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6/16/2006
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In Depth: When Outsourcing Goes Bad

Companies have been burned by outsourcing. That has taught some hard lessons.

Lawsuits, recriminations, millions squandered on failed projects--and outsourcing is supposed to be a good thing for businesses?

It's true that many companies benefit from turning over technology management, customer service, and back-office functions to third parties, and the outsourcing business is booming. But the stampede to outsource over the past few years has trampled more than one company. In the past six months alone, Sprint Nextel and Diebold have scrapped or renegotiated big outsourcing engagements. The growing list of deals that have backfired is raising fears in CIO offices and corporate boardrooms that outsourcing can be a high-risk, caveat emptor practice.

Outsourcing is like any other business initiative: It can be executed well or painfully botched. The secret is avoiding the pitfalls that can be seen in some of the more recent high-profile failures. Lack of awareness of IT's true costs is a big one--many companies underestimate what their in-house IT departments do and the flexibility they offer, until they send work to a third party that wants to charge every time it lifts a finger. Other common traps are failure to plan for management transitions, inability to manage a team of vendors, overly ambitious projects, lukewarm executive buy-in, and failure to acknowledge the complexity of offshoring.

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Precisely half of companies rate their outsourcing efforts a success in InformationWeek Research's recent survey of 420 business IT pros. Yet, a third are neutral, and 17%--nearly one in six--call them disasters. That range should give pause to anyone looking to outsource IT or a business process for easy money. Companies also had better be prepared for the possibility of taking work back in-house, because it has become commonplace. Half of companies in our survey have done so, 23% on a major project.

For obvious reasons, most parties to a failed outsourcing engagement--if they're still employed--don't want to talk about the particulars. We tried with the companies that follow, and most turned us down. But in many cases, there's a paper trail as more and more bungled deals end up in court or as the subject of a company's Securities and Exchange Commission filings because they put such a dent in the bottom line.

Understand The Real Costs

Road To DisasterIn 2003, Sprint tapped IBM Global Services to handle a number of key software development and IT management tasks, such as developing a Web services environment that would let Sprint rapidly provision new services to businesses and consumers. There were high hopes for the engagement, valued at $400 million over five years. Sprint CIO Michael Stout heralded it as the best way for the telecom company to "focus on areas of growth and innovation." Sprint was counting on the deal as part of a plan to cut $2 billion in operating costs over two years.

Fast forward to 2006. Stout is no longer CIO, Sprint has merged with Nextel, and the company is accusing IBM in court of failing to achieve the promised productivity improvements and of concocting a scheme to "falsely bolster" its performance metrics.

Where did it go wrong? Sprint's internal accounting didn't properly value the work performed by the in-house IT staff, says a former Sprint IT worker who, along with about 1,000 of his colleagues, was "rebadged" to IBM as part of the deal. When those functions were turned over to a contractor, Sprint was hit with sticker shock and balked at the price for a number of projects meant to boost productivity and hit the goals in the contract. "No new projects were going through the pipeline," says the source, who spoke on condition of anonymity and no longer works for either company. Two hundred or more top engineers also left, he estimates, amid the confusion and lack of projects.

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