Failed Deals: CSC Sues Sears over Termination
October 9, 2009 by Bierce & Kenerson, P.C.
Sears and Computer Sciences Corporation entered into a $1.6 billion IT infrastructure outsourcing in June 2004. By April 2005, Sears had given notice of termination for cause. Claiming the termination was in bad faith as a means of escaping a termination fee, CSC sued Sears alleging irreparable injury to reputation and seeking to enjoin the termination. The dispute took the case out of an arbitration clause and into the courtroom in proceedings seeking an injunction. What happened? What lessons can we learn?
Background.
The following report of the facts is based on allegations in court documents and SEC disclosures. The author has no access to sealed records or the actual agreement or correspondence between the parties.
Sears hired CSC in 2004 for a $1.6 billion outsourcing to manage IT infrastructure for Sears’ operations. The scope of services included managing desktops, servers, systems to support Sears-related websites, voice and data networks and decision support technology, for Sears and its subsidiaries. K-Mart, with a fresh start after completing its reorganization in bankruptcy, then entered into an agreement to acquire or merge with Sears. The merger was to take effect on about March 3, 2005, but occurred on March 24, 2005.
The Termination Fee.
The termination provisions in the Sears-CSC outsourcing contract required Sears to pay a termination fee upon any termination for Sears’ convenience. If Sears were to terminate for cause, Sears would not pay the termination fee.
The amount of the termination fee was not fixed for the entire contract term. Rather, it would increase from the date of contact signature as CSC invested in software, hardware, subcontracts, training, process development and other implementation during transition. After completion of transition, the termination fee would decline over the remaining term of the contract.
The Dispute.
Before March 3, 2004, Sears probably anticipated that its merger with K-Mart might be delayed for legal or regulatory reasons. The Sears-CSC termination fee was increasing over time as CSC continued to invest in the transitional implementation phase of the statement of work. Evidently, the termination fee would be greater after February 28, 2005 than before that date. Thus, Sears was motivated to terminate the agreement early, but would still pay a large termination fee if the termination were determined to have been for Sears’ convenience and not for cause.
Sears apparently approached CSC to negotiate a ceiling on the termination fee. CSC refused to negotiate.
Sears then terminated for cause. Sears alleged that CSC had breached because it had failed timely to meet implementation milestones and had been forced to bring in the Red Team (crisis management) to rectify CSC’s alleged breach.
CSC sued Sears for an injunction to terminate the notice of termination for cause and to enjoin Sears from invoking the post-termination provisions of the outsourcing agreement unless the termination were characterized as done for Sears’ convenience.
Legal Issues.
Confidentiality of Court Records.
At CSC’s request, the lower court sealed the pleadings, affidavits and supporting documents such as the outsourcing contract and correspondence between the parties as to the fulfillment of contract obligations. The appellate court rejected CSC’s request to seal all appellate records and findings, thus opening the record for some public perusal.Disclosure of the Dispute.
Sears filed a disclosure with the Securities and Exchange Commission that identified the termination of a material contract. This disclosure, mandated by the SEC under a rulemaking effective August 23, 2004, simply alluded to a dispute over whether the termination was for cause or for convenience. Sears informed its investors that the difference involved tens of millions of dollars. CSC also filed its own SEC disclosure.Injunctive Relief: Was this Just a Dispute over Money Damages?
Sears claimed that CSC had no right to seek judicial relief because an arbitration clause mandated that all disputes be arbitrated. CSC sought judicial relief because the arbitration clause probably allowed an exceptional right for either party to seek equitable relief from a court.
Equitable relief is a concept developed centuries ago under common law principles, which require that the injured party must prove that it is suffering or will suffer irreparable injury as a consequence of the threatened or ongoing actions of the respondent. Equitable relief is not granted if the dispute is merely an argument over the non-payment of money.
Consequently, Sears responded that the dispute was only a matter of money, not one involving irreparable injury. CSC claimed irreparable injury due to the existence of Sears’ allegedly “pretextual” claim, made in bad faith and concocted to evade a termination fee, for termination for cause.
The lower court and the appellate court both agreed with Sears and rejected CSC’s request for equitable relief, sending the case to arbitration.
Lessons Learned: New Best Practices.
This dispute highlights a number of issues under contractual clauses governing relationship management, dispute resolution and termination. Aside from the contractual provisions, the dispute shows from evolving concerns for the enterprise customer and the service provider under common law principles of equitable relief, the Sarbanes-Oxley Act of 2002 and implementing SEC regulations. The dispute suggests some new clauses and planning tools should be included in the normal outsourcing contract as new “best practices.”.
Hewlett Packard and NEC, 2002 Joint Ventures in Outsourcing
October 9, 2009 by Bierce & Kenerson, P.C.
Overview.
On December 12, 2002, Hewlett Packard and NEC announced a joint venture (“JV” or “alliance” for our discussion) with NEC to deliver managed information technology outsourcing services in Asia, the United States and Europe. The legal structure of the joint venture was not fully disclosed, but some guesses may be made. This case study explores business and legal issues frequently arising in joint ventures. We trace some of the prior relationship and the resulting economic, cultural and operational fit of the venturers.
Joint Venture as a Business Model in a Depressed Global Economy.
The joint venture starts with the realization that the resources of each joint venturer are insufficient to meet a particular market need. ( In a sense, a shared services center is a joint venture of the department or lines of business of a large enterprise.) This particular JV targets a need to serve global companies engaging in mergers and acquisitions. This view of the world suggests that increasingly, for the foreseeable future, consolidation and concentration of multinational enterprises will continue. In essence, the HP-NEC joint venture targets this wave of global consolidations across industries.
Prediction for Future Restructuring of the Joint Venture.
Business analysis suggests that, after NEC completes a spin-off of its semiconductor business, the new joint venture will be a candidate for merger into HP, provided that the joint venture achieves satisfactory performance goals. NEC’s Chairman and CEO, Koji Nishigaki, observed at the December 2002 news conference that “we have laid the foundations [for a merger], so the potential is there. Part of the companies could be merged. We will see many dynamic changes.”
Ultimately, like any joint venture, the potential for any merger and the success of the joint venture will depend on the joint performance of the JV partners, raising the issue of what commitments each is making to compete successfully in an increasingly competitive, increasingly concentrated market for outsourced international services in information technology management.
The joint venture presents a number of legal issues that are common to any international joint venture in information technology, hardware, software and managed services.
Geographical Scope.
The alliance will market to multinational companies that have offices in one or more territories. Initially, these territories are limited to China, Japan and the United States. As of 2004, the joint venture will expand the territory to South East Asia and Europe. The phased introduction of jointly-provided services into targeted territories should enable the parties to manage the inevitable transitional kinks in their relationship before taking the relationship to distant markets.
Service Scope.
The JV includes marketing, systems integration and customer support services.
Target Customers.
The JV partners intend to create a new market for IT outsourcing for customers that are not dependent on mainframes. They admit that IBM dominates the mainframe computer market. Rather, the JV will be targeting large global customers in the “post-mainframe-era market,” particularly the integration of computer systems after mergers of large global corporations that have disparate IT infrastructures. In Japan, the two have already worked on an integrated system for Sumitomo Mitsui Banking, which is the product of a recent merger of two banks. That deal not only inspired the joint venture, but probably will also serve as the “sweet spot,” template and benchmark for future joint venture service offerings.
Legal Structure.
The two alliance partners indicated that they will establish one or more joint ventures to provide a range of information technology services. The HP-NEC announcement did not elaborate on the terms or structure of the JV, so we will speculate.
Under a joint venture, there are basically two methods of developing a “joint venture”
- Contractual Joint Venture:
In a “contractual” joint venture, the two partners establish a business operation that is based solely on a contract. No new legal entity is formed. Such joint ventures were popular in East-West trade during the Soviet era. At that time, contractual joint ventures had several ideological and legal advantages for the Soviets. No one had to establish a legal entity that would have an existence independent of the joint venturers. The Soviets did not have to implement a capitalist tool of an entity owned by someone other than the State (the Fatherland). Accounting could be defined in the contract, leaving everything to negotiation and nothing to the application of capitalist legal systems. (Did you hear of Hollywood Accounting? It spawned many lawsuits. The Soviets had their own style of contractual accounting, too!). And termination could be achieved by contract termination, without transfer of any assets from an entity. We doubt that the HP-NEC deal was inspired by a contractual JV structure. - Entity Joint Venture:
In an “entity” joint venture, the joint venturers agree to form a new entity (the “JVCo”), which then serves as the focal point for the business operations. In an outsourcing JV, the joint venturers typically contribute cash to the JV Co. to conduct certain defined operations (such as its officers and key employees in administration and marketing). But, the JV partners rarely transfer ownership of intellectual property, operating employees, real estate or technology systems to JVCo. Instead, the JVCo takes licenses and leases from its JV partners, who also agree to provide defined services to the JVCo so that JVCo can, in turn, deliver the outsourcing package to the JVCo customers. A JVCo need not have much capital: any transitioning of customer employees and other resources under management could be made to either, or both, of the JV partners instead of to the JVCo. In fact, JVCo might have no assets at all, assuming that the JV partners each make available, on a “secondment” basis, its own employees performing functions in the name of the JVCo. Maybe the Soviets had a smarter idea, since at least the third parties dealing with the JV under a contractual JV could make a claim against some deep pockets!
Structure of Services to Target Customers.
Under the JV, the partners agree to establish a “joint sales force,” which might be under a JVCo. When a customer signs a contract with JVCo, the customer’s transitioned employees would probably be hired by a separate jointly owned entity (“JVServiceCo”), with services being provided separately and jointly by HP and NEC. The exact nature of the legal relationships between the service providers, as a team, the customer-specific JVServiceCo and the customer would reflect a number of legal and business considerations. The authors of this case study offer to provide details of such considerations, and related strategies, to their clients on request.
Scope of the JVCo’s Operations.
Under corporate law, the JV partners must carefully define the scope of the JV’s operations. Like lines in the sand, the scope defines the realm of business opportunities that each JV partner must bring to the JV, rather than perform on its own. Anything outside the defined scope does not involve any fiduciary duty of a JV partner to bring the corporate opportunity to the JV and to avoid competing with the JVCo for the opportunity.
Scope of Contributions in Kind.
In the HP-NEC deal, the announcement failed to mention anticipated financial contributions. This suggests that the two parties will minimize invested capital by allocating functions in a complementary, non-competitive, fashion. Such an allocation justifies a joint venture since the two companies might not have been able to offer or compete in the marketplace alone. See Antitrust in Joint Ventures in Outsourcing.
In the press conference, HP’s President, Carly Fiorina, said that HP “focuses on capability, invention and innovation,” while NEC “brings important capabilities in open mission-critical systems.” This suggests that NEC would be providing managed services for data centers operating legacy systems under Unix (or variants), and HP would be providing customer solutions design, project management and custom services in software development, product design, technology improvement plans and strategic consulting.
HP’s Contribution.
HP is already a leading outsourcing company in North America and Europe. In September 2002, Canadian Imperial Bank of Commerce awarded HP with a seven-year, $1.5 billion contract for the provision of IT services.NEC’s Contribution.
Customer Base.
NEC has an installed customer base in Japan’s financial and business markets, especially in telecom. NEC also has extensive business relationships with technology companies in China, which should help open the Chinese market for HP’s computers and, in combination, NEC’s and HP’s technology services. But, in the JV, new markets will be targeted, so the Japanese market will be only an incidental target market. Accordingly, the JV will allow NEC to enter new geographical markets using HP as a sales agent and distribution channel.
Technology Solutions.
NEC’s Solutions group offers custom consulting and systems integration services that could be used to provide back-office support in Japan. NEC Solutions offers highly reliable computing solutions to enterprise, government, and individual customers by providing software, hardware, and services necessary to design, integrate, and operate these elements. NEC Solutions focuses on customized solutions packages for new technology deployments for customers.In addition, NEC’s Systems Integration services group, which has approximately 13,000 systems engineers, provides end-to-end systems design, development, deployment, and systems operation solutions. System integration is provided directly and through NEC Soft, Ltd. and other subsidiaries. SI services consist of (a) systems design, development, and deployment services, (b) operational support services, including system problem diagnosis and correction, and (c) consulting services on systems architecture design and technology planning, including the evaluation and selection of technologies and platforms.
In software, NEC develops and provides software products primarily for use in its computers. Software products include operating systems, middleware for managing large-scale distributed data processing systems, and application software. NEC continues to further develop its capabilities in middleware to enable the more rapid, cost-effective integration of different systems, protocols, and software.
Rationale for a Joint Venture in Outsourcing.
Several key factors brought this joint venture into being:
Prior Collaborative Relationship over Many Years.
Since at least 1995, HP and NEC have been collaborating on technology other than services. They share mutual competitors, including Microsoft and IBM. Prior to the merger of Compaq into HP, HP had already established a series of joint activities in research and development, design, manufacture and distribution of computers and their components. The past relationship focused on combining mainframe technology expertise of NEC and, in at least one case, Hitachi, Ltd., with HP’s operating systems and computers.
In 1995, the two companies partnered in the Unix server arena, allowing NEC to purchase large-scale servers and related technology from HP on an OEM basis for resale in Japan. As a result, the NEC NX7000 product line is based on HP technology.
In 1997, HP became an OEM supplier to NEC and Hitachi, Ltd. of entry-level models in the HP 9000 D-class Enterprise Server family. Also, HP signed a multi-year software development agreement with NEC and Hitachi to integrate Japanese mainframe expertise into HP-UX operating system for grater modularity, scalability, performance, reliability and management by self-healing enhancements to detect and repair unexpected software problems in the HP-UX kernel. Incidentally, in 1989, HP and Hitachi signed a broad alliance including the joint development of HP’s Precision Architecture RISK CPU chips and the design and construction of HP’s PA-RISC systems. The two companies established a technical support center in Japan (the “HP-NEC Enterprise Solution Integration Center,” or “HP-NEC ESIC”).
In 1998, HP and NEC signed a development agreement to optimize HP’s HP-UX operating system to run on systems using the upcoming Merced 64-bit processor. As of 2002, the Merced processor has not generated widespread market demand.
In 1999, HP and NEC agreed to collaborate on what they called was the next generation of Japan’s Internet Protocol (IP) network. Under the 1999 agreement, NEC distributed IP servers using HP-UX (HP’s Unix-like operating system) and HP OpenCall (HP’s middleware) together with NEC’s application software and IP network equipment. On the R&D level, the two companies agreed to combine their computer and telecom technologies to provide real-time high performance for telecom carriers.
In May 2002, HP and NEC announced a strategic collaboration to deliver large-scale, open mission-critical solutions for targeted industries. They noted that, together, they had already jointly delivered several complex mission-critical solutions in the financial and telecommunications industries. This collaboration expressed an intention to target a number of U.S. financial services companies and a range of global Japanese companies. They intended to explore broader market opportunities worldwide, common systems integration and solutions, to leverage each other’s enabling technologies such as NEC’s OpenDiosa middleware for high-availability applications on non-mainframe servers and HP’s Utility Data Center and Integrated Service Management. The allocated roles for HP to provide IT infrastructure services and outsourcing capabilities and NEC’s systems integration and support technologies.
Common Technology Architectural Orientation.
While each of the JV partners has developed thousands of patents, every patent is subject to challenge and invalidation.
Concentration and Vertical Integration in the International Markets for Information Technology Outsourcing.
In 1997, Computer Associates reportedly offered to acquire Computer Sciences Corporation so to support distribution of CA’s software products. CSC successfully rebuffed the offer. But the dialogue raised the question of the viability of a future IT outsourcing business where the Service Delivery group was merely the distribution channel for proprietary software of Computer Associates and its favored channel partners.
Restructuring of NEC.
NEC has been hard hit by a combination of a decline in global demand for computers (and the computer components that NEC manufactures), falling prices for IT hardware, excess capacity in broadband telecommunications (and consequential decline in optical networking), and a general economic decline in Japan during the 1990’s and early 2000’s. As a result, NEC has restructured for cost-cutting, redirection of capital investment and supply-chain management to improve manufacturing efficiency. The restructuring includes closing of aging factories, layoffs, transfer of semiconductor business (including system LSIs, integrated circuits and discrete devices and compound semiconductor devices but not DRAM’s) to a new subsidiary that NEC intends to spin off in a public offering. Since 2000, NEC has also separated its plasma display panel division and merged several similar units at group companies.
In short, NEC has decided to slim down from its “giant” size into a series of separate companies, each with its own business plan. Development of an outsourcing business suggests a new business plan. In announcing the JV, NEC’s President and CEO Koji Nishigaki admitted that NEC had no experience in the full-scope type of outsourcing business, and hoped to learn from HP’s business model.
Restructuring of HP.
HP is the fish that swallowed the second fish that swallowed the third fish. HP merged with Compaq Corporation, a computer manufacturer and outsourcing services provider, after Compaq had acquired Digital Equipment Corporation, a computer manufacturer and outsourcing services provider especially for distributed networks of computers. As part of the post-merger integration, HP has shed thousands of workers and sought economies of scale and new channels for leveraging core competencies — including outsourcing — into new geographical markets.
Coopetition: Competition and Collaboration amongst Outsourcers.
“Coopetition” refers to the anomaly of companies that compete in one sector cooperating closely in another sector.
IBM.
In this case, HP, NEC and Hitachi, who have all worked closely to compete with IBM and other computer manufacturers, have joined IBM in the promotion of “open source” computing, to be supported by a non-profit Open Source Development Lab in Portland, Oregon, to test enterprise-class Linux.
Microsoft.
Microsoft licenses eHome technology to NEC and HP.
HP and NEC.
Each of HP and NEC sell computers, personal digital assistants / Windows CE devices and other technologies that perform similar functions.
Securities Law Disclosures for Joint Ventures.
Joint ventures involve significant risk to the business and reputation of each party. Formation and operation of a joint venture could require disclosure under securities laws, since a significant venture could have a material impact on the financial performance of either party. Each of HP and NEC has annual revenue in the neighborhood of about $35 billion to $40 billion. A venture that does put at risk 1% or 2% of that revenue stream (consisting of $350 million to $700 million) probably is not “material.”
On the other hand, such information might be disclosed generally in the issuer’s “management discussion and analysis.” This disclosure is much more general in nature.
As NEC said in such discussion in its Form 20-K filed in August 2002:
WE RELY ON OUR STRATEGIC PARTNERS, AND OUR BUSINESS COULD SUFFER IF OUR STRATEGIC PARTNERS HAVE PROBLEMS OR OUR RELATIONSHIPS WITH THEM CHANGE
As part of our strategy, we have entered into a number of long-term strategic alliances with leading industry participants, both to develop new technologies and products and to manufacture existing and new products. If our strategic partners encounter financial or other business difficulties, if their strategic objectives change or if they perceive us no longer to be an attractive alliance partner, they may no longer desire or be able to participate in our alliances. Our business could be hurt if we were unable to continue one or more of our alliances.
Under the Sarbanes-Oxley Act of 2002, joint venturers such as NEC and HP will probably need to disclose more information relating to joint venture operations. While that law generally does not change the definition of materiality, it does require disclosure of information the previously was ignored under former financial accounting principles. The act does require closer attention to disclosure of “off-balance-sheet” transactions. The SEC has issued a proposed rule on such disclosures.
Failed Deals, Bankruptcy and Class Action Securities Fraud in Global Outsourcing: In re Alcatel Securities Litigation
October 9, 2009 by Bierce & Kenerson, P.C.
In a pre-Sarbanes-Oxley time, the hypergrowth Dot.Com era disintegrated into “Dot.bomb” implosions. Reciprocal deal-making in speculative ventures was almost the norm, particularly in telecommunications transport. The litigation aftermath of failed deals, bankruptcy and class actions for securities fraud is reaching resolution. This short case study provides a synopsis of some key points of failure in reciprocal transactions, with a focus on telecom.
Background.
Alcatel is a French technology corporation. On October 20, 2000, the company issued a U.S. initial public offering (IPO) for its Class O shares. This class was 100% owned by Alcatel, but served as a “tracking” stock for the company’s Optronics Division. The IPO raised approximately $1.2 Billion and created additional shares that could be used as currency in mergers and acquisitions.
The Reciprocal Deal.
Soon after the IPO, Alcatel announced that it had invested $700 million in its customer, 360networks Corporation. In turn, the customer agreed to purchase over $1 billion in equipment from Alcatel to create a proposed trans-Pacific fiber-optic network.
Announcements to Investors.
When Alcatel’s proposed merger with Lucent fell through, Alcatel issued an unexpected announcement to investors that warned of a projected $2.6 billion loss for the second quarter of 2001. The loss included charges associated with a write-down of goodwill for two acquisitions (Xylan and Packet Engines), a full write-down of the $700 million invested in 360networks and various inventory write-downs. Allegedly, the announcement downgraded its Optronics Division in light of that unit’s “high exposure to the submarine market and the increased lack of visibility and potential delays in large projects, as well as inventory build-ups.” In re Alcatel Sec. Litig, __ F.3d __, NYLJ Mar. 11, 2005, p. 23, cols. 1-4, p. 24, cols. 1-4, at p. 24, col. 3 (S.D.N.Y. Mar. 11, 2005) (Judge Casey) [“In Re Alcatel Sec. Litig.”].
Violations Alleged.
The Alcatel investors claimed securities fraud. Most of the claims were dismissed because of late filing. The case is a cautionary tale and reminds us of the interests of investors as key stakeholders in outsourcing, whether as shareholders in global enterprises or as shareholders or bondholders in service providers.
Recommendations.
The story of Romeo and Juliet brings to mind the aphorism “‘T’is better to have lived and loved than to never loved at all.”
In securities fraud litigation, the love has turned to hate. So we posit the modern aphorism, “‘T’is better to have solicited investment and warned than to have never solicited investment at all.”
In short, participants in outsourcing should each refocus on the specificity of their warnings surrounding the risks of outsourcing and other strategic relationships, the nature and risks of the issuing company’s supply chain of suppliers and customers, and the particular risks in the industry. The generic warnings might not be sufficient, so constant updating may be appropriate, even without considering the special certification, audit and control issues presented under the Sarbanes-Oxley Act of 2002.
Service Providers.
Reciprocal Dealings and Joint Ventures Pose Special Securities Risks.
Typically, the service provider’s investors are the ones with a securities fraud claim. To be put on notice to inquire further, the service provider’s investors need to receive a storm warning of the seriousness of a material problem that could affect an ordinary investor’s decision to buy, sell or hold the securities of the service provider. In the case of reciprocal business dealings and joint ventures between service providers and their enterprise customers, the standards of disclosure are heightened because the materiality is heightened: a bankruptcy by the enterprise customer (as in the case of WorldCom for EDS or in the case of 360networks for Alcatel).
Designing and Planning for Investor Notification.
Service providers should therefore consider the following prudent business practices:
- Interdependencies:
warnings to investors whenever they enter into reciprocal business dealings or joint ventures with customers, to identify the mutuality of commitments and dependencies for success, particularly specific risks of such dependencies. - Material Changes:
warnings to investors whenever such dealings or ventures give rise to material losses or other material risks of liability. - Keeping the Risks Small:
keeping the size and financial value at risk below the “materiality threshold” so that any failure to disclose would not trigger a claim of material securities fraud (or, in cases of a consortium contract with leading enterprise customers in an industry vertical, a claim that the contract restrains trade or otherwise violates competition laws).
Enterprise Customers.
Enterprise customers face questions, as securities issuers, surrounding the viability of their key suppliers. Best practices to avoid securities fraud claims should be considered.
- General Warnings about Dependency on Suppliers.
It is customary to identify that the issuer is dependent on its suppliers for continuity of business operations. - Specific Warnings about Limitations on Liability of Suppliers.
It is customary for commercial enterprises to negotiate limitations of liability. Enterprise customers seek such limitations when they are sellers, and they customarily allow certain limitations of liability to their service providers, subject to unlimited liability for certain key failures by the service provider. The enterprise customer should provide specific warnings of the risks of outsourcing. Any disclosure of mitigation measures taken would be in the nature of “comfort” to the investor, which could backfire and render the warning useless. - Consider Investing in Your Service Providers and Suppliers.
Enterprise customers may have more leverage over a publicly traded service provider if the customer is also a shareholder. The amount of the shareholding is not as significant as the fact that the enterprise customer can have access to company information for a valid corporate purpose in relation to its decision whether to buy, sell or hold the shares. Being a shareholder gives the enterprise customer a seat at the table in the judicial selection of the most representative shareholder to prosecute any shareholder class action. And it permits the shareholder to opt in or opt out of the securities litigation, which could be useful in governing the personal and corporate relationships as customer. - Negotiate a Good Contract.
A solid outsourcing contract, accompanied by effective contract administration and relationship governance, makes a difference. In-house counsel not experienced in the art of outsourcing should hire specialized lawyers. Reliance on consultants to process legal issues may be courting investor inquiry.
Frequently Asked Questions For Employees
October 9, 2009 by Bierce & Kenerson, P.C.
A) “Outsourcing” does not mean the automatic loss of your job.
It may improve an employee’s career opportunities by opening the door to new environments for providing service. Indeed, with the technical training that an outsourcing service provider gives its new employees, being “outsourced” can be a ticket to personal growth, improved opportunities for lifestyle change (e.g., telecommuting, or flex time), and backup to avoid being burned out as the only, “indispensable” employee supporting a business operation. For the employee, the challenges create opportunities. But, because the external service provider will be held accountable for agreed service levels, the employee will also be guided by new measurements and standards of performance.
B) “Outsourcing”: Same Threat to Your Job as in a Merger?
Employees in a company or department that is being targeted for outsourcing normally feel threatened by the uncertainty. This is similar to the fear, uncertainty and doubt experienced by employees in a merger. Yet the outsourcing decision is quite different. Indeed, in an outsourcing, management elects to maintain and effectively deploy all useful resources. External services providers typically do not want to hire someone just to fire them later. By hiring an employee whose job is being outsourced, the outsourcer (external service provider) assumes many responsibilities. Such responsibilities generate high costs in recruitment, training, transitioning in and transitioning out (including outplacement and severance, if applicable), pensions, labor law compliance and other legal and economic obligations. So the outsourcer will normally plan to maintain certain employment levels and efficiently use all personnel whose jobs are being outsourced.
The threat is not the same as in a merger. In a merger, attrition and job terminations are generally one of the compelling reasons to marry the two companies. So your job is more at risk in a merger than in an outsourcing.
C) Can We Avoid Outsourcing?
Yes. When a work group – however large and complex – has been mismanaged through neglect, lack of vision and poor processes, outsourcing might not be the only answer. Improvement of business processes before outsourcing can avoid those outsourcings that occur based solely on “cost savings.” But even good management and leadership cannot escape the compelling advantages of certain types of “strategic outsourcing” that adds a strategic benefit beyond mere cost savings.
D) Should Service Level Agreements Be Used only for Outsourcing?
No. In fact, today’s well-managed businesses often establish “service level” commitments from internal “in-house” staff. Indeed, some information technology departments propose “service level agreements” as a means of setting realistic expectations for business users. Studies have found that frequently, an in-house service department may suffer from criticism by frustrated in-house clients. After going through the process of asking what the in-house clients expect, and showing the costs of fulfilling those expectations, the in-house staff can compare itself to the “best of breed.” The process of defining internal service levels will help harmonize expectations of users and reduce stress by in-house service providers.
E) When Should We Outsource a Function?
Within a globally competitive environment, outsourcing could be useful, or it could unbalance a well-managed organization. The key is to find and maintain one’s balance. Rebalancing involves a candid reassessment of organizational strengths, weaknesses and the threats from the marketplace. Confronting this constant challenge, management must determine what functions fit within the core competencies of the organization, retain those and seek ways to minimize investment and risk in areas that do not add as much value to shareholders – and other stakeholders – as the core competencies.
F) What Alternatives Exist?
Outsourcing is one of a wide range of possible management strategies. Considering “in-house” strategies include:
- Inaction:
Do nothing. We’re doing a great job already. - Cuts Projects:
Eliminate wasteful projects (especially those that require an excessive investment). - Cut Jobs:
Eliminate jobs. Load more work onto existing staff. - Reallocate Resources:
Shuffle personnel to new, more effective tasks. (Training may be required. Transitions could be bumpy.) - “Strategic” initiatives include:
- Competitive Departments:
Make each department into a separate cost-center and allow it to compete for customers both in-house and in the market. General Motors follows this practice.- Shared Services Subsidiaries:
Form an alliance of similarly situated customers of the same service, and transfer the “generic” workload to a jointly owned “shared services subsidiary.” (This “shared services” subsidiary might compete in the market as well.) This requires some submission of control and political alliances with outsiders. Experience proves that a jointly managed subsidiary, without independent management of its own, can lose its way and flounder. In this case, outsourcing has been shown as an effective alternative to a failed experiment.- Joint Ventures with Services Providers:
A joint venture involves a sharing of risk and rewards. (Outsourcing involves shared responsibilities and possibly shared risks, and rarely involves shared rewards). Joining forces with a services provider can be useful where the functions performed by the joint venture do not require you to promote, directly or indirectly, the cannibalization of your own core business. The services provider, as your joint venturer, will undoubtedly expect a rate of return on its investment by selling the joint services to others – including your competitors – in the marketplace.- Other Paradigms:
Organizational management includes a panoply of other paradigms for speed, skill, technological competency and other goals. The authors of this Website would be pleased to explore such other paradigms with you, and to receive your comments on the effectiveness of outsourcing in relation to other possible paradigms.