Take advantage of a merger or acquisition to ask some old questions all over again.

by Tom Torlone, Marc Mancher,, Olivier May

Usually when two companies merge, or when one acquires another, IT is challenged to reconcile two or more different service delivery models. Should IT be outsourced or kept in-house (captive)? Should IT operations be located onshore, near-shore, or offshore? One company may have outsourced its IT processes, completely or partially; the other may have offshored its IT function, again completely or partially. Yet another possibility is that either may have kept IT completely captive, onshore. Most likely, each company has opted for some hybrid model combining two or more of these options. 

Not surprisingly, the M&A event can suddenly make any or all of these arrangements “wrong” for any number of reasons, including redundancy (of processes, applications, or infrastructure),  the voiding of contracts because of a change in ownership, or a poor fit with the new company’s competitive strategies.

So, as part of its merger mandate, IT has to ask: “What service delivery approach is most appropriate for the new business?”

While the task of answering that question can be daunting, there is good news: The merger or acquisition can give the new company a “second chance” to get more service at the right cost.

At the heart of the question—“What service delivery approach is most appropriate for the new business?”—is the significant role of IT in making the merger or acquisition a financial success. In fact, IT is on the line for three important results: Synergy, Day One readiness, and ongoing Support of the new business.

When a deal promises millions in synergy, the merger team is typically challenged to find those dollars in cost savings. The first place everyone usually looks is IT. The IT team might be expected to choose one company’s service delivery model over the other’s, or to combine elements from each, or to design a completely new model for the new company.

The first step is to determine the relative merits of the many choices available by performing objective comparisons, analyses, and assessments of the two legacy IT organizations. Usually, some redundancies become immediately apparent. Other times, the pay-off in a “substitution” might be obvious; for example, one company might already have a robust offshore facility or one company’s IT organization might have the scalability and skills to replace the other’s outsourcer (assuming no contractual penalties are triggered). It’s worth mentioning that an offshore facility can move beyond the “cost reduction” play. For example, in financial services, we have seen offshore sites that are large (thousands of employees) revenue-generating operations.

But after that, the assessment process can quickly become complicated: Emotions can run hot when one option is chosen over another, when one company’s ways of working are deemed “better” than the other’s, and when people have to give up a model they’re invested in and are comfortable with.

This is a good argument in favor of asking an objective, independent third party to manage the assessment process—a third party that can enforce neutrality and bridge the gap between various points of view and vested interests.

Do no harm on Day One: Who’s in control of processes that need to be integrated first? 

In preparation for Day One, IT has to be ready to support the new legal entity. Which service delivery model would most effectively enable a smooth Day One? More importantly, which IT service delivery model would be most effectively suited to achieve efficient and effective ongoing operations? What level of integration—between both companies’ existing IT organizations, as well as between IT and any offshore facilities or third-party outsourcers—is required for both a smooth transition on Day One and ongoing operations after Day One?  The IT merger team needs to expose any risks to the integration process.

Support value and stability: Which option most effectively satisfies the needs of new enterprise?

While “synergy” in IT typically equates to cost cutting, in many cases strategic opportunities or necessities come into play. Does the merger or acquisition enable market expansion, cross-selling, increased flexibility, or better risk management? The IT service delivery model needs to contribute to those expectations, and IT’s consideration of those variables can make all the difference in choosing a service delivery model. What IT organization would most effectively support the company in achieving its strategic goals?

One Size Doesn’t Fit All
Given three key drivers—cost cutting, post-merger integration, and value delivery—the company needs to choose an effective IT service delivery model. While there’s no “right” answer, not all options are equal. In fact, what’s “right” can and should vary based on the new company’s unique objectives.

The first choice—to enter into an agreement with an external services provider (outsourcing) or to keep IT part of a captive operation (in-house)—needs to fit advantageously with the new company’s scale, capital, and talent. For example, the CIO might ask, “Is outsourcing a viable choice?” IT outsourcing is a mature model and continues to grow at a very impressive rate (Figure A). Many different IT functions can be outsourced within a scalable solution (Figure B). The key driver for outsourcing is typically cost savings or the ability to rapidly execute a strategy within the new company structure. If IT functions are not core to the business, retaining all of them in-house is typically not the most effective answer.

Once that decision has been made, the next question is, “Should we locate IT operations onshore or offshore?” A site’s attractiveness depends on many factors. Labor arbitrage is the obvious driver in considering locations (especially since IT compensation is highest in North America). But other geographical risks—political stability, talent availability, attrition rates, language fluency, and time zone differences that might preclude live interaction—need to be factored into the decision.

A third option, called near-shore, is a relatively new option that combines some of the most desirable attributes of offshore and onshore locations, without some of the risks. For a company based in North America, a site in South America (S.A.) would be a near-shore alternative. While the command of English in South America might not be as high as it is in India, the closer geography could have some distinct advantages:
• The ability to interact in near-time is important for collaboration-intensive projects or operations;
• S.A. currencies are not as susceptible to inflation or appreciations as compared to Indian currency (12 percent to 15 percent increase, year after year – “Impact of Currency fluctuation and Wage Inflation on Outsourcing” January 2, 2008, www.TransWorldNews.com); and
• In South America, the job market for people with IT skills is less competitive, so attrition is also lower.

As a result of these factors, many global companies have established captive centers in South America (mainly Brazil and Argentina), while an increasing number of Tier-1 and other ITO service providers have established, or are in the process of establishing, a presence in these countries and in surrounding ones (such as Chile). Figure C highlights some key considerations in choosing between onshore, near-shore, and offshore models.

Recently, a large healthcare service provider decided to outsource the entirety of its IT infrastructure hosting to a service provider based in North America. This choice would allow the company to focus its energy and resources on core business needs aimed at growing its market share. The company was growing rapidly and, for this reason, faced key decisions about the potential expansion of its existing data centers. Rather than trying to consolidate all of its aging computing systems in a large data center, it decided to test the market for complete IT infrastructure hosting. After a carefully led sourcing and selection process, a vendor was selected and services were transitioned into the outsourcers’ data center.

The transition took less than six months from contract signature to go-live with no disruption of services. All systems and applications were migrated to the new platform, thereby gaining the scalability and flexibility needed to adapt in support of the anticipated market share growth. Additional efficiencies and substantial cost savings were also derived by leveraging virtualization, storage, and backup shared across platforms and by deploying additional technologies, tools, and optimization techniques that had not been available within the company’s existing environment because of lack of both expertise and resources.       

Captive/Offshore
A large oil and gas company took advantage of its operational presence in low-cost countries to consolidate a significant amount of shared services functions (in IT, finance and accounting, procurement, and even HR) in a strategically positioned mix of global and regional centers. This approach enabled the company to remain focused on its aggressive growth, while enabling a sustained and significant lowered cost of services and even improving some processes by consolidating many variances into centralized locations with common processes.      

Outsourcing/Offshore
A large telecom company had outsourced all of its application development and maintenance (ADM) to several offshore vendors, retaining in-house only a few IT applications/ organization:
• Governance roles to efficiently manage and leverage the outsourcing partnership; and
• IT business liaison roles that translate the business needs of the various internal
stakeholders within the organization to the IT service providers, which then develop, test, and maintain the new applications in support of the company’s business needs.

As a result of a strong governance program, clearly established service level objectives and service level agreements, and a committed effort from the executives within the company to leverage the outsourced partnership, the large telecom company has saved hundreds of millions in ADM. Also, the company can now rapidly respond to shifts in the marketplace and in consumer demands, without having to worry about retaining and managing the proper skill sets.

Captive/Onshore
When two large insurance companies agreed to merge, their IT organizations worked together, under the direction of the new company’s CIO, to evaluate each company’s model and decide on a going-forward strategy. In one company, IT was entirely outsourced (processes, applications, and infrastructure); in the other, IT was entirely captive.

During an eight-week assessment, the team discovered that while total operating costs would be lower with a third-party outsourcer, other strategic priorities made an in-house service delivery model desirable. Given the criticality of rapidly executing the integration of the two companies’ portfolio of services, the CIO decided to keep the IT services in-house. Management felt that the risks associated with integrating all the systems, while at the same time trying to outsource the combined IT operations, were too significant and outweighed the savings associated with a third-party outsourcer.

Hybrid (Captive Plus Outsourced)
Two telecommunications companies merged with the expectation of substantial synergies through the renegotiation of several IT outsourcing contacts. The merger team conducted an eight-week assessment of the two IT organizations and decided that some functions—those with immature processes—should move back in-house, while others should be outsourced (the choice of provider would depend on how two incumbents responded to a new bid.)
The results of the analysis pointed to more than $200 million in potential annual savings. While the IT representatives from both companies were somewhat defensive in the beginning of the evaluation process—each group was attached to its own model—the process itself united them in finding the most effective approach model for the new business.

A methodical process
The process for deciding on a service delivery model should follow a traditional phased approach, likely used in many other parts of the overall M&A planning and execution cycle:
• Due diligence: A detailed accounting of the current outsourcing contracts and offshoring relationships should highlight the financial and strategic impact of potential changes. The outcomes might include termination, augmentation (with greater scope) with a reduction in total unit costs, or maintenance of the status quo. The output of due diligence drive the initial targets of an IT assessment.
• IT assessment: The purpose of the assessment (which should take about eight week) is to identify short- and long-term synergies (not just cost savings). At this time, the two IT organizations have their first chance to work closely together. An atmosphere of trust and cooperation is necessary for the combined team to deliver the most effective results for the new entity.
• Comparative analysis: The two legacy models are compared along the attributes of costs, service levels, and operating strategy to expose the most effective operating model and synergies for the merged functions.
• Business case: No matter what the choice—outsourcing, offshoring, domestic, or any combination—a strong business case, qualifying and quantifying synergies both cost and strategic, is required.
• Operational assessments: How much of IT (processes, applications, and infrastructure) should be performed domestically, at an offshore facility, or by a third party? What model would work most effectively in the short term? In the long term? Above and beyond cost, other elements (such as risk, taxes, labor quality, flexibility, and market growth) need to be taken into account.
• Business impact analysis: Is IT a source of competitive advantage? Could it or should it be? The proposed delivery model has to support the company’s product/service/customer strategy. Also, all IT investments have to be aligned with the company’s actual or implied promises to investors and stakeholders.

During a merger or acquisition, IT is under pressure: A lot can go wrong, but a lot can also go right. The choice of a service delivery model can have enormous consequences, not just on Day One, but also for months and years beyond. An M&A event is a rare opportunity for a “do over”—when the CIO organizes and leads the effort to redesign the IT service delivery model, the business benefits can make all the difference between a merger’s financial success or failure.

Tom Torlone is a principal, Deloitte Consulting LLP. Marc Mancher is a principal, Deloitte Consulting LLP. Olivier May is a senior manager, Deloitte Consulting LLP.