Global Information Technology Outsourcing:
Search For Business Advantage
Chapter ThreeFive: Inside Mega-Contracts
(A) South Australia and Dupont
There is generally an expectation of management on the user side that here is this knight in shining armour, I’ll get three times better service at half the price… so you have this large gap in expectations from the start.” -- Contract Administrator, South Australian Government
“The principal reason we separately sourced applications is quite simple. There is no single supplier who could cover the range of applications to cover hospitals, utilities, government… There are best-of-breed suppliers in those areas and it’s not sensible to outsource to one.”-- Contract Administrator, SA Government
“In terms of a positive outcome [on economic development], EDS has exceeded our expectations.” -- Contract Administrator, SA Government
‘We didn’t do it because it was broken.” Dupont Global Alliance manager, 1999.
"This is a commercial business transaction, not a partnership. Suppliers have to keep earning the business everyday." Dupont executive, 2000.
Introduction
In the last chapter we 3found that the most common practice continues to be selective outsourcing of targeted IT activities. So why does press coverage of mega-deals significantly over-shadow the more common practice of piece-meal outsourcing? Simply this: mega-deals fascinate. The magnitude of billion dollar contracts amaze most organizations still struggling for incremental IT budget increases. The ten-year deals perplex most organizations that have difficulty planning for IT past a three-year time horizon. The scope of mega-deals astonish organizations reticent to hand over even minor responsibilities to outsiders. But most of all, mega-deals fascinate us because they are potential bellwethers to the future of internal IT functions.
In this chapter and the next, we present four in-depth, mega-deal, case studies of South Australian Government, DuPont, British Aerospace, and Inland Revenue. These cases provide a rich context for understanding because they embrace nearly every conceivable aspect of IT outsourcing. Each case covers the business context driving the decision, the decision process, and most importantly, post-decision experiences and management practices. As such, there are many lessons to be learned from what these organizations did right, as well as the practices they would have done differently in hind-sight.
Although the cases cover three continents (Australia, United States, and the United Kingdom), two public sector and two private sector organizations, and span four years of start-dates, the similarities of experience among cases far out-number the idiosyncratic differences (see Table 1). The reader will immediately begin to see patterns of experiences in the following stories. Throughout chapters 5 through 9, the cases will be used as contextual examples of general lessons, practices, and experiences. In particular, chapter 9 will draw heavily from these cases to explain relationship management across the different phases of any IT outsourcing arrangement.
The cases were selected for study because they were visibly debated in the trade press. The South Australia Government contract with EDS was under severe attack from the public officials as well as decentralized government agency users who claimed that IT costs increased as a consequence of outsourcing. Despite the controversy over the internal operations of IT, the economic development portion of the South Australia-EDS contract won an award for best government outsourcing relationship sponsored by the Outsourcing Journal (see DuPont's $4 billion dollar deal with CSC and Andersen Consulting warranted media attention due to the sheer size of the deal. British Aerospace gained media attention when the IT outsourcing decision prompted a strike by BAe IT employees belonging to a trade union. The United Kingdom Inland Revenue's IT outsourcing contract brought fears of breeches of confidentiality because an American Company would have access to citizens' tax data. But headlines are newsworthy for short periods of time. What was actually happening to these organizations during their ten-year outsourcing deals?
Overview of Case Studies
Customer / Supplier / Contract Signed / Contract Duration / Value of Contract / Scope of ContractSouth Australian Government / EDS / 1995 / 9 Years / AUD $600 million / IT infrastructure
Economic development of SA
DuPont / CSC & Andersen Consulting / 1997 / 10 Years / $4 billion / IT infrastructure
Applications
British Aerospace / CSC / 1994 / 10 Years / £900 million / IT infrastructure
Applications
Inland Revenue / EDS / 1993 / 10 Years / £1 billion / IT infrastructure
Applications
The cases presented in this chapter are based on interviews with senior executives, business unit managers, senior IT managers, consultants, and supplier managers from the four organizations. These stakeholders invariably stated that the media failed to disclose all sides of issues and failed to take a larger view of the outsourcing deals. Our resulting cases may be less dramatic (or traumatic) than the press coverage surrounding these deals, but the accounts seek to illuminate all sides to sourcing issues.
Case 1: South Australian Government
In 1997, the Australian federal government announced a decision to outsource all federal government information technology (IT) within one year. To attract better prices and to simplify the decision process, government IT was bundled into four large clusters to be outsourced via four, large-scale, long-term contracts (later reduced to three clusters/three contracts). Facing such short deadlines, government servants need to quickly learn how to create requests-for-proposals, analyze supplier bids, and successfully implement and manage IT outsourcing contracts. Although government IT outsourcing has been done on a piecemeal basis, the only large Australian IT outsourcing contract that has been active for a substantial period of time is South Australia (SA) government’s $600 million[1], nine-year contract with EDS, signed in 1995. Subsequently, SA’s contract has gained the attention of government and the media as a learning vehicle.
South Australia’s IT outsourcing contract is distinctive from more traditional outsourcing. One contract is used to govern two distinctive components: one component for the development of South Australia’s economy, and one component for IT service provision for 150 South Australian agencies.
“Our strategy for outsourcing, if you distill it all down, had two thrusts. One was to improve the effectiveness of the use of our computing infrastructure, lower cost, higher quality, and shift management focus to the business and end-use. On the other side, we wanted to build a critical mass of IT industry leaders by attracting global players. So we needed a deal big enough to attract them.” -- Contract Administrator, SA Government
The economic development package has been a success. EDS has exceeded their yearly targets to meet the overall goal of pumping more than $200 million into the South Australian economy during the nine year relationship. EDS established a large base in Adelaide, South Australia, that increases employment, provides international marketing channels for local software firms, generates housing starts, plus many other multiplier effects. This one-off opportunity provides an exemplar of thinking about IT outsourcing in a strategic way. However, generally speaking, such an advantage is non-replicable for other government agencies because large IT suppliers have already established their worldwide homes.
Eighteen months Five years into the contract, the IT service provision contract has been more controversial. Opponents argue that agency costs have significantly increased. Proponents argue that across the whole of government, total costs of IT have been reduced. In addition, proponents credit EDS with almost doubling the LAN capacity, facilitating a government restructuring, and improving service in a number of areas. Such controversy was expected because IT outsourcing was a top- down decision by the centralized government of South Australia.
A key lesson that emerges from the case is the need to foster realistic stakeholder expectations about the cost/service trade-offs of IT delivery (a point also emerging from our survey – see Appendix A). With so many stakeholders involved--government officials, centralized contract management teams, agency delivery teams, end-users, IT personnel, and suppliers--quite naturally different groups have had different objectives and expectations of the cost and service to be delivered via the IT outsourcing contract. Contract managers for both the South Australian government and EDS had to work together to temper expectations and perceptions of the contract. Once transition tasks almost were complete, the partners then looked to focus on more strategic issues, in the mature phase of the contract (see Chapter 9). The outsourcing contract continued to be controversial in its performance aspects into 2000.
South Australia: Background
As at 2000, The Commonwealth of Australia had a population exceeding 19 million. The democratic, federal government comprises 6 states and two territories. In 1996, of the 1.5 million people in the State of South Australia, 1.1 million lived in Adelaide. As the Contract Administrator for the SA Government notes: “So we are really a city state.”
Table 2 -- 1996 Australian Population
State (Capital) / PopulationNews South Wales (Sydney) / 6,190,000
Victoria (Melbourne) / 4,541,000
Queensland (Brisbane) / 3,335,000
Western Australia (Perth) / 1,763,000
South Australia (Adelaide) / 1,479,000
Tasmania (Hobart) / 473,000
Capital Territory (Canberra) / 308,000
Northern Territory, (Darwin) / 178,000
Prior to outsourcing, tThe SA government comprisesd 150 agencies, providing many services that are often privately owned in other state governments, such as in the USA:
“Our government agencies cover a broad spectrum: all health systems, the hospitals, public schools, water utility, power utility, justice, corrections, policy, courts, standard government administration, forestry management, community welfare, public housing, and more. Compared to the U.S., for example, water is usually privately run. Electric is usually privately run. So it covers in all, about 150 agencies. So we are dealing with heterogeneous agencies here, like every hospital has its own Board. The power authority and water authority have their own Boards. The courts have to be separate from government so they have a Justice Council. So you talk about managing all these different agencies, they are all separate government agencies under the administration of the Crown.” -- Contract Administrator, SA Government
In 1994, the Premier of South Australia wanted to stimulate economic growth. Manufacturing was not seen as a growth business, with plant automation actually decreasing employment. The Premier envisioned information technology as a basis for long-term economic growth. His cabinet created the Information Technology Development Task Force, which subsequently created the IT 2000 Vision. The Vision declared that by the Year 2000, South Australia would be recognized as an international centre of excellence in IT, particularly as a source of software and IT services for the Asia/Pacific region. But how can such an industry base be bootstrapped? The strategic implementation of this vision was tocontract out “whole of government” IT to attract a sufficiently-sized international IT leader to South Australia:
“In order to do that they needed to attract a world-class, multinational company to town to serve as the anchor department store in a shopping mall. And so in looking to do that, they would outsource the entire infrastructure of IT for the whole state. It had to be big enough to attract a big company.” -- VP of Operations, EDS
SA Government’s IT Department Prior to Outsourcing
Prior to outsourcing, 60% of the 90,000 people employed by the South Australian government had desktop computing. The government owned/leased and operated 12 data centres, 11 mainframes, 376 midrange computers, 1,102 LAN servers, and 3,193 WAN devices. At the time, information technology decisions were completely decentralized, causing inefficiencies from lack of economies of scale and duplicate functions. For example, the government operated 24 different accounts payable systems. Government IT managers had tried to consolidate and standardize, but such cost reduction tactics were continually thwarted by the agencies. Services were substandard in many agencies--only three agencies had service level agreements. And most of IT was used for back-office operations, not for services visible to citizens:
“There was a major benchmark done in 1993 on IT computing and management done by Deloittes. What it showed, the public sector with a $6 billion turnover, we had 24 accounts payable systems, 5 general ledgers, for basically the same activities. And so, to be best-of-breed, we needed more resources, because most of our IT was back office. So most resources were managing the infrastructure rather than the business. We wanted to shift our resources to managing the business, not the infrastructure.” -- Contract Administrator, SA Government
IT costs were not controlled well due to job categorizations and the different cost-based accounting system used by most agencies. During the Request For Proposal (RFP) process, it was estimated that 1,000 people were doing some IT work in the agencies, but their job classifications did not capture this as an IT cost. The different accounting systems also hid IT costs. For example, the Treasury paid for IT assets on behalf of a significant number of agencies, but agencies were not charged back a depreciation expense on these assets, which masks anywhere from 8% to 25% of total costs of IT ownership:
“We found asset accounting in IT is not good. It doesn’t matter whether you are in government or in a commercial organization. An upgrade here, an upgrade there, it’s hard to control. If anyone tells you they can get at 100% of IT costs, it’s just not true because it’s spread throughout the business. It’s much more pervasive and it’s not managed as a cost center. We added 25% for additional hidden costs we knew we would never find. A lot of that is how you give personnel support from your peers next to you.” -- Contract Administrator, SA Government
SA Government’s Outsourcing Decision Process
By February of 1994, the overall sourcing strategy to implement the IT 2000 Vision was established:
- Convert the IT infrastructure to an outsourced utility
- Standardize in-house desktops and common applications
- Redirect agency personnel to mission critical/customer systems
Initially, the SA Premier wanted to implement the IT 2000 Vision by signing a contract within two months. But the IT managers, along with the support of hired consultants, convinced the Premier that the contract must be detailed to be successful. In the end, the entire decision process took over two years (a similar length of time for the Inland Revenue deal – see Chapter 4).
Table 2 provides a view of the sourcing strategy that was ultimately implemented. The SA Government included most of the infrastructure in the scope of the Request For Proposal, including mainframes, midranges, file services, and network management. Although telecommunications, voice, and mobile networks are normally considered part of the infrastructure, they were excluded from the scope of the contract. The SA government felt these growing areas could be used to attract another economic development partner in the future.
Table 2 - South Australian Government’s I.T. Sourcing Strategy
Standard Desktops / Public InterfaceStandard Desktop Application Packages: e.g., MS Office
Common Applications: Human Resource Management; Financials; Records Management
Agency Sector
Applications / Agency Sector Applications / Agency Sector Applications / Agency Sector Applications
EDS provides: LAN/WAN Network Management / AATP provides: Telecommunications
Services Management / Telco provides:
Mobile Network / Voice Network
EDS provides:
LOCAL PROCESSING; File Servers and Midrange
EDS provides:
LARGE SCALE PROCESSING; Mainframes
Desktops were excluded from the scope of outsourcing because SA could obtain better prices than a third party could offer:
“Our view is that suppliers cannot add value there. Price competition is such that prices change every 3 months, that’s how fast the life cycle is. When the price drops, you don’t want to lock yourself into a long-term contract. You have to pay that negotiated price, unless somehow you have some complicated flexible pricing system. That would also make us have a monopoly supplier which would be a considerable risk.” -- Contract Administrator, SA Government
Application development and support were also excluded from the scope of outsourcing:
“The principal reason we separately sourced applications is quite simple. There is no single supplier who could cover the range of applications to cover hospitals, utilities, government. It’s just a pipe dream to think you can do that. There are best-of-breed suppliers in those areas and it’s not sensible to outsource to one.”-- Contract Administrator, SA Government
The RFP requested two proposals, one for economic development, and one for IT service provision for the in-scope infrastructure. The former requested a supplier to stimulate the development of an IT industry in SA. The latter requested a supplier to provide the same level of IT service at a reduced cost.
At the end of March 1994, two suppliers were selected as potential IT partners: EDS and IBM. The SA government felt these suppliers could build an IT-based industry in Adelaide because of their size and global competitiveness. Both companies responded to the RFP. Two SA teams independently evaluated the suppliers, one team evaluated the economic development proposal, the other team evaluated the IT services provision proposal. In September of 1994, both teams selected EDS’s proposal as the best and final offer.
After the RFP process, it was readily apparent to both SA and EDS that they were very far from a final agreement. Because SA’s RFP for the IT service provision was loosely defined, EDS could not rely on the government’s data to make a specific bid. For the next seven months, the partners went through due diligence to gather and verify the cost, volume, and quality of current IT services in the agencies. Because the outsourcing decision was forced on the agencies, many agencies resisted the due diligence process, claiming it was expensive and unwarranted. The SA government outsourcing team spent much time convincing Agency heads that the effort was required because their payments after outsourcing would be based on baseline figures. The following agency data was collected:
- Complete list of hardware and software
- Software licenses
- Hardware leases
- Maintenance agreements
- IT costs included in user budgets
- IT costs of internally developed software, some of which was expensed, others capitalized
- Each IT person’s salary and benefits
- Information on people who spent less than 50% of their time doing IT work
Besides the agency resistance, the next biggest challenge was normalizing the cost and service data across 150 agencies. Costs were difficult to normalize because of the different accounting systems: