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Buyer Beware

More companies than ever have experience with outsourcing. So why are deals still failing?

By many measures, outsourcing is a great success story. Service providers may have taken a severe beating from politicians and the press this election season, but they seem to have won the battle that counts most — persuading executives that outsiders can often do nonstrategic work cheaper and better. The result is a worldwide IT and process outsourcing market that Gartner predicts will swell from $293 billion in 2003 to $429 billion by 2008. As one executive said in a CFO magazine survey last summer, “Outsourcing cannot be stopped.”

But you don’t need to look far for signs of trouble. First, there are the high-profile flops, including JPMorgan Chase & Co.’s recent decision to pull the plug on a seven-year, $5 billion deal with IBM; the cancellation of a big contract between The Dow Chemical Co. and EDS; and EDS’s ongoing trials with the U.S. Navy, which have cost the outsourcer $1.1 billion and contributed to a recent credit downgrade. Then there are the failure rates for outsourcing in general, which range from 25 percent to well over 50 percent, depending on the study.

Granted, failed transactions are nothing new. But the size of these failed deals alone demands a closer look at what went wrong — shredding a $5 billion contract is jarring for both client and provider. Moreover, it appears that better project management may not be the answer: most outsourcing problems derive from the way executives conceive their deals and set them up.

Inside Outsourcing

Last year, the board of a New England-based technology company decided that the firm should emulate its peers and outsource its software development to India. It seemed like a good idea — the average hourly cost of a software developer in India is $6, compared with $60 in the United States. But the project has gone poorly: the U.S.-based employees are struggling to manage programmers sitting halfway around the world, and much of the work coming back from India has been subpar. “The board said, ‘We want you to outsource,’ ” reports a finance manager at the company. “That command flowed down to the executive team and they forced it onto the guys managing the project. We just rushed into it.”

This illustrates two problems that undermine many outsourcing efforts. One is that companies simply sign up for projects without enough preparation. “It can be like an M&A activity,” says Mark Lutchen, partner and leader of PricewaterhouseCoopers’s IT business risk management practice. “Once the CEO has decided he wants to do the deal, it’s up to the CFO and everybody else to make it work.”

The second problem is more worrisome: executives often strike big deals for the wrong reasons. They may, for instance, blindly imitate competitors when in fact outsourcing is not appropriate. Or they may turn to outsourcing as a way of papering over deeper problems.

Consider a situation that was common in the early 1990s — outsourcing as a backdoor way for financially strapped companies to raise cash. “The dark side of outsourcing has always been that it can really just be financial engineering,” says Bruce Caldwell, an analyst at Gartner. “The outsourcer might say, ‘We’ll take over your assets to help you balance your books. You’ll get some cash to the bottom line for the next quarter, and in exchange we’ll have revenue from you for the next 10 years.’ It’s basically a loan.”

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