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Risk Management

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a contributed article by Robert D. Thomas, a consultant focusing on the evolution and economics of h
a contributed article by Robert D. Thomas, a consultant focusing on the evolution and economics of h
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Selecting a Vendor -- Usually, You Get What You Pay For

Selecting a vendor based on cost alone can be dangerous.

Pitting vendors against each other may save a few dollars now but could cost more in the long run.

IT-services firms invest a significant amount of time and money in an attempt to differentiate their offerings at some level (i.e. vertical expertise, skilled resources, level of service, etc.). Despite these dogged attempts, the message from the services firms often goes unheard or ignored by potential customers. Instead, customers continue to focus solely on the price of an engagement and do all they can to squeeze every penny out of the vendors. This is a practice that is not only destroying many isolated-services engagements, but it also has a significant negative impact on the business and financial prospects of all parties involved.

Once a customer decides to pursue a services engagement, they will typically issue an RFP or invite a variety of firms to hear their pitch and submit a proposal. By the end of the sales cycle, the competition is narrowed down to a small number of firms (1-3) bidding on the business. Each of these firms engages in fiercely competitive behavior, focused on reducing price by the elimination of work hours, rebalancing resources, and compressing time schedules. When the decision is finally made, the winning firm normally signs a deal that is 5 percent to 20 percent below their "lowest offering," in terms of work effort. This practice produces a two-pronged curse: The Winner's Curse (services firm) and the Loser's Curse (customer).

The Winner's Curse
The "winner's curse" describes a situation in which the services firm is cursed for winning the engagement, because they have placed themselves in a position where they cannot possibly deliver what they have signed up for in the contract. It is likely that the firm has disadvantaged themselves even further by trying to compensate for this error by using cheaper resources or just absorbing hours that should be billed to the customer. These fixes employed by the services firm have a drastically negative effect in the form of quality and profitability. The cheaper resources are less skilled and therefore the quality and client satisfaction on the project begins to deteriorate. Meanwhile, the unbilled hours begin to lower the margin on the engagement. In summary, the winner's curse lowers the profitability of the engagement, reduces the quality, and erodes the customer satisfaction. These effects often lead to the loss of a customer or, possibly, a lawsuit.

The Loser's Curse
The curse on the customer is labeled as the "loser's curse" because, in the end, they lose more than any other party involved in the deal. By driving hours and resources out of the project effort, the customer puts the vendor in a situation in which they cannot deliver and meet expectations. Accordingly, the customer sees delays in the project, a loss of time and money, and often reduced morale concerning the project. Further, and potentially even more costly, customers will often see reduced customer satisfaction from their customers, because they are often promised things that are never delivered on time or at all.

Once the customer realizes the reality of the situation, they typically either investigate the idea of a lawsuit or pursue another vendor. Lawsuits are an expensive endeavor where no one wins (except the lawyers) and if they pursue another vendor, they must start all over in their efforts.

This explanation of the winner's and loser's curse is designed to make a few points to all the CEOs/CTOs/CIOs etc., who are investigating different projects: You are doing yourself a disservice to gauge vendor selection based solely on price. Forcing vendors to compete on price will set your company up for the loser's curse. A good deal at signing time will often destroy the long-term benefits of a project. The fastest and surest way to destroy the ROI on a project is to put your services partner in a situation where they cannot meet expectations.

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