Multi-billion-dollar outsourcing deals turn bad

Ten years ago in IT, Y2K had come and gone without catastrophe, security chiefs were grappling with the ILOVEYOU virus, and the dotcom bubble was bursting. But in the IT services industry, the year 2000 was notable for another reason–it was the year of the giant outsourcing deal.


A total of 24 IT outsourcing mega deals (multi-year contracts worth a billion dollars or more) were signed that year–more than the industry had seen before or since. All told, they were worth more than $54 billion, according to outsourcing consultancy TPI. They included the EDS-U.S. Navy contract worth $6.9 billion, the Bank of Scotland’s $1 billion deal with IBM Global Services, and the $3 billion IT services contract between Nortel Networks and CSC.


The year 2000 was indeed a “defining year for the outsourcing industry,” says TPI’s director and chief research officer Paul Reynolds, and one that led to record profits for outsourcing providers.


But times have changed. “The outsourcing market today is vastly different than when the majority of these mega deals were signed,” says Reynolds. In 2010, outsourcing contracts tend to be shorter in duration and smaller in value. The average total contract value of an IT outsourcing deal in 2000 was $360 million. Today, it’s nearly a third of that, according to TPI.


What will become of the supersized IT outsourcing contracts of 2000? All signs point to some mega break-ups. (See The Demise of the Outsourcing Mega Deal.) Eleven of the 24 contracts signed in Y2K are set to expire this year, along with seven others signed in subsequent years.


“As large contracts approach their renewal dates, buyers in mature markets like the U.S. and U.K. are increasingly likely to divide the contract scope among multiple service providers,” says Reynolds.


He predicts more of what TPI is now calling mega-relationships–deals with an annual contract value of $100 million or more–rather than mega deals.


“Outsourcing buyers are likely to continue signing shorter, more targeted contracts that are driven by cost-saving goals,” says Reynolds.


From Outsourcing Mega Deals to Multisourcing


Increasingly mature customers, a more competitive IT service marketplace, and a greater acceptance of offshore outsourcing should lead mega-deal customers to unbundle their work, awarding it in separate contracts to specialized suppliers, a practice known as multisourcing. That’s exactly what the Commonwealth Bank of Australia did when its ten year, $5 billion IT outsourcing contract with EDS wound down in 2007.


While the course of mega-deal relationships may not always run smooth–EDS’s deal with the Navy, for example, hit some very public rough seas throughout the years–multi-sourcing is not necessarily a day at the beach for customers.


For many, however, the benefits of breaking up a big deal into smaller–and competitive–outsourcing relationships may outweigh the costs. “Spreading the work allows the clients to mitigate their risk and increase competition amongst service providers,” says Reynolds. “The trade-off is that there is added complexity to the governance function, but many companies are willing to manage multiple delivery models in exchange for cost savings.”


Mega deals continue to be signed, though at about half the level of a decade ago. Reynolds expects to see at least twelve new deals with a total contract value of a billion dollars or more this year, though they’re more likely to be inked in less mature markets within Asia and parts of Europe.


Meanwhile, some customers are sticking it out with massive, single-sourced IT services deals. DuPont bucked the trend toward multi-sourcing five years ago when it renewed its multi-billion dollar deal with CSC through 2014. And IT executives at Proctor & Gamble have said the 10 year, $3 billion deal they have had with HP for seven years gives them valuable preferred status with the vendor.


“The primary reason that a client would renegotiate a mega deal with their current service provider is that they are receiving acceptable benefits from the relationship and they find it easier than taking the contract to a competitive process,” says Reynolds.


Nevertheless, he predicts that these mega deals will be the exception rather than the rule. He adds, “In most cases the market has changed fairly substantially since these deals were originally signed and clients have more options available to them.”

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Jim Love, Chief Content Officer, IT World Canada

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