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J.P. Morgan and IBM Outsourcing Failure Report

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Updated: Jul 30th, 2021

Introduction

The outsourcing of Information Technologies (IT) implies the use of external service providers by firms to deliver the IT-enabled business process and the application of infrastructure and service solutions for business outcomes. Clients who use IT outsourcing can develop the capacity to improve their effectiveness using the expertise of parties that specialize in technology services. Many companies resort to outsourcing to reduce costs, take advantage of external expertise, assets, and intellectual property, as well as accelerate time to market (IT outsourcing 2019). While some outsourcing deals between companies work, others fail due to different reasons.

In this paper, the case of the outsourcing failure of J.P. Morgan and IBM will be discussed. The deal between two companies involved a contract under which IBM would provide IT outsourcing services to J.P. Morgan on a pay-for-service basis. This meant that IBM would be paid for services only when needed. However, two years after the deal’s signing, the bank decided to terminate the agreement as a result of its merger with Bank One. The merger led to the shift in needs and capabilities of J.P. Morgan in terms of its IT processes, which led to the moving of the IT talent back in-house. The exploration of the deal’s failure will involve the discussion of the client and supplier perspectives to understand why the contract was terminated as well as what implications were in place as a result of this.

Executive Summary

When companies that operate in the sphere of finance engage in IT outsourcing, they expect to expand their capabilities and deliver unique and custom products to customers. Many organizations invest in outsourcing to cut costs necessary to hire IT talent, provide appropriate training, and ensure the available resources necessary for efficient operation. Due to the need to follow the needs of clients to get the best results, delegating IT tasks to other companies is a way of getting the best results.

The example of an outsourcing deal that IBM made with J.P. Morgan shows that banks require significant support from organizations with IT expertise to deliver the best possible results. The uniqueness of the deal was associated with the fact that IBM was paid on a ‘pay-as-you-go basis, which meant that there was no regular compensation. The amount of outsourcing work that IBM had done was proportionate to the amount it was paid. Overall, it was expected to earn around $5 billion as a result of the deal with J.P. Morgan.

Two years after the deal’s implementation, the client decided to terminate the contract with an outsourcing firm. The termination of the deal was linked to the merger with Bank One, and it thus made sense for J.P. Morgan to bring the IT talent back to the company and eliminate its outsourcing efforts. The case is evidence of the ever-changing needs of companies operating in the financial service industry. Moreover, the example of the deal’s failure shows that mergers and acquisitions can also have a significant impact on whether an organization requires outsourcing. For IBM, the termination of the deal meant a loss of a large client who could have brought a considerable income.

For J.P. Morgan, the failure of the deal involved significant restructuring of the IT department and the rehiring of personnel that would facilitate the enhanced capabilities of the bank to provide adequate services to customers. Despite the failure, the collaboration between IBM and J.P. Morgan illustrated a unique perspective on outsourcing, which implied the pay-as-you-go approach that would facilitate transparency.

Outsourcing Project Overview

In 2004, J.P. Morgan Chase & Co. canceled its contract with IBM intended to facilitate the return of the IT talent back in the house. Despite the contract was made for $5 billion and was expected to last seven years, the bank decided to terminate it, following the acquisition of Bank One Corp. The statement made by J.P. Morgan was associated with the belief that the merging with Bank One would facilitate the increased effectiveness in the management of IT infrastructure internally and more sufficiently than through outsourcing.

According to CEO Austin Adams, the company believed that “managing their own technology infrastructure was best for the long-term growth and success of their company” (Garland 2015, para. 7). Even though J.P. Morgan did not make any accusations of IBM failing to meet its obligations under the contract, IBM lost billions as a result of the contract’s termination. Moreover, the decision to dismantle and then reassemble its Information Technology team would cost J.P. Morgan millions of dollars.

Initially, J.P. Morgan and IBM agreed on a deal in 2002 to allow the client to buy IT services on a “pay as you go” plan (Golden 2002). IBM had been the front-runner for improving J.P. Morgan’s capabilities and competed with Electronic Data Systems Corp. The contract was considered to be the largest in the range of agreements reached by IBM in 2002 to take over data-processing services for firms that provide financial services.

According to the agreement between the two companies, IBM would be paid for computer services on demand instead of having a pre-determined payment upfront. Such an approach was modeled from the example of paying for bills and utilities to electronic companies as a method of saving costs and enhancing flexibility. Similarly, rather than purchasing computer hardware, it becomes possible to rent a bank of IBM computers under the system.

In August 2004, J.P. Morgan decided to terminate the contract with IBM as a result of the merging with Bank One. The project failed because the merger created a firm with an increased capacity to address the needs of its infrastructure and technology (Gardner 2004). Therefore, there was no need for J.P. Morgan to remain in contractual relations with IBM as it could manage its IT needs on its own. Thus, the deal failed, leaving considerable ground for consideration regarding the reasons for which the outsourcing deal failed.

Client Perspective

According to the expectations of J.P. Morgan, the company forecasted to receive total cost savings, the increased access to research, and improved service levels from its agreement with IBM. The approach of “paying as you go” was intended to help J.P. Morgan to respond quickly to the ever-changing conditions in the market (Golden 2002). J.P. Morgan analysts stated that the agreement with IBM would popularise the on-demand payment system for computer services in the banking sector.

In addition, the company saw the opportunity as beneficial for its supplier that was experiencing a decline in new service contracts in 2002. J.P. Morgan expected its supplier to take over a significant portion of the infrastructure for data processing, including its data centers, help desks, voice, and data networks (Golden 2002). In addition, it was expected that more than 4,000 J.P. Morgan workers and contractors should be transferred to IBM at the beginning of 2003 (Oz 2009).

With regards to the sourcing model that was selected for the contract, it was appropriate for the client and the supplied. The pay-as-you-go model meant that IBM would only be paid for specific services that it provided, and nothing beyond that, which was a favorable approach for the bank (Rooney & O’Hanlon 2002). In this way, both IBM and J.P. Morgan had an understanding of why specific amounts were paid and what services were provided in exchange for the payment.

In terms of the client’s outsourcing strengths, the bank understood the purposes of outsourcing and heavily relied on IBM for IT services. On the other hand, the weakness of J.P. Morgan was associated with the fact that it considered other solutions for ensuring the provision of IT services, which eventually led to the deal’s termination.

The merger with Bank One led to the creation of consolidating data centers and reducing the number of computer applications used. In this way, J.P. Morgan would switch from the services of IBM to self-sufficiency to take advantage of the know-how that Bank One cost-cutting know-how. For J.P. Morgan, it was beneficial to include Bank One into its operations because the latter managed to reduce its headcount by 12% between 2000 and 2003 while increasing its revenue by 17% to $16.2 billion (Strassman 2005).

In contrast, J.P. Morgan decreased its headcount by 6% during the same period while being able to grow its revenue by 1%, from $32.9 to $33.3 billion (Strassman 2005). As a result of the merging, Bank One swallowed the underperforming J.P. Morgan Chase, which led to significant cost savings and the elimination of IBM from the equation.

Considering the cost-cutting efforts of J.P. Morgan is essential for understanding the outcomes of the deal’s failure for the client. Between 1999 and 2003, the bank’s expenses on technology services grew from $2.18 and $2.84, and the agreement with IBM was also a contributor. However, it is also important to note that the increase in such expenses was driven by innovation in the financial industry. Compared to other technology budgets of companies, J.P. Morgan should have been spending nothing higher than $2.11 billion in 2003, which means that there should not have been an increase in spending between 1999 and 2003.

Therefore, only a significant restructuring of the bank’s organization could address the spending disparity. The most apparent solution was to cut ties with IBM that increased technology spending and bringing the IT talent back in the house. Therefore, the excessive expenditure of the bank was the real reason behind the contract’s termination and the failure of the outsourcing project (JP Morgan Chase’s excessive-tech spending killed IBM outsourcing deal 2005). The bank could have collaborated better with IBM to determine the areas in which it should have invested and the regions in which it could have been necessary to save. The management of the bank failed to understand that the expertise of IBM could have helped it to differentiate between the types of IT solutions needed for the increased performance.

Supplier Perspective

For IBM, the deal implied imposing some risks on the company. It was in danger of losing revenue in the case when its client, J.P. Morgan, turned out to need less computer time than initially anticipated and therefore canceled the contract in midstream. According to Paul Sweeny, the general manager for the financial-services sector of IBM, the deal with J.P. Morgan was “the largest and most comprehensive on-demand deal that the company had ever signed” during that time (Golden 2002).

The deal was considered a good pick for the contract as it was envisioned to take the company to a new level despite being guaranteed to get payment of only $1 billion in fixed costs (Golden 2002). Despite the seemingly low expected costs, it was projected to earn $5 billion during J.P. Morgan’s usage of IBM IT services. Nevertheless, the risk of the bank’s reduced need for information technology services pointed to the fact that IBM was acting knowingly regardless of the threat to fail the deal.

The subsequent decision of J.P. Morgan to end the deal with IBM was a significant ‘blow’ to the chief executives of IBM who had underlined the importance of their growth strategy as related to IT business process outsourcing. Furthermore, despite the seemingly understandable move from outsourcing to in-house IT operations for J.P. Morgan, IBM was sure that more time was needed for the deal to bring actual benefits for the bank. At the early stages of implementing the contract, it was unclear whether IBM could bring any benefit to J.P. Morgan. The cancellation of the contract meant a strategic reversal for IBM as the company tried to persuade customers to outsource not only its IT infrastructure but also business processes including human resources, back-office finance, and customer care.

In addition, IBM also expected to outsource sales, general, and administrative spending as primary opportunities for growth (Wighton 2004). Moreover, the management of the technology company is expected to facilitate an increase in revenue through various business outsourcing processes. The related market was estimated to cost $500 billion, and IBM aimed to capture 10% of the market. Thus, despite the range of opportunities for IBM to facilitate growth through outsourcing multiple J.P. Morgan, the deal failed.

For IBM, the merging of J.P. Morgan with Bank One meant returning the IT talent in-house meant calling off the critical technological infrastructure that was associated with the improved capabilities, tools, and processes. There was also a decision taken to rehire 4000 workers back to J.P. Morgan, with the bank having to pay IBM millions to proceed with the deal’s termination (Overby 2005). Bringing the IT capabilities back in-house is known as back sourcing, which has negative consequences. Among such implications were the decreased morale and the loss of trust of employees in their organizations.

Furthermore, many experts suggested that bringing IT talent back in-house was both costly and complicated, and the services that IBM intended to provide could indeed improve J.P. Morgan’s capabilities, and the breach of the contract meant that there would be a lack of IT services. Technologies could not be updated efficiently while new projects could not be scheduled (Backsourcing – JP Morgan and IBM – outsourcing 2005).

As IBM lost a major IT client, the organization was forced to review its strategy of outsourcing services and adjust to the ever-changing needs of the market. This meant that more companies, not only J.P. Morgan and Bank One, would need less IT outsourcing services as they bring talent back in-house (Iqbal & Dad 2013). The pay-as-you-go model replaced the rip-and-replace effort as the customer refused to continue receiving IT services from IBM. However, as mentioned by Cowley (2004), the termination of the contract would cause much disruption in the processes as “at the end of the day what was happening was that 4,000 people would turn in their IBM badges and get J.P. Morgan ones” (para 5).

In addition, it is noteworthy that IBM’s spokesperson mentioned that the company would still provide software, hardware, and other services to several units at J.P. Morgan, which include retail banking, security services, treasury services, and investment banking. It was also expected that the termination of the deal would not have a significant effect on the headcount at the organization because of the plans to hire 18,000 new workers to reach the highest staffing ratings since 1991. The majority of the new hires would come from developing countries with a relatively lower cost of labor. It is also important to mention that IBM intended to continue investing in building resources to facilitate its IT outsourcing capabilities and did not expected the cancellation of the contract to influence the financial results for 2004.

Conclusions and Recommendations

The outsourcing agreement between J.P. Morgan and IBM was intended to popularise the system of on-demand Information Technology services. IBM was ambitious about the deal and aimed to facilitate the further outsourcing of services that encompass a wide range of IT operations, ranging from data processing to data networks.

In addition, the deal was expected to boost the capabilities of IBM in terms of capturing the market of outsourcing IT processes, which was much needed for the company that was experiencing a decline in contracts in 2002. However, despite the positive intentions of the deal, the merging of J.P. Morgan with Bank One led to significant consequences for the outsourcing deal. The merger provided J.P. Morgan with the increased capabilities of moving its IT talent back in the house, which meant that IBM services were no longer needed.

The failure of the outsourcing deal can be attributed to the fact that the IT needs of J.P. Morgan changed as a result of the merging. As the contract implied the pay-as-you-go approach, the bank could refuse the services from IBM because there was no obligation to continue using the outsourcing supplier as the source of IT services. This feature of the deal is what made the contract encouraged the decision to refuse the services of IBM eventually. Therefore, the case has several implications for consideration regarding outsourcing cases.

As mentioned in the study by Gupta and Joseph (2005), the outsourcing strategy of J.P. Morgan was associated with finding the most suitable solutions for the management of its IT needs. According to the researchers, before being involved in an outsourcing solution, it is recommended to analyze the range of issues about technology management in large companies. Moreover, it is essential to understand how IT integration will be achieved after mergers as well as examine the reasons for which outsource IT infrastructure management and how the process is managed (Fagoe 2014).

Furthermore, companies involved in IT outsourcing should look at both the advantages and disadvantages of outsourcing and in-house management of infrastructure. When parties involved in outsourcing are transparent about their concerns and the potential changes to their corporate structure, such as the merger with Bank One, the higher the likelihood of an outsourcing deal to work. J.P. Morgan could have been more open to changing its strategy after the merger with Bank One and could have offered IBM an opportunity to be involved in other outsourcing processes.

Overall, the rapidly changing needs of companies in the financial industry can have a significant influence on the deals that they make to facilitate outsourcing. At some points, organizations may need to employ the expertise of other service providers to reach maximum efficiency and reduce costs. Furthermore, collaborations through outsourcing are also expected to foster positive connections between organizations operating in different fields and thus facilitate greater engagement. During other points, the needs of organizations will change and encourage a shift in perspective as to whether outsourcing services are needed.

The example of the deal between IBM and J.P. Morgan shows that outsourcing may not work on a contract basis in the financial sector, which is highly flexible and volatile as the economic conditions and the demands of customers change.

Reference List

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