Avoid the "curse" of cheap outsourcing deals

Outsourcing deals based on selecting the supplier with the cheapest bid are the most likely to run into trouble, according to research by the London School of Economics (LSE).

Cost savings are still a key driver for many organisations looking to outsource all or part of their IT infrastructure but the LSE research of 450 real-life case studies found that in one in five deals the supplier is not expected to make any profit - with a negative impact on both the provider and the client.

Professor Leslie Willcocks, of the information systems and innovation department at the LSE, warned: "Make sure the supplier makes a reasonable profit."

He suggested that 10 to 15 per cent is a reasonable gross profit margin figure for an outsourcing supplier to be aiming for on a deal where the customer is looking to make cost savings of around 15 per cent.

Willcock's said three-quarters of "winner's curse" outsourcing deals - where the provider makes no profit - also result in a bad experience for the customer.

The LSE's CEO guide to selecting effective suppliers, sponsored by LogicaCMG, said: "There can be severe repercussions when the provider is saddled with a contract from which it stands to make no money. Under worst-case scenarios providers may even bank on securing a profit through restricted interpretations of the contract and exploiting contract loopholes and ambiguities."

But he said the outsourcing supplier community also needs to be responsible when bidding for new work by not deliberately under-bidding purely to win new business.

Willcocks said: "Suppliers have to be mature enough to walk away."

Instead of cost alone the LSE research said companies should look at the supplier's capability to respond to day-to-day operational needs, its ability to deliver radically improved services in terms of cost and quality and its willingness to align itself with the company's values, goals and needs.

The research said the best approach to selecting suppliers is a collaborative one involving the CEO, CIO and the CFO - although Willcocks warned that the CIO is often not the best person to manage an outsourcing arrangement once the deal is done.

He said: "CEOs divorce themselves from the process of selecting suppliers at their peril. If you are not managing that as a CEO you are running your organisation into dangerous waters."