Law Times

lAw Times • April 26, 2010 FOCUS Despite risks, offshore contracts key to competing, lawyer says are now in their second or third iterations, the benefi ts and risks of contracting out critical func- tions remain, particularly in the case of off shore outsourcing agreements. "In some ways, you can say Assessing the costs and benefits of IT outsourcing W BY PAUL BRENT For Law Times hile most informa- tion technology out- sourcing agreements that we are kind of into out- sourcing 2.0," says Ravi Shukla, counsel with Lang Michener LLP's information technology law group. "We started to see the end of the fi rst wave of outsourc- ing agreements, which run from fi ve to 10 years, and people are saying, 'What did we do well and what did we do wrong?'" Shukla, who acts mainly for companies seeking outsourced service providers, presented a paper on the benefi ts and risks of outsourcing to the Canadian Corporate Counsel Association in Montreal earlier this month. Companies that enter out- sourcing agreements are typi- cally seeking advantages such as increased effi ciency, reduced risks associated with running IT departments, freed-up capital, in- creased focus on core businesses, and access to world-class capabili- ties. But with those fairly well-un- derstood advantages come some lesser-known disadvantages. Th e downsides may include hidden costs, such as a more ex- pensive and lengthier vendor selection process; a longer time frame to hand work over to the off shore partner; severance and expenses related to layoff s of local employees; turnover costs; and expenses associated with address- ing language and other commu- nication or cultural diff erences. As well, managing the actual off shore relationship can be a major additional and some- times unforeseen cost. Overall, do poorly.' A lot of clients don't do that," Shukla notes. Besides costs, Shukla has a long list of other risks would-be outsourcers should consider be- fore handing off IT functions to off shore providers: • Data and security protection: While most IT organizations fi nd off shore vendor security practices impressive, the risk of security breaches or com- promised intellectual prop- erty rights is inherent when working internationally. 'In some ways, you can say that we are kind of into out- sourcing 2.0,' says Ravi Shukla. a company may end up paying up to 50 per cent more in front- end costs than initially expected and only achieve a savings of up to 15 to 25 per cent in the fi rst year. Th at's well below the expected 35 to 40 per cent in savings, which companies typi- cally realize in the third year of the agreement. Higher front-end costs may paradoxically lead to a lengthening of the term of the agreement to generate the re- quired fi nancial benefi ts. First-generation outsourcing agreements "run the gamut," Shukla says. "Often, you will hear that the cost savings didn't materialize, and quite often that was a key component of why the company did it." But determin- ing why the parties fell short can be a complicated task as well. "Th ere is a saying in the out- sourcing business: 'outsource what you do well, not what you • Process discipline: Th e ca- pability maturity model, a measure of a company's pro- cess model maturity, is a key part of its readiness to adopt an off shore model. Research fi rm META Group found that 70 per cent of client IT organizations are at the lowest level, while off shore vendors require a much higher stan- dard of capability. As a result, companies face higher costs as vendors fi ll in the gap. • Vendor failure to deliver: A common oversight for IT organizations lies in failing to implement a contingency plan to deal with the risk that a vendor, for whatever reason, fails to deliver as expected. • Compliance with government regulation: Highly regulated organizations, such as utilities, fi nancial services institutions, and health-care organizations must ensure that the off shore vendor is aware of and will adhere to industry-specifi c re- quirements and that compli- ance will be demonstrable to all necessary auditors. • Culture: Cultural diff erences include religion, mode of dress, social activities, and even ways of asking or an- swering a question. Although most leading vendors have education programs, the chal- lenges and costs associated with cultural alignment may not be insignifi cant or trivial. • Turnover of key personnel: Common turnover rate lev- els, especially in India, are in the 15- to 20-per-cent range. To address this concern, cli- ents have recently tended to demand that contracts place a liability on the vendor for any personnel it has to replace. • Productivity fl uctuations: Most IT organizations expe- rience a 20-per-cent decline in productivity during the fi rst year of an agreement, largely due to time spent transferring both technical and business knowledge to the vendor. As well, off shore outsourcing cost savings of- ten come through personnel layoff s that can cause signifi - cant morale problems among the in-house survivors. "I think on balance, most of them have worked out pretty well," Shukla says. He adds, however, that there is still a large "potential client base" of organizations that have held back from jumping into outsourc- ing over worries that an outsourcer can "make the fi rst term look good" only to squeeze the cli- ent on renewal after the internal skill set has withered away. "Th at is why in the paper, I talk about always [keeping] a competitive tension so that nobody feels like a total incumbent . . . [through] programs where you have strategic sourcing partners and you select two or more. So there is always some idea, even at the renewal time, that the incumbent could lose the bid." Richard Corley, co-chairman of Blake Cassels & Graydon LLP's information technol- ogy group in Toronto, notes the scope of outsourcing agreements is growing. "Outsourcing has become a far more complex and subtle business tool and it has also moved far beyond the application only to IT transactions," he says. "It is now extending deeper into the organizations and is being used for a vast variety of things ranging from [human resources to] fi nance and accounting mat- ters, some business intelligence functions, analytics, all kinds of manufacturing design work. It is much more than the original IT outsourcing trajectory." Not only is outsourcing here to stay, it's a key tool for Cana- dian companies, Corley adds. "Many Canadian companies, because of the small size of the Canadian market, are looking to compete on a global basis and need to be globally competitive. One of the ways to achieve that is through eff ective outsourcing." But because of their relatively small size, Canadian fi rms typi- cally seek smaller outsourcing agreements that are relatively more expensive to implement and administer as a percentage of the deal's value. "So that has placed a signifi cant pressure on Canadian businesses," Corley says. 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• Cover
• Judicial Supervision
• Aging Lawyers
• Focus On IT/Telecommunications