Outsourcing defined - cis.gsu.edu defined •“Companies handing work that used to be ... Run rate savings are often 50%+ with overall net savings of 30% Nearshore Resource

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MBA 8125Information technology Management

Professor Duane Truex III

Outsourcing to Offsourcing:Models and rationales for the global

redistribution of work

Professor Truex MBA 8125Informatioon Technology management

Outsourcing defined

• “Companies handing work that used to beperformed ‘in-house’ to outside firms.”– The Economist A world of work, Nov 13 2004 , 2.

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Outsourcing: Why Do It?• Focus on Core Competencies

– Production, sales, finance/accounting• Realization of Greater Economies (Lower Costs)

– Vendors argue they can recapture scale because they specializein IS and have lower costs because of volume discounts,sharing of resources and expertise, etc.

– Savings are partly passed on to customers (theoretically, atleast!)


Outsourcing: Why Do It?• Greater Flexibility and Expertise in Workforce

– Organization obtains value-added specializedknowledge the agent brings to the transaction

– Flexibility – organization does not have long termcommitment to employees

• Reduces Risk– Places burden of risk on vendor, rather than on internal

IT department

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What work?

• Manufacturing initially• Any digital good

– IT services– Banking– Accounting– Administration of all sorts

• White collar work


In the realm of IT

• “Outsourcing is defined as the contractingof various information systems functionssuch as managing of data,centers,operations, hardware support, softwaremaintenance, network and even applicationsdevelopment to outside service providers.”

(Chaudhury, A., Nam, K. and Rao, H.R. Management of information systems outsourcing: A biddingperspective. J. MIS 12, 2 (1995), 131–159.)

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Outsourcing: Where toOutsource?

• Which functions or processes should youchoose to outsource?– Core-versus-Context Model– Decision should be made by CIO, COO, CFO


What’s Being Outsourced?

Source: Aquent Survey

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Sourcing Models

• Outsourcing domestically• Production and services produced offshore• Outsourcing offshore

– A.k.a., ‘Offsourcing’


• No face-to-face servicing requirement• High information content• Work process is “telecommutable”• High wage differential with similar occupation in

destination region• Relatively low set-up barriers• Low social networking requirementBased upon these criteria13 Million jobs in the US are candidates for offshoring

a study by the UC-Berkeley Fisher Center’s Real Estate andUrban Economics group estimates

Source: R. Welke

Attributes of Offshored Jobs

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Drivers offshore outsourcing

• Declining shipping costs• Abundant and cheap bandwidth• Open standards on the internet• Labor-cost differential


ROI – Information technologyTypical IT ScenarioAnnual cost per programmer (US $ 1000s)1

OnsiteEmployee

OnshoreConsultant

OffshoreDeveloper

Run rate savings are often 50%+ with overall net savings of 30%

NearshoreResource

1 Fully loaded cost including salary, benefits, space, andoverhead costs like transportation, cafeteria

OffshoreQ&A

OffshoreDocument

OffshoreArchitect

A 100 person IndianA 100 person Indiansoftware developmentsoftware developmentteam can result in $6Mteam can result in $6M

savings per yearsavings per year

50-80,000U.S.A.28,000Canada3-8,000China

5-10,000Russia7,200Malaysia6,600Philippines

6-10,000India4,800Poland

Average programmersalaries

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Some News Quotes

• Accenture Ltd said it planned to more than double its staff in Indiato 10,000 people in 12 to 14 months, taking advantage of relativelylow wages paid to software engineers in the country

• Dell Computer will no longer route its corporate customers (85%)to a technical support call center in Bangalore, India due tocomplaints by customers

• Swedish outsourcing companies are experiencing difficulties incompeting with large U.S. firms. Outsourcing deals take considerabletime to sew together with quite a number of people involved.Investment figures per deal are worth around 700,000 to well overa million dollars for potential suppliers.

• The majority of enterprises in Europe deploying applicationoutsourcing are German, according to a recent survey by BusinessCommunications Review International; Only BPO activity which verypopular in France is payroll management

Source: R. Welke


The economic models based on importantassumptions

• That displaced workers will find (acceptable)replacement work– The McKinsey study assumes on balance at 70%

of previous wages• Cost of capital assumptions• That the rising affluence of those countries

doing the work will spend sizable portionsback in the outsourcing economy.

Are these assumptions solid? Valid?

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Not just a “U.S. thing”


Sequencing of IT Sourcing

• 1st Wave– Hardware

• 2nd Wave– Software and IT Services

• Mostly big companies using IT extensively• Not SMEs who use more tailored solutions and

customer care

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Outsourcing only commodity goods?

Three layer model1. Top layer-

Tailored IT services, bespoke one-off, custom, services2. Middle layer

stuff on the way to becoming commodities3. Bottom Layer--commodity services and goods

• Common standards, well known problems replicableprocesses

• E.g., help desk functions, low level coding, bookkeeping,telemarketing, collections, credit validation


The Indian Players are?

Who benefits?McKinsey consulting says that for every$1 US moved to India, the US gains$1.14. Depending on some optimisticassumptions about the rehiring of thoseUS workers who have lost jobs in theprocess.

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• Hire an intermediary as a broker and guide to quicklymove through learning curve

• To manage risks– Pay attention to legal issues and contracts– Communicate strategy to stakeholders

• Establish meetings and communication with suppliers (andtheir workers) to work effectively

• Think about production and transaction costs

Offshoring Best Practices

Rottman & Lacity, MISQ Executive 2004


Outsourcing topics commonly discussed

Is there a sustainable best model?Competitive Advantage

How realistic is IP protection when goods, designand production is shared between countries?

Intellectual Property

What are current consumption patterns? Willthey inure to the outsourcing nation?

New Market Opportunities

What costs with each model?Political

Need standard infrastructure? Minimums?Infrastructure

How does one differentiate goods and servicesthat can be commoditized?

Commoditization

Is the labor pool large enough? Language?Education

Are the gains the same for physical and virtualgoods? Transaction costs, efficiency issues

Cost reduction

Played indefinitely? Market potential?Labor Arbitrage

What is the role of…?

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Four case studies (Truex et al, 2006)

Case 1 Case 2 Case 3 Case 4

Apple iPod Volvo in India GECIS in India Intel in Costa Rica Factors

Model(s) Production and

Services Offshore

Outsourcing

Offshoring

and Offshore

Outsourcing

Offshore

Outsourcing Offshoring

Cost

Reduction

By outsourcing

production and services

in a Taiwan based

company, it is decreasing the overall cost of

production of the iPod

Source auto

components

for exports,

developed as fourth largest

export hub,

added engineering

center and IT

services

Concept

introduced by

GE- low cost

high quality manpower,

which is now

the mantra for most

multinational.

Found software

engineers

By establishing an

R&D and

production facility

outside the US is decreasing the

cost. Labor is

cheap, it has all the benefits provided

by the Costa Rica

government - low tax and free trade

zone

Taiwan has focused its

education towards the production/manufacturing

profile. It provides

opportunities for Taiwan

(and its strategic country partners) towards

reducing unemployment

and for businesses which could take advantage of

the supply of specialized

and cheap labor

India

continues to invest in

education and

companies

can continue to hire highly

educated

workforce at competitive

global salaries

India continues

to invest in education and

companies can

continue to hire

highly educated

workforce at

competitive global salaries.

It has developed

programs and strategic alliances

with recognized

local universities in

order to prepare them to be in the

intel profile:

"Intelization"

Whose Host (Government) Host (Government)

Host (Government)

Host (Government) and Home (Intel

facilities in Silicon

Valley)

Education

Where Host Host Host Host and Home

Short

Term

No new market

opportunities

No new

market opportunities

Initial scope

was servicing home country

No new market

opportunities

Creation of

New Market Opportunities Long

Term

Taiwanese manufacturer

can serve as a global

provider for Apple products, not just iPod.

Additionally, it will

enforce brand

recognition in Taiwan

Entered India

in 1998 and

today is head office for

SAARC region

As market

matures,

GECIS is getting ready

to diversify into

power,

plastics, healthcare,

financing, and

a variety of other services.

Additionally,

can serve

Economies of scale

and product.


Critical for Apple. It found the

appropriate partner to manufacture at a relative lower

price while protecting design

and innovation.

Engineering center can be

used for R&D purposes, retain talent in-house

Developed people locally

and today are 99.99% local, main strength in BPO

services

With the offshoring

model, Intel secured its property rights since the

facilities belong to the

company and not to a

third party

Intellectual

Property

Maintain first mover advantage

in innovation, product

development and business

model. Further IP is protected

Retain knowledge in-house

--> protecting IP

Retain knowledge in-house -

-> protecting IP

Maintain first mover

advantage. Retain

knowledge in-house -->

protecting IP

Whose Apple Volvo GECIS Intel

Creation

Yes. Apple concentrates in its

core business (design and

market). Partnership model for manufacturing

Yes, takes advantage of

the tax treaties amongst

neighboring countries.

Yes, first mover advantage

Yes, Highly specialized

and educated labor, low

cost structure, free trade zone benefits.

Geographical proximity

to headquarters.

What

Centralization of knowledge and dedication to core business.

Protection of IP is enforced

Access to trained cheaper resource pool of highly

educated manpower

Access to trained cheaper resource pool of highly

educated manpower

Access to trained cheaper resource pool

of highly educated

manpower

Whose Partners and Governments Government Partners and Government Government

Creation

By having the right resources

there is an increase of employment. Opportunities to

increase investment from other

companies

By having the right

resources there is an increase of employment.

Opportunities to increase

investment from other companies

By having the right


Opportunities to increase

investment from other companies

By having the right


Opportunities to

increase investment from other companies

Competitive

Advantage

What Maintain highly educated

population in host country and

increase in employment rate.

Maintain highly educated

population in host country

and increase in employment rate.

Maintain highly educated

population in host country

and increase in employment rate.

Maintain highly

educated population in

host country and increase in employment

rate.

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Outsourcing rationalization

• The near term rationalization is typicallyeconomic/financial– “In china it is $.11 per/hour vs. the US at $40.00

per/hour”But in the longer term it is:• Relational issues

– But we must consider• Transaction costs• Stakeholder Agency responsibilities


Transaction Costs = coordination costs in economics terms

Typically three types:1. Search and information costs are costs such as those incurred in determining that

the required good is available on the market, who has the lowest price, etc.2. Bargaining or negotiating costs are the costs required to come to an acceptable

agreement with the other party to the transaction, drawing up an appropriate contract,etc..

3. Policing and enforcement costs are the costs of making sure the other party sticksto the terms of the contract, and taking appropriate action (often through the legalsystem) if this turns out not to be the case.

Transaction costs consist of costs incurred in searching for the bestsupplier/partner/customer, the cost of establishing a supposedly "tamper-proof" contract,and the costs of monitoring and enforcing the implementation of the contract.

Transaction costs vs. production costs.Transaction costs, are "all the information processing necessary to coordinate thework of people and machines that perform the primary processes,Production costs include the costs incurred from "the physical or other primaryprocesses necessary to create and distribute the goods or services being produced"

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Ouchi: “Markets, bureaucraciesand Clans” (ASQ, March 1980, v 25 #1, pp 129-142.)


Transaction cost vs.Trust and Control mechanisms

Transaction

Cost

Trust

Bureaucracye.g., accepting an employmentcontract with a company vs. working as an independentlaborer contracting daily

Rule-governed, impartial,impersonal, yielding to legitimateauthority, needs reciprocity

Clanse.g., managing complex multinational arrangements in highlydynamic environments

Driven by shared values andnorms, acceptance of legitimateauthority

Marketse.g., buying a candy bar atthe corner store.Highly impersonal,reciprocity required.

Low

Low

HighHigh

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Kishore et al FORT Framework(Communications of the ACM (46:12 (December) 2003, pp 86-92)


Kishore et al and the FORT framework

• Illustrates that outsourcing variations can rangefrom simple to quite complex– Support– Reliance– Alignment– Alliance

• Highlights the essential role of relationship and oftrust

• Considers coordination costs of various sourcingalternatives

Increasingdegrees ofrelationalintimacy andintegration

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FORT’s: Four relationships


Other views

• Who?– Lou Dobbs (CNN financial analyst)– Labor– Some economists and sociologists

• Concerns– That we are outsourcing competence in the

process– Sociological change is afoot

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The New Rich-Rich Gap(Robert Reich, Newsweek, ‘Issues 2006”)

• 15 years ago Reich described and predicted– a three-tiered workforce common to advance societies

1. Bottom tier– Workers offering personal service in retial and service industries

2. Second Tier– Production workers

3. Top -tier– Symbolic analysts

» E.g., Engineers and lawyers» All well-educated, critical thinkers» The ‘knowledge workers’ of the new economy

• That wealth and opportunity gaps would widen withAdvances in technology and globalization


Prescient and surprised

• Top-fifth of workers held 85% of US wealth• Faster than expected

– The top and bottom tiers grew the middle shrank– Symbolic analysts make up > 20% of all jobs in advanced

economies• Their income is soaring relative to other workers’• In China the wealthiest 5% control > 50% of bank deposits.• India’s symbolic analysts have become a new national elite

• Two types of symbolic analysts have emerged– National– Global

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National and Global Symbolic Analysts

• Most symbolic analysts– Work within a national economy– Manipulate symbols with aid of computers– The core of the middle class

• Accountant, engineers, lawyers, and other university-trained professionals

• But new powerful class has emerged at the top


The ‘new class’ of Global Symbolic Analysts

• CEOs, CFOs of global corporations– Partners and executives in global investment banks, law

firms and consultancies– Most have been educated at the same elite institutions

• America's Ivy League universities, Oxford, Cambridge, theLondon School of Economics or the University of California,Berkeley.

– Most work in similar environments, tend to work veryhard,they live comfortably, and enjoy first-class lifestyles and their income and wealth far surpass those ofnational symbolic analysts.

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Why has the global symbolic analystsemerged on top?

• Global commerce is on a scale and complexity nocommercial contract can adequately cover and nosingle legal system can enforce

• Dealmakers must rely on Trust– people they can trust– The extended relational network of people whom they

trust– Trusted circles developed in the jet-setting live world

round– Significant time in face-toface meetins


Symbolic analysts grow the bottom-tier• 15 years ago

– 1/3 of jobs in advanced economies were service-oriented, face-to-face jobs

• Today– is > 50%– More work in

• laundries, dry cleaners than in steel mills,• Hospitals and nursing homes than in banks and insurance

companies• More work for Walmart than the entire automobile industry!

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Why and what implications?

• Aging populations, dual income families– Outsource housework– Require eldercare– Top 10th have enough discretionary income to afford

pampering and hire• Gardeners, coaches, trainers, cooks

– Yet the supply of labor grows faster than the demand• immigration and declining manufacturing sector

– And real wages are dropping as a result


The middle-tier?

• Ranks of production workers– Fallen from 1/3 in advanced economies to 1/4– Alliance Capital Management in New York, studied 20

major economies• found that between 1995 and 2002 more than 22 million

factory jobs vanished.– US lost 11% of manufacturing jobs– Japan lost 16%– Brazil lost 20%– China lost 15%

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Why? What is happening

• Productivity Gains– New equipment and new technologies– Market reforms force state-run plants

• Greater production with fewer workers– Office work not immune to productivity gains

and job replacement with software• Digital symbolic work is heading to lower-wage

countries– Accounting, filing legal papers, call centers, tech support,

routine coding…etc


A class of interests between Nationaland global symbolic analysts

• For National Symbolic analysts– in advance economies– National symbolic analysts are becoming

interchangeable• Jobs transcend boarders and travel where work is cheaper

• Global symbolic analysts– Relational capital is far less transferable– So they have a huge, and growing, stake in

globalization– As globalization grows they are in ever more demand

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Should national symbolicanalysts be afraid?

• Despite the new competition the demand isstill rising– Growth of salaries of university grads out pace

those without; the professions do even better• If the demand for Symbolic analysts were dropping

salaries would drop


BUT….

• Without substantial investment in basicR&D and education– We will lose the advantage in science,

engineering and high-value added production– Symbolic analysts will lose ground– Global symbolic analysts will gain and the gap

will widen– The income and wealth gap will widen and the

culture wars will increase.

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Is design a commodity?• Michael Marks, CEO of Flextronics thinks so

(BusinessWeek on line , March 21, 2005)– Predicts that engineering and design will experience the shift manufacturing experienced– Massive downsizing of in-house R&D operations– “Design is not competitive advantage, it is as inefficient as manufacturing and supply-chain

management used to be”– “you can save 15% to 20% moving manufacturing to low-cost countries but achieve MUCH MORE

dramatics savings shifting design abroad.– OEM firms spend 3 to 5 times we we spend to design a product

• Driver?– All intellectual property is going onto silicon

• The winners?– Those using ODMs and developng their own brands vs.

using OEM products• The Dells, Walmarts and ‘Bestbuys” of the world


Jobs least likely to be outsourcedSource InformationWeek � Jan. 30, 2006URL: http://www.informationweek.com/story/showArticle.jhtml?articleID=177104711 �

• Customer Facing• App developers• Web-apps programmers• Data-warehouse and

business-intelligence specialists• ERP and CRM pros• Database developers and analysts• Help-desk specialists

•Infrastructure Jobs•Security•Data modelers•Network managers and engineers•Wireless engineers andadministrators•Software engineers•Disaster-recovery specialists•System auditors and integrators•Storage administrators •Enablers

•IT or business architects•Business analysts•Business technologists•Business-process modelers•Project managers

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Outsourcing: When toOutsource?

• Sooner the better, for a given project– Don’t try to outsource problems– Don’t relinquish total control to vendor– Learn from the vendor


Outsourcing: So Why NotOutsource?

• Loss of Strategic Assets– IT frequently represents ability to lead the

industry and change structure of the industry.– Managers who do not realize that IT can be a

strategic weapon are more likely to trade thisstrategic asset

– Do you really want this trade away or losecontrol of this strategic asset?

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• Do Not Realize Greater Economies (actually higher costs!)– Vendors argue that they can recapture scale, but if the contract

overly favors the outsourcer, the organization may pay more thanif the function were insourced

• Lose “Loyal” Workforce– Even if the vendor hires your best people, vendor may put them on

other accounts to attract new customers– OR, if you outsourced to get vendor’s expertise you may just be

getting your own


• Cannot readily access or utilize increasedsystems expertise– Experts on your system belong to the vendor

• Threat of vendor opportunism– Extreme outsourcing (selling assets, people,

etc) puts you at mercy of vendor– Additional fees


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• Cost Savings might have been achievedinternally– Large companies should be able to achieve

economies of scale on their own– In-house data centers can automate and

streamline operations and invest in newproductivity-improving technologies just asoutsource vendors do


Managerial Guidelines forOutsourcing

• Be self-interested• Assess strategic value of current and potential IT assets• Ensure (through contract) assets will not be traded away or

lost through unbonded outsourcing– bond the agents (outsourcers) legally to ensure that the firm will

not suffer loss of trade secrets.– bond the agents through insurance to recover from losses through

non performance of contract

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Summary

• Offsourcing is a feature of Globalization• It is technology enabled and dependent• It is a growing phenomena

– In frequency– $$ size– Complexity and– In the types of arrangements


Iff you choose toOutsource-Offshore-Offsource

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Request For Proposal (RFP)

Detailed list of questions submitted to vendorsto determine if vendor’s product meetsorganization’s specific requirements.


Criteria for Evaluating Vendors

• Financial viability of vendor

• Other vendor characteristics

• Contract terms and conditions

• For application software packages…– Opinions of other users of the package

– Package characteristics

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• Does vendor have sufficient capital/surplus to meet on-goingobligations and absorb unexpected financial losses?

• Does vendor have contingent liabilities (e.g., lawsuits) that couldadversely affect its financial condition?

• Has vendor achieved profitability from its operations?

• Concentration of revenue in one or relatively few customers?

Financial Viability of the Vendor


• Can vendor provide timely on-site and/or telephonesupport?

• Does vendor track user questions/problems?• Does vendor adequately test new products and

releases?• Does vendor have sufficient knowledgeable staff?• Does vendor provide quality training and

documentation?

Other Vendor Characteristics

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Contract Terms and Conditions

• Is the timeframe within which the vendor is required torespond to problems/questions clearly defined?

• Is the extent of vendor support, training, anddocumentation clearly defined?

• Is the timetable for all deliverables and payments clearlydefined?

• Has a favorable relationship between deliverables andpayables been negotiated?


• Are all costs clearly defined?• Are there penalties if contractual agreements

are not met by the vendor?• Does the contract allow for in-house use of

the package for acceptance testing purposesprior to purchase?

Contract Terms and Conditions

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Software Packages:Other Users’ Opinions

• How satisfied are they? Would they purchase itagain?

• How responsive is the vendor to problems?• Is the system easy to use?• What kind of conversion/implementation

problems were encountered?• How difficult is it to interface the package with

existing systems?• What other products were considered?

Why did they select this one?


• Does it provide the needed functionality?• Is it easy to use?• Is its design flexible enough to allow

changes?• Does it have good documentation and help

functions?• Does it include appropriate control features?

Software Packages:Package Characteristics

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What Buyers Want

• Clients want vendors to:– Listen to real needs– Be responsive– Be honest and realistic about capabilities– Vendors to be "selective" about clients


What Vendors Want• Vendors Want Clients To…

– Be selective in sending out RFPs. It costs $$$ to respond.• If you send RFPs to a long list of vendors to do your research, you

may not get quality responses. If you are in research phase, say so.Issue an RFI (Request for Information) instead.

• If you are asking for a response just to comply with Purchasing’s ruleto have 3 responses, tell us. We can generate a "form-response" muchcheaper than one we want to be taken seriously…

– Be honest about what you want.

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Tips for Success

• In evaluation phase, use network of others who haveexperience in buying similar products/services to help youidentify qualified vendors (Trade Shows, User Groups)

• Build penalty and performance clauses into contracts.Shared risk and reward.

• Define responsibilities and activities on both sides.• Good project management is critical


More Tips for Success

• Clearly define expectations up front• Define scope/change control process at start• Define relationship• Price is important, not everything.• Price for value is critical issue.

Documents

Outsourcing defined - cis.gsu.edu defined •“Companies handing work that used to be ... Run rate savings are often 50%+ with overall net savings of 30% Nearshore Resource