Introduction· Reasons to Outsource · Outsourcing Methodology · Outsourcing Decision Process· Risks of Outsourcing · Conclusion · References
Outsourcing is the subcontracting of some or all of the IS functions by one firm to another firm. Outsourcing has become a competitive alternative to in-house procurement of the IS function because it is a means of increasing efficiency and cutting costs. |1| Outsourcing is no longer just an afterthought for companies that want to cut costs and avoid the overhead of managing technology. Instead, IT has become an integral part of business strategy and increasingly defines how well companies compete in the global marketplace. |13| This paper discusses the reasons for outsourcing and describes the outsourcing methodology and decision process.
Reducing Costs and/or Infusing Cash
The most direct and immediate benefits associated with outsourcing are those associated with reducing expenses by obtaining external services at a cost less than a firm's internal costs to provide those services, and with obtaining cash through either the sale of assets or transfer of IS staff to an external vendor.
Developing Information Technology Applications More Rapidly
Off-loading IS activities to a vendor enables a firm to focus its internal resources and energies on those IS activities which remain internally. Such a strategy is particularly attractive when scarce internal resources are being applied to mundane or support activities rather than being directed toward activities that focus on the core business mission or that otherwise enable business strategies to be more effectively pursued.
Improving service quality and Productivity
Often, the quality and productivity of information technology or services improve after they have been outsourced. |14| For example, the vendor may
Gaining access to Leading-edge Technologies
Developing close relationships with external vendors enables a firm not only to utilize the vendor's technologies but also to tap into the vendor's links it to other technology providers and users. Thus, the firm may be able to gain access to leading-edge technologies faster and less expensively than otherwise. "Numerous companies consider outsourcing partly for the access to greater IS expertise it would bring." |5|
Reducing Technological Risk and Increasing Technological Flexibility
If much of a firm's technological infrastructure is shifted to a vendor, the vendor rather than the firm must bear the risks of both technological obsolescence and variable services demand. As the vendor provides the investment for this infrastructure, it is easier for a firm to move to a different or improved infrastructure either with the same vendor or with a different vendor.
Implementing Change More Rapidly
Quite often, it is more effective or much easier for an information services vendor to implement a radical (managerial, technical or organizational) change than it would be for an internal IS group. There are two reasons for this. First, the vendor might simply have more expertise and experience with a particular initiative and with managing change initiatives. Second, the vendor is under far less pressure to bend to the bureaucracy or politics of an organization. |11|
Accessing Current Information Management Capabilities
The existence of external service vendors provides a readily available "reality check" on the quality and cost of a firm's internal capabilities to handle a certain information services activity. Just the process of conducting a feasibility study contrasting internal versus external sourcing can be of great managerial benefit.
Enhancing the Status of the Senior Information Services Executive
Through IS outsourcing, it is possible for senior information services executive to dramatically reduce their firms' short-term information services expenses and investment base and to both broaden and redirect their personal organizational role to reflect a more strategic business orientation. The political value of such benefits alone are sufficient to induce many managers to consider the outsourcing alternative.
Easing the Information Services Management Tasks of Senior Management
By its nature, IS outsourcing makes the associated costs much more visible and provides the potential to manage theses services in a fashion similar to many other corporate functions. Such benefits are especially attractive to the senior executive who has become disenchanted with a CIO's inability to demonstrate the business value being obtained from the firm's investment in information technology.
"Outsourcing methodology is essentially the embodiment of good practice in taking management decisions. The decision to outsource needs to be the subject of a proper management process and not simply made, as too many are, on financial or technical grounds." |8|
The disciplined outsourcing process parallels the phases of the time-honored waterfall application development methodology with its customary stages of feasibility and planning, analysis, design, build, implement, and operate. |4|
As in standard application development methodologies, phases can overlap to some extent, and there can also be iteration back to earlier phases. The methodology provides a discipline that leads to better outsourcing decisions, better outsourcing contracts with vendors, and better outsourcing results than a casual approach to outsourcing. It also provides a framework for management decision-making.
As noted earlier, in general, the goals of an outsourcing arrangement are to reduce costs, increase the level of customer service and quality, and realize a better price/performance objective for IS functions. Outsourcing may not be the only option available to achieve these goals, as inefficiencies could be discovered and corrected by in-house staff and resources. The insight gained from such an evaluation makes it possible to improve the economics of the IS function without outsourcing, focusing instead on improving internal IS operations. |7|
An Outsourcing evaluation can be undertaken in three phases:
Such an evaluation seeks the optimal allocation of IT resources. To accomplish the analysis, senior management must be prepared to support the individuals performing the evaluation as they develop performance models, conduct interviews and user surveys, perform industry comparative analyses, and attempt to quantify IS productivity. In addition to the evaluation conclusions themselves, the organization can benefit from the evaluation in several respects. IS management can become better equipped to work in a more cost - conscious manner and can develop a better understanding of the IS function's actual, rather than perceived, effectiveness, implying more knowledge about financial and performance metrics. Also, there will be greater insight into the role IS plays within the organization and how it can better support the various business functions and the organization's operations as a whole.
Step 1: Development of PMO
A baseline model of the existing IS functions must be developed in order to identify and define organization IS functions, analyze the IS cost structure, and identify the embedded technology components that will have to be taken into account if a transition to a new technology platform is contemplated.
One needs to develop an understanding of the organization's dynamics, its economics, and the functional and technological platforms. In view of the business process reengineering goals that an organization may have set for itself, this step should also include an analysis of the various existing processes that support the company's functions and the type of workflow interfaces that the organization currently has.
This phase also includes establishing a framework for IS performance objectives and measurements. These measures should be developed with input from management, IS personnel, and users. Productivity measures are critical to the evaluation study for two reasons:
Step 2: Setting strategic directions
This step of the evaluation process contemplates the global business posture of the organization and how this posture relates to IT: The IS function is evaluated as to whether it is (or should be) an important contributor to the organization's success. |7|
The goals of the organization can be categorized into one of four groups: provides competitive advantages for the organization, enables the organization to be a low-cost provider, makes the organization a low-cost operator, and affords high flexibility for the organization.
Competitive advantage implies that an organization plans to remain competitive through strategic investments in general, and implementation of strategic IS systems in particular, that directly increase market share or improve profit margins.
A low-cost provider outlook takes the position that IS contributes to the organization's competitive posture by providing low-cost processes and operations through inexpensive transaction processing.
The low-cost operator category assumes that IS will not play a role in differentiating the organization. Therefore, the IS function is expected to provide adequate service while consuming a minimum amount of resources.
High flexibility is a posture that enables IS to react quickly to support business contingencies, including the addition or divestiture of corporate divisions. It is likely that different departments of an actual organization may subscribe to different computing postures. The challenge of IS is to figure out how it can meet all or at least the majority of these requirements in an effective manner.
Perhaps outsourcing can help mediate some of these potential differences. Consider a large bureaucratic company with ten departments. Nine of these departments have established procedures using mainframe legacy systems for customer records, inventory management, billing, etc., that work relatively well. However, the sales department, whose members are always on the road, needs a new flexible and highly effective order entry system that will enable salespeople to enter complex service orders right at the customer site, rather than holding on to then for one or two days and then trying to enter the information off-line, where it is impossible to obtain a missing field in real time. Without such a system, it may take up to five days just to enter the service order, and filling the order takes an equally long or longer period. Clearly, the ability to use wireless technology for on-site entry is an excellent competitive advantage, improving the ability to deliver service ahead of the competition. If the IS organization is not able to design, deploy, and manage such a state-of-the-art network, this one function could be outsourced to a vendor that can do it. Hence, while the other nine departments may be low-cost operators, the sales department may be more in the competitive advantage category. |7|
Step 3: Evaluating Alternatives
When the PMO has been constructed and the IS strategy and purpose clarified, the outsourcing evaluation process progresses to the third phase. The initial step of this phase is to establish how closely the PMO IS environment aligns with the strategic focus. If they are aligned, further evaluation is not needed; the evaluation effort is suspended for, say, twelve months, after which the process is redone. Often organizations find that the two purposes diverge. For example, the IS scenario analysis may demonstrate the need to be in the competitive advantage mode, but the PMO shows that the organization is actually geared to being a low-cost operator. In this case, IS restructuring may be ultimately cost-effective.
If restructuring (or reengineering) is needed, one should next evaluate the degree of restructuring that is required. After this, one needs to examine possible alternatives and determine the preferable approach. This is done using both technological considerations and cost considerations. Two methods for restructuring exist: outsourcing and internal improvements. Finally, one needs to identify the steps necessary to implement the chosen alternative. The decision as to which alternative to choose, outsourcing or internal improvements, must be arrived at carefully, looking at both cost implications and organizational implications.
Once the decision is made to outsource, IT managers, perhaps in consultation with other managers in the organization, should identify persons in the IT department who will be given responsibility for oversight and management of the outsourcing arrangement and vendor relations after the contract is signed. |15| These managers should be part of the team that crafts the contract. Their inclusion is critical for several reasons. First, there is no better way to understand the issues involved in outsourcing than to be involved in all aspects leading up to the deal. Second, relationships with vendors start at the moment discussions begin. Being on the ground floor and having continuity in the relationship with people in the vendor organization contributes to success.
When outsourcing threatens to upset the status quo in an organization - as in instances of outsourcing motivated by high costs or poor performance of the IT department - it may not be possible to rely on internal sources for accurate estimates of internal costs or internal effectiveness. Under these circumstances, it is important to bring in objective outsiders to do some of the assessment work.
It is rare to experience opportunities in organizational life where the managerial actions taken to produce benefits are not also associated with potential risks. It is necessary to analyze the risks, and if they are unacceptably great or can't be managed, outsourcing should be avoided. If the risks are not too great or can be managed, outsourcing should be considered.
Increased Costs
Over the long term, it is questionable whether or not a vendor can deliver information services at lower costs than those experienced by a well-managed, well-equipped and well-staffed internal IS function.
Increased Risk
To the extent that the decision to outsource is a manifestation of organizational risk taking, it is a decision of extreme complexity. Whenever an agent performs tasks for a principal, the principal always bears the risk of the agent not completing the task as expected or of being less vigilant than would be the principal. And, when vendors outsource their contractual responsibilities to secondary vendors, it can become very difficult to pinpoint responsibility for particular activities. Another well-documented source of risk that arises is the potential that the vendor may not act in the client's best interest but may instead opt for "solutions" that benefit the vendor more than the client. |2| In addition, as a vendor's staff is naturally less sensitive to a client's culture, tradition and business strategies, instances of customer or user dissatisfaction are likely to arise.
Loss of Internal Technical Knowledge
Every company depends increasingly on knowledge about business processes and technologies, management and technical skills, information about customers and suppliers, and the vast tacit understanding about the company and its activities that are bound up in the experience and intuition of its employees. Whenever a service is outsourced to a vendor, the client loses some understanding of the service over time. Whenever vendors undertake innovative services for a client, much of the new knowledge to be gained remains with the vendor and is not transferred to the client. If a significant amount of information services are outsourced and if the client firm takes no steps to encounter this loss of expertise, it may not only find itself lacking technical specialists who understand the firm's business needs but also lacking in business managers or professionals who remain aware of the business and strategic roles of information technology. There are managers who fret about the use of contractors or consultants for fear that they could pick up information that will be given to other organizations and so damage the competitive situation." |3|
Loss of Flexibility
If a firm becomes locked into long-term outsourcing contracts, it can be very difficult to reverse the decision to outsource, as the firm would have to rebuild its internal technological infrastructure. Also, given the nature of the contractual relations, vendors may find it very difficult to respond to significant workload increases / decreases or to a desire to readjust priorities, or to move in new technological directions.
Increased Information Services Management Complexity
Often, the initial motivation to consider an outsourcing arrangement is driven by the assumption that information services management needs will be simplified by delegating these responsibilities to an external vendor. It is quite likely that the absolute level of management complexity being faced may increase. In particular, procurement and contract management will become much more important and complex. In managing both an internal IS staff and a vendor staff, responsibilities must be negotiated among each, conflicts over these responsibilities are likely to flare periodically, and the potential for compensation inequities and procedural differences always exist. |11|
Outsourcing an IS function involves proceeding through a life cycle of activities, starting with determining whether outsourcing is warranted and culminating with engaging and monitoring outsourced services if appropriate. Information systems outsourcing decisions should start with analyzing the current situation thoroughly, by examining the problems that gave rise to considering outsourcing and evaluating all available internal and external alternatives.
Outsourcing decisions have long-term impacts and must be based on a long-term IS strategy. This strategy should include analysis of the IS activities to be performed, evaluation of the internal IS services, the possibility for internal improvement and the evaluation of all expected effects of IS outsourcing. While outsourcing yields benefits, there are also costs and risks. Therefore, outsourcing decisions should be the outcome of a careful management decision-making process.