Thursday, October 18, 2012

Caveat Venditor

IT Outsourcing is an exciting business in Malaysia, captive IT outsourcing organizations like Felda-Prodata, iPerintis, iCIMB and VADS collectively generates well over half a billion US dollars in revenue. As far as global multinationals are concerned, we have the major stalwarts likes IBM, HP, CSC, Dell, SAP and T-Systems offering their wares to financial services and oil and gas sectors; the top two most lucrative sectors within the Malaysia Economy.

According to the Malaysian government’s Enterprise Transformation Program (ETP), IT Services and Outsourcing contributes 37% of GNI or RM7.215 billion in 2009 with a projected growth of 6.8% yearly, bringing the estimates to about RM9 billion by 2012 (approx. USD3 billion).

Although many foreign vendors and IT Outsourcing suppliers are keen on getting into the Malaysia market, a number of hidden costs needs to be accounted for in order to make a respectable margin and I’ll be sharing with the readers some of my experiences within the last 10 years.

The scenario that I’ll be discussing is a straight up open or by invitation only tender of competitive bids; and large government link organizations such as PETRONAS (a Global Fortune 500 company) and Maybank (Malaysia’s No. 1 bank) are extremely supportive of competitive bids to attain the best IT services at the best price.

The devil however, lies in the details.

The following are the typical cost components associated with participating and executing an IT Outsourcing contract in Malaysia. The scenario applies for large enterprises as well as government link organizations. There seems to be a lack of new paradigm when applying these cost components; so unfortunately for the IT industry, customers have adopted paradigms from the property/construction industry.
My personal debate is that a number of these cost elements are irrelevant, but unfortunately non-negotiable from where the customer stands.

1.       Buying the Tender Document (Not refundable)
The nominal sum is anywhere from RM100 to RM5,000 (USD30 to USD1600). The rational is that the customer had to spend money preparing for the tender specifications.

2.       Preparing, Printing and Shipping the Tender Proposal Document.
Tender documents tend to be divided into 2 parts, Technical and Commercial. These need to be sealed separately and mixing the details together can disqualify the bidder. The catch is, most of the time it needs to be in physical paper printed form, and yes, in multiple copies. The most painful tender that I’ve heard off, required 21 copies in total, while my personal experience averages about three to five copies of each document or 10 documents in total. So we’re talking about massive administrative work within a very short time frame!

3.       Bid Bond (A banker’s guarantee - Refundable after the tender has been awarded)
Cited as a reason to filter companies that does not have the financial strength to carry through the project, it can be substantial. The amount varies, from a flat fee of say USD25,000 or 1%-3% of the project budget. Here’s a hint, I use it as an indicator of the budget because of the percentage. The larger the banker’s guarantee, the larger the budget; but do use your own discretion and proceed with caution, lest you overprice your bid.

The challenge to vendors is the lengthy tender period from RFP (Request for Proposal) to actual award, typically anywhere from three to nine months. Substantial investment interests could have been earned from the bond.

4.       Performance Bond (A banker’s guarantee upon award - Refundable after the outsourcing contract scope has been performed)
This is treated like a piggy bank that customers can dip their hands into to penalize the vendor should they underperform. The trend that I am exposed to is a 5% figure of the overall contract cost but this can vary. Again, this places a strain on cash flow as you need to pony up at the beginning of the engagement.

5.       Service tax of 6%
This may seem obvious, but during negotiations, the customers in Malaysia have a tendency to compel the vendor to reduce the bid price to negate the 6%. The only rationale that I can think off is a negotiation technique to immediately shave something off the top.

6.       Escrow Services
These are payments a 3rd party provider that maintains a product’s source code in the event the vendor goes bust. Relevant only to bespoke software development scenarios, and not particularly as yet, although I’ve seen a situation where the customer insisted on it.

7.       Premiums from Insurance
Again, the construction industry paradigm is heavily adopted here, particularly requests for Public Liability Insurance, a need that is irrelevant within a software development project that is only use in house. So the risk of “public” users being “hurt” by the software is extremely rare. There is however, a growing trend of requesting for Professional Indemnity Insurance, covering liabilities equivalent to the outsourcing project value or more. The premium unfortunately, can be prohibitive.

8.       Risk of not getting paid when contracting through a 3rd party
The question is whether you as a vendor should “prime” the contract. On one hand you expose yourself to all the risk as the primary contract participant; however, you could also fall prey to situations where the prime does not pay you as a subcontractor, citing customers not paying as a reason to renege.

Although this may be true, you are legally entitled to go after the primary contractor; sadly, if the situation gets really bad, the primary vendor tend to file for bankruptcy. So it is highly important that you pick your friends carefully within Malaysian shores.

9.       Margins at risk
a.       Accepted Liabilities
Depending on the customer, this can be a negotiation point. Some have chosen to disqualify vendors that choose not to comply with the terms of liabilities. The advice is to qualify first and negotiate the terms later once you’ve successfully been shortlisted. Values vary from 50% to 200% of the outsourcing project price should you fail to deliver the project.
b.       Penalties for lateness, delivery completeness, service level breach
There are usually a daily prescribed rate, which can be anything from 0.5% of the project cost per day or a flat rate of several thousand ringgit. The challenge here is negotiating for a ceiling and a penalty figure that makes sense for the customer. A service level breach is more straight forward, dip below the guarantee, and you will be accorded penalty points which can be translated to monetary terms or more free services in man days.

To end, while the list may not be conclusive this represents the major hidden costs that needs to be accounted for.

As a vendor we like to argue that contracting terms should not be punitive, and relationships are built upon trust, but the realities of Malaysian IT Outsourcing can lead to vendor cost overruns for those who are not prepared. Sales would divert the risk to the delivery team for the sake of meeting numbers, but suffice to say the business will not last long when it bleeds from winning a Pyrrhic IT Outsourcing Contract.

My advice for Malaysian customers is that it’s high time to review some of the terms, as it unnecessarily heightens the risk of failure from a vendor cash flow standpoint; secondly, it also forces the vendor to pass the risk back to the customer through the prices.

So I wish everyone good luck on your respective IT Outsourcing endeavours, Caveat Emptor e Caveat Venditor!