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IT Outsourcing Perspectives: When Deals Go Bad

IT Outsourcing Perspectives: When Deals Go Bad

Insight by: Steve Martin

There have been scores of articles written, and studies conducted, highlighting the statistics around unsuccessful IT outsourcing deals – many establishing the failure rate at well above 50%.  Moreover, if we study the hardest hit industries, healthcare is often cited as one of the most vulnerable sectors with respect to “deals gone bad.”  While the authors of the article “High Stakes of Outsourcing in Healthcare” focus primarily on the challenges associated with patient facing/care outsourced services (e.g., emergency medicine, radiology, laboratory services), many of the same consequences, including those described so poignantly in the article around putting patients at direct risk, can unfortunately be adverse byproducts of non-patient facing 3rd party services, such as IT application and infrastructure outsourcing. This is even more problematic when those services are used in tandem with off-shore technology centric patient facing services such as teleradiology, which currently represents global annual revenues of more than $6B and is growing at a CAGR of over 20% Straits Research: Teleradiology Market Size.  Although running the IT department in-house doesn’t immunize an organization from poor service delivery, when a service is turned over to a third party, there is inherently greater risk that the loss of direct control will lead to reduced focus on the healthcare provider’s core values including patient care, quality, efficacy, and security.

The concept of IT outsourcing is not fundamentally flawed, however the execution in many cases is – i.e., the classic distinction between “doing the right thing” versus “doing things right.”  This article does not focus on “why” deals come off the tracks, but rather what to do once they have.

To start with, healthcare organizations should recognize an immutable principle – there is a high probability that their IT outsourcing contractual arrangement will not survive the initial term and/or extension periods.  Consequently, IT executives need to develop a clearly defined exit strategy prior to executing their agreements, which, needless to say, is a challenging endeavor when in the throes of attempting to build a sustainable partnership with that same supplier for the future.  This goes well beyond standard termination-transition language and gets into tactical areas such as the provision of incident management and asset data to a succeeding supplier, the rights to configured tools that have been used in the delivery of the services, and the minimization of financial consequences of a termination for convenience event (recognizing that proving “cause” is an incredibly arduous undertaking even under the most dire circumstances).

Inevitably, virtually all contracts will come to an end – either during the contract term or after the expiration of the initial term or extension options.   So what should a healthcare provider do when contemplating the termination of an existing IT outsourcing agreement?

First ask the question, “what problem(s) are we trying to solve?”   The answer generally falls into one or more of the following five categories: 1) the supplier is failing to meet the agreed upon service level agreements (SLAs), 2) the supplier is meeting the SLAs but is failing to meet the non-documented performance requirements (the so-called watermelon effect, green on the outside, red on the inside), 3) the quality of the supplier personnel is inadequate, 4) supplier pricing has become misaligned with the market, and 5) the outsourced application and/or infrastructure services have not been maintained at a state of the art level.  Notwithstanding the fact that the customer is generally complicit – whether through a failure to: negotiate adequate protection in the underlying contact, enforce the contract, implement appropriate governance, accurately represent the current environment prior to turning the services over to the outsourcer, or perform those activities contractually required to be performed by the customer – the second question becomes, “which is the best path for addressing the problem(s)?”

Restructure or renegotiate the existing supplier contact:  As this strategy clearly has the potential to be the least operationally disruptive approach, unless the relationship between the supplier and customer has become irreconcilably dysfunctional (or the supplier has become financially unstable), this approach should always be considered first.  That said, customers should be vigilant about time-boxing the effort as allowing negotiations to drag on generally results in the problems metastasizing.  The contract restructuring or renegotiation should squarely address the core issues (or subset thereof) identified above.  For example, if the SLAs are being met but there is dissatisfaction with the overall performance, then redesign the SLAs.  If the quality of the personnel is inadequate, (re)identify the key personnel positions, develop minimum qualifications for replacement personnel, and ensure that market based key personnel terms (e.g., customers’ approval and dismissal rights, limitations on turnover, and financial consequences for failure to meet personnel requirements) are incorporated into the future contract.  If the rates have become misaligned with market, provide the supplier with the target rates and negotiate benchmarking or other terms to protect rates from becoming misaligned going forward.

Recompete the services: This is generally the approach taken by the vast majority of customers, but in the words of the great philosopher, George Santayana, “those who cannot remember the past are condemned to repeat it.”  Customers need to revert back to the underlying current-state issues when approaching the competitive market, but at the same time, understand and control the root causes of those problems. While it’s relatively straightforward to draft an RFP, and even negotiate an agreement with a new supplier that addresses the problems on paper, a highly disciplined governance framework needs to be established to ensure that the contract, supplier, and internal customer stakeholders are all tightly managed.  For example, the most favorable key personnel language will not result in the delivery of the supplier’s “A” team if the customer is unwilling or timid about exercising its right to cause the supplier to replace underperforming personnel.  Likewise, best in class rate benchmarking provisions won’t result in rates being marked to market each year if the customer doesn’t trigger the benchmarking process.

Even with a new supplier contract and a world-class governance process, transferring services to another outsource provider is far from trivial, particularly for a healthcare provider with 24×7 operations and near zero-tolerance for down time.  These types of moves are often transformative in nature (i.e., are done in concert with a major change in the underlying service delivery model), are extremely resource intensive, and often result in a near term degradation of service performance, albeit all with an expectation of sustainable performance improvements in the future.

Repatriate some or all of the services – Clearly not for the faint of heart, this model presupposes that the only way to control one’s destiny is to own one’s destiny.  While it is unusual for companies to do wholesale insourcing or repatriation of outsourced work, companies are increasingly pursuing more surgical initiatives by carving out components of an outsourced service model and managing the component of the operation in-house.  Repatriation areas tend to focus on the higher value IT services, e.g., architecture, engineering, and level 2/3 support, rather than resource intensive, commodity services such as desk-top support, level 1 help desk, and managed network services, as the outsource model for the latter set generally offers a more competitive cost structure and absorbs the burden of hiring and retaining which will be discussed more in a future article.


First, and even second/third generation IT outsourcing relationships, generally become stale over time – ostensibly due to underperforming suppliers, but often times owing to customers taking their hands off the wheel.  Customers need to realize that they get what the “spec and inspect,” not what they “expect.”  While there are no shortages of options available for deals gone bad – ranging from renegotiating to recompeting to repatriating – IT executives should place a premium on spending the cycles to preclude the deal from veering off the tracks in the first place.