Recent outsourcing deals have caused a resounding buzz within the executive suites of many insurers. Prominent vendors are proposing seductive deals with no up-front cost, immediate and dramatic savings, and most recently, computing on demand. Some executives see it as a silver bullet that will drive substantial and sustainable cost reduction along with measurable improvements in performance.Far from a new idea, this is a rocky road that many companies have been traveling down for decades. History has shown that for every raging success, there is a bone-crushing failure and most deals fall in between these extremes.

Will companies be any more successful today in capturing the Holy Grail of a successful outsourcing arrangement than in the past? Perhaps, but it would be prudent to heed the lessons learned from the many historical deals, both good and bad.

Customer Beware

Outsourcing options include information technology outsourcing, application and application maintenance outsourcing and business process outsourcing. Simple, redundant, standard activities can be outsourced with lower risk than complex, one-off legacy activities.

Many successful deals have focused on help desks, desktops, networks, infrastructure and simple, transactional business processes. Because vendors have experience in these areas, investment, costs and risk are well understood.

Many companies have successfully and economically launched new products using the existing platforms of third-party administrators. Application maintenance outsourcing for packages such as SAP, Oracle and Seibel can also be successful as vendors develop deep skills with specific technologies.

With proper governance, service level agreements and vendor management, even new applications can be successfully developed and maintained. Although within this context, pricing often becomes a problem.

Risk grows substantially when companies pursue application maintenance outsourcing of unique or complex legacy applications. Maintenance of thousands of lines of decades-old COBOL or PL1 code is challenging enough when kept in-house. Sent outside, it is a highly risky proposition.

For this to work, the customer must retain competent estimating and project management capabilities, and have bullet-proof processes for gathering user requirements. It is not likely the vendor can develop economies of scale in the maintenance of such systems. In most cases, the ongoing cost reduction from such an arrangement can only be achieved by using much cheaper offshore resources or by an investment-intensive conversion to a standard platform.

A troubled outsourcing arrangement is like a bad marriage: Both parties to an outsourcing deal must derive benefits over the life of the contract and the benefits must approximate the expectations each had going in.

Unlike a real estate deal where there can be a winner and a loser, the outsourcing deal is either win-win or lose-lose. If the contract turns out to be unprofitable for the vendor, service (and the customer) will suffer. Or, if agreed upon service levels are not achieved, the customer will be dissatisfied and seek remedies.

The outsourcing of unique or highly complex legacy activities is most prone to failure because vendors often underestimate the resources and transformation required to deliver at the agreed upon price. The vendor must be given the opportunity to develop adequate understanding of the complexities of the activities under review.

The most successful deals are actively managed on a daily basis by the vendor and the customer, and this includes involving the vendor early when planning business changes that may affect downstream outsourced activities.

Exit Strategy Necessary

With an estimated 70% of contracts being renegotiated or cancelled, a well-formulated exit strategy is a must.

Many contracts imply substantial up-front investment by the vendor and have substantial penalties for early termination. If the customer's function has been moved to the vendor's platform, re-integration of the function will require investment in another platform and associated conversion costs.

Companies have been forced to spend millions of dollars just getting back to square one after a failed outsourcing arrangement. Savvy companies have provided for re-integration in their contracts and are moving toward shorter-term, more flexible arrangements to better address unforeseen changes in business needs and to take advantage of future innovations in technology.

First and foremost, don't outsource what you can't manage. The expectations of both vendor and customer must be clearly documented and in alignment. Comprehensive acceptance criteria, service level agreements and benchmarks are a must; as is a governance structure appropriate to the scope and complexity of the outsourced function.

Finally, the customer should employ legal counsel and business advisors that have the deep expertise and experience in outsourcing planning and implementation. A company would never begin construction of a building without appropriate professional assistance. Shouldn't the same approach be taken when constructing an outsourcing arrangement?

Michael LaPorta is the senior partner for insurance at New York-based Braxton (formally Deloitte Consulting). He is a certified management consultant.

Register or login for access to this item and much more

All Digital Insurance content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access