The evolution of outsourcing appears to validate economist David Ricardo's law of comparative advantage. Ricardo said that optimal economic efficiency resulted when each country specialized in its area of strongest relative performance. Between nations, the interdependence this suggests is frequently resisted by countries afraid to let defense or other strategic industries migrate elsewhere.
In parallel fashion, though the economics of outsourcing may be superior to in-house processing in many cases, the frequent objection of banks to farming out operations to a third party remains the loss of control and the creation of dependency.
Meanwhile, the business world continues to increase interdependency. It seems that we cannot compete and still have the luxury of complete self- reliance, particularly where high technology is involved.
Even if you are already committed contractually to an ongoing "outsourcing" arrangement, you must actively manage the dependency implicit in this. I suggest you might approach this problem with the following thoughts in mind.
Interdependency - live with it, carefully.
Some of us remember being in the painful position of the high school boy desperately infatuated with a girl who could not care less. This unilateral dependency does not work well for you if you are the boy. Mutual dependency is generally more satisfactory.
How dependent are you? Can you replace the servicer without great expense and difficulty? What are your alternatives? What does your contract allow? What information do you now lack on your own operations that you will need if you ever replace your supplier?
If you are heavily dependent on a servicer, ask yourself how the servicer is dependent on you. Are you responsible for significant revenues? If not, are you an influential member of a user group that is? Is the servicer concerned with your approval? Recommendation? Visibility? Why does the servicer need to keep you happy?
In assessing your dependencies, ask where your servicer deals directly with your customers or represents you to them. Does your servicer control your reporting to customers? Do incoming calls for assistance go to the outsourcer? Does the servicer become involved in marketing or customer relations - even indirectly? Has this enhanced customer satisfaction?
After you have understood the mutual dependencies thoroughly, reduce those that should need not be part of the equation. One example might be ignorance of aspects of your own operation that you have ceded to the servicer.
If there is a mutual interdependency, then you have a relationship that should be amenable to constructive engagement and adjustment. It is not appropriate for the servicer to attempt to "own" your business by failing to cooperate in reasonable measures necessary to avoid an unproductive and unbalanced dependency.
Define your goals and competency, and work backwards.
Examine the effectiveness of your outsourcing relationship, starting with your own goals as an organization. Ask yourself what functions in your organization could never be outsourced. The rest, by definition, can be examined to see if outsourcing will be beneficial.
Outsourcing started and still largely is justified as a measure to reduce costs. The service provider can bring economies of scale to the effort. It can hire highly qualified professionals in the field, pay them well, develop and maintain state-of-the-art software, and spread these costs over numerous installations. Furthermore, you can rent the technology infrastructure, or at least pay out over time. Some outsourcing deals involve the sale of equipment by the customer to its servicer, with the purchase being amortized in the servicer's fee structure.
Today, many data processing servicers want to go beyond the cost rationale. Information management can enhance your service delivery. Outsourcers also are seeking to play a role in enhancing revenues and otherwise supporting the organizational mission. They may suggest creating new reports for your customers, providing support for new service offerings including on-line access by your customers and supplying to you new analytical information on your customers - and prospective customers - enhancing marketing and creating new services.
Without a clear definition of your core competencies and market direction, you may run the risk of making mistakes in how to pick and choose which of these capabilities can be useful. Even if you already have an outsourcing arrangement - and especially if it has been in place for more than a year - you should analyze your needs without preconceptions.
Rapidly changing technological capabilities represent just one of the important reasons to reexamine your outsourcing function and its desired and actual roles in your organization no less than once a year. Do not limit yourself to analyzing the information-processing function solely on its own merits. (Is it working smoothly or did it break down lately?) This stops short of the important questions concerning what is needed to optimize the organizational mission.
Stay proactive - you can make changes to your outsourcing arrangement if you have done the analysis and act in good faith. Precisely because the information function is so important, it should not be left to your supplier. Those who have signed a contract that takes them through the coming five or even 10 years may be prone to take a fatalistic attitude towards the operation: "It will either work out or it won't."
Nevertheless, proactive management of this dependency is too critical to avoid. Entering into an agreement with a third party in which you give up a great deal of control and rely on them to conduct a critical aspect of your operation is a qualitatively different relationship than that embodied in most contracts.
If the contract itself, and the parties' attitudes, do not allow for flexibility and change - if the deal is not "interactive," to use one popular buzzword - then the seeds of a problem have already been planted. Staying proactive is your responsibility to your organization, shareholders, and even your supplier, who can only fulfill your needs imperfectly without effective and informed communication.
Your contract: useful business tool or impediment? In long-term information management and processing agreements, the contract term may exceed the organization's ability to predict the nature of the technology or how it will be used.
This aspect, coupled with the critical nature of the dependency created, is the reason why flexibility is a must. Though the specifics of change are unpredictable, its occurrence is a certainty.
If the jacket does not fit, it must be altered. The sophisticated outsourcing contracts of today are full of mechanisms for communication and adjustment of goals, procedures, and the settlement of disputes without recourse to the courts.
It may be threatening to do a review of your existing contract. In reviewing an existing agreement, you risk concluding that you should have done differently earlier. But do not discount the possibility that the result will be constructive. The effort may result in the addition of new functions that your supplier is happy to take on (for a price.)
It may result in discussions leading to tradeoffs that, in turn, avoid later crises. Best of all, it may also lead to a clearer internal assessment of the organization's goals and its positioning five or 10 years down the road. Once there is some internal consensus on the long-term outlook, then challenge your supplier to show how it can develop your information operation to facilitate your plans.
If, in the worst case, you conclude that certain changes are needed and your supplier is not willing or able to make the necessary adjustments, then you are probably better off knowing that now. This should lead to legal review of your contract and decisions concerning the discontinuance of the relationship, and alternatives.
No one should look for disputes in an attempt to show who is boss. If trust is abused by either side, the results can only be destructive. Acting in good faith does not mean that the other party will agree with everything you say. Either party, however, should offer willing cooperation to make reasonable and necessary improvements and adjustments on terms that make sense.
Staying proactive requires good communications. Not just in the operations area, but by senior people on both sides. It should be systematized by agreement on regularly scheduled meetings at defined organizational levels. Also, many contracts will specify an organizational hierarchy for dispute resolution, with unresolved disputes going to higher levels in the organization for hearing and/or appeal. Once the courts are involved, the relationship will have turned extremely negative and perhaps irretrievable. The outcome is likely to be damage to both parties.
If you are negotiating a new arrangement or renegotiating your present one, be sure that the new document provides a number of specific mechanisms for adjustment of objectives, services, pricing, equipment, and software - as well as dispute resolution and termination.
Vagueness in an agreement, in my experience, does not create flexibility so much as it creates disputes. Flexibility must be built in by means of specific provisions. Also, in the current environment, one must not overlook the issue of how mergers and acquisitions might be handled.
Mr. Kellogg is a lawyer and consultant in New York. He was a Citicorp vice president throughout the 1980s in areas including data processing and capital markets.
