Outsourcing Service Provider as Distributor for Customer’s Core Services

In early February 2004, IBM and Sprint Corp. prepared to announce a major outsourcing agreement for IBM to assume the responsibility for customer services for Sprint wireless PCS telecom services.   The deal affects 5,000 to 6,000 jobs at Sprint.   According to news reports, the value of the deal is estimated at $2 billion to $3 billion, which equals the total amount that Sprint forecasts in its own savings.

Scope; Metrics.

The arrangement appears designed to restructure existing call center operations, some of which had already been outsourced, to integrate call centers with technology-enabled data management on customer demand, customer satisfaction and market conditions in real time.  IBM will be seeking to dramatically improve Sprint’s customer satisfaction through better customer segmentation, more efficient call routing, reduced average call handle times and a higher rate of first call resolution.   IBM will provide customer self-service tools via the Internet and web-based services.   IBM will also provide ongoing consulting services to Sprint to continually improve customer satisfaction.  IBM will take over management of Sprint’s existing vendor-operated call centers (moving from one outsourcer to another) as well as a Sprint-owned call center in Nashville, Tennessee.  IBM claims that in such outsourcing arrangements, “IBM is transforming, integrating and managing key business processes for [its customers] to become more flexible in adapting to market and customer variables in real-time.”

Countertrade: “Counter-Distribution Services.”

The transaction makes IBM one of Sprint’s largest distributors.   In the joint press release, the two companies said the relationship will include “a long-term business alliance that designates Sprint as a key IBM vendor for wireless and wireline services and enables IBM to incorporate Sprint’s national PCS wireless services and its IT and data products and services into customized on-demand solutions for IBM’s customers.”   Thus, IBM is expected to market Sprint’s core services — wireless and land-line voice and data services — to IBM’s other customers.

By appointing the outsourcing services provider as a distributor, this multinational outsourcing customer barters its purchasing power for marketing and sales, particularly with a global sales organization with easy access to the technical procurement executives in multinational enterprises.   And as service provider IBM incurs risks of the failure of its customer Sprint to deliver promised services to IBM’s other customers.   That results in a common effort that could be called a joint venture, but the parties did not call it more than a “business alliance.”

Countertrade: “Counter-purchase Agreements.”

The counter-distribution agreement has substantially lower risk of failure for the services provider than a simple counter-purchase by the service provider of its customer’s goods and services.   When WorldCom went bankrupt in 2002, EDS took a substantial charge to its revenues, since the balance of trade was negative.  EDS owed money to WorldCom for WorldCom’s services, but WorldCom was able to reduce its payments to EDS by reason of the bankruptcy protection for WorldCom’s operations.  (Later, WorldCom changed its name to MCI).  But if Sprint fails to deliver its services to IBM’s customers, IBM’s reputation will be tarnished, which could cause greater harm to IBM.

Outsourcing as a Tool for Business Process Transformation.

This deal contemplates the transitioning of Sprint from delivering classic telephony services in a “stand-alone wireless and wireline network.”   Reading between the lines, IBM will probably help Sprint convert to Internet telephony, or “voice over Internet protocol” (“VOIP”).    Telephony will integrate into the desktop and computer network environments.

The press release suggested initially that the deal looked like simply a transfer of Sprint’s existing call center operations from its existing service providers (and some insourced call centers) to a new service provider. IBM’s commitment to improved service level agreements was heralded as a means of “dramatically” improving customer satisfaction.

But the joint press release suggested, without saying clearly, that the deal has much more strategic impact, by asking IBM to convert Sprint’s wireless and wireline telephone service to a network capable of Internet telephony (called “voice over Internet Protocol,” or “VOIP”) for IBM’s other corporate customers. To cushion the shock of cannibalizing its own classic telephony services, Sprint probably enlisted IBM to bundle Sprint’s services into IBM’s other IT-enabled outsourcing services. IBM became a reseller of Sprint telecom services. More significantly, Sprint’s business was to be transformed into an Internet-based service provider to IBM’s other customers.

The deal has the potential, therefore, to transform Sprint’s customer base, its method of service delivery, its revenue profile, and its marketing alliances in addition to hiring a service provider to improve service levels in call centers.

Lessons Learned.

The counter-distribution model offers substantial flexibility for both the service provider and its customer.

• Service Provider’s Perspective.
  For the service provider, credit risks (from a prospective bankruptcy of the customer) may be managed by financial management of the delivery of the customer’s goods or services.   Similarly, the service provider might not need to make any financial commitments to secure and retain the right to resell the customer’s goods or services.
• Enterprise Customer’s Perspective.
  For the enterprise customer, access to a global sales organization may serve as a scorecard criterion for selection of prospective service providers.   The customer might rightly conclude that a bigger, more global, more diversified service provider would assure a wider channel for the distribution of the customer’s own core business services.   For telecom companies, using an IT services provider to distribute telecom services is a logical extension of the service proposition in response to the convergence of the Internet, telephony and digital communications.  Reportedly, IBM will be selling Sprint  services to large corporations so that employees of Sprint customers may transfer data from their networked desktop or laptop computers to wireless devices such cell phones, Blackberry® and Palm® handheld mobile devices.
• Mutual Dependency, Mutual Risk.
  For each party in a countertrade transaction, however, the lessons of the past invite caution.   Once two parties are interdependent as customers or as marketers, the relationship requires a more complex management interaction.  The risks for each are increased.  If the customer wanted to fire the service provider for a breach of service level agreements, for example, the service provider might have the right to cancel the distribution rights (if unprofitable) or might seek to retain the distribution rights free of any “cross-default” clause.  The stakes are higher for potential “win-win” or potential “lose-lose” outcomes.
• Long-Term Impact.
  If a Sprint-IBM countertrade model for distribution of the customer’s services were to become the model for a long-term outsourcing contract, securities law and antitrust laws might come into play.
  • Securities Regulation.
    As to securities laws, the impact might be so important that investors might consider it “material” to decisions whether to buy, sell or hold the enterprise customer’s corporate securities.   Initially, such a distribution model does not appear likely to generate any “material” revenue streams for the enterprise customer.  Over time, the impact might grow particularly if the outsourcing has the goal or potential of restructuring the enterprise customer’s business model.

    At some stage, the disclosure required under applicable securities laws might become problematic, as information publicly disclosed could be used by competitors.  As a result, both enterprise customer and the services provider have some incentive not to enter into transactions that are not so important and material as to require disclosure under applicable securities laws.

    In reviewing the press release, one may question whether investors are adequately informed of the true nature of the risks of this transformation of the customer’s business, not from the standpoint of the risk of IBM’s nonperformance, but from the standpoint of Sprint’s ability to successfully transform its own service model by the counter-trade structure with IBM promoting VOIP to IBM’s other customers.

  • Competition Policy and Antitrust Laws.
    As to antitrust laws, reciprocal dealings by organizations in the same competitive arena could be unlawful as anti-competitive under U.S. federal antitrust laws and European Union competition policy.   Before entering into a countertrade transaction, the parties should consider the likely impact of the distribution or counterpurchase operations as to exclusivity, market size, concentration of suppliers and customers in the relevant market, and other factors that define structural anticompetitive activities.  As global customers hire global service providers to provide distribution services, the impact in any single country’s marketplace may be small compared to a similar business relationship between parties located only in one country or regional market.  Consequently, the antitrust risks are relatively small at the global level.
  • If IBM were to repeat this paradigm in other industries, though, IBM might gain market power in an important array of global non-IT services.  Further anti-trust reviews might be appropriate in such a scenario.