Due Diligence – a way to improve sourcing success

Every IT outsourcing transaction involves a phase of due diligence. The purpose of due diligence is for the buyer and seller to validate whether the assumptions they’ve made about the details of the sourcing relationship are true. If not, the parties can correct or realign their plans to improve the likelihood of success.

When suppliers submit their initial bids, the solution and pricing proposals arrive with a set of underlying assumptions. These assumptions are necessary to frame the discussion around solution and price; however, the intent is not to allow the assumptions to remain in the final contract. To resolve these assumptions, the client will allow a period of due diligence for the supplier to request documents, visit facilities, and interview key personnel. Typically though, clients push suppliers to define their own requests and ultimately bear the risk for their assumptions.

Unfortunately, many clients view the service provider’s due diligence on their internal environment as an inconvenience, as entirely the service provider’s responsibility to define, and as a risk to the business case and schedule.

Such perspectives are misguided. When entering into a long-term sourcing relationship, both parties benefit significantly from a realistic understanding of the situation at hand. It’s crucial for the client business case to ensure that costs do not vary widely from initial service provider quotes. Likewise, for the service provider business case to make sense, it’s necessary that their estimations of cost are as accurate as possible. Much of the effort in any outsourcing negotiation is focused on who will bear the risks when things go wrong, and this is a necessary part of the process. But is it better to feel confident in an ability to point a finger or to avoid a failure? If a car is skidding on an icy road, is it better to have no-fault insurance or to avoid the accident in the first place?

What actually happens when there’s a big disconnect between supplier solution and client environment is something like this:

Imagine we have an antiquated backup environment that consists of direct-attached tape drives scattered across geographically diverse locations. The supplier has proposed to replace this with a modern, centralized disk-based backup solution, which will backup these remote sites over the network. The initial supplier bid contained an assumption stating all sites had sufficient bandwidth in order to utilize the new centralized backup solution. During the due diligence period the supplier requested and reviewed the documents that were available relating to site bandwidth, backup frequency, and size. Unfortunately, no telecom inventory had been performed recently and the bandwidth records were only partially complete. Additionally, no utilization reports were available for the network. The backup systems contained logs on size and frequency of backup, but each individual server had to be logged into in order to retrieve the logs, which resulted in the use of only a sampling.

After contract signing it is discovered that while most sites have sufficiently large circuits, they are also typically using most of their bandwidth. Additionally, certain sites have far larger and more frequent backups than the numbers assumed in the supplier bid. The supplier and the client together are now faced with a difficult situation. Either the supplier will have to invest in a remediation of the backup system, the client will have to invest in more bandwidth, or the supplier will need to operate the legacy backup solution at greater cost than was included in their bid. This is further complicated by the fact that many of the solutions to this problem touch on areas that are part of a different services silo. A review and reworking of backup policies may reduce the need for bandwidth but require the involvement of application groups and business units. Purchasing larger circuits may solve the problem, but in some cases, network might be outsourced to another provider under a separate contract.

Even in a situation where a supplier is determined that the client will bear no additional costs, this solution miss creates real problems. No supplier account team has infinite resources; they all work within a budget and need to make choices for how they will allocate the scarce labor and capital they have been allocated. Additional backup system costs mean fewer resources elsewhere in the environment. If an account is actually losing money, the management will replace the supplier account executive with someone who is given the charter to fix the problem.

This is why it is so important for all agreements to benefit both parties. The true purpose of inbound due diligence is not to allow the supplier to remove assumptions from their bid but to ensure that the supplier solution is a good fit for the client environment. Both the client and the supplier should be equally excited about finding bad assumptions, missing costs, and other gaps.

Luckily the solution to the problem described above is relatively straightforward. The parties need to work together on due diligence to ensure the completeness and fit of the supplier solution. The client should enter the phase with a mindset to offer as much transparency as possible and pre-organize information that might be relevant for the suppliers. Due diligence should also include a great deal of dialogue rather than simply passing documents back and forth. And above all, the client must recognize that the supplier’s due diligence is not for the supplier’s own benefit; rather, it’s key toward ensuring an effective solution fit and a successful relationship for both parties.

– Chris Payne
5-Mar-2014 – [bio]
 Chris Payne