Information Technology (IT) outsourcing is a change agent of traditional IT departments, and provides a view of the organisational IT structures for the coming centuries.
The IT Outsourcing Concept
IT outsourcing as such is not a new concept, it is a new word for an old practice, as organisations, for many years, have used and depended on outside suppliers for access to specialised computing power, software and systems development skills.
Outsourcing practice has however evolved in several ways over the last few decades. For example, nowadays it is considered an integral part of senior management’s Information Management agenda, particularly due to its transformational impact on the IT function and organisational effectiveness. It has also become widely regarded as an important paradigm for managing and structuring an organisation’s IT function.
In essence, IT outsourcing is the contractual delegation to an external third party of the continuing management responsibility of the provision of business services. It is a process that involves selecting, negotiating and contracting a vendor partner for those services that were previously resourced internally. IT outsourcing has been often inaccurately used by organisations and studies alike to refer to situations which are not about contractual commitments to service levels, but which concern procuring or hiring IT service suppliers for a specific project. For example, organisations have claimed that they outsource by virtue of buying PCs from the same supplier for the past 5 years.
Many outsourcing services solution providers take a broad-brush view and do not distinguish between outsourcing and other practices, thus providing vague insights into potential of outsourcing. As many other findings outsourcing is often distorted by mythological or ‘voodoo economical’ benefits and the range of outsourcing descriptors adopted, such as ‘contracting-out’, ‘facilities management’, ‘co-sourcing’, ‘externalisation’, ‘multi-sourcing’, ‘selective sourcing’, and ‘consortium sourcing’ describe a service that has existed in one form or another for decades.
Outsourcing can in essence be framed as a ‘make-versus-buy’ decision. I commonly refer to, IT outsourcing as the decision taken by an organisation to contract out or sell the organisation’s IT assets, people and/or activities to a third party vendor, who in exchange provides and manages assets and services for monetary returns over an agreed time period.
IT outsourcing has provided opportunities for innovation, access to necessary resources but also assisted in reducing the frequent frustrations and costs of managing an organisation’s IT function. In public sector organisations it has presented opportunities to improve efficiency and effectiveness of operations by restructuring them into agencies, privatised divisions and management buy-outs.
Significance of IT Outsourcing – Market
Macro impact - Market
The macro impact of IT outsourcing has fostered a sizeable market and a substantial increase in the numbers of IS service suppliers globally. It is difficult to determine the exact size of the local and hence global outsourcing market, as variations in market studies’ use of methods, terminology and agendas hamper a clear compilation of reliable figures. Nevertheless, there is a noticeable stream of press reports about global outsourcing mega-deals, even though studies have shown that the majority of outsourcing is done by smaller (turnover of less than $50m) organisations. Hence outsourcing is common practice for small and medium-sized firms and most deals are in sizes between 50,000 to 10m.
With mega deals such as Kodak-Eastmann outsourcing excelled to a global IT practice. This in part explains its phenomenal growth since the early 1990s, which has outpaced most optimistic predictions, and today (2008) stands at a global market size of approximately $190 billion dollars with an annual growth rate of 15-20%.
Micro impact – Customer Benefits
The micro impact of IT outsourcing on the client organisation has been described as both advantageous and disadvantageous in terms of added value and performance. The true risks and costs of outsourcing, however, are often lost amid the rhetoric about its benefits. Organisations seldom outsource for a simple reason and single objective. Complex factors foster reasons that outline the benefits sought, which commonly identify financial, business, technical, strategic or political benefits.
The most common advantage sought is financial, which has supposedly led to dramatic cost savings of between 10 to 40%, has entailed improved cost control, enabled organisations to change from a fixed cost structure to a variable one, and provided substantial cash flow benefits. An argument often put forward by clients for outsourcing is cost clarity:
“While ‘soft’ costs are often concealed in in-house development, all costs are real and visible in an arm’s-length arrangement” (Hurst & Hanessian, 1995).
However, financial benefits, especially cost savings, are often bloated by vendors for their sales benefit and rarely meet expectations. Indeed findings identified two hidden cost factors. First, companies underestimated the set-up costs. Second, companies underestimated the management costs.
It has been shown and proven that on average there are real cost savings to be had and they tend to be more frequent in: a) selective outsourcing deal, b) when both senior and IT managers make the outsourcing decision, c) when both internal and external bids are invited, and d) when ventures agree short-term (less than 4 years) and have set-up a detailed fee-for-service contracts.
Business, strategic and/or political improvements can lead to benefits in the form of, for example, new conjoint business start-ups, facilitate a refocus on the core competencies, and diminish the often political debates about new IT projects. The core competencies argument is often quoted as a fundamental advantage. However, the disadvantages are the loss of knowledge, human resources and assets, loss of control over services, security, and confidentiality, increased dependency on the vendor, and possible vendor lock-in.
Finally, technical advantages are supposedly easy access to expertise, improved services, new technologies and technological innovation. Once again, clients often found that no real technical benefits materialised either in access to personnel, expertise or innovation.
Outsourcing Practice – Strategy & Options
Outsourcing can no longer be considered in terms of a simple dichotomy of ‘out or in’. A far superior conceptualisation is to consider ‘the degree of outsourcing along a continuum’. The two polar archetypes one encounters on this continuum are ‘selective’ or part outsourcing where selected functions are externally sourced while between 20 to 80% of the IT budget is still internally provided, and ‘total’ outsourcing where more than 80% of the IT budget including management costs is contracted out.
The variety of options one finds within this continuum have been described by experts and can include for example:
a short-term transitional outsourcing arrangement in which a vendor supports a client organisation’s migration from one computing platform to another by freeing up time, money and/or staff;
shared-service arrangements in which clients pay a fixed monthly fee to run computing services on a vendor’s IT installation;
a remote computing option which is similar to shared services except the client has the option to customise the vendor’s hardware and technology to some degree;
netsourcing or application service sourcing via a online network solution to access core company applications;
strategic alliance sourcing, also referred to as joint venturing with the vendor; and
multiple selective sourcing arrangements in which an organisation negotiates with a range of suppliers to deliver as a single entity services back to the client.
Total outsourcing has been found to be an exception rather than the rule. Organisations, i.e. potential customers more commonly tend to outsource selectively, but this is not to say that a significant proportion may be contracted with a portfolio of vendors.
The unravelling of outsourcing is the reverse insourcing process, in which the client organisation perceives a greater benefit in centralising the IT function and brings the management and technical capabilities back in-house. This tends to be a complex and often more difficult task than outsourcing, especially when many of the IT knowledge workers were transferred with the outsourcing initiative.
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Outsourcing Vendor – Selection Process
Given the significance and impact of outsourcing on the performance of IT and the client organisation, it is vital that an appropriate vendor partner is selected. In fact, the right vendor choice has been found paramount to the success of outsourcing. The common criteria that generally informs the outsourcing decision and hence the selection process is a richly discussed and common consulting and advisory area in IT outsourcing. The decision process underpinning the selection process commonly takes account of organisational and IT objectives, internal requirements, and benefits of outsourcing. Frequently the external pressures a company is confronted with are though neglected in the process!
The selection process begins in earnest with the short-listing of relevant vendors. Common practice seemed to be an open short-list process, in which clients advertised for vendors to apply, and a closed short-list process, in which vendors were directly approached by clients. Identifying and creating a short-list commonly involves issuing a request for information (RFI) to vendors first, before selecting those most suitable to invite to bid. With the issue of an RFI the client outlines its objectives, services, assets, transfers, and anything else of relevance to its outsourcing intention, and requests in return certain information from the vendor as to their likely approach to addressing their proposal, its capabilities, experience, references, etc. Those short-listed are subsequently invited to tender (ITT) or issued a request for proposal (RFP). Depending on the company’s approach, the tender or proposal is the means to select a vendor or is used to enter into detailed dialogue and information exchanges to further narrow down the short-list before making a final selection. Both selection approaches tend to be preceded by the client’s evaluation, although findings suggest that clients choose vendors more on qualitative than quantitative criteria. The selection process is a costly undertaking for both parties in terms of time, effort and resources in bidding for work, but further costs will arise with the ensuing negotiation and contract development.
Negotiating and contract development has received considerable attention from law firms and practitioners. Simply seen, outsourcing negotiations focus on what the objectives are, what the outsourcing process is expected to achieve, and what enforceability should be incorporated into the contract should any aspect of the transaction go badly wrong. The contract’s role is then to set out what has been agreed between the parties, covering broadly, amongst other things, the services to be provided, the charges, the rights and responsibilities of each side, the management of the contract, the extent of the parties’ liabilities, how variations to the services may be made, and how the contract may be terminated. The average contract’s length in outsourcing is approximately 5 years, because most organisation strategic planning horizons only cover 3-5 years.
The outsourcing contract’s peculiarity is its general split into the contract itself, specifying at length the legal nature of the relationship, and the service level agreements that define the detailed requirements and performance measures. Little attention has focused on the long-term influence of contracting, except to identify different types, some key dimensions and emphasis on its general criticality. However, the contract’s actual impact on the venture over time has not been addressed or researched empirically in any form, even though it is clear that that it has a guiding role and acts as a reference document.
The Outsourcing Relationship
The post-contract management agenda primarily focuses on operationalising the contract. It is during this stage that the outsourcing relationship has been found to truly evolve and take shape. Post-contract management by nature heavily depends on the cooperation of both parties and subsequently engenders some form of relationship. Irrespective though of its form, the relationship is generally vital to the overall success of the outsourcing initiative. It is thus surprising that for the overall success of the relationship has received so little focused attention.
The primary focus on outsourcing has almost exclusively concentrated on its determinants, benefits, vendor selection and contracting. It is undisputed that these do affect the success of the outsourcing initiative, yet its success also largely depends on the way the client-vendor relationship is subsequently managed for the duration of the contract.
In fact my and our research highlights that the pre-contract phase in length is marginal in relation to the post-contract management period, which on average spans five years in terms of contract length. Ongoing relationship management forms an integral part of the post-contract management agenda, and its effective handling can make the difference between achieving the outsourcing objectives or not.
Seminal work dating as far back as the early ‘90s had already highlighted the importance of the relationship for outsourcing, emphasising the urgency for detailed work into the phenomenon to improve managers’ understanding and provide means for managing it. By the mid ’90s, the importance of the relationship dimension was drawing much more attention. By this stage outsourcing had passed the five year ‘management fad’ stage and a number of organisations were in the process of re-contracting their initial deals, giving light to the fact that relationship management was the key to success.
Our understanding is still at a very basic level, and is insufficient to be able to explain the outsourcing relationship comprehensively. In fact the IT outsourcing relationship to date has received still the least conceptual, managerial and empirical attention, even though so many continue to allude to its criticality for an initiative’s success. Moreover, this paucity of research has made it a favourite area for consultants to advise on and offer checklists of do’s and don’ts. However, these diverse checklist suggestions about what needs managing, do not exactly provide a better understanding of the relationship. It is worthwhile though to examine the suggestions made by academics, researchers and consultants to get an understanding of the prevailing perspectives on outsourcing relationships and to get a glimpse at how outsourcing relationships have been characterised and explained so far.
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Gestalt of an IT Outsourcing Relationship
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Exploring IT Outsourcing Relationship – Theory & Practice
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Avoid Relational Trauma in Outsourcing - Take Note!
Winners Curse in Outsourcing
The process of evaluating, selecting and subsequently contracting out or selling the organization’s IT assets, people and/or activities to a third party supplier raises significant concern in light of the inherent ‘Winner’s Curse’ that may arise when the supplier over-promises on what can be delivered for the contract price.
In a longitudinal outsourcing case we were able to highlight the often abstruse Winner’s Curse, its effect on post-contract management and the relationship, and how it was alleviated by agreeing to mutually renegotiate the terms of the deal.
Building on auction and IT outsourcing theory, we developed a model of IT outsourcing processes, and a Winner’s Curse typology for understanding IT outsourcing ventures. We found that a Winner’s Curse in outsourcing may not be evident to either party during negotiations.
However, it will result in:
additional costs for both parties in the form of increased management time and resources;
may result in service slippage and high dissatisfaction levels and possibly demand service level renegotiations;
may lead to relational loggerheads; and
ultimately may result in early contract termination.
To avoid experiencing such a relational trauma as a consequence of a Winner’s Curse, we identified six lessons that client and supplier companies should consider before signing IT outsourcing deals.
The key message being ‘never to mistake a relationship for an auction’ – outsourcing is a long-term venture.
Relational Trauma in IT Outsourcing – Strategies for avoiding a Winners Curse
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