Outsourcing

Prof. Eddy Vandijck

Reasons for IT-outsourcing

Companies are increasingly outsourcing IT aspects for several reasons:

Concern for cost and quality Lagging IT performance Supplier pressure Access to special technical and application skills Other financial factors

Outsourcing fits very well with a tendency towards strategic alliances.

Problem

The outsourcing arrangements are easier to set up than to maintain or dissolve.

Long-term, sustained management of

a strategic alliance is the dominant

challenge of effective outsourcing.

Why is it difficult ?

A standard contract takes 8 to 10 years, but: Chip performance is growing by 25% per year Switching cost issues New situation after 3 years

From the client point of view: The first year payments fit very well with the

planned output, but after a few years the payments do not fit anymore with the anticipated outputs.

This leads to new negotiations and misunderstanding.

Why is it difficult ?

From the supplier’s perspective:First year often a capital paymentHigh cost for switching responsibility to themHigh cost for appropriate cost-reduction initiativesWhen the outsourcer is finally moving into its

earning stream, the customer feels the need for new services.

Only few outsourcers have the critical mass and the financial means to handle larger outsourcing contracts.

Changing IT Environment

High pressure due to keeping the old system running while moving to a new architecture

Outsourcing can give access to the required skills Outsourcing can speed-up the transition Part of the code is already outsourced (WP,

Spreadsheets, …) Transition of legacy systems

Internal transaction Processing systems

Integrating Internalsystems with those of

customers and suppliers

Drivers for outsourcing

General managers’ concern about cost and qualityEasier planningUse of low-cost labor forceApplication of world-class standards and re-qualify IT personnelBetter management of excess hardware capacitySLA’sHigher level IT staff skills sometimes via advanced packages

Breakdown in IT performance via new approach Intense supplier pressure Simplified general manager agenda Financial factors (intangible IT assets, fixed-variable

cost) Corporate culture Elimination of internal irritant

Information Resource ManagementStrategic grid

Uninterrupted service-oriented IRMOutsourcing: yes, unless company is

huge and well managed Economy of scale for small firms Higher quality service and backup Management focus facilitated Easier international IT solutions

Support-oriented IRMOutsourcing: yes Access to higher IT professionalism Access to current IT technologies Risk of inappropriate IT architecture

reduced

Strategic IRMOutsourcing: noReasons to consider outsourcing Rescue an out-of-control internal IT-

unit Facilitate cost flexibility Facilitate management of divestiture

Turnaround IRMOutsourcing : noReasons to consider outsourcing Internal IT-unit not capable in

required technologies Internal IT-unit not capable in

required project management skills

Source: Corporate systems Management

Importance of sustained, innovativeInformation resource development

Cu

rren

t d

epen

den

ce

on

info

rmat

ion

High

Low High

When to outsource IT

Development portfolio The higher the percentage of system development portfolio in

maintenance or high-structured projects (outputs well defined), the more the portfolio is candidate for outsourcing (labor, skills)

High-technology, highly-structured work (skills) Low-structured projects difficult to outsource

Organizational learning Sophistication of organizational learning facilitates the ability to

manage outsourcing arrangements Responsibility for BPR difficult to outsource The more experience a company has in BPR the easier outsourcing will

be Position in the market

The farther a company is from the network era, the more useful outsourcing can be to close the gap

Current IT-organization The more IT-development and operations are separated, the easier it

will be to specify a enduring outsourcing contract

How to Outsource

Smart sourcing Technical help desk Skill sourcing Network management Security management Configuration mngt Performance mngt Fault management

Simple contracts Hardware maintenance Cabling Moves/adds/changes

Non-candidates Personal help-desk Service level management IT product management Research and development

Legacy outsourcing Mainframe COBOL programs System programming Software maintenance Physical site management

High

Low

In-house skillsLow High

TechnologyTransfer

From: Chapter 12 Wendy Robson

Str

ate

gic

Va

lue

Structuring the Alliance

Contract flexibility10-year contract cannot be written without flexibility

• Evolving technology, changing business/economic conditions

Mutual interest in the relationship is important

Standards and controlWith IT, an important part of the firm’s operation is handed over

to a third partyMust be handled carefully but can be accepted (e.g. electricity)A company should carefully develop detailed performance

standards for system response time, availability of service, responsiveness to system requests, …

Penalty clauses for not respecting SLA’s coherent with real loss

Important questions

Can proposed outsourced piece be separated easily from the rest of the firm?

Does the piece requires particular specialized competencies that we do not have or lack the time to get them?

How central are the proposed outsourced pieces to our firm?

What about the stability and quality of the supplier? Is there compatibility between the technology used by the

client and the outsourcer’s skill base? Is there a potential conflict of interest?

Time to finish

Application Outsourcing

TopicsApplication developmentPackage integrationConversion and migration IntegrationApplication portfolio renewal

Vendor criteriaHas the vendor similar contracts for a long time? Is application outsourcing his main business? Is it his only business?Has the vendor useful methodologies?Has the vendor experience in your business?Has the vendor a strategic plan and vision?Has the vendor good alliances?Has the vendor an organized R&D unit?

Concerning the benefits

Save Money is Relative !

The easiest way to save moneythrough outsourcing,

is to spend too much moneybeforehand.

Enterprise budgetBefore and after outsourcing

Staff

Software

Hardware

Source: Gartner group July 2000

Telecom

Otherexpenditure

Depreciation(assets, investments)

Outsourcer’s direct cost

StaffSoftwareHardwareTelecom

OtherDepreciation (assets, Investments, goodwill)

Outsourcer’s Overhead

Outsourcer’s Margin

Client Retained cost

Old

New

Client final cost reduction

Before After

ESP’sInvoice

NeededReduction ofDirect costs

VAT

Enterprise budgetOutsourcing budget model

Price is baseline rate for certain resources and services to be delivered through the contract’s duration.

Consider initial migration cost (during a year)

Do not underestimate retained cost (difficult to estimate)

Assets transfer cost

Taxes might be higher (VAT)

Outsourcing risk and effect on internal and external cost

Anticipate cost at the end of the contract

Source: Gartner group July 2000

Where can we save money

Economy of scalePurchasing advantages via increased buying capacitySharing indirect costsBetter usage of assets and resources

Best practicesManagementProcesses Procedures ToolsKnow-how and feedback

Standardization

Vendors prefer long-term contracts

Biggest possible contact (salesman)

Loock the customer for many years

Amortize first-year investments

Dilute the risk of acquiring assets and people

Exploit infrastructure cost decrease

Enterprise Risk

Overall risk (service in-house)

Cost to reduce that risk early on (lawyers,

consultants, …)

Residual risk after contract is signed

Possible economic impact of that risk