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 payment  High cost for switching responsibility to them  High cost for appropriate cost-reduction initiatives  When 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 Internal systems with those of customers and suppliers

Drivers for outsourcing  General managers’ concern about cost and quality  Easier planning  Use of low-cost labor force  Application of world-class standards and re-qualify IT personnel  Better management of excess hardware capacity  SLA’s  Higher 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 Management Strategic grid Uninterrupted service-oriented IRM Outsourcing: 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 IRM Outsourcing: yes  Access to higher IT professionalism  Access to current IT technologies  Risk of inappropriate IT architecture reduced Strategic IRM Outsourcing: no Reasons to consider outsourcing  Rescue an out-of-control internal IT- unit  Facilitate cost flexibility  Facilitate management of divestiture Turnaround IRM Outsourcing : no Reasons 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, innovative Information resource development Current dependence on information 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 skillsLowHigh Technology Transfer From: Chapter 12 Wendy Robson Strategic Value

Structuring the Alliance  Contract flexibility  10-year contract cannot be written without flexibility Evolving technology, changing business/economic conditions  Mutual interest in the relationship is important  Standards and control  With IT, an important part of the firm’s operation is handed over to a third party  Must 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  Topics  Application development  Package integration  Conversion and migration  Integration  Application portfolio renewal  Vendor criteria  Has 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 money through outsourcing, is to spend too much money beforehand.

Enterprise budget Before and after outsourcing Staff Software Hardware Source: Gartner group July 2000 Telecom Other expenditure Depreciation (assets, investments) Outsourcer’s direct cost Staff Software Hardware Telecom Other Depreciation (assets, Investments, goodwill) Outsourcer’s Overhead Outsourcer’s Margin Client Retained cost Old New Client final cost reduction BeforeAfter ESP’s Invoice Needed Reduction of Direct costs VAT

Enterprise budget Outsourcing 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 scale  Purchasing advantages via increased buying capacity  Sharing indirect costs  Better usage of assets and resources  Best practices  Management  Processes  Procedures  Tools  Know-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