visible artifacts

By: Chris Malek

Jan 05 2009

tags: screening_exam

Category: Articles, Exam Essays

1 Comment »

Discuss outsourcing as an option for IT org in satisfying the needs of the business.  What are the: range of available options?  When is outsourcing a viable option? When is it not indicated?  What is current thinking on outsourcing?  What about offshoring?

In this essay, I discuss outsourcing and offshoring as options for the enterprise.  I discuss available options and considerations and discuss a framework for deciding when and what to outsource.   I then finish with current thinking among CIOs regarding outsourcing.

Outsourcing in an IT context is contracting with a third party to provide the enterprise with an IT related function.  This can be from as simple from hosting a website to as complicated as taking on the entire IT function for the firm.  There are two classes of outsourcing: networked incremental outsourcing and full scale outsourcing.   Firms choose to outsource for a combination of primarily three options: cost and cost structure (being able to trade a intermittent fixed cost for a periodic variable cost), quality and capability of the in-house IT organization, and whether the IT function to be outsourced is a core competency for the enterprise.

In networked incremental outsourcing, the enterprise wants to outsource a single service from a suite of similar services to an outsourcer.  Internet hosting are the paradigmatic example of incremental outsourcers.  They offer anything from managed web software services (Wordpress hosting companies, for example)  to shared servers (in which you are given a slice of a server on which you can manage the website configuration and data, but they maintain the machine, operating system and database server) to co-location (in which you are given physical space, power, network connectivity and possibly other support services, but you supply and maintain the hardware and software you need).   These are called incremental outsourcing arrangements because a firm can either start at the low end (the cheap end) and trade up, or start at the high end (the resource expensive end) and trade down should their confidence in the company increase.  Incremental outsourcing allows a company fine grained control over what IT functions on what services to keep in-house, and what to outsource.  Characteristics of enterprise architecture and financial arrangement in a company which are conducive to incremental outsourcing are: the internal costing structures are prepared for the periodic small variable cost of many services; and the IT architecture and skillset of the IT organization can effectively integrate the outsourced service.   Drivers for this kind of outsourcing are: a shortage of IT staff resources because they’re too busy doing other things or don’t’ have the requisite skills; decreased time to market because the outsourcer already has the infrastructure and servers built and provisioned; the need to support 24×7 operations when your IT org can’t supply it; outsourcing has a more favorable cash profile because you don’t need to make an initial capital outlay to buy servers; you can decrease desktop complexity because you push applications onto the server and maintain one copy instead of many.

Full scale outsourcing concerns outsourcing large parts of the IT function, or all of it.   Candidates are infrastructure (desktop, network, and server provisioning and maintenance; call center support), development (new product development, product and service innovation, enterprise software development and integration), business process transformation (business/IT alignment consulting and project management), and everything.  Drivers in this domain fall into three categories: issues around the IT organization; issues in the business organization; and market pressures.   Business leaders my opt for large scale IT outsourcing because vendors have better economies of scale than the in-house IT organization, or because the IT organization lacks skills, or is historically reticent to align with business.   The business itself may not see IT as a core competency and may want to outsource it to reduce management oversight to only those functions that are central to the business model.  Or they may opt to take advantage of the financial characteristics of outsourcing, trading periodic capital investment and expensive staff for periodic variable costs, which helps their bottom line.   Business leaders may also feel pressure form competitors who are already outsourcing their IT function, or from aggressive outsourcing vendors.

In determining whether to outsource an IT function or not, a firm should carefully consider whether that function is core to the business model of the firm.  In most cases, outsourcing core competencies is not indicated.  The firm should also think carefully before outsourcing IT management and governance, IT architecture management and vendor management functions.   If we look at the strategic grid model, in which one axis is importance of IT operations to the business model and the other is the importance of strategic use of IT to the model, businesses who are good candidates for large scale IT outsourcing are high operations/low strategy (in which case we outsource the IT strategy functions) and low operations/high strategy (in which case we outsource the operations functions).    In outsourcing projects, well understood, straightforward projects are good candidates, while open ended projects in which the requirements are poorly understood or which require research to complete are not as good of a candidate for outsourcing.  Cost alone is rarely a good indicator of when one should outsource, especially if the desire for cost reduction is short term.     The enterprise should also consider that functions, once outsourced, are very difficult to bring back into the firm due to lost organizational knowledge and capacity, and also that the cost of duplicating function and moving data may be high.

Large scale outsourcing frequently involves long term contracts (ten years) and involves a substantial commitment on both sides: be sure that the outsourcer is both willing (in terms of aligned interests and corporate culture) and able (financially, technically) to fulfill its obligations.  Contract negotiation can take six to nine months for such deals, and it is important to consider in the negotiation how the relationship is going to be maintained over the years.  The IT org must be capable of managing relationships with the vendor for the long term; they should maintain tight relationships with them, because in these long term contracts the outsourcer becomes almost a partner to the company.   Relationship management is a skill that that is not intrinsic, and must be learned by the IT org.

Offshoring is outsourcing to vendors which are overseas, typically in India and China where the costs of personnel are lower than in Western countries.   Things to consider when thinking of offshoring are the dramatic cultural (both organizational and national) and language differences between client and vendor, the communication cost of communicating half way around the world and not being able to meet face to face, and the time differences.

In today’s recession, firms are opting for smaller and shorter contracts with vendors, and are staying away from open ended contracts (innovation and business process transformation).  Firms should think carefully about obtaining or renewing outsourcing agreements for several reasons.  First, be sure that you’re not doing it for short term cost reasons only, because once the economy improves you’ll still be saddled with the contract even if you’re ready to move on.   Learn from the mistakes of the great outsourcing push of the late 1990s.  Second, since many firms will rush to do outsourcing, we can expect vendors service levels to drop (because they’re taking more customers) while simultaneously, the balance of power between clients and vendors shifts in the vendors’ favor (again, because they have many customers).  Third, the recession affects outsourcers just as much as it affects everyone else, and we can expect some vendors to fail.  Firms should monitor the health of their vendors carefully, and examine the health of new vendors carefully before signing any contracts.