Trusting Your IT Outsourcer
Companies across the globe must analyze current outsourcing relationships and develop risk mitigation strategies.
The allegations of accounting fraud at Satyam have raised serious concerns for CIOs of companies with outsourced IT operations. Companies working with Satyam are anxious as to whether or not it will survive, and its current customers need to determine how this will affect their operations. The long-term issue is whether Satyam’s difficulties will lead to a loss of trust in the Indian outsourcing community as a whole or remain focused around Satyam, says a new report by Booz & Company.
“Customers will no doubt expect much higher standards of financial transparency and due diligence after this; and every company needs to set up a systematic way to analyze current outsourcing relationships and develop workable risk mitigation against short-term service disruptions,” explained Ramez Shehadi, a partner at Booz & Company.
An Unprecedented Incident
The Satyam Computer Services scandal sent shock waves through the global IT community, making CIOs worldwide wonder if it was an isolated incident, or a watershed in the globalization story of Indian business.
CIOs that have outsourced large portions of their IT portfolios will be seriously concerned about risks of potential knowledge loss and service disruptions should major issues arise with their outsourcing vendor. This scenario requires they answer tough questions from the CEO and board members: on the management of their current Indian outsourcing arrangements, long-term structural questions about using outsourcing firms and whether changes to their vendor governance models are necessary.
“Companies with long-term relationships with Satyam have one primary concern: Satyam’s survival,” commented Shehadi. It will not be in a position to invest significantly in client engagements, staff development, or R&D; all critical elements for an IT services company; and it must spend a great deal of time and resources working through its accounting issues and dealing with extensive external regulatory investigations in both India and the U.S.
Despite most Indian IT and BPO companies stating they will not poach Satyam employees or clients; several companies are trying to wean away Satyam clients. On the positive side, most of the outsourcing work in India is done out of centers in Hyderabad, Bangalore, and Chennai—home to many Satyam competitors. Plans for the absorption of staff and clients are expected to be drawn up by competitors within days, and shifting to take place within weeks. For CIOs, the possibility of this upheaval has caused a concern regarding the operational resilience of these new relationships.
“We recommend Satyam’s clients move quickly to assess the damage and put in place contingency plans for service continuity,” said Shehadi. They must determine their exposure to, and reliance on Satyam, with a comprehensive inventory of the projects Satyam was working on. Next, they must identify the most mission-critical systems being developed or maintained by Satyam and put together a plan for bringing those systems back in-house or migrating them to another vendor. They should also review every contract covering work with Satyam, paying attention to exit clauses governing the transfer of work and ownership of any intellectual property.
CIOs must assess which vendors might be able to take over from Satyam. They should also review the governance and accounting oversight of all offshore suppliers, and catalog and capture the intellectual property and domain expertise residing with Satyam. “Jobs or incentives should be offered to Satyam staff as part of transferring that knowledge back,” said Shehadi. This exercise, while challenging, will help mitigate against short-term service disruptions and give the IT organization a greater understanding of its current outsourcers’ activities, which can be leveraged in the future to negotiate more favorable contract terms.
The Erosion of Trust
Before the scandal broke, the sector had been feeling the impact of major recessions in developed economies, with concerns around the likely stance of the Obama administration toward offshoring. Companies have already been evaluating near-shore alternatives and offshore destinations including Brazil and Poland due to Indian political and security concerns, hyperinflation in Indian technical salaries, and soaring real estate prices; the Satyam issue may expedite the move to alternatives.
Trust in outsourcing has been damaged. When overseas clients choose offshore providers, they must be able to trust them with the sensitive data, proprietary systems, and complex processes that are instrumental to their businesses. “Now, CIOs must demand much higher standards of transparency and conduct even more due diligence, especially during the current economic crisis,” commented Shehadi. Well-governed providers of outsourcing services with established disclosure norms and robust accounting practices will be favored, while weaker, smaller players will likely suffer.
Governance in Corporate India
The long-term question raised by Satyam’s downfall is whether foreign investors will grow skeptical about corporate governance standards in India. Does it warrant an extensive overhaul of corporate governance and regulatory frameworks for Indian outsourcing providers? No regulatory regime is perfect in design or perfectly enforceable and instances of financial malfeasance crop up regularly, in spite of tightening regulatory regimes. “Existing market and legal mechanisms should be able to deal with isolated incidents and discipline the wrongdoers, but it is dangerous to conclude that a fundamental breakdown in corporate governance has taken place in India,” stated Shehadi.
If companies continue to pull back their spending and if the liquidity crunch continues, more outsourcing companies could run into difficulties. Every company therefore needs to set up a systematic way to analyze current relationships with all outsourcing vendors—and develop workable risk mitigation strategies.