The "Winner's Curse" in IT Outsourcing

So I'm a bit behind in my reading. A couple of years ago Thomas Kern, Leslie Willcocks and Eric van Heck wrote an interesting IT outsourcing case study with lessons on what they've termed the “Winner's Curse.” The idea is that sometimes you don't want to win — whether it is a vase at an auction or a huge five-year contract to provide application support services for a “blue-chip company.”

The case study outlines a situation in which a high-profile oil services firm asked a smallish outsourcing company to bid against an existing supplier whose contract was due to end. The current supplier was considered a “Rolls-Royce service,” and the client decided it was paying more than it needed to. In order to get the deal, the new service provider bid less than it should have — perhaps because it was naive about the savings it could squeeze out of the current IT operations, or because the supplier wanted the deal (and the reference) at any price, or because the people putting the bid together weren't the same ones who had to make the plan operational and so they didn't look as hard as they needed to at the details.

At any rate, after 18 months of losing money and missing service levels, the new service provider decided it either had to back out of the contract or renegotiate terms. Fortunately, the client decided renegotiation made sense too — because of the expense of starting the process over with yet another new firm. New relationship managers were brought in on both sides, the contract was reevaluated and reworked, and they all lived happily ever after.

Why should you care if the vendor hurts? Because, as the paper points out, in the vendor's efforts to reduce costs, you may get less experienced staff (and fewer staff members altogether); you may experience dimished service levels; you won't be able to build on the relationship in forging new business initiatives without paying a true premium (to make up for lost revenues elsewhere in the deal); and continued losses could call into question the viability of the long-term nature of the contract (which is going to cost you in some form).

One part that's interesting to read are the terms of the initial deal — how much was paid out for core services as a flat rate and how much was planned for service additions and changes. (Alas, the case study doesn't provide numbers on the renegotiated agreement.)

Of practical use: the numerous strategies you can take to avoid experiencing what these academics call “a relational trauma” and what I'd call “making a bad thing last longer than it should.”

Here's one tidbit from the text: “Fixed price contracts will create inflexiblities…Consider flexible prciing options including cost plus, market pricing, fixed fee adjusted by volume fluctuation, benefit sharing. Track supplier costs via 'open book' accounting. Allow for biannual assessment of pricing adjustments.”

You can buy the electronically-delivered 24-page case study here for $6. Or you can track down the January 2002 issue of California Management Review at a library and read it in there.