Increasing technical complexity in developing firm-specific applications, rising labor costs for software maintenance and rapid obsolescence of information technology favor the shifting of internal IT costs to externally purchased services. Hence the need for outsourcing information technology function arises. Perhaps the most crucial contemporary issue of information management has become whether to outsource all or some of the information technologies to specialized-services firms. The issue is not a transient phenomenon; the shift from company-management computing to outsourcing is accelerating. The decision when, how, and where to outsource is likely to be one of the few information-management issues that will be coming up for review at board meetings.
Some corporations claim that their information technologies are not an essential part of their business anymore but, rather, like electric power or the water supply. For others, the divestment of routine processing is expected to make it possible to concentrate on strategic systems. One also hears that outsourcing is preferable because the contractors offer technical expertise that the firm cannot muster by other means. According to Strassmann, so far there is only one good explanation that fits almost every case of outsourcing information technologies: The outsourcing corporations are trying to return to profitability by cutting costs.
It’s impossible to list all the reasons for outsourcing. It has become the computer business’ fastest-expanding segment. In 1995, worldwide outsourcing revenue was $76 billion, with the United States making up 48 percent of that total. Most of the outsourcing (64 percent) was for processing standard transactions such as claims, billing, and credit cards. Only 33 percent was for IT services. Maintenance and support of centralized computing facilities accounted for about half of these services. Only a small fraction of that (less than 10 percent) was for systems planning, integration, and implementation. (Strassmann, 1998).
Strassmann stresses on the point that top management view massive outsourcing of IT as a new and imaginative way to obtain services, or as an excuse for getting rid of responsibilities that they have been unable to manage all along? According to him there are discernible characteristics among corporations that chose to outsource more than half of their IT resources. His analysis shows a connection between outsourcing and a firm’s economic value-added. Those corporations that outsourced more than 60% of their IT budget were economic losers when they began outsourcing. They were probably shedding IT resources along with other corporate functions because they were in financial trouble. He could not find any corporation with a consistently large economic value-added and rising employment that outsourced most of its information technologies, despite claims of synergy or the advantages of getting rid of commodity work. The losers were casting off IT because they were shrinking their firms anyway. (Strassmann, 1998).
Companies that try to jump on the outsourcing bandwagon may be chasing a parked car. We found no association between outsourcing and success. If anything, companies that outsourced more of their information systems work tend to have lower productivity and profitability. The only performance measure heavy outsourcers did well on was stock-market returns. In the short term, the market reacts favorably to outsourcing. Whether the market will continue to react favorably, especially if productivity doesn’t improve, remains to be seen. (Brynjolfsson and Hitt, 1993).
As for the opinions discussed so far it is considered it unwise for management to let someone else manage all of their information systems processes. Information management and information systems (whether computerized or not) are indeed the core competence of almost every business in the information age. With the increasing embodiment of information management into software, the control over information systems remains one of the essential managerial functions that an organization should not fully abdicate. However there is still another side to this story that needs to be considered. In the year 2000, the Information Technology industry reached an important milestone. For the first time, more than half (54%) of IT services purchased in North America were outsourced. A surprising feature of outsourcing is that its momentum is continuing even after the red-hot economy of the millennium has simmered down. The aim of these transformation efforts is to improve the cost-effectiveness and flexibility of the IT organization, while maintaining, and ultimately improving on, current processes and service levels. Whether it involves designing network infrastructure, setting up a help desk, rolling out a new messaging system, or building an on-line business application, outsourcing allows IT service expenses to grow in a more linear fashion than is possible by building up an all-purpose in-house IT staff.
With workers in offshore locations such as India and the Philippines commanding only 10% to 30% of the salaries that U.S. workers earn (with average IT employee costs ranging from $5,800 to $6,500), there is no doubt that savings can be achieved purely from a head-count perspective. However, the greater benefit of outsourcing is the migration from a fixed-cost IT environment to a variable pricing model that allows firms to gain better control over operating costs. There will be a reduced need for software and hardware infrastructure, as well as reduced costs for maintaining and upgrading hardware and software and for training software developers on the latest technologies. Most firms also underestimate the true cost of hiring an internal employee. Taking an employee with a base salary of $50,000, also have additional costs such as Benefits; medical, dental, administrative costs, Orientation/training. Therefore, the total actual cost of the employee would be close to $78,000 a year – a 56% increase on the initial estimate. Also attempts to pilot or deploy advanced technologies fail because of immature or non-existent infrastructure for support and education — not because of some basic flaw in the technology itself. Outsourcing companies are frequently called upon for piloting and implementing leading-edge technologies. They have developed proven methodologies and best practices to assure success. Clients get where they want to go faster, and avoid the costly scenario of spending significant amounts of time and money only to end up where they started. Outsourcing helps when the organization is incapable of attracting or retaining talent for specialized technologies, especially for innovative uses. It is increasingly true in the public sector. The learning curve for a new or risky technology is especially steep. Therefore, it pays to have an experienced firm introduce the technology at a much lower cost. If the new service becomes attractive, one can always reconsider the outsourcing decision. Scenarios such as when organization is internally in turmoil and cannot manage IT because its managerial energies are concentrating on the survival of the firm or the organization is very profitable but does not wish to devote scarce managerial resources to managing IT call for inventing new forms of relationships that may not be arm’s-length commercial contracts.
My only concern to outsourcing comes from the fact that when outsourcing IT services, most employers focus on finding the right company for the job. While this is important, there are bigger issues to address. With concerns like increasing computer crimes and growing government control over business practices and protection of private information, the real focus should first be on whether or not outsourcing IT services is even a viable option given the associated security risks. Whether you’re hiring a third-party for desktop support, security testing or network monitoring, the more eyes and hands you have on your electronic assets the greater the risk of something bad happening. The potential for loss increases given the seemingly endless amount of data stored on so many different computers. While most IT consultants are trustworthy and responsible, some aren’t. Seemingly not so bad people are doing bad things on computers all the time – and often the company who hired them doesn’t even realize it. One of the critical issues in outsourcing is the safeguarding of uniquely confidential information. The outsourcing contract between Swiss Bank Corp. and Perot Systems solved this problem admirably. The bank retained all of the input and output processing within the bank, while Perot Systems handled only encrypted data, without ever having access to the encryption keys. Swiss Bank gave up nothing of importance, because it had reserved to itself all options and privileges. It had not yielded any of its essential managerial functions. (Strassmann,1998)
Another successful example comes from Sun’s Outsourcing Initiatives. According to Bob Worrall (CIO, Sun Microsystems, Inc.), the areas Sun has outsourced — datacenter support, ERP support, network infrastructure management, internal helpdesk, and application development — have become less costly and more efficient. For example, after transition costs, we’re seeing about 30 percent run-rate savings through the outsourcing of our application maintenance and development function. As far as productivity goes, the returns depend on the outsourcing contract, but the productivity improvements average somewhere between 3 and 5 percent annually. Outsourcing opportunities have given Sun more variability and flexibility to meet changing business conditions. What makes this settlement a success is figuring out what to outsource and what to keep. This usually starts with identifying core competencies and which internal IT activities can be done best by third parties. They take into consideration how much proprietary and sensitive information the enterprise should make available to an outside vendor.
Outsourcing makes sense for everybody, companies need an outsourcing model that is flexible, affordable, and aligned with their business goals. The aim is to find outsourcing solutions that address the special needs of your organization while protecting the integrity of the processes and information.
References
Progent (2002) Outsourcing Advantages, How small businesses can benefit from outsourcing IT services. Web.
Strassmann, P. A. (1998). The Squandered Computer U.S.A.: Across the Board.