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C. Gopinath

IBM ANNOUNCED last week the receipt of a major outsourcing contract from Visteon Corporation. Under this contract, IBM will takeover and run most of the computer operations of Visteon, a manufacturer of auto parts which includes data centres and help desks. The contract is valued at $2 billion (Rs 9,600 crore) spread over the next 10 years. IBM will absorb some of the employees but no layoffs are planned. Visteon will continue to staff a group whose responsibility will be to chart its IT strategy. The attraction for Visteon in handing over the responsibility will be the saving in costs that can come from not having to invest in IT hardware and software and only pay a fee based on services used.

IBM has been moving into services rapidly and through contracts such as this, it will make use of the capacity it has built to serve several clients. Seems a logical deal that benefits both parties and increasingly we see such networks that firms belong to as a means of getting control over costs of doing some activities that they feel less inclined to undertake themselves.

Two major areas of management are critically involved for this to work for Visteon. First, the senior management must be fairly sure that the operational aspects that have been handed over are not critical for the execution of their strategy. As the strategy changes, it must have flexibility in how its IT operations are handled. Second, it must have the proper control systems set up to be able to monitor if the work being done by the external contractor meets the objectives and cost estimates originally planned for.

Poor controls

Once a long-term contract is handed out, it has a tendency to grow roots and embed itself so deeply in the system that controls get weakened and there is a blurring between the organisation and its contractor. Even if we use such new jargon as `network associate' or `strategic partner,' it does not in any way minimise the need for close supervision and monitoring of the work of the contractor.

The state of Massachusetts is currently learning this lesson the hard way. In 1985, the state embarked on what has turned out to be the largest public works project in the US. It was a project to drop about two kilometers of an overhead roadway that cuts through the city down into the ground through a tunnel. The project cost has grown from $5 billion (Rs 24,000 crore) to $14.6 billion (Rs 70,080 crore) and is now scheduled to open next year.

`The Big Dig', as the project was nicknamed, has been a by-word in local circles of everything that can go wrong, from cost overruns, time overruns, to corruption at local and state levels. Now, The Boston Globe, a local newspaper, in a detailed investigation of the management of the project has revealed how poor controls and supervision can take some of the blame.

The managers of the project were Bechtel/Parsons Brinckerhoff, a partnership of two large engineering firms. The specific problems include: the original drawings failed to include a major stadium near the work site and work had to be redone; a costly flooding that took place in a tunnel were due to flaws noted by engineers two year earlier but the managers failed to order repairs; design problems arising out of tunnel tubes being too short; and so on. The newspaper estimates that these poor decisions and mistakes have resulted in cost overruns of $1.1 billion (Rs 5,280 crore). The contractor disputes these charges. Failures both by the contractors and by the state officials who were to supervise them have hurt the tax-payer. Only 3 per cent of overruns have been subject to cost-recovery efforts in the 12- year history of the project.

From a control systems point of view, the project had several flaws. The state viewed its contract as a `special relationship' that went beyond that of a contract making Bechtel virtually an extension of the government. Bechtel was being paid by the state on an hourly basis rather than specific prices for various jobs, hence the firm benefited from all the delays. The state even paid the company overtime rates to correct mistakes that the latter had committed in the first place. The state also guaranteed a minimum profit. As both the chief designer of the project and the project manager, the company was in effect supposed to be supervising its own work. Thus, the firm was reviewing and recommending that the state pay for the overruns.

A Cost Recovery Committee was set up but would rarely meet. In a quote that would surely go down in history, the chairman of this committee recently said, "cost recovery was admittedly never the front-burner issue for me". Many of the claims have now become time barred. Pursuant to the newspapers investigations, the state government is now initiating a process of trying to recover some penalties from the contractors.

Setting proper objectives and control mechanisms to direct the contractors towards the objectives will also gain prominence as the investigation into the Columbia shuttle crash on February 1 gets underway. The day-to-day management of the shuttle programme is with a company called United Space Alliance (patriotically shortened to USA) which is a joint venture formed in 1995 between Boeing Co. and Lockheed Martin. As a means to cut costs and in pursuit of greater efficiencies, the National Aeronautics and Space Administration (NASA) of the US has been contracting work out to private companies. It is estimated that 90 per cent of NASA's budget amounting to $12.7 billion (Rs 60,960 crore) is given out on contracts.

The company USA employs about 10,500 people on NASA related activities. They train the astronauts, write software for the systems, do security checks, repair and rebuild parts. Although investigations into the crash are underway and it will be a long time before we know who or what is at fault, the Congressional Budget Office, the investigative arm of the US parliament, in a recent report said that NASA lacked effective systems and processes for overseeing activities undertaken by contractors and did not stress the need for controlling costs.

The present contracts provide for bonuses for safe return of a spaceship and rewards for coming under budget. Sometimes, one would have to wonder if it is wise to specify in great detail when safety can be an issue.

Good management will always dictate that parts of the work that can be done better and cheaper by others should be contracted out. But this also means that strategic objectives must be kept in mind when deciding what work is to be given out, and appropriate control mechanisms need to be devised. Sometimes these can be contradictory objectives. Ideally, we would want the level of trust to be such that the contractor works almost like an extension of the company. But this can rapidly lead to reduction in oversight which would negate the cost and efficiency objectives.

(The author is professor of international business and strategic management at Suffolk University, Boston, US. His Internet address is cgopinat@Suffolk.edu)

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