8 Outsourcing Lessons From Indiana's Largest Failed Outsourcing Deal

What Can Be Learned From Indiana's $1.4 Billion Failed Outsourcing Contract

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While case studies about successful projects make for interesting reading, they aren't always the ideal resource for learning how to avoid missteps. Case studies about failed projects -- though rare -- may enable us to learn more than a mere summary of a successful project. Consider an engineer who is designing a bridge: 10 well-designed bridges that remain standing for 100 years tell us less about engineering than the one bridge that collapses. The case study about a faulty bridge may help us answer questions about metal fatigue, poorly manufactured parts, inspection oversights, clues that may have been overlooked or dismissed, wind force and untested materials used to build the bridge. Success may only tell us that we didn’t fail. Failure, when carefully studied, tells us what went wrong.

A Look at the Biggest Outsourcing Failure

Given the increasing number of outsourcing decisions that organizations of varying sizes make, case studies about outsourcing failures also prove helpful in learning what to do and what not to do. The data from failed outsourcing experiments can be found in our court system, where former business partners are arguing over who was at fault for the failure. An excellent example of this is the $1.4 billion contract between the State of Indiana and IBM.

Indiana wanted to outsource its welfare processing systems, and the court record essentially is the case study from which to learn about Indiana's missteps. In this case, we know the details because the client and the vendor chose to sue each other, and the details of their disagreement are now in the public record. In the words of presiding Judge David Dreyer, "Neither party deserves to win this case. This story represents a 'perfect storm' of misguided government policy and overzealous corporate ambition. Overall, both parties are to blame, and Indiana's taxpayers are left as apparent losers."

8 Lessons for Avoiding Outsourcing Failures

There are many lessons to be learned, but here are the top eight lessons about outsourcing to be learned from the state of Indiana and IBM's contract.

Change Requires Commitment
This contract was to transform, “the nation’s worst welfare system, (apparently rife with criminal fraud, rampant incompetence, favoritism, etc.).” Also, Indiana sought to introduce a new service delivery model that would reduce costs and fix decades of federal regulation violations. Accomplishing any one of these goals would have been remarkable. Achieving them all would be unprecedented. But to achieve all the goals requires the client (State of Indiana) to give the vendor (IBM) its absolute and unconditional support. Instead, court evidence shows that state representatives intentionally undermined the program (and violated the contract) by interfering with IBM’s management of (politically connected) subcontractors. Change management is successful only if the organization supports change, and in this case, Indiana did not.

Learn From Other Examples

As part of the preparation for the Indiana-IBM contract, similar programs in Texas and Florida were examined. These programs failed (or were failing), in very much the same way that Indiana's eventually would. The problems in Texas were so severe that “the rollout of the project was stopped.” IBM decided that these issues didn’t apply to them or that they would be able to manage the issues. IBM is unquestionably a great company, but what this contract needed was more than IBM could provide. Mega-contracts blind vendors to flaws and limits; the client must see physical evidence that risks have been sufficiently mitigated.

Mega Contracts = Mega Risk
A single big contract is riskier than several smaller contracts. You may choose to take the risk because a single big contract can cost less to manage if it is successful. If not, however, a failed big contract is very expensive. The potential benefits of lower management costs can be compared to the increased risks of failure, and the cost of risk mitigation can also be factored in. Court records show the parties' acknowledgment of some risks, but there is no evidence that the client or the vendor ever did the math and calculated the costs. Size alone is a factor for failure, but size tends to have co-factors (as this contract did) that lead to failure. Contracts with potentially high risks require in-depth risk analysis and mitigation.

Change Happens
Many outsourcing contracts are designed to drive change. However, outsourcing contracts that are supposed to drive change -- but do not allow the vendor to make changes -- tend to fail. In this case, the client tightly controlled the change mechanism and did not approve most vendor-requested changes. The conditions of the program changed, such as the addition of new programs and expanded volume of work. Even for client-initiated changes and expansions, they did not allow the vendor to add staff (and cost) or make other changes.

This was a 10-year contract. Over a decade, things will change in unexpected ways. For example, the economic downturn doubled the volume of requests for welfare aid. Simply saying, “we don’t want changes” is not a change management plan; if you want a successful program, you need a reasonable mechanism to approve and implement change.

Disputes Lead to Lawsuits
Lawsuits are time-consuming and costly, but if neither party to a dispute is willing to work out the issues, you’re headed to court. A smaller vendor might hesitate to sue the government, or might give in when threatened with a lawsuit, but huge vendors like IBM have equally huge legal departments (another risk of mega contracts). Everyone has disputes, but when communication stops, then other avenues for resolution are closed, and both parties start to think about lawsuits. An old rule of project management is, “Settling a dispute in court is the most costly and least effective solution.” When communication starts to close down, do everything to keep those communication channels open. Make compromises and be inventive now because a court-ordered solution will be more expensive.

Be Consistent
In the first three years, Indiana officials repeatedly agreed the program had succeeded, and (as per the contract) told IBM to move on to the next stage in the program. When the State of Indiana sued IBM, they said the program had failed and had been in failure for years. This sort of inconsistency seriously undermines credibility -- inside the courtroom and in the business community. You have a right (and duty) to change your position when new evidence becomes available, but if you add unsupportable embellishments, you will do more to undermine your credibility that to support your argument.

Perfect Execution” Doesn't Exist
Clients often build massive contracts as insurance that vendors will understand what they want and flawlessly execute the contract. In real life, assumptions are wrong, conditions change, and the goalposts move. Still, both the client and the vendor will select the individual clauses that support their position. The courts take a different position. A judge is not interested defining perfection; judges are interested in defining what is reasonable. Unless one party or the other was completely incompetent or malicious, a judge will seek a compromise position that will make neither party completely happy. Going to court doesn't increase your control, rather, it sharply reduces the control of both parties.

Both Sides Can Lose
It is the culmination of all the other outsourcing lessons and perhaps the most important. As the judge put it, all three parties lost: the State of Indiana, IBM, and the state’s taxpayers. Each of the issues was avoidable, but each problem led to the next until the chain of events was too strong to break. Every person who ever ended up in court asks themselves, “When did this go wrong?” And the answer is always, “long before the lawsuit began.” Difficult problems can be overcome, but not without effort and planning. Problems must be identified and resolved when the client and vendor begin to pursue a different agenda; if you wait too long the momentum of events will reach a point where the matter is past resolution.

The Bottom Line

In the end, the failure of Indiana and IBM's outsourcing contract seemingly could have been avoided with some common sense. Both parties appeared to be intelligent and resourceful and were more than sufficiently competent to know significant problems needed to be overcome. The court found that the real issues -- self-interest, conflicting agendas, lack of competence, and unacknowledged risk -- were largely ignored until it was too late. While they didn’t learn from previous failures, we can. Whether you are planning a mega deal or something more modest, make sure that you don’t repeat the same mistakes!