InformationWeek
Defining The Business Value Of Technology
November 15, 1999
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Navigating Uncharted Waters
Flash Electronics found that dedication to detail during contract negotiations pays off
Not wanting unexpected costs to affect future budgets, Liu eventually agreed to pay for the upgrades as part of Applicast's monthly service fee. But the intense contract negotiations over such details illustrates the huge effort it often takes to find the right application-hosting provider and ensure a successful relationship. The process required hundreds of hours for Liu, who even interviewed support personnel at the application-hosting candidate firms as part of his due diligence.
According to analysts, this is time well-spent; such dedication to detail is critical for long-term outsourcing success. Most outsourcing arrangements shipwreck on the shoals of issues that aren't adequately explored during negotiations or defined in contracts. These include the negotiations over response times, availability, and such soft metrics as "innovation" or "business-process improvements."
"Too many executives, under pressure for an immediate solution, don't go through appropriate risk analysis," says Dean Davidson, program director at the Meta Group. "What if core technologies aren't delivered? What if service is inconsistent or doesn't meet expectations? Determining these issues up front can avoid communications gaps that later create problems or lead to dysfunctional relationships between the vendor and customer."
Liu knew the benefits of outsourcing, especially since companies such as Nokia often outsource electronics manufacturing to Flash's Fremont, Calif., facility. When a previous material requirements-planning system was unable to keep up with its fast-track growth, Flash purchased a complete enterprise resource planning package from SAP. But with a two-person IT staff and budgets that had to be dedicated to manufacturing equipment, not IT infrastructure, Liu knew he could not afford SAP implementation and support for just 21 users. He estimated the break-even point for bringing the SAP application in-house at 60 users.
The two key issues when negotiating contracts involve pricing and performance, says Richard Raysman, managing partner of Brown, Raysman, Millstein, Felder & Steiner LLP, which specializes in outsourcing and other technology issues. Raysman says customers sometimes think they have a fixed-fee arrangement, but are surprised by contract exclusions, such as fees for higher-than-expected transaction volumes or new development charges. Defining service levels and measuring improvements also consume negotiating time.
McGrory says the most difficult issue revolves around implementation ownership. Although Flash owns the SAP license, it was concerned about the rights to implement changes, such as alterations to a shipping module. "A lot of proprietary business processes are captured. Customers want to make sure they own what is theirs, even though they don't have possession of the software," he says. Applicast tries to structure its deals so that it owns the templates and technology, while the customer owns every instance of it.
Another issue centers on service-level agreements: Which problems require a 15- minute response time, and which can wait for routine maintenance? What are the procedures for keeping customers informed? Applicast works from a generic service-level agreement for two to three months, then revises the pact according to the experience gained. In his negotiations, Liu emphasized specific definitions of responsibilities, down to specific positions, and performance measurements. Other issues included backup, maintenance, security, and Y2K compliance.
Liu's overriding concern was an exit strategy--a lot could happen in three years. Liu and McGrory spent considerable effort working out the details of various scenarios that would let Flash recover its code quickly.
Although contract negotiations are important, Wainewright cautions against letting legalities alone define a relationship. "It's like a prenuptial agreement," he says. "You want to be safe, but you really want the relationship to work without having to fall back on a contract." Rather than depend on the penalties outlined in the contract, Liu says he prefers the incentive of a good referral in an increasingly competitive business.
The intense initial effort Liu put into investigating providers and negotiating the contract has paid off. "Now we can grow faster without any operational limitations," he says. Not only is SAP an operational success since going live in March within the facility, but Liu's staff needs to spend only 5% of its time on ERP outsourcing issues.
Photo by Alan Blaustein
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atthew Liu sat at his desk to review once more the marked-up outsourcing contract with Applicast Inc. Liu, CEO of $40 million Flash Electronics Inc., wanted Applicast to administer and support the SAP application he had purchased. After all, Applicast was chosen for its full-service ability to support and deliver SAP applications. For two months throughout the fall of 1998, the 25-page legal document was passed between the two companies to settle issues such as performance measurements, service-level agreements, and, most important, an exit strategy. The snag: Who would pay for required hardware upgrades?
The three-year contract that Liu and Applicast CEO John McGrory worked out is pioneering in many ways. A lot of unknown terrain, such as best practices, still needs to be mapped out, and the field of "packaged applications outsourcing" is relatively small--it's expected to reach $21 million by 2001, according to Forrester Research. Phil Wainewright, managing editor of ASPnews.com, which tracks the emerging application service provider industry, faults application-hosting providers--many of which are just out of the venture-capital blocks--for not doing a better job with customers. "Customers have to ask about key issues because, in some cases, service providers have not even thought about them," he says.
Go on to the next story, "Electrical-Parts Industry Has A Bright Idea."
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