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The Way Business Is Moving

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Issue Date: May 2006

Remind me why we outsourced?

May 2006
Terry White

The argument is attractive: Outsourcing allows you to focus on your core business, save costs and upgrade your IT service at the same time. In fact it is so attractive that we wonder why we have not outsourced. But all is not well in the land of outsourcing.

First let us look at why companies have tended to outsource in the past, then let us look at the moves vendors are making to expand on their offerings and shore up the weaknesses that have been found in the traditional outsourcing reasoning.
Firstly, what are the 'traditional' reasons for outsourcing: mostly companies were driven by the cost cutting motive - it made business sense to expect two factors to come into play: firstly, economies of scale would allow the outsource vendor to leverage their larger facilities, broader and denser networks, and even greater purchasing clout to be able to deliver their services cheaper and to pass these savings on to their clients. Secondly, by moving their IT staff to the vendor they would save not only on the cost of these staff but also on the support staff, equipment and training needed to keep their IT people happy. (Or even just keep these people in the company). And in many cases the outsourcing organisation was able to transfer assets to the vendor, improving profit margins and balance sheets.
However, outsourcing to save costs in IT has not been all that it promised: last year Deloitte Consulting published a study in which it found that 44% of their survey respondents did not see the anticipated cost savings materialise.
There are other reasons that organisations outsource: the notion that you are tapping into a superior competency is appealing. The reasoning goes like this: the service-provider can afford to keep specialists, and do the constant refresh training needed to keep IT people up-to-date and happy, and they can leverage these skills across a wide range of their clients. Other reasons include the ability to update your technologies more regularly by handing the problem to the vendor. And of course the compelling argument that by dealing with a vendor that specialises in IT, you will achieve visibility, predictability, quality and professionalism in relation to the IT services that are provided to your company.
Again the reasons appear irresistible, and again there are some troubling findings. Coming back to the Deloitte Consulting report, they indicated that 70% of the study respondents had 'significantly negative experiences' in respect of their outsourcing contracts. And 25% of respondents have brought their IT services back in-house.
These are significant numbers, and the implication is that outsourcing is not living up to its promise. That is probably true, but to a large extent the problem does not lie with the vendor, it lies with the client, but we will get into that later.
Outsourcing companies are making changes in their value model to respond to these negative experiences and also to expand on their offerings to the market. According to a recent Datamonitor study, the primary drive by vendors is to separate their offerings into two bands: their IT infrastructure and operations offering is placed firmly in the 'maintaining the business' band and their value-adding offerings into BPO (business process outsourcing), and ASP (application service provider) related offerings. The trick here is that they want clients to see that the operational IT outsourcing band is governed by a different set of ROI rules than those value-adding services that they offer.
In the operational band clients can expect minor cost improvements, as well as efficiency and quality improvements. Vendors are offering to take IT operations off the hands of their clients with all that this implies, but client expectations should be realistic within this band. Where vendors want their clients to expect major value from outsourcing is in the business area: business process (BPO) and applications (ASP) outsourcing, where the vendor plays a role in business operations, much more so than in IT operations.
Interestingly, Germany is already way down this ASP/BPO road: another Datamonitor study reports that in 2005 German companies spent $3,5 billion on BPO and ASP outsourcing while spending a mere $1 billion on infrastructure outsourcing. Compare this with the UK, which spent about $1,5 billion on infrastructure outsource contracts and virtually nothing on ASP and BPO outsourcing. For example Zurich Financial Services outsourced their centralised Shared Services division which runs all their business applications (even the core business applications) to CSC. They retained their strategy, management and vendor management functions.
Also it is interesting that vendors are targeting CIOs for their infrastructure outsource sales and CEOs for their 'value-added' services in BPO and ASPs.
What should be the client response to this vendor differentiation? At the IT infrastructure outsourcing level, CIOs should see a significant element of the failure to realise projected cost savings and the general dissatisfaction with their outsourcing experience often lies with themselves. For example, vendors can only offer cost savings if they are able to leverage their operating models across many clients. This naturally means that the SOEs (standard operating environments) and standard IT procedures of their clients should change to the vendor SOE standards and operating procedures.
Many CIOs resist this, insisting that their current standards and procedures be maintained. And therein they constrain the vendor's ability to reduce their costs of supporting particular clients. Another element that needs to change in the client perspective is to do with resourcing. I know of a recent outsourcing deal in which the vendor promised 10% savings provided they could automate as much as possible. The client accepted the cost savings commitment but then insisted that the staffing levels at their sites remained the same as in pre-outsourcing days. They also insisted that the vendor take over all their people at their current inflated salaries. This is obviously wanting both the upside (cost savings) without the downside (staff rationalisation). Cost cutting is almost impossible in this situation.
But probably one of the biggest barriers to cost savings and client satisfaction in outsourcing is a failure by the client IT Department to change their own roles (and mindsets) after they outsource. Yes they move their operational staff across to the vendor, but their remaining management team keep their old job descriptions. So we end up with vendors complaining that they are being micro-managed and interfered with by their clients. Outsourcing is much more than shifting your operations and staff to your vendor and then it is business as usual, except that your managers are now bossing people who now belong to the vendor.
CIOs need to realise and act on the fact that all of their roles will change after outsourcing: managers should move away from managing IT service delivery to managing the vendor. It is the vendor's job to manage service delivery while it is the client management job to manage the vendor against the SLA. But management after outsourcing is more than just that. IT managers really have to turn into communications specialists, dealing with issues and perceptions within business, reporting on deliverables, changes in IT operations practices, and strategies.
But wait, there is more... If the client IT organisation can effectively change their role in the above ways, this should free them up to get into value-adding territory in their own business. They should be working with their business to realise the benefits promised by their systems; they should get into business process management; they should manage the portfolio of IT systems using business strategic criteria; and they should get into the content of the information that is flowing through their business. Then, maybe outsourcing will have made sense.
Terry White is a director at MarketWorks, the research-based consulting group. He is also the author of three books on IT management. Contact him at terryw@marketworks.co.za


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