Information Technology Outsourcing

Introduction

Outsourcing in recent years has been considered highly enigmatic as it is hard for companies to entrust their extremely valuable activities to another company or third party. It genuinely depends on who you ask as whether they personally feel that outsourcing benefits their company or hurts their company overall. “Outsourcing is the contracting out of any task, operation, job or process that was originally performed by employees within your company to a third party for a significant period of time” (Bucki, J.).

One thing that outsourcing is not is if a company hires an employees from a temporary agency while one of their full-time employees is on leave; could be medical or vacation. An activity within a company is more than likely either completed in-house (within the company) or through outsourcing (outside the company). It is important to note that outsourcing is sometimes more commonly called offshoring as the most common example of outsourcing involves various jobs being sent overseas to different countries like India or China.

Volume of Outsourcing

Today’s world is considered the age of outsourcing as more and more firms are contracting out various sets of activities, “ranging from product design to assembly, from research and development to marketing, distribution and after-sales service” (Grossman, M.). One primary example is Nike, Inc. who is considered one of the largest suppliers of athletic shoes on a global standpoint. Nike outsources 100 of its shoe production and manufacturing to countries like Vietnam and Indonesia. “Nike even outsourced the advertising component of its marketing program to Wieden & Kennedy, whose creative efforts drove Nike to the top of the product recognition scale” (Quinn, J.). Due to strategic outsourcing, Nike experienced a 20% growth rate will simultaneously earning a 31% ROE in the recent decade.

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Another well-known example of a company that outsources is Apple, Inc. Apple knew that it would be difficult to be the absolute best at developing products such as chips, cables or keyboards. Upon realizing this, they decided to outsource 70% of its manufacturing costs and components including the design, printers, and even marketing. “Apple thus avoided unnecessary investments, benefited from its vendors’ R&D and technical expertise, kept itself flexible to adopt new technologies as they became available, and leveraged its limited capital resources to a huge extent” (Quinn, J.). Besides lowered fixed costs being an advantage, Apple benefited from having three times the capital turnover and the highest market value in the 1980s.

In a perfect world, savvy companies would outsource every activity except those that gave them in a competitive advantage, which would be their core competencies such as analytical and creative thinking. Since that is not the case, companies must strategically pick and choose what they outsource and to who. In the United States, more than 90% of the major corporations have outsourced some services. “The 1990 worldwide outsourcing market is estimated to be $30 billion, and is project to grow to $50 billion by 1995” (Altinkemer, K.).

Today’s Situation in IT

The strategic move toward service outsourcing began with the Information Technology(IT) sector, more specifically with Kodak outsourcing major components of its IS sector. “Industry analysts predicts that the global market will grow from 86 billion in 1996 to more than 137 billion by 2001” (DiRomualdo, A.). The ideology of information technology outsourcing is the practice of contracting out the organization’s IT assets, people, and/or activities to a third party vendor. It is said that the IT outsourcing industry has reached an estimated market size of $140 billion just in 2001. The IT services industry has developed into a highly competitive market. One company that sets an excellence example of business practices and outsourcing is Google. They outsource everything from virtual assistant work to IT development. Below is a valuation of outsourcing contracts from the 1990s, but the characteristics would still apply for outsourcing contracts today. (Altinkemer, K.)

Factors Driving Need to Outsource

Outsourcing, since the early age of commerce, has been around mostly for financial motives. Since the dawn of manufacturing, companies have been attempting to lower their fixed costs of production by having the best financial deal possible through outsourcing to overseas third parties. These financial deals were considered mostly one-sided as information would move from the vendor to the client and the vendor would complete the project. Information would rarely ever flow back from the vendor to the client as the client was most often the more knowledgeable one in the industry. In financially based outsourcing, the contracts were usually long-term so get the best possible financial deal will simultaneously securing a sturdy relationship between the vendor and the client.

On the other hand, strategically based outsourcing, has been making its way in the past 30 years or so. The efforts in this case when looking for a suited vendor are capability and competency-intensive. Companies looking to outsource are wanting to tap into specialized expertise, knowledge, processes and capabilities found outside the organization, and use these to give them a strategic and competitive advantage. Opposite of financially driven outsourcing, strategic outsourcing would involve partnerships will multiple vendors. A prime example of this would be in the case of Dell Computers. Dell’s core competency, the component that makes them strategically competitive, is the information systems paired with their supply chain management systems. Since they do not hold a large amount of computer hardware in their inventory, they must rely on an extensive network of suppliers and/or manufacturers for their products as well as their knowledge. It is impossible for Dell to have the up-to-date information on every single computer part. Due to this, it’s extremely likely that the computer you have came from many different parts of the world.

There are several factors that influence companies in terms of if to consider outsourcing or not and they are as follows. It is important when an organization can access external resources and knowledge rather than owning it themselves. In today’s world, rarely is a company ever self-sufficient as there will more than likely always be an opportunity cost, which is the value of the best alternative use of a resource. The central reason companies engage in outsourcing is the cost savings. Costs savings can come from the simple move from fixed to variable cost models or they can come from the company doing the outsourced work as wages and costs of labor in other countries can be lower. Focusing on an organization’s core competencies is dire as this is what makes them industry leaders. Outsourcing involves the transfer or work as well as decision rights which allows a company to reduce its need to focus on decision making efforts. Some of the other important factors are rise of global knowledge workforce, increased sophistication of IT and global diffusion of knowledge.

Types of Outsourcing

One main question commonly asked by top executives in a company is what to outsource? This could include if the company should outsource an entire department or only certain activities and it all really comes down to the nature of the the company. There is a multitude of different types of outsourcing, and an in-depth model is found below from The Outsourcing Handbook. (Power, M.)

At the very least, outsourcing can either be done on-site or off-site in terms of location. Within off-site, work arrangements can either be onshore, nearshore, or offshore. Onshore is the ideology that a vendor will complete the project within the same country as the company. One obvious benefit when onshoring is there are fewer cultural boundaries to handle. Near-shore arrangements in the United States involve transferring work to neighboring locations outside the country. A lot of US companies have begun using Canada as a resource for business partners. An offshore arrangement is where a vendor is a considerable distance from the client such as India.

Outsourcing projects can also be segmented by their depth level which could either be individual, functional, or competency. Individual outsourcing involves outsourcing specific positions out of the organization and is considered the simplest form of outsourcing. The company is engaging in outsourcing a single staff function like is considered to be like hiring a full-time consultant. Functional outsourcing involves outsourcing a functional area of the company such as the accounting department. The most common motivations for this type of outsourcing are cost savings and superior expertise possessed by vendors.

And last, competency outsourcing is includes outsourcing activities that control how products and services flow throughout the entire organization. Some examples include technology development, human resource management and even supply chain management. When implementing competency outsourcing, the company must have a great deal of trust in the vendors ability to develop on the project in an efficient and effective manner.

Lastly, the efforts of outsourcing can be classified on the nature of the work – process or project. Process-oriented work is centered around the outsourcing of well structured, standardized and documented operations. This could include the outsourcing of a payroll function. On the other hand, project-oriented work would involve outsourcing unique and non-routine work like software development. Process-oriented work is considered easier to manage and project-oriented work is most often more laborious as it involved knowledge deep experience and detailed information.

Risks

Along with any ideology comes risks that indicate there is a Ketler and Walstrom classified outsourcing advantages and disadvantages on personnel, economic, control, data/segment and organizational dimensions which are shown in Table 1 and 2. Furthermore, a vast majority of companies that are choosing to outsource for the first time aren’t aware of various trivial costs that could include but aren’t limited to, finding a vendor, drafting the contract and managing the effort. Companies incur contract costs before a third party company even begins to start working so companies run the risk of possibly spending a lot of time researching a company that they end up not choosing to outsource to which means wasted time and financial effort. Spending additional time and expenses early on helps avoid problems later, such as having to re-negotiate the contract or constantly monitoring the vendor to make sure performance is delivered.

When outsourcing, a primary risk would be vendor contract issues which entails a multitude of issues from experience to communication. A vendor could not have enough experience or credibility in terms of prior success in outsourcing or even knowledge in the industry that the company needs outsourcing is in. If planning takes up a huge allotted period of time, that possibly cuts into time that could be used for the actual activity being outsourced. But in countries that have a dependency on trust when it comes to doing business, this may be a necessary factor as the working relationship between the vendor and the client is imperative.

In order for a vendor to be considered appropriate for the job, especially in the IT sector, they must have state-of-the-art technology paired with trained personnel in appropriate areas. When dealing with vendors, both parties need to have a flexibility in regards to entering and exiting a contract as there needs to be a willingness to negotiate. Listed below in Table 2 are some more detailed disadvantages from the point of view of the company that is outsourcing. (Altinkemer, K.)

Rewards

No company can afford not to join the digital ecosystems forming around every industry, but each must do so without giving away the keys to the business. One evident reward is the speed of technological innovation. “According to Outsourcing and Technological Innovations: ‘As the pace of innovations in production technology increases ,the firm has less time to amortize the sunk costs associated with purchasing the new technologies. This makes producing in-house with the latest technologies relatively more expensive than outsourcing’” (Yu, L.). Technology has advanced even further than it had in 2008 when that quote was extracted which makes this even more applicable. The internet and advancement of communication technology has made it easier and cheaper for companies to pursue suppliers in foreign countries. Outsourcing could be an example of a disruptive strategy that would force companies to take part as higher expenses and inflation occurs.

Another reward is the reduced costs that could arise from outsourcing. IT is one of the most expensive parts of the organization to establish and maintain. With inflation and the cost of labor and materials rising, along with competition forcing the lowering of prices, outsourcing could save a company money as other countries can do the exact same job for a cheaper price. Improved performance is also perceived as a reward. It is difficult for an in-house IT department, especially in large companies, to be on top of today’s technology. When you outsource to a specific company, it is sometimes their sole job to following the trends of leading technology including software and hardware. In Some outsourcing scenarios, the customer’s flexibility is improved as IT staff is able to focus on other projects in the department. Below is another table listing the advantages of outsourcing from The Outsourcing Handbook. (Altinkemer, K.)

Industry Best Practice

There are crucial points to bear in mind when engaging in an outsourcing initiative which are the best practices. They are listed below.

Outsource for business value and strategic advantages

It is important for company top management to all be on the same page about the rationale for outsourcing. It is imperative to not outsource for scanty and short-term operational issues as the cost of outsourcing would far outweigh any benefits that would possibly be received. It is absolutely critical that outsourced project stays in line with the company’s current strategic position. The project needs to contribute to the business value and have increasing strategic advantages. In order for this to happen, top senior executives need to be a board and rally support behind the effort in order to build success.

Specify your needs – do not have it done for you

It needs to be clear who is outsourcing to whom or else you’ll quickly run into trouble. It is necessary that the client or company is the one in charge of defining the needs and goals of the project being outsourced. Failure to do so could result in longer contract negotiation times or even longer project completion times.

Shop around for a vendor using multiple criteria

Make sure to acquire a vendor through thorough multiple criteria, not just low cost which is the most popular. Vendors are known to present low costs in the beginning because a lot of companies will pre-screen vendors mostly based on low cost before anything else. Most vendors who “low ball” are considered desperate for business and will say a lot of things to get you to sign a contract. Vendors must be evaluation based on multiple criteria that includes, but isn’t limited to, quality, reputation and experiences, with cost being the last factor.

Ensure negotiation and contracting for a win-win situation

It is key that you remember that you’re entering into a relationship with another business partner who is attempting to create a profit as well. A successful relationship depends on whether both parties are in a win-win situation. You can’t get too selfish and try to get maximal profitability. A vendor is considered your business partner and most likely wants to sustain a positive business relationship as much as you do.

Do not be rigid during project initiation and transition

Because the initial stages of outsourcing can be chaotic and confusing, it is important to not panic as well. An inexperienced manager can get overly concerned and become rigid in terms of handling certain situations. Experienced managers will be flexible in this initial stage. This is a stage where two companies have more than likely never interacted before and are now collaborating. You must accept the friction or tension that could arise and use that to build a positive future relationship with the client.

Have well-defined metrics

Measurement is an important factor and most often overlooked by beginners in the outsourcing business. Have well-defined metric and agreed upon metrics between the company and the vendor. This will evaluate the state of the outsourcing relationship. With defined metrics, it takes the guesswork out of an engagement and gives parameters to meet and perform upon. These metrics need to be simple, concrete and comprehensive while simultaneously accounting for the process and output aspects of the project.

Always have a viable exit strategy

Do not assume that there won’t be any problems during this whole process. Actually assume the opposite and plan ahead with this. You may have to exit the vendor relationship urgently for a unforeseeable reason and this could cause hostility. Have a detailed exit strategy from the absolute beginning before signing any contract. You can’t rest on or control the future of the vendor you’re doing business with. Due to abnormal circumstances, a vendor may not be able to continue to perform the task you have given them. Or worse, they may no longer want to continue the business relationship at all. Don’t assume that the vendor has a backup plan set in place. It is better to have two backup plans, rather than none.

Do not be content with the process – improve continuously

Improvement is critical in the outsourcing process as any process can be built upon to become better. Without improvement, companies won’t likely be able to strategically compete for long. Don’t be the company that insists that their outsourcing process is the best and can’t be optimally improved. First you need to embrace these improvements in order to make them better. How good your process is compared to others in your industry or even others makes a huge difference. Having a stagnant outsourcing process will not serve strategic purposes.

Conclusion

It is said that the outsourcing business has a bright future ahead as this industry has also come so far. Like mentioned above, IT outsourcing is not considered a new circumstance as it began in professional services and manufacturing. With the outsourcing industry growing rapidly in the past two decades, the debate has come up with what to outsource and how much to outsource. Regarding any topic that are risks and rewards, it depends on the company to decide whether the risks outweigh the risks in terms of outsourcing. Outsourcing as whole brings about efficiency and effectiveness for those companies who utilize it. The future success of a company depends on the quality of its information technology innovation. To achieve this, more and more companies are pursuing outsourcing. There are some IT industry best practices in regards to outsourcing that should be taken into account whenever attempting to take part in this industry. With the advancement of technology, outsourcing as we know it could change in the coming millennium.