December 3, 1995
Outsourcing is the turning over of an Information System (IS), in whole or in part, to one or more external service providers in order to supply human or technical IS resources to the organization. The concept of outsourcing of IS started in the 1960s when companies timeshared a mainframe computer from a service bureau. However, in 1989 when Eastman Kodak turned over its entire data center, network and micro computer operation to a third party there were only a handful of large suppliers to choose from. (Gray, 1994) Now, with the explosive growth in outsourcing in the last 5 years, there are dozens of large suppliers to choose from. The growth has been assisted by the public press reports of new outsourcing contracts which only report the honeymoon period, 1 year into the contract, when all costs are still estimates.
The notion of whether IS is a competitive and/or strategic advantage in a firm or is it just a commodity service has been studied by many people. "A Massachusetts Institute of Technology study concluded that technology rarely gives business a competitive advantage; rather, it only reduces the cost of doing business." (Benco, 1993, p.47) In a counter example, Merrill Lunch's Cash Management Account (CMA) system provides a competitive advantage by printing a single monthly statement that includes the client's balance and activities from their money market, brokerage, debit card, and checking accounts. (Benco, 1993) A mistake when analyzing if a system is truly strategic, is the ability to differentiate between the strategic function and the IS systems supporting the function.
There are two forms of outsourcing: entire and selective. The most extreme outsourcing of the entire department is when all the IS assets are sold to the outsourcing vendor as in the case of Eastman Kodak. In selective outsourcing, a part of the IS operation is contracted to a third party (for example the storage of backup tapes).
An advantage of outsourcing is that senior managers will have time to deal with core business decisions and not need to worry about the routine IS functions "such as information center management and hardware acquisition." (Grover, 1995) This will only happen if IS managers are transferred to other functions. This actually rarely happens because to manage an outsourcing vendor is often more difficult and time consuming than managing an internal IS department. (King, 1994)
Economies of scale can be utilized in the areas of hardware, software and staffing by pooling projects from multiple clients. The outsourcer generally receives very little discount on hardware and corporate specific software licenses are the norm. The savings come from the consolidation of data centers and when "economies of scale occur across corporate boundaries -- for example, in long-distance communications." (Meyer, 1994, p.23)
Businesses are going to great lengths to reduce costs in all aspects their operations. IS departments in the US received 40% of corporate capital investments and their expenditures are third largest corporate expense, so any way to reduce these figures will contribute considerably to the bottom line. (Benko, 1993) For example, the First Fidelity Bank in New Jersey was able to cut more than $20 million (or 20%) from its 1990 IS costs with outsourcing. (McLellan, 1994)
When the entire IS department is transferred over to the third party this provides rewarding career paths to the clients' employees. Before the SHL Systemhouse and Amoco outsourcing contract, Amoco was quoted as saying "We had to wrestle our [training] budget down, but we didn't want this to be at the expense of the employee." (Minoli, 1995, p.279) After the transfer, many of the former Amoco employees have received promotions, retraining, and reassignment in new technology areas.
Outsourcing will allow the firm to gain access to certain technologies. With this access the firm may be able to increase competitiveness by receiving new technology faster then its competitors. In practice this maybe false because vendor will "bring new products to the attentions of the internal IS staff in any case." (Mayer, 1994) Also, if the outsourcing services is owned by a computer vendor then they may be reluctant to offer products from the competition.
When a firm is looking at downsizing the notion of outsourcing might be attractive because they will be able to move "surplus" employees to other jobs served by the outsourcing service. If there are any jobs left then the remaining employees will have to compete for them. Whether or not the surplus employees will get the jobs depends upon their qualifications, because a competitive outsourcing company will not retain individuals who do not possess the proper skills.
When signing an outsourcing contract the service receiver will have exposure to vendor risks. For example, how financially stable the service provider is and can they provide the service levels stated in the contract? If the third party can not supply services according to the contract then the contract can be terminated or the service provider can be forced to pay a penalty. These penalties usually do not fully compensate for the loss of service by the firm and should be used only as the last resort. (Minoli, 1995)
By outsourcing the entire IS department the risk of obsolescence increases because "the possibility of being locked into older technology is no longer in the hands of the service receiver." (Minoli, 1995) This risk has greater importance to firms that are depending on the information system to allow them to keep up to or ahead of the competition.
When the entire IS department is outsourced the lose of flexibility and control can be very high. By not having the IS department in-house there might be "delays and reduced responsiveness to organizational needs". (Grover, 1993) Since the work is not done by people under the direct supervision of the service receiver the "real control over both the quality of software and the timetable of a project" might be jeopardized. (Grover, 1993)
To negotiate and monitor the contract between the parent company and the service provider are potentially wide ranging, indirect, and substantial. These cost not only cover billable items, for example legal costs, but also the increasing amount of time to communicate and coordinate with the service provider. These costs can easily be underestimated because they are hard quantified and the suggested saving might be overestimated.
The service provider has different goals than the service receiver. The outsourcing company is in business to maximize their profits while the service receiver's interest is usually to reduce costs. In one case, an automobile rental company wanted a new computer system. An expert in the field had an "off-the-self" software to do the job, but because the exclusive outsourcer would not make any profit from the deal, the rental company spent hundreds of thousands of dollars studying the alternatives (almost the price of the package) and more money replicating the package. (Meyer, 1994)
Every point made above has certain advantages and disadvantages tied to it. The decision whether or not to outsource is rather simple: If the outside party can do better quality work in a better time frame at a lower cost then the organization itself, then the outside party should enter an agreement; if the organization's employees can do the job better, then the works should remain in-house.
Before any outsourcing decision is made the internal IS department should be thoroughly evaluated and only the weaknesses should be outsourced while keeping strengths in-house. The company objective should be to maximize flexibility and control by allowing management to redirect the IT efforts as circumstances change. One way to achieve maximum flexibility is by selective outsourcing from multiple providers and looking for partnership contracts and not to outsource the entire IS department to one long term service provider simply because they have the lowest bid.
Finally, always allow the internal IS department the chance to compete for the outsourcing contract. If the internal department does not win the contract the company still wins by having a better knowledge of its current system and therefore allowing more vigorous negotiations with the service provider.
Benko, Cathy, "Outsourcing Evaluation", Information Systems Management, Vol 10, Spring 1993, pp. 45-50.
Gray, Paul, "Outsourcing and Other Strategies", Information Systems Management, Vol 11, Fall 1994, pp. 72-75.
Grover, Varun and Teng ,James T.C., "The Decision to Outsource Information Systems Functions", Journal of Systems Management, Vol 44, November 1993, pp.34-38.
King, William R., "Strategic Outsourcing Decisions", Information Systems Management, Vol 11, Fall 1994, pp. 58-61.
Lacity, Mary C., Willcocks, Leslie P., Fenny, David F., "It Outsourcing: Maximize Flexibility and Control", Harvard Business Review, May-June 1995, pp. 84-93.
McLellan, Kerry, Marcolin, Barbara, "Information Technology Outsourcing", Vol 59, Autum 1994, pp. 95-104.
Meyer, N. Dean, "A Sensible Approach to Outsourcing", Information Systems Management, Vol 11, Fall 1994, pp. 23-27.
Minoli, D., "Analyzing Outsourcing - Reenginerring Information and Communications Systems", 1995.