REACHING OUT
With pressure to cut back on IT spending, CFOs are learning to do more with less.
By Steven Crane

Three months after its merger with Union Carbide in February this year, US-based Dow Chemical announced that its post-merger integration program would achieve annualized cost savings of US$1.1 billion. Job cuts were the easiest part of the equation, with 55 percent of the total savings attributed to an 8 percent reduction of the global workforce.

The remaining 45 percent now depends on how well Dow and its IT outsourcing partner, New York-based consultancy Accenture, manage the integration of existing IT systems. At the moment, that process is running smoothly. Networks and connections were set up in advance so that on day one, more than 400 of Union Carbide's key employees were equipped with Dow's customized workstations to bridge all IT systems in the combined US$29.5 billion company. At the same time, all Union Carbide workstations were connected to the Dow intranet for information sharing. As a result, Dow's regional finance director for South Asia, Sam Ong, was able to consolidate the balance sheet exposure for the combined company in five days.

"We can bring in people to implement the Dow applications in acquired companies pretty seamlessly," says Singapore-based Ong. This allows the company to quickly achieve cost savings though IT economies of scale. The next step is to develop an outsourcing strategy. On this, Ong already has strong views. "The first rule in outsourcing," he says, "is to know what you want and not subscribe to what people sell. The second rule is to retain control where it's critical to the business strategy."

Ong also recommends that the outsourcer be held liable for its promises. As with Dow's other projects with Accenture, the consultancy's performance targets are tied to financial incentives in the Union Carbide merger.

Out But Not Forgotten

Dow, of course, is in a unique position to squeeze the most from its outsourcing efforts. Many CFOs turn to outsourcing as a quick and relatively painless way to cut costs. But a focus on asset efficiency and cost reduction alone won't drive sustainable shareholder value, says Sydney-based Phil Hassey, an outsourcing analyst at IT researcher IDC. Moreover, too much emphasis on driving down costs, he cautions, can backfire, as the supplier may become less flexible and neglect the client's long-term interests.

Indeed, past IT outsourcing arrangements have often failed to deliver. While CFOs generally have well-defined reasons for outsourcing, Melbourne-based Pim Roest, director at KPMG Consulting, says there's a big gap between what CFOs expect in terms of costs and benefits, and what's achieved. "In the past," he says, "CFOs viewed outsourcing as a blanket solution to their IT problems. At the same time, the vendors' approach was to promise the world." The result, according to a recent KPMG Consulting survey, is that a mere 10 percent of companies are satisfied with their outsourcing contracts.

Finance managers are also finding that key in-house skills are often lost in traditional outsourcing arrangements. Most companies recognize that the scale of IT investment and complexity of the systems demand external expertise, but once such in-house skills are gone they're very difficult to get back. For some companies, the short-term answer is to cease outsourcing all but the most basic IT-related services. Despite this, IDC estimates total outsourcing contracts were worth US$8.5 billion in the region in 2000, and Hassey says that number is likely to hold steady or even increase for 2001.

Bernard Lim is well aware of the importance of matching IT requirements to business strategies. Earlier this year, the Singapore-based finance director at Crompton, a US specialty chemicals company, cancelled the only existing IT outsourcing contract in the Asia Pacific. "With the uncertain economic climate, our focus on costs took on increased priority," says Lim. "But we're also concerned about losing in-house skills that are hard to replace," he says.

US$3 billion Crompton inherited a mixed bag of IT systems - SAP, Oracle, BPCS and other legacy systems - following a series of acquisitions. With the US and Europe working towards a unified SAP system, in Asia the strategy is to maintain the IT status quo until its turn comes. Lim's mandate, after consolidating all systems to either Oracle or BPCS, is to keep both systems running, while cutting IT expenditure as much as possible.

Last year, Lim insisted all IT requests for increased spending, no matter how small, be justified in terms of adding value to the business. He also reexamined the original outsourcing contract with US-based IT service provider Electronic Data Systems (EDS). EDS was initially brought in to install and maintain the regional Oracle system, handle IT project management, and fill in the IT skills gap missing in-house.

That gap was ever-widening as Crompton found it increasingly difficult to find and keep skilled Oracle system specialists who feared redundancy once the company switched to SAP. But the high cost of outsourcing with EDS also became unnecessary with the impending move to SAP. Lim found costs could be reduced two-and-a-half times by not renewing the contract and hiring new IT staff, with skills more appropriate to requirements.

Crompton now has a total of just six employees covering its IT operations in 13 countries in the Asia Pacific. While IT plans are on hold until SAP is rolled out regionally, some divisions have outsourced call centers, and plans for shared service centers (SSCs) are under review. "We're not interested in cutting edge in IT for its own sake," says Lim, "but, simply put, we plan our IT needs to match our business requirements." Lim says the main problem with outsourcing "is that suppliers promise 100 percent customer satisfaction guaranteed - at the cost of 10 percent added yearly and a loss of control and expertise."

Lim's grievances aren't uncommon. In part, this is because suppliers hold the IT knowledge and therefore the upper hand. "As a general rule," says IDC's Hassey, "CFOs aren't IT experts and find it difficult to decide on what's necessary to the growth of the business and what's not. Because of this, contracts aren't negotiated clearly up front, and often when the year-end review arrives suppliers will tack on extra costs based on their needs, not the clients."

Some experts argue that CFOs can offset their lack of IT expertise and better manage the outsourcing process by relying on more than one supplier. "CFOs can either employ the selective outsourcing approach for specified areas, or use multiple suppliers for one area," says Roest. "It may cost more but it's a worthwhile experience," he says.

Learning Curve

Jeral D'Souza agrees. In February 1999, the financial controller for Cargill Asia Pacific in Singapore initiated plans to outsource the company's Singapore-based data center, along with support operations spread across 14 countries in the region. Concurrent with D'Souza's efforts, the US$49 billion, privately held conglomerate was exploring the set-up of an India-based shared services center for global operations, including outsourcing the development of some software applications and help services.

D'Souza's main reason for outsourcing was the small size of the IT operations - with one or two staff in each country and high turnover because of little room for career advancement, staff departures caused big disruptions. In addition, the decision to outsource was based on the supplier's larger IT resources and its ability to provide access to new technology and expertise. Finally, there were cost considerations. "Our goal," says D'Souza, "was to extract more value from our IT expenditures without adding to costs. We wanted pay-as-you-go flexibility, and to eliminate the purchase of infrastructure that's underutilized."

D'Souza, along with Singapore-based John Crawshaw, Cargill's administration manager, entered into negotiations for a US$10 million-per-annum deal with IBM to take over the data center. IBM, says Crawshaw, was selected because of its track record of delivering on its promises.

Three months later, contract negotiations had proceeded to the stage where a fee of a few hundred thousand dollars was agreed upon to fund the due diligence process and to ensure the commitment of both parties. Cargill was able get IBM to agree to split the costs 50/50 and guarantee that Cargill's share would be returned on signing. An exit strategy was built in to the contract providing for a six- to nine-month transition period to maintain services in the event of termination. Lastly, though IBM wanted Cargill to lock in for the longest possible term - nine years - eventually, both parties agreed to seven.

At that point, just before signing, the deal was postponed. Cargill's IT staff recommended attending to looming Y2K issues and revisiting the outsourcing study in the new year. Next came disruptions due to internal restructuring within Cargill on a global level. Finally, the whole project was overridden on orders from the Minneapolis headquarters as the global SSC plans in India took precedence.

Benchmarking

Still, D'Souza says the outsourcing process provided a worthwhile experience. "Our in-house operations," he says, "still suffer relatively high staff turnover. But the potential to outsource the operations provided existing staff with new benchmarks. In the last two years they've addressed some problems that were identified during the due diligence process."

CFOs aren't always able persuade all business divisions (especially those that operate with some autonomy and may have different priorities), to come on board once outsourcing negotiations are completed. Roest advises CFOs to complete due diligence internally first and ask the outsourcer to help sell to the divisions. Alternatively, divisional managers can be given a shortlist of outsourcers to choose from.

While the gap between expectations and achievements in outsourcing may never close entirely, technology advances have made it possible to move towards consolidating both infrastructure by specialist, and number of vendors. As a result, costs are dropping, implementation is faster, and contracts are more flexible.

Also, says Singapore-based Andrew Vlachiotis, director for Cisco Systems' enterprise business in the Asia Pacific, contract negotiations are getting tougher. "The recession has added pressure on CFOs to control [cashflow]," he says, "so instead of a cash deal, a leasing arrangement or outsource contract with deferred payment frees cash for other uses."

CFOs, says Vlachiotis, are asking why not construct an off-balance sheet deal instead of paying cash with a four to five year amortization period. "At the end of five years, of course, the expenditure is written off," he says, "but with a lease or outsourcing arrangement you stay current with the technology and the asset isn't a problem."

This argument found favor with Mak Chee Wah. In August this year, Singapore-based Mak, vice-president of finance at privately held electronic supply chain systems provider ECnet, signed his first major infrastructure outsourcing deal for Internet data center operations with Singapore's hosting provider i-STT.

"We decided to outsource," says Mak, "because the operation of the data center was no longer considered a core competency, and continuing heavy investments in infrastructure was using cash best employed in growing the main business." In addition, client requirements for security, geographical reach, back-up in the event of system failure, and capacity (ECnet handles on average US$1 billion in transactions per month) could no longer be met in-house.

Mak performed due diligence on four suppliers. He wanted to find an outsourcer that understood ECnet's business and could meet its requirement for a seamless and fast migration process. Indeed, planning the move to i-STT took three months, and when finalized both parties had agreed to a maximum downtime of three days.

The transition was completed in 27 hours. ECnet's contract with i-STT doesn't include any performance-based incentives (which are unnecessary for transaction-based data center services). But because ECnet's own clients impose penalties if the service fails, similar penalties were included in the contract with i-STT. "With any outsourcing relationship," says Mak, "it's crucial to have a certain comfort level before signing the contract, which hopefully will rise as performance targets are met."

For Mak, outsourcing has paid off. ECnet's IT headcount was reduced by four. Monthly payments of US$9,900, spread out over three years, provide a flexible payment schedule. ECnet also enjoys cross-over benefits with i-STT clients and the contract provides for capacity expansion and upgrades as ECnet's business grows. "If the relationship continues as well as it began," Mak says, "renewing the contract is as good as done."

Role Model

While some CFOs are outsourcing non-core functions in fixed-price deals, a number of MNCs with Asia subsidiaries are turning to new partnership models, where the risk associated with IT investments is shared with suppliers, either through performance metrics with both penalties and incentives, or an equity interest. The advantage in this type of relationship, says Dow's Ong, is that it reduces fixed IT costs, keeps skills and expertise in-house, and allows the development of industry-leading IT systems to create new sources of revenue.

Dow's relationship with Accenture, for example, formed in 1996, now has more than 1,000 employees drawn from the two organizations, based in four 'client solution centers'. "The continuity and control of our IT strategies," says Ong, "is guaranteed by ensuring Dow's IT staff become staff at the outsourcer, be it Accenture, IBM or whomever, for a two to three year period."

That strategy appears to have paid off. During the first four years of the relationship with Accenture, 800 IT projects were completed, with an estimated US$150 million in new business value in 1999 alone. (Dow hasn't yet completed audits for 2000 projects.)

Over the same period, the alliance claims productivity gains of 30 percent and output per employee growth of more than 50 percent. Time to market has increased 10 percent and time to zero cashflow for projects has plummeted 50 percent. Lastly, IT employee satisfaction has increased from 50 to 70 percent, according to internal surveys.

Dow has numerous other outsourcing relationships, including one with IBM for computer equipment, Compaq for global call center services, and most recently for DowNet, an Internet Protocol phone system built by EDS and Cisco. These are all big contracts - Cisco's alone runs seven years at US$1.4 billion. "The key to success in any outsourcing deal," says Ong, "is based on the same principle: do your research and push for the best machine, with the best service and the best connectivity."

Adds KPMG Consulting's Roest: "I always warn my clients when they're considering going into outsourcing: remember the service provider has done many more deals than you have." In other words, when approaching a new outsourcing contract, dust off those negotiation skills.

Steven Crane is executive editor at CFO Asia based in Singapore.