences remains in place, LeFave says, because the economics are better and the impact on end users isn't as great. MONY replaced managers associated with the original outsourcing contract and completed a new organization for the company's IS operations earlier this month. About 60 more people must be hired to round out the staff, says Rogers. There are some promising signs: When one employee received an outside offer of a higher salary, MONY countered-not with araise, but with an analysis of the benefits that the employee would lose by leaving and those that would accrue by staying. The employee stayed. Not everyone agrees that outsourcing problems are on the rise. Stephen Huhn, VP of global business development at IBM Global Services, says the level of con tract renegotiations has remained steady over the years. Renegotiations simply reflect necessary adjustments to changing conditions, he says. But John Halvey, an outsourcing attorney at the New York law firm of Milbank, Tweed, Hadley & McCloy, sees the situation differently. Contract renegotiations used to be almost nonexistent, he says. Over the last three years, however, the law firm has handled renegotiations leading to a dozen contract terminations. In at least one case, a company had to pay the outsourcing vendor "tens of millions of dollars" to cancel, Halvey says. Contract problems were partly responsible for EDS's recently announced disappointing second-quarter earnings. EDS vice chairman Gary Fernandes said 10 to 12 contracts "were forecast at a level we don't think we can achieve," while another contract involved a "substantial dispute" with the client. No one suggests that outsourcing problems are entirely the fault of the outsourcers. Allen Gonchar, president of Compass America Inc., an IS performance-measurement consultancy in Reston, Va., says it's "scary" that many companies outsource operations for which they haven't measured pre-outsourcing costs and service levels, making it impossible to judge a vendor's performance. Telecom carrier Ameritech in Chicago has acknowledged that it outsourced its desktop computing to IBM-then retained Compass to determine total cost of ownership for its 35,000 desktop computers. Many analysts think the outsourcing trend is shifting from mega-deals toward smaller, project-based deals that can be more easily defined-and that let users retain more control. Even in EDS's poor second quarter, the company won nearly one contract per day, averaging $71 million in size. "Companies are mixing and matching, outsourcing application development, for instance, but retaining control over performance and strategy," says Dan Sullivan, a senior VP at Entex Information Services Inc. in Rye Brook, N.Y. Several users are also correcting earlier mistakes in relyi ng too heavily on their outsourcer. General Motors Corp., for example, signed a new 10-year agreement with EDS last summer, then began hiring hundreds of IT execs for an organization that will manage the company's technology and vendor relationships. But some big users still favor large, long-term outsourcing contracts as a way-they believe-to lock in IT skills. DuPont & Co. and Ryder System Inc. both recently signed 10-year deals. Still, CIOs at those companies maintain that their deals are more flexible than earlier contracts, with more guarantees that they will be able to manage, direct, and control the contract. Tom Conarty, IT director at Bethlehem Steel in Bethlehem, Pa., says the company's 10-year, $500 million deal to outsource its day-to-day IT operations to EDS was a big plus because it "allows Bethlehem to focus on strategic business initiatives, on that which distinguishes us." Few experts expect the outsourcing industry to grind to a halt-especially not the vendors. "We continue to see more and more people come to outsourcing decisions in all industries," says IBM's Huhn. And it may take time before it's possible to judge the success of users' moves to bring IT back in-house. But at the very least, their progress so far may dispel the fear that, once outsourced, IT operations can never be reclaimed. 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