Analyzing The Outsourcers 3

And the penalties need enough teeth to keep the vendor's attention. Though Wejman is pleased with the service EDS provides, Continental's IT systems, using customized monitoring software, automatically invoke substantial penalties outlined in the outsourcing contract when EDS doesn't meet a service level, which typically happens about once a year. "It doesn't compensate for our loss in revenue, but it gets senior-management attention, and there's no forgiveness," she says. Wejman adds that the fine is hefty enough that it goes across the desk of EDS CEO Dick Brown, ensuring that the problem gets immediate attention and repair.

Pinpointing the appropriate penalty is the tricky part. Businesses typically want to tie penalties to revenue losses, but vendors resist that because liabilities could be huge. Outsourcers generally get penalized less than it costs businesses but may pay in other ways. "Most companies don't want to earn a penalty because the amount of penalty won't make up what they'll lose in business," says EDS's Frederick.

Some executives think there's room for reason in outsourcing relationships, especially early on. "When we bring a new person or company in, we give them a runway," says Nextel's LeFave, who has negotiated seven deals. For instance, Nextel is giving EDS a six-month grace period as it moves Nextel's data center from Atlanta to Charlotte, N.C. On the other hand, Nextel renegotiates and ratchets up its service-level agreements each year. Amazingly, Nextel hasn't had to invoke any fines with any of its outsourcers.

Rather than pay substantial penalties, outsourcers try to work into their agreements options to earn back penalties -- if a vendor doesn't meet a service level one month, it can earn back that penalty based on superior performance the following month. But Providian CIO Saber warns that because outsourcing vendors are more experienced at the bargaining table, they're better equipped to write service-level agreements to their advantage. So rewarding outsourcers for superior performance must be tied tightly to business value and financial gain, he says. For instance, a hosting vendor suggested Providian pay a bonus for consistently providing 100% uptime. "If I wanted it at 100%, I'd ask for it," he says. "If you're not driving business value to me, I won't pay it."

Accenture prefers to measure performance by the success of a business and earn a bonus based on financial results -- as well as pay a penalty when it fails. Accenture runs all IT, computing, and applications for the London Stock Exchange under a deal that ties its bonus to the exchange's ability to process transactions. "If you're always using a stick on a provider, it's hard to give it an incentive to perform better than the base level," says Martin Cole, managing partner for global outsourcing at Accenture.

Another key for service-level agreements is to make sure they're flexible. As companies' needs change, IT executives must be able to renegotiate the agreements. 7-Eleven outsources 75% of its IT operations, including its mainframe data center to Affiliated Computer Services, midrange data center to EDS, help desk to Telvista, and network operations and management to AT&T. The convenience-store chain reworked its service-level agreements after Sept. 11, to include getting more granular network monitoring. And 7-Eleven made substantial changes to security relating to response time and limits of liability.

As the emphasis on service-level agreements suggests, an executive's relationship with an outsourcer in many ways is marked foremost by caution: "I'm bringing you in to save us money; don't screw it up." The slow economy, coupled with bankruptcies such as WorldCom's, have heightened executives' financial concerns. Six out of 10 survey respondents consider financial viability and size to be highly important. The companies have had their financial challenges, with the market capitalization for the publicly traded outsourcing firms we rated dropping nearly 47% in the past three years. In an effort to boost revenue, many vendors have expanded their offerings. "But the depth isn't there anymore. Many don't have a core group and a core expertise anymore," 7-Eleven CIO Morrow says. "Now, it's 'We do everything.' At the same time, technology has become more complex."

Executives are clearly spreading their risks across multiple outsourcers, including small and midsize vendors focused on specific areas. While we rated nine top firms, nearly everyone interviewed for this story had multiple outsourcing relationships, including many with ties to firms in India for application development or software maintenance. Two-thirds of people surveyed cite companies outside this top nine as among their three main outsourcing providers. Still, Enterprise Management Associates' Wilson recommends checking the books of outsourcing partners, big and small. "I'd look for a company that will be around for years to come," he says.

It's also clear that, differences aside, outsourcers and their customers are cautiously increasing their commitments to one another. A third of companies say they'll increase spending with outsourcers next year, and 44% will keep it the same. Almost 40% say they're more reliant this year than last on outsourcers, while only 17% say they're less reliant.

Continental's Wejman offers an example of why. Outsourcing relationships aren't always perfect, but she likes the fact that she doesn't have to worry about mundane necessities such as battery-powered backup in her data center. "I can focus on more important things to Continental's business," she says. That's the kind of value in a relationship that can be tough to measure. But it's even tougher to do without it.

See how the companies ranked. Click here. Photo of Claudio by David Strick.
Photo of LeFave by David Deal.