Costly Surprises of Outsourcing

Computerworld - A headline may say that a company signed a $320 million IT outsourcing contract, but the actual costs will likely be much higher. Behind the scenes, the client spends big bucks on evaluating vendors, managing the contract, enhancing security, traveling to offshore sites and potentially paying severance packages for laid-off employees.

And that's only part of what can inflate the dollar figure quoted in a basic contract.

"Things change over time, and that inevitably leads to some form of cost-shifting," says John Hill, CIO at Praxair Inc., a Danbury, Conn.-based manufacturer of gases. He suggests that contracts be designed to accommodate some flexibility, such as changes in labor or computer and network hardware.

Other IT managers and outsourcing consultants point out that unexpected costs can arise during any phase of the project. Anyone considering outsourcing should take a close look at these potential costs or risk miscalculating the true benefits of outsourcing.

Vendor Selection

Many organizations overlook the costs associated with evaluating and selecting a contractor. The process typically can drag on for many months, depending on the project's complexity, and requires time commitments from senior executives in IT, human resources, finance, legal and other departments.

"It's a very complex [market], with many service providers that have changing terms and conditions," says Shawn McCray, a partner at TPI Inc., an outsourcing advisory firm in The Woodlands, Texas.

If the potential contractors are located offshore, organizations could incur extensive travel expenses for visits to evaluate services. "A lot of times, offshore service providers have very good sales and marketing abilities, but companies need to [scrutinize potential contractors] to see what their real capabilities are," McCray says.

In some cases, organizations will need to buy studies from independent research firms—at a cost of thousands of dollars—to evaluate outsourcing vendors, says Atul Vashistha, CEO of NeoIT.com Inc., an offshore outsourcing advisory firm in San Ramon, Calif.

Credit: Monika Melnychuk

All told, choosing the right vendor and writing the contract costs about 3% of the total outsourcing cost, according to a 2001 study of 50 IT outsourcing deals by French academic Jerome Barthelemy.

Transition Period

Unexpected costs can crop up during the early stages of the outsourcing relationship, when knowledge is transferred from people on staff to members of the outsourcing team. If the contractor is located offshore, that can mean extensive travel expenses and cultural or language training for employees who visit the contractor's site, possibly for months.