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Outsourcing Risks: The Looming Threat of Vendor Lock-in

June 4, 2024 Roberto Magalhães

This is part 1 of our Outsourcing Risks series. In it, we provide solutions to the potential pitfalls that companies face when outsourcing IT in the current scenario.

Today, the vast majority of business is conducted on a global scale, regardless of the customer's location. Even for companies whose customers are primarily or exclusively located in one country, that company's suppliers and administrative functions are often located in other countries.

Cloud computing has dramatically expanded the reach and scope of many companies, allowing them to operate globally without the need to have a ubiquitous physical presence. And while this can be very beneficial in a digitalized world, the reality is that it exposes companies to a myriad of new risks that can threaten both operations and profitability.

The COVID-19 pandemic is a clear example of how an unpredictable event can completely disrupt this digitally-based business scenario. But it is far from being the only one. In fact, there are common threats that are often ignored – threats that can seriously harm any business. From constantly changing tax, financial and HR regulations, to restrictive or territory-specific partnership agreements, to geopolitical risks, there are countless challenges that executives must anticipate and resolve.

To kick off this new series, I'll dive into one of the technology outsourcing industry's most overlooked threats: vendor lock-in.

The latent possibility of supplier dependency

The notion of vendor lock-in is not new, but it has become a greater risk for modern businesses over the last decade. The main reason is the growing need for partnerships with different vendors to carry out a successful digital transformation.

Modern businesses need cloud computing, AI and machine learning, big data , IoT, 5G and other cutting-edge technologies to support their operations in today's business climate. And while these companies can certainly work with in-house engineers to develop their own implementations, the reality is that most of them choose to outsource software development. Simply put, the challenges of finding, hiring and retaining these types of qualified engineers, in combination with the high expenses associated with these skill sets, often outweigh any reluctance a CTO or CIO may have to outsource.

It makes sense. Why build, say, your own cloud computing infrastructure when you can easily hire pre-built solutions to meet your needs? Doing so can accelerate your digital transformation and add value from the first minute (provided, of course, that you tailor these technologies to your specific needs).

While partnering with external software development teams and technology companies is a modern business imperative, doing so in a non-strategic way can leave you relying almost exclusively on these teams. If you rely too heavily on a specific vendor or platform, the result will inevitably be greater risk and fewer options – you will be trapped!

You may also fall victim to unclear agreements or contracts, be tempted to sign up for long subscriptions in exchange for certain financial “benefits,” or be forced to work with a specific vendor who doesn't have enough staff or is in a niche they aren't. qualified to work. To be clear, the notional benefit of a discount is typically more than offset by increased costs elsewhere: additional offshore staff, additional administrative expenses on the client side, and costs associated with testing, audits, etc.

Key issues with vendor lock-in include:

Decreased quality or responsiveness of the supplier's service
Security breaches and vulnerabilities in vendor infrastructure
Lack of updates or upgrades to vendor offerings
Changes to supplier offerings that make them unsuitable for your business
Increased geopolitical and territorial risk depending on the location of a supplier's delivery centers
Price increases, including potential currency fluctuations

Being locked into a single supplier often means you won't find quick relief from these supply problems when they happen. And if you're single-source, they will happen! Of course, you can always switch suppliers and pay a price to do so, but the actual price is typically much higher than the literal switching costs.

Changing one supplier for another doesn't just mean losing part of the investment you already made in a supplier and adding the costs of hiring and growing the new company. There are operational costs associated with any vendor migration, including management and procurement efforts, code reviews, possible refactoring, documentation or other rework, training internal personnel to work with the new vendor, and of course, upgrading the new vendor. .

The threat of vendor lock-in is vastly underestimated at the moment – and certainly by larger vendors! There is a feeling among customers (you!) that you can easily switch from supplier to supplier without paying a high price, or that certain suppliers must be trusted regardless of whether they are too big to fail or always at the forefront of technological development. The truth is that larger providers (20,000+ employees) routinely hire a higher percentage of cheap (for them!), less qualified junior resources, thus ensuring their profitability.

Exercising caution when hiring new vendors, managing existing partners, and ensuring you are never locked into a single vendor are the best ways to avoid the negative consequences of vendor lock-in.

Evaluate all potential vendors carefully and thoroughly to find the ones that best meet your needs and have a good reputation.
Use a multi-provider strategy that brings together different vendors to take advantage of their best capabilities while reducing the likelihood of vendor lock-in.
Develop your own custom solutions to limit dependence on external software packages that may pose functional, security, or other risks.
Avoid storing data with an exclusive provider, as this can make it difficult to move when necessary.

These actions can mitigate the risk of vendor lock-in, but they can never eliminate it completely. This is because you never know what could happen to your supplier that could end up affecting you and leaving you a “prisoner” of a particular supplier. For example, a change in country regulations could affect how you operate with a particular supplier and could complicate your mobility. Keep this in mind when evaluating the risk of vendor lock-in.

Vendor lock-in is a real threat that can completely disrupt your outsourcing experience. This is why you should adjust your outsourcing strategy from the beginning to avoid falling victim to it. Following the suggestions I just shared is a great starting point, but the only way to truly avoid vendor lock-in is to be vigilant, flexible, and agile.

This article is part of the Outsourcing Risk series.

If you liked this article, be sure to check out some more articles about outsourcing.