Outsourcing The Outsourcing

Today's huge service deals need consultants as watchdogs

The numbers are big. DuPont Co. will pay Computer Sciences Corp. about $3 billion to run its computer operations over the next 10 years. In May, J.P. Morgan & Co. signed a $2 billion deal to turn over its data processing operations to a consortium of five computer services companies for seven years. Those are just two of the 35 "megacontracts"--outsourcing deals for more than $100 million--signed last year. Nearly $20 billion in big deals were awarded in 1995 and an additional $32 billion in 1996, says Merrill Lynch & Co. analyst Stephen T. McClellan. And business doesn't appear to be slacking off. In 1997, McClellan expects $40 billion in giant deals to be signed.

Now the big numbers are fostering some big collisions. Mutual of New York and Computer Sciences are just two years into a $205 million, seven-year contract and they're already bickering. The companies refuse to discuss the deal, but MONY acknowledges it's in arbitration to settle disagreements over the scale and scope of the continuing work. Analysts say the dispute is hardly out of the ordinary. CSC, for example, found its profits squeezed when work not originally specified in the deal was added. MONY, meanwhile, had an agreement to share in revenues CSC made from selling to other insurers programs both companies developed. That part of the deal lost its luster last April when CSC said it would pay $1.5 billion in stock for Continuum Co., which specializes in supplying software and running computers for banks and insurers. "Outsourcing deals are inherently not fluid enough," says Howard A. Rubin, a professor of computer science at New York's Hunter College who has done consulting for both CSC and MONY. "Business environments change, technology changes, people change. A lot of outsourcing deals are going to blow up."

The result is yet another consulting business. Think of it as consultants to watch the consultants. Only it's not as redundant as it sounds. These watchdogs will monitor the work of both parties and develop specific technical guidelines for a contract; say, how long the corporate help desk should take to answer calls from personal-computer users. Lucent Technologies Inc., for example, used consultants to help write a contract that calls for yearly reviews during the 10 years of its outsourcing agreement with IBM. "Static contracts don't talk to 1997 business problems," says Peter Brown, a partner with Brown, Raysman, Millstein, Felder & Steiner, a law firm specializing in high tech.

Add one more element to the already complex business of outsourcing corporate information systems. Major outsourcing deals include everything from installing PCs to maintaining millions of lines of software code to managing global networks. To make these deals succeed over the long haul, companies are working out in excruciating detail everything from how fast the corporate mainframe will crunch data to how many lines of code they expect at the end of each day. Market researcher Yankee Group Inc. began a service 18 months ago to help customers understand their computer systems and measure how well they perform. Many Big Six consulting firms are also being called in to offer similar services in outsourcing deals.

STAYING FLEXIBLE. Companies need to know all sorts of arcane data to be certain their systems are humming along with the best performers. How many forms can the top insurer do in an hour, for example? Or how many online reservations does an airline book every day? And companies want to be able to move to the latest technology--fast. "A contract can be written in 1995 and be only 75% valid by 1997," says Stan Goldman, president of Technology & Business Integrators of Woodcliff Lake, N.J. His company has been involved in six deals since getting into this area 12 months ago.

The way to stay up-to-date is to be flexible. At Lucent, its contract with IBM--worth an estimated $6.2 billion--calls for yearly "tune-ups" to see if the equipment and services covered are outdated. Consultants also helped Lucent set up the contract so it could check IBM's fees against the going rate. If IBM can't meet the market price, Lucent can bring in another service provider. "We brought in outside help because we were going to do this once," says W. Douglas Lewis, Lucent's chief technology officer. "Outsourcers do this for a living. We couldn't expect to be as smart."

That's O.K. with IBM. Says Douglas T. Elix, general manager of IBM's $16 billion outsourcing unit: "In three years, who knows what has to change?" A lot. It's just smart business to be flexible.

Before it's here, it's on the Bloomberg Terminal.