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During the next few years, over US$110 billion worth of outsourcing agreements will be up for renewal, and billions more will be subject to mid-term re-negotiation. Examining the key market drivers behind the current rise in re-structurings and the factors that prompt contracts to be re-negotiated will shed some light on this occurrence. Clients must consider the multitude of options and opportunities that exist when re-structuring outsourcing arrangements or as current contracts come to term. In either set of circumstances, the aim is to give clients a better chance at success the second time around.
Current State of Re-structurings
Last year witnessed an unprecedented volume of contract re-structurings, representing almost a quarter of the total contract value awarded globally in the broader commercial outsourcing market --- contracts worth more than US$50 million. This compares with a historical average of just 15%. Both the volume and the value of re-structurings in 2005 (more than US$18 billion) were all-time highs.
All indicators point to more re-structurings ahead. Indeed, re-structurings accounted for more than 40% of all contracts signed in this marketplace during the first quarter of 2006.
The industry is entering a period in which it will see a heightened volume of first-generation agreements being re-structured. Industrywide, there are some 315 transactions, originally valued at more than US$92 billion, which will reach their contracted end dates during 2006 and 2007. These 315 transactions represent more than a fifth of the active outsourcing agreements in the industry today.
Many contracts are also re-structured during their initial terms. Dynamic business conditions often force re-structuring of large outsourcing deals within 18–36 months. Clients want to be able to adjust quickly to significant changes in their own business and marketplace.
Factors Driving Re-structurings
After experiencing first generation or even second generation outsourcing deals, companies feel more comfortable about breaking their sourcing approach up into smaller pieces handled by a number of best-of-breed service providers. Multisourcing allows clients to leverage multiple service provider capabilities, deploying the best of each service provider's core competencies. Multisourcing also keeps the cost of service delivery at market-competitive levels. Companies must, however, ensure that they are able to handle this new level of complexity by having adequate governance and relationship management arrangements in place.
Clients are also looking for more options when it comes to offshore service delivery. The growth of Global Service Delivery (GSD) or offshore outsourcing is undeniable, and this growth is expanding to encompass multiple operational models, a greater number of countries, a broader and deeper range of outsourcing activities and much more competition in the form of diverse service providers offering improved capabilities.
In addition, clients want improved access to service provider creativity, innovation and best practices. A large number of the contracts approaching renewal are with large, full-service line, multinational service providers. These enterprises have the capabilities and technologies at hand not only to deliver an efficient and effective operational service, but also to fully support a client's strategic agenda. However, many outsourcing clients have found that in past contracts they have been delivered a rather "soiled" approach and that their service provider did not leverage its considerable resources and expertise to its benefit. Many buy-side companies are, therefore, now considering re-structuring their contracts in order to gain better access to and benefit from such assets.
These drivers all center on the client's desire to benefit from advances in the sourcing market. Clients also look to re-structurings as a means of increasing their options, flexibility and control within their sourcing relationships. For some clients, re-structurings are driven by a desire to eliminate that "locked-in feeling" and improve long-term manageability by re-establishing a "normal client" relationship, where the continuation of the contract is a free choice at the client's discretion.
A New Competitive Market
Historically, most outsourcing re-structurings have been re-negotiated with the incumbent service provider. Indeed, research shows that less than 15% of companies change service providers, and only a handful of organizations bring the service back in-house. While this may seem like great news for service providers, the trend is toward both switching service providers and moving from a single service provider strategy to a multiple service provider strategy.
Underpinning these shifts is a change in client preferences, a greater diversity of competition, a leveling off of growth in the IT outsourcing market and a relative decline in the total value of new IT outsourcing contracts awarded. Today, there are many more bees and much less fresh honey.
By any measure, competition in the outsourcing market has intensified significantly. There were 34 different service providers that signed the Top 100 deals in 2005, up from 29 service providers in 2004 and 20 in 2003.
Also, at a time when the number of outsourcing contracts signed continues to increase each year, their aggregate contract value is remaining relatively static. The significance of re-structurings within the market is, therefore, growing markedly from a historical average of 15% of total signings, to 24% in 2005, and potentially more than 40% in 2006 and 2007.
To grow in this environment, a service provider must not only have to retain renewed contracts, but also to win new deals and re-structurings. For incumbents, therefore, protecting market share has never been so important. This is especially pertinent for the "Big Six" of outsourcing --- Accenture, ACS, CSC, EDS, HP, IBM --- which are the current service providers on 72% of the contract value up for renewal across 2006 and 2007.
It can no longer be taken for granted that the existing service provider will retain all or even part of the original deal through a re-structuring. Client retention will increasingly depend upon an incumbent's ability to offer a competitive proposition for every facet of the service. This will often require significant changes in price, contractual terms, scope and delivery approach from the original agreement.
With market conditions now strongly favoring buyers, it is perhaps hard to believe that there is still a significant risk that they will fail to gain any additional material benefit from a re-structuring. The danger, however, is that too few will learn from the lessons of the past. If the objective is to improve satisfaction with an outsourcing arrangement, then it is important to understand and avoid the main sources of dissatisfaction.
Research into the causes of problems with outsourcing indicates that approximately one third of issues arise because the original strategy was flawed, while a further 15% are the result of bad or inadequate contractual terms and conditions. However, more than half of the major difficulties experienced by buyers result from a poor or damaged relationship between the parties.
Organizations must, therefore, be aware of the folly of looking for a purely contractual solution to what is in fact a much broader management problem. All too often, buyers believe their existing contract provides insufficient control when, in reality, many of the necessary provisions are present but have just not been exercised properly.
If a company is disappointed with its service provider, it is important to recognize that very rarely is the service provider solely to blame for the problems with the relationship. It is critical that the client be honest and acknowledges that it may have contributed to some of the problems or challenges with the existing relationship.
Clients should review objectively and in detail how well the current outsourcing arrangement has worked. What services did the service provider perform both well and poorly? What did it do both well and poorly as a client? What deficiencies, as well as strengths, does the current contract have?
Creating a Re-structuring Strategy
A successful restructuring initiative should start with a review --- or perhaps the creation --- of a companywide sourcing strategy. Regardless of the circumstances that have led to the re-structuring, it is vital that the project not simply center on the need to fix a series of current commercial or service deficiencies. Together the business strategy and support requirements should define the appropriate service delivery framework --- that mix of shared services, in-sourced, outsourced, onshore, nearshore and offshore capabilities under a coherent governance structure and delivered as an efficient, effective whole.
Within the context of a broader sourcing strategy, it becomes possible to outline the strategy for the specific re-structuring initiative. This will start by defining the business drivers and objectives going forward --- such as cost savings, service improvement, contract flexibility and improvement. These must be balanced with both the company's internal realities --- including their business model, internal politics, risk tolerance and any regulatory issues --- and external factors, such as the incumbent service provider's business position, market dynamics and commercial best practice. All of these elements need to be evaluated in making the decision about whether to re-negotiate, re-compete or re-configure.
The crucial, but often forgotten, question is "What level of outsourcing complexity can I manage?" It is essential that organizations look candidly at their ability to manage and govern outsourced relationships. Too often, what are perceived as faults with either an existing contract or a current service provider's performance are as much a result of the buyer's inability to effectively manage the existing service provider relationship. Buying a new car never made anyone a better driver. Similarly, changing service providers or moving to a multi-service provider strategy will only exacerbate, rather than solve, any service provider management weaknesses.
The 10 Golden Rules of Re-structuring
- Do not initiate a restructuring initiative in isolation --- A strategic context is critical
- Make sure that time is your ally not your enemy.
- Start with clearly defined, agreed-upon and realistic objectives
- Take it seriously. Establish an executive steering committee, executive sponsorship, and a high-quality, full-time project team
- Do not negotiate in the dark. Investigate market prices and commercial terms
- Invest in building a clear picture of "as-is" and "to-be" services and costs. A firm basis for comparison is key
- Think carefully about the shape of the opportunity from the service provider's perspective. Not every restructuring has automatic appeal for the service provider
- Do not bluff unless you are prepared for your bluff to be called. Most of thetime it will be!
- Think of this as a step on a journey, not an end in itself. Position for where you are today and will be tomorrow
- Do not buy what you cannot manage. If you struggle with simplicity now, you might collapse under the weight of greater complexity.
Organizations need to review all of their options thoroughly and objectively.
The following options are available:
- Renew the contract with the incumbent
- Review and amend the current scope of services and/or the current service provider mix
- Go to market via the RFP route
- Terminate the contract and bring the services back in-house
- Consider a combination of the above.
All of these options have their own specific advantages and also significant challenges. It is important not to assume that another service provider will automatically be better or more capable of solving the problems that the incumbent could not. Similarly, do not assume that moving services back in-house will inevitably result in lower costs, higher quality service, and better alignment with your business strategy unless you first understand the cost and complexity of repatriating services.
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