Pay As You Go - InformationWeek
07:18 PM

Pay As You Go

American Express endorses flexible pricing approach with $4 billion outsourcing deal.

What's worth more: predictable IT costs or operational flexibility? With conventional outsourcing, CIOs sacrifice a degree of independence for fixed-cost IT services. But some executives want alternatives--like American Express Co. executive VP and CIO Glen Salow, who just signed a seven-year, $4 billion outsourcing contract with IBM Global Services. A portion of the IT services rendered will be provided--and paid for--as needed.

Glen Salow

CIO Salow expects utility pricing to save American Express "hundreds of millions of dollars" in costs related to IT during the next seven years

Salow chose IBM's utility-based model of service delivery to support American Express' campaign to convince its customers to use their credit and charge cards for more than travel and entertainment, two areas of the economy where spending has dropped. "We want people to use their cards on things less tied to the economy," such as groceries or online purchases, he says.

If that happens, IT is on the hook for keeping operations running to meet the increased demand. But Salow says his team is more valuable building revenue-generating apps designed to support planned growth. Enter its contract with IBM--one of the largest outsourcing deals in recent years--in which American Express will pay for the use of resources such as CPU hours, megabytes of storage, and help-desk services.

"The majority of this deal is based upon a utility model, although there's an element of each area we outsource that has a fixed price," Salow says. He expects the company to save "hundreds of millions of dollars" in costs related to hardware and software acquisition and maintenance during the next seven years.

American Express is buying into an emerging form of outsourcing that few large companies have embraced. Called utility computing, on-demand computing, or usage-based pricing, it's a relatively new wrinkle in outsourcing, as well as in software and hardware purchases. Think of the new model as "pay-as-you-go" computing. Businesses get the IT resources they need, as they need them, and are charged accordingly.

IT research firm Gartner says spending on outsourcing will grow from $101 billion in 2001 to $160 billion by 2005. And if deals like American Express' are any indication, the utility approach could be a significant factor in that growth.

Convenience-store chain 7-Eleven Inc. last month signed a seven-year, $175 million outsourcing contract extension with EDS that's structured much like the AmEx-IBM agreement. EDS also has signed utility-based outsourcing contracts in the past six months with chemical maker Solutia Inc. in St. Louis and Coors Brewing Co. in Golden, Colo. Management consulting firm Towers Perrin and flooring maker Dal-Tile International Inc. also have signed usage-based contracts with IBM Global Services.

Vijay Gurbaxani, professor of IS at the University of California at Irvine's Graduate School of Business, says utility-based computing appeals to senior business executives, who like the idea of paying only for what's used. One criticism of conventional outsourcing contracts has been the difficulty of determining just what a company is being billed for. "Pricing by Mips didn't make intuitive sense," he says.

Outsourcing has always been a trade-off, offering financial predictability but not operational flexibility. Usage-based pricing flips that around, at least in theory, prompting rapid response from contractors as IT needs change.

chartThat apparently was a trade-off worth making for American Express, a company that saw revenue slide 5% in 2001 to $22.6 billion. About one-third of American Express' 6,000-person IT staff will become IBM Global Services employees working out of AmEx data centers, which the company will still own. American Express has some experience with the model: It has an existing usage-based outsourcing contract for PCs and servers with Compaq.

Like Salow, 7-Eleven CIO Keith Morrow chose the usage-based model in order to free resources needed for new IT initiatives. By 2004, the Dallas company plans to install what it calls virtual-commerce terminals at 3,500 stores nationwide that would let customers conduct bank transactions, pay bills, and buy money orders. The agreement with EDS takes the place of a fixed-fee contract. It covers storage, hosting and maintenance of Oracle Financials, project management, and other tasks.

In another utility deal, this one between Hewlett-Packard and cell-phone maker Nokia Corp., HP Services is taking over management of seven operations centers and 4,000 Windows servers. However, HP Services president Ann Livermore acknowledges that this model isn't for everyone. Uncertainty about IT demand holds some customers back. "They're only willing to go to a usage-based model if they feel they have control over consumption," Livermore says.

Even when it works, utility pricing can be tricky. "The key to any service level, using the utility model or some other type of outsourcing model, is that there's shared risk between you and your service provider," Morrow says. "If you have an outage that costs your company money, you have to make sure it also costs your outsourcer money."

CIOs should make sure their prices fall if the cost of the underlying technology decreases, he advises. 7-Eleven negotiated price breaks that kick in when it increases the storage it uses, giving the company incentive to grow. "You need to be vigilant and price your utility-based contracts this way," Morrow says.

Another area that requires vigilance under the utility pricing model is how data is used. Jeff Vogt, VP of sourcing at Brunswick Corp., a maker of leisure products, is creating "digital cockpits" that let managers gauge supplier performance by various measures related to cost, freight charges, and quality. To do that, workers at the Lake Forest, Ill., company need up-to-date information from a variety of legacy data sources--mostly mainframes managed by an outsourcer. That means each request for fresh data carries a cost. While the staff would like to work with real-time data, Vogt says, it's not always worth the price. "That's the balance we have to find," he says. "Financial data you might have to refresh every day, but it might make sense to do supply-chain data weekly."

Some business-technology managers say utility pricing works best if the vendor can implement asset-management systems that are compatible with those the customer uses. David Doney, IS director at Blue Cross/Blue Shield in Detroit, says he chose Compaq to implement utility-based PC services for that reason.

The health-care insurance provider uses software from Peregrine Systems Inc. to track assets. Doney says Compaq was the only vendor willing to implement Peregrine at its end. "They even went out and hired someone with Peregrine expertise," Doney says. Blue Cross/ Blue Shield uses about 10,000 PCs and notebook computers. Under a five-year contract, Compaq will add or subtract PCs and adjust the monthly services bill accordingly. However, variable pricing applies only to services such as help-desk and on-site support. Blue Cross/Blue Shield still leases the hardware, even if it isn't being used. Still, Doney says the program produces big savings, noting that services can comprise up to 40% of his monthly desktop costs.

Utility computing looks promising if vendors can deliver on their pledges to save businesses money while at the same time delivering computing power and services as needed, analysts say. "This really is a more efficient technological way to buy processing power," says Andrew Schroepfer, president of Tier 1 Research, "and a more efficient way to pay for it."

-- with Eric Chabrow, John Foley, Paul McDougall, and Chris Murphy

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