1. Outsourcing and Offshoring
Slide 1
MIT5312: Systems Analysis and Design
Outsourcing and Offshoring

2. Outsourcing Outsourcing is …. MIT5312: Professor Kirs Slide 2
A free market thing
A Special form of international trade (CES IFO Institute ,Germany)
A matter of polarized public debate (European Foundation for ILWC,2004)
About your “core”
A question of trust
Unevenly dispersed on the globe (yet growing)
Generating fear (fear of change?- Cochrane,2004)
A relationship and arrangement
Partner quality
Subject to areas of high attrition ?
(ex-Call centers)

3. Outsourcing Basic Terminology Outsourcing: Best Sourcing: Offshoring:
MIT5312: Professor Kirs
Slide 3
Outsourcing
Basic Terminology
Outsourcing:
Delegation of non-core operations from internal production to an external entity. Sharing organizational control.
Best Sourcing:
Associating with the ‘best of the best’ (Tom Peters)
Offshoring:
Transferring Activities to another country by hiring local subcontractors or by building a facility in an area where labor is cheap (er).
Nearsourcing:
Similar to offshore (yet close distance)
Insourcing:
The opposite of outsourcing

4. Outsourcing Why Outsource? Cost Concerns:
MIT5312: Professor Kirs
Slide 4
Outsourcing
Why Outsource?
Cost Concerns:
It has been reported that more than 80% of European companies engaging in Offshoring are satisfied with the results, and that the cost savings realized have generally ranged between 20% and 40% [UNCTAD, 2004].
The average salary of an Indian programmer stands at $6,000 to $12,000. But, it's much lower in China at $5700 to $9000
The pay range for agents at call centers in Mumbai is INR 8,000 to INR 15,000 per month, or $ to $344 at current exchange rates

5. Outsourcing Why Outsource? Access to Specialized Skills & Expertise:
MIT5312: Professor Kirs
Slide 5
Outsourcing
Why Outsource?
Access to Specialized Skills & Expertise:
India has over 2,100,000 English-speaking graduates are added annually and 460,000 of them are IT grads.
China has over 200,000 IT professionals and 50,000 new graduates are added to the pool every year.
China produces 52% of all Science and Engineering graduates

6. Outsourcing Why Outsource? Access to Specialized Skills & Expertise:
MIT5312: Professor Kirs
Slide 6
Outsourcing
Why Outsource?
Access to Specialized Skills & Expertise:
The United States has falling education standards
The number of scientists, engineers, computer scientist and other technical professionals has been falling in the United States
“Bill Gates recently said there's an insufficient amount of skilled people in the U.S. labor pool. As he put it, "Anybody who's got good computer science training, they are not out there unemployed. We're just not seeing an available labor pool."

7. “In China today, Bill Gates is Britney Spears.
MIT5312: Professor Kirs
Slide 7
Outsourcing
Why Outsource?
Access to Specialized Skills & Expertise:
“In China today, Bill Gates is Britney Spears.
In America today, Britney Spears is Britney Spears
and that is our problem.”
Thomas Friedman

8. Outsourcing Why Outsource? Lagging IT Performance:
MIT5312: Professor Kirs
Slide 8
Outsourcing
Why Outsource?
Lagging IT Performance:
The performance gap is widening between organizations that have achieved world-class performance levels in their back office operations versus typical companies, with top performers generating significant savings while delivering improved effectiveness and reduced risk, according to new research released by strategic advisory firm The Hackett Group.
IT might improve business processes, but capitalizing on this improvement is out of control of the IT function.

9. Outsourcing Why Outsource? Focus on Core competencies:
MIT5312: Professor Kirs
Slide 9
Outsourcing
Why Outsource?
Focus on Core competencies:
Core competencies are the key skills, characteristics and assets that your company brings to the marketplace. These competencies, on an organizational level, are a synergistic blending of the core competencies that your people individually bring to work every day.
Core competencies are "focus points" that funnel peoples’ skills and efforts to make a greater effect
Aligning IT with the business is crucial to success, yet IT is too often seen as a "support" service and is not included in high-level decision-making.
The core competency of the outsourcee is IT

10. Outsourcing Why Outsource? And other reasons: Economies of scale
MIT5312: Professor Kirs
Slide 10
Outsourcing
Why Outsource?
And other reasons:
Economies of scale
Bulk Purchasing
Better use of capacity
World-class standards applied
Improved control/standardization
Flattening of Hierarchical Structure

11. Outsourcing Why Outsource?
MIT5312: Professor Kirs
Slide 11
Outsourcing
Why Outsource?
It is something you can’t (nor want to) avoid-
Even if we stop, our competitors wont.
CSIS Report
It is irreversible.
It is a product of free trade—it adds value to shareholders.
Requires a society that can imagine and invent the future demand.
Means we must go to high touch/high concept jobs
and away from high tech jobs
Daniel Pink

12. Outsourcing Why Outsource?
MIT5312: Professor Kirs
Slide 12
Outsourcing
Why Outsource?
Every Morning in Africa, a gazelle wakes up.
It knows it must run faster than the fastest lion
or it will be killed.
Every morning a lion wakes up.
It knows it must outrun the slowest gazelle
or it will starve to death.
It doesn’t matter whether you are a lion or a gazelle
When the sun comes up,
YOU BETTER START RUNNING!
African Proverb

13. MIT5312: Professor Kirs
Slide 13
Outsourcing
Why Outsource?
We aren’t going any further until the class comes up with at least three other reasons why outsourcing is a good idea.

14. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 14
Outsourcing
Some arguments for NOT outsourcing
Loss of jobs:
A University of California Study that estimates 14 million U.S. white collar jobs - one in nine - are at risk.
A 2004 report by Forrester Research suggests that a total of 3.4 million U.S. white collar jobs will move overseas by 2015, with 830,000 jobs leaving by the end of 2005.
A Progressive Policy Institute report claims 12 million jobs are vulnerable, with most paying more than the U.S. median wage.

15. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 15
Outsourcing
Some arguments for NOT outsourcing
Loss of control:
"I've had people approach me and offer to save us money by consolidating our technical support," said Monad.net President George Scott. "But I think technical support is a major competitive advantage. I therefore want control of that -- I don't want to give it away."
"Everyone knows that differentiation is the key in the ISP business, and this also goes for dealing with the pressures of handling technical support," said the operations manager of a Massachusetts ISP. "No ISP is happy with the fact that they have to handle so many calls from customers who are not adept with their PCs, but we understand that handing them over to a third party is the wrong business move."

16. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 16
Outsourcing
Some arguments for NOT outsourcing
Concerns about quality:
"You have to take a total business view of outsourcing technical support," said the customer service manager of a New York ISP who chose to remain anonymous. "And first of all, you have to look at the overall importance of offering quality technical support. When you're talking about capacity and how much you can sell, you have to look not only at technical capacity, but also your customer service capacity. If you're selling within your technical capacity but over your technical support capacity, you're in for ruin. Outsourcing technical support is certainly an option, but it's not something we would do."

17. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 17
Outsourcing
Some arguments for NOT outsourcing
Social Impacts:
"In the three years ending in 2003, more than 5.3 million U.S. workers who had held their jobs for at least three years were displaced," Outsourcing America states. "In January 2004, only 65 percent of them had found full or part-time work, and a third of the employed suffered a pay cut of at least 20 percent."
A July 2004 survey in the San Francisco Bay area found 27 percent of those polled are worried about losing their jobs. "Economists could attempt to estimate the lost wages and benefits from unemployment and reemployment at lower salaries, but there is no way that they can calculate the costs extracted from individuals, their families and their social networks."

18. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 18
Outsourcing
Some arguments for NOT outsourcing
Hidden Costs:
The Cost of Selecting a Vendor
“With any outsourced service, the expense of selecting a service provider can cost from .2 percent to 2 percent in addition to the annual cost of the deal. In other words, if you're sending $10 million worth of work to India, selecting a vendor could cost you anywhere from $20,000 to $200,000 each year”.
“Some companies hire an outsourcing adviser for about the same cost as doing it themselves. To top it off, the entire process can take from six months to a year, depending on the nature of the relationship”.
“Bottom line: Expect to spend an additional 1 percent to 10 percent on vendor selection and initial travel costs”.
Source: The Hidden Costs of Offshore Outsourcing. Sep. 1, 2003 Issue of CIO Magazine

19. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 19
Outsourcing
Some arguments for NOT outsourcing
Hidden Costs:
The Cost of Transition
“The transition period is perhaps the most expensive stage of an offshore endeavor. It takes from three months to a full year to completely hand the work over to an offshore partner. If company executives aren't aware that there will be no savings—but rather significant expenses—during this period, they are in for a nasty surprise.”.
“It took an awful lot of time to bridge the Pacific and getting that to work correctly," remembers Textron Financial's Raspallo, who spent six months and $100,000 to set up a transoceanic data line with Infosys in 1998, It also cost an extra $10,000 a month to keep that network functional.”.
Bottom Line: Expect to spend an additional 2 percent to 3 percent on transition costs”.

20. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 20
Outsourcing
Some arguments for NOT outsourcing
Hidden Costs:
The Cost of Layoffs
“To begin with, you have to pay workers severance and retention bonuses. You need to keep employees there long enough to share their knowledge with their Indian replacements. People think if they give generous retention bonuses it will destroy the business proposition. They cut corners because they want quick payback. But then they lose the people that can help with the transition and incur the even bigger cost of not doing the transition right.".”.
Bottom line: Expect to pay an extra 3 percent to 5 percent on layoffs and related costs.

21. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 21
Outsourcing
Some arguments for NOT outsourcing
Hidden Costs:
The Cultural Cost
“You simply cannot take a person sitting here in America and replace them with one offshore worker," GE Real Estate's Zupnick says. "Whether they're in India or Ireland or Israel”
“a project that's common sense for a U.S. worker—like creating an automation system for consumer credit cards—may be a foreign concept offshore.”
Bottom line: Expect to spend an extra 3 percent to 27 percent on productivity lags.

22. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 22
Outsourcing
Some arguments for NOT outsourcing
Hidden Costs:
The Cost of Ramping Up
"If you're an organization that develops and maintains by the seat of your pants, or it's a case where Mary Jo and Fred have been here for 30 years and they know how to do everything, you are in trouble"
“If a company doesn't create solid in-house processes, the vendor will have to put more people onsite to compensate for your inadequacies, and they'll spend all of your savings," says Meta Group's Davison.
“When you have to package specs to go outside the company, that has to be done exceptionally well and that is time-consuming and costly”
Bottom line: Expect to spend an extra 1 percent to 10 percent on improving software development processes.

23. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 23
Outsourcing
Some arguments for NOT outsourcing
Hidden Costs:
The Cost of Managing an Offshore Contract
"There's a significant amount of work in invoicing, in auditing, in ensuring cost centers are charged correctly, in making sure time is properly recorded," explains DHL's Kifer. "We have as many as 100 projects a year, all with an offshore component, so you can imagine the number of invoices and time sheets that have to be audited on any given day."
We knew there would be invoicing and auditing," he says. "But we didn't fully appreciate the due diligence and time it would require."
Bottom line: Expect to pay an additional 6 percent to 10 percent on managing your offshore contract

24. Some arguments for NOT outsourcing
MIT5312: Professor Kirs
Slide 24
Outsourcing
Some arguments for NOT outsourcing
We aren’t going any further until the class comes up with at least three other reasons why outsourcing is a BAD idea.

25. Organization-specific considerations in Outsourcing
MIT5312: Professor Kirs
Slide 25
Outsourcing
Organization-specific considerations in Outsourcing
Development Portfolios
Number
Attractiveness
Structure
Attractiveness
Organizational Learning
Experience in assigning responsibility
Attractiveness
IT Currency
Currency
Attractiveness
IT Organization
Segregation
Attractiveness

26. Structuring the Outsourcing Alliance
MIT5312: Professor Kirs
Slide 26
Outsourcing
Structuring the Outsourcing Alliance
Contract Flexibility
8-10 Years
Frequent Renegotiation necessary due to:
Technology changes
Changing business/economic conditions
Emerging competitive services
Performance Standards for System response time, availability of service, responsiveness
Controls
Safeguards against disruption of operations support

27. Structuring the Outsourcing Alliance (Cont.)
MIT5312: Professor Kirs
Slide 27
Outsourcing
Structuring the Outsourcing Alliance (Cont.)
Partial Outsourcing
Can the outsourced area be readily separated from the rest of the firm?
Does the outsourced area require expertise not possessed by the firm?
Realistic determination of Cost Savings
IT departments will view outsourcing as a threat
Outsourcing Consultants tend to skew outcomes
Senior Management Involvement necessary
Post implementation audits a must

28. Structuring the Outsourcing Alliance (Cont.)
MIT5312: Professor Kirs
Slide 28
Outsourcing
Structuring the Outsourcing Alliance (Cont.)
Supplier Stability and Quality
Need to examine supplier’s financial structure
Note:
Insourcing is a more difficult than outsourcing
Management Fit
Similarity in Corporate Cultures
Conversion Problems
Expertise/Information gained by Outsourcer
Resolution of Internal Staff hiring/Lay-offs
Career paths/job security

29. Managing the Outsourcing Alliance
MIT5312: Professor Kirs
Slide 29
Outsourcing
Managing the Outsourcing Alliance
A Strong CIO should be retained
CIO responsibilities:
Partnership/Contract management
Long-term vision of architecture/interconnectivity
Assimilation of emerging technologies/ discontinuation of obsolete applications/technologies
Establishment of continuous internal learning/ training programs
Establishment of realistic performance Measures
Must include intangible measures

30. Managing the Outsourcing Alliance (Cont.)
MIT5312: Professor Kirs
Slide 30
Outsourcing
Managing the Outsourcing Alliance (Cont.)
Mix and Coordination of In-house/ Outsourced Tasks
Customer/outsourcer Interfaces
Outsourcing may imply delegation of final authority to the outsourcer
Internal Coordination necessary

31. Outsourcing A General Strategy Strategic Alignment:
MIT5312: Professor Kirs
Slide 31
Outsourcing
A General Strategy
Strategic Alignment:
Instead of the traditional hierarchical organization, world-class organizations understand that "flatter" management structures are more effective. For example, an IT leader who interacts with other business leaders as an equal is more likely to be tuned into their needs and to the overall business strategy. Hackett's research shows that world-class CIOs are twice as likely to report directly to the CEO or chairman as CIOs at typical companies.
Aligning IT with the business is crucial to success, yet IT is too often seen as a "support" service and is not included in high-level decision-making. Having a "seat at the table" is essential to improved performance. At 77 percent of world-class organizations, the senior IT executive is a member of the company's primary management committee, compared to just 52 percent of typical companies.
Source: Performance Gap Seen Widening in the Back Offices of Large Global Corporations

32. Outsourcing A General Strategy Complexity Reduction:
MIT5312: Professor Kirs
Slide 32
Outsourcing
A General Strategy
Complexity Reduction:
While words like "streamlining" and "standardization" have become overused terms, world-class organizations achieve tangible benefits by abolishing unnecessary complexity in business processes. For example, world-class procurement organizations reduce complexity through strategic sourcing, consolidating their purchases among 78 percent fewer suppliers than typical companies. They also centralize processes; Hackett found that a typical company with $1 billion in annual spend can save $8 million in process costs alone by increasing the percentage of contracts negotiated centrally from 20 percent to 80 percent.

33. Outsourcing A General Strategy Technology Enablement:
MIT5312: Professor Kirs
Slide 33
Outsourcing
A General Strategy
Technology Enablement:
Companies with world-class IT organizations now spend significantly more on IT — 7 percent more per end user — than their peers, making IT the only area studied by Hackett where world-class companies spend more than typical ones. While world-class organizations spend more on IT, their use of technology results in improved performance across other SG&A areas. Hackett's research found that of the companies that achieved world-class status in multiple functions, IT was one of those functions 86 percent of the time — suggesting that cross-functional excellence relies on world-class IT performance.
Examples of the value of IT abound in Hackett's research. In part by using technology to streamline and automate operations, world-class organizations spend 45 percent less than typical companies on finance operations, while at the same time generating tens of millions of dollars in savings by getting clients to pay their bills 28 percent

34. Outsourcing A General Strategy Business Process Sourcing:
MIT5312: Professor Kirs
Slide 34
Outsourcing
A General Strategy
Business Process Sourcing:
Understanding how to effectively leverage business process sourcing options such as outsourcing, shared services and offshoring is a hallmark of a world-class company. They do this at the process level and do not hesitate to change sourcing solutions if they fail to produce the desired result. Most executives miss the potential impact of service globalization due to "under-scoping" of initiatives, not realizing that offshore resources have matured significantly in the last few years.
A good example of this is in IT. World-class IT organizations spend 17 percent more on outsourcing technology infrastructure than typical organizations, but this enables them to spend 20 percent less in IT labor, resulting in 8 percent lower overall technology infrastructure process costs.

35. Outsourcing A General Strategy Cross-Functional Partnering:
MIT5312: Professor Kirs
Slide 35
Outsourcing
A General Strategy
Cross-Functional Partnering:
World-class organizations seek synergies across business functions through cross-functional cooperation to achieve common goals. For instance, procurement staff work alongside their functional peers to understand business needs, plan spending and supplier selection (at the best price), taking into account both current and future needs. World-class procurement organizations are more than three times as likely as typical companies to rely on cross-functional teaming for supplier development. World-class HR managers are up to four times as likely as their peers to partner with management in key areas such as developing business strategies.

36. MIT5312: Professor Kirs
Slide 36
Outsourcing