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The Importance Of An Outsourcing Prenup

Rift between Sears and CSC shows the need to plan an exit strategy

A merger can quickly change a company's IT strategy, and in particular strain relationships with vendors. That was made clear last week when Sears Holding Corp. subsidiary Sears, Roebuck & Co. terminated its 10-year, $1.6 billion IT outsourcing deal with Computer Sciences Corp. less than one year into the agreement.

Sears ended the engagement "due to CSC's failure to perform certain of its obligations," the retailer said in a Securities and Exchange Commission filing. CSC countered in its own SEC filing that Sears' reasons for ending the deal are "contrived" and that Sears' merger with retailer Kmart is what's really behind the decision.

The CSC deal may have been a victim of cost-cutting at the combined Sears and Kmart.

The CSC deal may have been a victim of cost-cutting at the combined Sears and Kmart.

Photo by Jim Cole/AP
Sears wouldn't be the first company to walk away from a major outsourcing deal following a merger. Last year, J.P. Morgan Chase & Co. scrapped a $5 billion services agreement with IBM in the wake of its merger with Bank One Corp. In 2002, Australia's Suncorp-Metway Ltd. acquired AMP General Insurance and terminated that company's outsourcing contract--also with CSC.

Regardless of why a company ends an outsourcing engagement, these examples point to why executives who are considering outsourcing need a detailed road map for bringing IT operations back in-house. "If you wait until a problem arises, it's usually too late," says Cutter Consortium analyst Jeff Kaplan, who last week released a report on "backsourcing." Terms for disengaging should be detailed in the original contract. "You need to know who's going to be responsible for what if you don't want to end up spending a lot of time and money in court," he says.

Sears and CSC won't avoid time in court, it appears. Sears' filing, dated May 13, revealed that CSC sought a federal court injunction to prevent Sears from ending the contract. The court denied the request. Sears and CSC declined to comment.

Sears signed the deal in June for CSC to provide a range of IT services, including support for desktops, servers, and telecommunications systems.

With both sides not talking, speculation is rife about the deal's failure. The fact that Sears is backing away from the agreement in its early stages may suggest that "the transition has failed," says William Bierce, a New York attorney who specializes in outsourcing contract law.

Yet the reasons for ending the deal might merely come down to changed priorities. Former Sears CIO Gerald Kelly authored the outsourcing plan. Kelly left this year following the merger, and Kmart CIO Karen Austin was given the top technology job at the combined company. Kmart chairman Edward Lampert wants to cut costs. "A $1.6 billion outsourcing deal may have looked like an easy target," says Michael Guilbault, a Technology Business Research analyst.

CSC may have to take a charge against earnings to cover costs, including software and equipment, related to the Sears deal, its filing says. Cindy Shaw of Moors & Cabot estimates CSC "may have already dropped more than $100 million on the contract." CSC says it will seek to recover those costs in court, if necessary.

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