The 'Winner's curse'

* One in five IT outsourcing deals are doomed to failure

Clients do not win by squeezing outsourcing vendors on price to the point that they cannot deliver good results and still make a fair margin. This is a concept I have discussed in this newsletter many times and is supported in the results from a study by London School of Economics professor Leslie Willcocks.

The study found that one in five IT outsourcing deals are doomed to failure because they favor the client at the expense of the vendor from the outset. This effect, labeled the ‘Winner’s curse’ is a very real issue from my experience as both a vendor and a client.

You might think that vendors would just walk away from deals where the price is too low. So as a client, you can just push for the absolute lowest price that a vendor will accept. It is a bit more complicated than that. The term loss-leader applies to selling behavior in both business-to-business and business-to-consumer marketing.

A very low price is used to get a customer relationship started with the intention of building on that relationship and making additional sales where the ultimate profits will be made. This is not a bad concept when applied with reason, but it can manifest some negative outcomes when it becomes unreasonable.

One form of unreasonable use of the loss-leader deal is when a vendor agrees to any price just to win the deal away from competitors, and then looks to nickel and dime the customer on every out of scope request with change request after change request. The customer will never be happy in this scenario as every question to the vendor spawns another quote for extra work.

The reasonable form is when a vendor enters the deal knowing margins will be thin, but expects to win more business through great customer service and real value-add to the client’s business. The latter can only happen when the vendor can bring enough resources to the table to do a good job.

Another reason a vendor may agree to an unreasonably low price is when there is a disconnect between the sales and delivery teams within the vendor organization. Some sales people will do whatever it takes to close a sale. The sales folks will move on to the next deal and leave the client to a delivery team after the sale is closed. I have lead those delivery teams and I have had my share of deals to delivery where there was insufficient revenue to do the job well. Good sales people will ensure that the delivery team can do a good job for the client.

Good outsourcing organizations will have strong controls on the sales cycle and include delivery people in the sales cycle to ensure that the client requirements are understood and sufficient resources are available to do a good job. If a deal is strategic enough to do at abnormally low margins, it should be an organizational decision within the outsourcer such that sufficient delivery resources will be applied and everyone knows the deal is a loss-leader. If it is not an organizational decision, then management will squeeze the delivery team to maintain typical margins on a deal where that is not possible.

So how do you know when you are pushing too far on price or if the vendor is making a poor decision on price just to win your business?

First, make sure you have interacted with delivery people during the sales cycle. Make sure they know your expectations and requirements. Ask about the resources that will be applied and how changes in scope will be priced. If you see smart and capable delivery people involved you can trust that they will provide checks and balances within their company. Be wary if you are getting limited access to delivery people and your sales representative is more willing to give price concessions than to provide access to those that will do the work.

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