Negotiating better deals

The approach of Middle Eastern enterprises to the concept of IT outsourcing has been hesitant at best, but the trend continues to gain momentum globally. How can enterprises retain control when they hand over the reigns to a third party? Sarah Gain investigates.

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By  Sarah Gain Published  October 9, 2005

|~||~||~|IT outsourcing, by its very nature, involves turning over managerial and operational control for all or part of a corporation's operations to a third party service provider. With reports that the global outsourcing market exceeded US$200 billion in 2004, a large number of enterprises are evaluating whether the potential rewards of outsourcing outweigh the inherent risks associated with relinquishing control of key business functions. "Analysis has shown that apart from the popular and often incorrect belief that outsourcing reduces costs only, there are several main reasons why companies outsource," says Ayed A Al-Ruwaili, operation and maintenance unit supervisor for the CR IT division of Saudi Aramco. "It allows the organisation to focus energies on its core business, obtain greater flexibility and predictability in service costs and gain access to world best practices. It enables [the customer] to gain immediate access to scarce skills and resources and realise cash for under-utilised assets," he adds. Despite the benefits, however, there are still a number of risk factors frequently identified by companies when it comes to outsourcing, including lack of accountability for the delivery of quality services and reduced ability to reinstate or continue operations in the event of a major service failure or contract termination. "Things change when you outsource. New processes are introduced, and new relationships are formed, new management is involved and new procedures are enforced. Given the amount of change that is occurring simultaneously, experience has shown that generally-accepted service levels will drop in the first few months of a new outsource relationship," Al-Ruwaili explains. Outsourcing contracts offer up a potential minefield to be negotiated by both parties to the agreement. The Simmons & Simmons International Survey 2005 reveals that 70% of outsource deals leave either or both the parties unhappy and have to be renegotiated within the first two years. A staggering 50% fail to prove satisfactory within year one. 90% have major issues arising between the parties, and 55% have disputes, many of which lead to litigation. 95% end early, with half being formally terminated. Such results are not acceptable to either the customer or the service provider, resulting in loss of revenue to both sides. According to David Barrett, global head of IT and outsourcing and partner at international law firm Simmons & Simmons, "Often it is not a dramatic breakdown in delivery. Sometimes the contract is met, but not the customer's expectations. A complex relationship is bound to have issues when it comes to communication, and these can escalate out of control if progress is not made when customers seek change or evolution,"he adds. Although there is a great need for outsourcing initiatives in the region, the Middle East's take-up of the concept has been somewhat held back for a number of reasons. In part, this can be attributed to the negative reputation that precedes outsourcing, but the immaturity of the marketplace, combined with a lack of understanding and a conflict between the way service providers and customers themselves perceive the true nature of outsourcing, are also significant factors, as Edward Cunningham, sales and marketing director for Injazat Data Systems, explains: "Many organisations look at IT outsourcing as a resource model, while providers look at it as a service based model." In order to overcome this, organisations must be prepared to make a paradigm shift, Cunningham continues. "When outsourcing to a service provider, organisations [should view the process as] procuring a service based on a defined scope, level of services and price [and] the service level agreement is ultimately the vehicle through which the business can exercise its control. Managerial control of the IT operation still resides with the service provider." The perception that they will lose the ability to monitor and motivate performance from the service provider is another factor that deters many businesses in the Middle East from the possibility of outsourcing even small areas of their infrastructures. While outsourcing, in the hands of a quality vendor, can allow a dispassionate review of IT and strip out the politics of purchasing decisions, there is still a concern on the part of customers that they may not be able to hold the vendor accountable for service failures. The element of mistrust can be avoided if customers select their service providers with care in the first place, as Richard Stockdale, CEO of Lloyds TSB Global Services, points out: "Always keep in mind the selected vendor will essentially be servicing your company's customers," he cautions. "Is this something with which, considered from a 360 degree view point, you feel happy for the vendor to be entrusted? If the vendor does not do it well, your customers will in turn blame your company and may vote with their feet," Stockdale adds. While good channels of communication are just as essential in an outsourcing partnership as they are in any other relationship, this may not always be enough to completely eliminate all risks associated with outsourcing. To ensure a more solid grounding for this type of undertaking there are a number of safeguards that companies can build into their outsourcing contracts that may reduce such risks, allowing enterprises to retain a degree of leverage and control over the vendor's performance obligations and its ability to keep operations going. "Risk is the possibility of loss as a consequence of uncertainty. For risk mitigation, two critical areas that demand managing have lacked serious attention. The first area is retained in house capabilities and the second comprises the formation, development and support of client/vendor relations," says Al-Ruwaili. Contract provisions may be used to retain control over service delivery. In fact most, if not all, outsourcing contracts contain detailed provisions requiring the vendor to meet predefined performance standards. The types and levels of standards vary depending on the deal, but may include availability, response time, accuracy and time to completion. Failure to meet these standards may incur damages for the vendor. "Service level agreements (SLAs), are a central facet of any vendor/ client agreement, born out of a reasonable need to make sure vendors consistently deliver at the standards the client requires," Stockdale explains. "There is a need for the vendor to be able to understand and track its performance in key contract areas, as well as a need for the client to keep the vendor in line by extracting financial penalties for under achievement of SLAs. To that end, SLAs are to an extent both a road map and an adversarial weapon," he adds. Many customers considering entry into large outsourcing transactions are looking to use the structure of the relationship as a medium for retaining control over the vendor and enhancing their own ability to motivate optimum performance. There are a number of innovative deal structures that can bring these results, including joint ventures, equity interests, strategic alliances and risk sharing and reward strategies. "A partnership contract needs to be comprehensive and capable of evolution, reflecting good practice," says Barrett. "[It must be] tailored to both sides' expectations at a senior level and understood by key players. It must reflect the wisdom of models and precedents, but not be a slave to them," Stockdale states. A joint venture (JV) contract structure involves the formation of a separate entity by both the customer and the vendor, with ownership interest retained by both parties. The JV acts as the service provider to the customer and potentially to other customers in the same industry or geographic area. Employees and assets of the customer, as well as those of the vendor, are transferred into the JV and in some cases, one or both parties make a capital commitment to the JV. E-Commerce & Trade Services (Middle East) (ECTSME), is just this type of venture. Established in 2001 by technology provider E-Commerce & Trade Services (ECTS) and Emirates International Bank (EIB), the company provides regional banks with an advanced and comprehensive trade services outsourcing solution. "The system architecture of the ECTS platform allows banks to retain branding and real-time controls over their trade service process, while reaping the many benefits provided by the solution," according to Daniel Cowan, CEO of ECTS. The full spectrum of document handling and processing activities is catered for by the JV's multi-bank solution and the trade finance processing solution combines the use of workflow, imaging and bar-coding technologies to provide a scalable platform that automates all trade finance activities. Banks sign a comprehensive SLA with ECTSME, prepared and endorsed by separate legal counsel for the parties. The documentation provides legal protection and defines the transaction processing service level standards. The banks then receive monthly service level reports to monitor performance against the agreed service delivery. The design of ECTSME as an independent service provider, combining the technological know-how of ECTS with industry insight from EBI, has enabled it to offer solutions more specifically tailored to the needs of the banking sector. The JV has also allowed its original customer, EBI, to flourish. General manager of corporate banking, Abdul Wahed Al Fahim, attributes the model with EBI's success in being named "Bank of the Year" in the UAE by several financial magazines in recent years. "ECTSME's innovative trade services solution has allowed EBI to extend to its customers the benefit of improved processing turnaround times, while at the same time grow the bank's trade finance activities and improve transactional bottom lines," he explains. Other agreement structures can also give the vendor a vested interest in the project and therefore promote greater concern for the venture's success. The customer may look to take an equity interest in the vendor or a vendor affiliate formed to provide services to a particular industry or in a particular area. The equity interest may be coupled with a management role, such as a seat on the board of directors, or in participation in strategy meetings. Alternatively, a strategic alliance entails the creation of a contractual relationship between parties following which the customer and vendor team up to maximise the benefits of the service relationship. "Such an alliance may include the cross selling of services so that not only is the vendor providing services to the customer, but may also agree to receive certain services from the customer as a preferred provider," according to Barbara Melby and Michael Pillion, lawyers at US law firm Morgan, Lewis & Bockius. A strategic alliance may also involve the implementation of a royalty or marketing strategy through which new technologies developed as part of the relationship are offered to third parties. One such alignment exists between Emaar IT (formerly Sahm Technologies), a subsidiary of Emaar Properties, and Indian services giant Wipro. In 2004 the firms formed a strategic partnership to provide Oracle e-business suite application management services for Emaar Properties' customers in the Middle East. The partnership is aimed at delivering cost-effective services that are key to its clients' requirements. "[Wipro's] relationship with [Emaar IT] is strategic and expands Wipro's services in the region," Arvind Bhatnagar, CEO of Emaar IT, explains. "Both companies want to bring new ideas to the market. These will take time to get bedded, however, just a couple of success stories will make others follow suit. There is always pressure on your bottom line and such partnerships help ensure that managed services methodology works," he adds. Raman Sapra, Middle East regional manager for Wipro, also concedes that there are challenges associated with outsourcing strategic alliances, such as maintaining clear communication between businesses and technical teams. "Managed service is a new concept and customers are cautious, as they should be. Customers are taking firm steps and using the understanding of initial pilot projects to build relationships with IT companies," he states. Many customers wish to implement some form of gain-sharing mechanism into the outsourcing partnership. This may include bonuses based on the vendor's ability to reduce the customer's spending, and incentives based on the number of projects or services eliminated without cutting front-end services. In some instances, the vendor has proposed reduced pricing or guaranteed increases in profitability by taking a bonus based on customer profitability and satisfaction. Stockdale emphasises the need for flexibility to come from both sides, however: "When an SLA is being drafted it needs to be realistically thought out, and of course a realistic and workable measurement tool must be developed and put in place to maintain performance," he acknowledges, "But an unfair and impractical SLA being foisted on a vendor is counterproductive. Ongoing dialogue and relationship building with vendor will result in a progressive acceptance of the client's requirement." As the outsourcing industry has become more mainstream and established, however, an element of unity and relationship management is increasingly being injected into the SLA process as both parties move to actively embrace joint governance measures and a joint commitment to the future. Nonetheless, Stockdale still underlines the need for caution: "These new world SLAs, though more collaborative, must still be closely monitored by both sides to ensure they remain dynamically flexible," he warns. "The longer a satisfactory situation exists between parties, the more logical it is that the vendor, if it has proved it can perform well, gradually becomes a part of the company's 'family'. This cannot be allowed to encourage complacency and neither should it lead to the disposal of penalties for non-achievement of SLAs," he adds. In the outsourcing contract, the customer may wish to include a general provision whereby it retains approval rights over certain strategic decisions relating to the technology and make-up of both system and network architectures. More focused provisions also require customer approval over specific types of changes to technology and service levels. For example, in a dedicated environment in particular, many customers seek to retain further approval rights over the implementation of new technologies, or changes and additions to existing technologies. "In any outsourcing relationship, the service provider and customer will have to manage issues of 'substance', [including] the replacement and updating of hardware and the terms of employee transfers," says Robert Kane, head of airline process outsourcing at Mercator. With resources either being terminated or transferred to the vendor, the outsourcing customer can easily lose touch with how its operations are run, as well as what is new in the technology marketplace. It is essential, however, to make efforts to keep in tune with operations, as well as with the developing landscape of the technology market. This is key to being able to bring the operations back in house, or even simply to have the knowledge to negotiate with a new provider if existing relationships go sour and re-sourcing becomes necessary. In order to tackle this, Stockdale says, "A client [should] set up a division tasked with managing all of its outsourced arrangements, seeing the various vendors are executing under the contract as they should be, keeping in touch with them and exercising the management control element of the relationships." Emaar IT's Bhatnagar agrees: "Educating staff is necessary. Implementation is one thing, but sustenance is a totally different ball game," he says. In addition, contract provisions may be used by companies to keep abreast of their own technology environment, as well as of changes in the industry. So that they remain up to speed with how the systems used to provide the outsourced services actually operate, periodic training sessions need to be arranged for the customer's employees. Training during which the vendor updates the customer on new technology trends, as well as the creation of detailed documents and manuals outlining procedures, may also be helpful to businesses, as will access to the systems and facilities used by the vendor for audit and information purposes. "Like any business relationship, [outsourcing] partnerships can fail at any stage - they require attention, care, and diligence," warns Abdul Karim Riyaz, business technologist for Computer Associates (CA). "There are some costs associated with giving up control of critical assets - a business may lose out on the experience, knowledge and skill development that would ordinarily be associated with managing its system itself," he adds. Indeed, the key to control in any outsourcing agreement is for the customer to be knowledgeable and in possession of the most up-to-date information. In order for this to be possible, the vendor, in turn, must be prepared to provide its customers with a variety of reports detailing the kinds of systems being used, the utilisation rates of such systems, any systems problems or failures, data and system security compliance, and whether or not the performance meets the predefined service levels. "SLAs should be supported by automated tools to collate and display agreed metrics for the purpose of objectively managing performance levels, carrying out ongoing process improvement, and being proactively engaged in the resolution of issues," states Stockdale. When considering outsourcing, customers invariably have concerns about what will happen if the vendor does not perform, and how to ensure business continuity and minimal disruption should the outsourcing relationship disintegrate. Many enterprises in the Middle East are under the misconception that they may be held hostage under an outsourcing contract. It is possible, however, to ensure that the impact of any service failures is minimised by observing some basic best practices, as Kane points out. "Businesses need to be aware of what they want out of the contract and how they can measure its success. For example, if they want to reduce costs, how much do they want to reduce them by, and in what areas? If the business benefits the customer wants to see can't be measured with numbers, how can they be written up in a contract?" he asks. "Companies should also be aware that their business will change over time, and that the contract must allow for that. The pitfalls in outsourcing usually come from taking a short-term, blinkered view of objectives." However, for many corporations in the region, the underlying reason for their caution when it comes to outsourcing is that, while it is possible to build a host of different clauses into the contract, it will simply not be possible for the customer to migrate off the vendor's systems quickly enough to avoid disruption if services become unacceptable. One contractual safeguard to this is to ensure the contract contains a termination assistance provision that prohibits the vendor from simply abandoning the customer for any reason. This assistance could range from providing a full range of services for a designated period of time, to providing specific transition and training assistance. Other protection could include an obligation to continue to perform during a dispute and the unfettered right to demand the return of customer data at any time. "Big problems do happen, and when relationships break down customers can begin to feel locked in by the contract," acknowledges Barrett of Simmons & Simmons. "If it is not possible to restore [the customer's] faith in the contracting process, and the dispute escalates beyond all possible resolution, there must be adequate termination rights in place. This clause must also include some form of post-termination rights and assistance for the customer," he recommends. As with many other types of contract, the ultimate weapon of any customer to motivate performance, however, is to withhold payment from the service provider upon termination of the contract, at least until conflicts have been resolved. Legitimate reasons for financially penalising an outsourcing service provider include breach of contract, failure to provide critical services, and/or repeated failure to meet the agreed service levels. "If a vendor fails to meet the service levels, a standard provision is that the vendor will then be liable for damages, which can be offset against its fees," according to Melby and Pillion, adding: "For implementation and transition failures, many customers also negotiate the right to withhold payment or impose liquidation damages for delayed or unsatisfactory services and deliverables." Prior to entering into any outsourcing agreement, proper legal counsel should be taken by all corporations, as the kind of safeguards available will vary from one deal to the next. The onus is on the service provider's team to listen to the customer's views regarding critical requirements, and to develop innovative ways to respond to the risks being identified. Industry experts believe there will be concerted efforts on the part of major vendors over the next few years as they attempt to convince enterprises to trust them, or their local partners, with elements of business operations. However many Middle East corporations recognise that outsourcing is not the only answer to their problem of increasingly complex technology architectures, as IDC points out: "An in house approach that involves sophisticated management technologies can enable companies to reduce operational costs and maintain full control over their networks simultaneously," says Heini Booysen, the research house's software programme manager for the MEA region. Despite of this, Middle Eastern companies need to boost effectiveness and grow their core competencies to better compete in the increasingly high-pressure environment and shrinking marketplace, and outsourcing selected systems or processes is slowly coming to be seen as one of the more viable options that enterprises have available to lighten the load. While the concept of outsourcing may have taken a little longer to become established in this region, the concerns are gradually fading as demand for streamlined, more convenient working practices grows. As long as enterprises are able to negotiate a strategic, mutually beneficial relationship with the correct partner, and actively manage that relationship, recognising that problems that arise can be attributed to failures on both sides, then it seems that, as Stockdale says, "Outsourcing has arrived in the Middle East and is here to stay." The drawing up of a contract with all the necessary safeguards; the creation of a competent management team that will oversee and implement the contract's terms, and the establishment of good channels of communication, can be used to significantly reduce many of the risks of outsourcing. It must be remembered; nonetheless, the signing of such an agreement is still only the beginning of the partnership. Re-assessment and negotiation must continue. "Many companies are under the impression that once the business has been outsourced it is no longer their problem. This could not be further from the truth," insists Aramco's Al-Ruwaili. "Signing the deal is only the start of the relationship. At the end of the day it is still your business, all you've done is appoint a specialised management team to look after it more effectively."||**||

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