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For example, when an organization’s IT application is used to enable the establishment of a specialized e-commerce channel that its competitors do not possess, it becomes a strategic function for this organization. In another similar organization in another country or business setting, the same IT application may be used by most of the other members of the organization’s industrial sector. In this setting, it is commoditized and has the role of a support function. The risk profile involved, when a strategic role applies, may be different when compared to the supporting role scenario.
There are many options available to mitigate the risk of information loss and operational downtime as well as erosion of technical and business advantage. A mechanism to reduce these risks has traditionally been a legal document called the buyer–supplier agreement. As this new tier of risks is introduced, the magnitude of risk exposure applying to the legal and operational risk groups increases. It is this fluctuation in risk for each of the risk groups that will be investigated in this book.
The role IT plays in the organization determines the strategy and route taken when it is outsourced. After the decision to outsource is made, however, the relevance (of its role) diminishes. The success of the outcomes of an IT service then comes to the forefront.
2.5
Outsourcing and the unique
role(s) of the IT function
As a strategic or primary function, IT networks encourage vertical de-integration of organizations by lowering the costs of
‘buying’ compared to ‘making’ in-house. Reduced co-ordination costs imply an ‘unbundling’ of functions, making it easier and more efficient to enter into value chains rather than maintain in-house ownership. This provides opportunities for the IT
function, which has a role as a competitive weapon for the organization. When IT as a supporting function is outsourced, there are obvious benefits to be gained. When IT is a primary function, however, the competitive advantage is enhanced through the strengths of the organization of origin in partnership with the supplier. The successful performance of the IT function hence, no longer pertains to the outsourcing organization but to the supplier that has been selected for its superior delivery of IT
outcomes. The ability to provide both a support as well as a strategic role within the organization is unique to the IT function. In both these roles, separate outsourcing models are used.
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As the role of IT changes, the outsourcing decision and governance tactics change. To illustrate this, Figures 2.1 and 2.2 show some of the possible choices. In Figure 2.1, the IT function is shown as a primary (strategic) function and as a support function on the x-axis. The organization’s position, i.e. whether the IT function is outsourced or not, is indicated on the y-axis. As IT
can be a strategic or primary function within an organization, outsourcing is seldom optimal (marked with an ‘X’). When IT is used as a competitive weapon, it should not be outsourced under most circumstances. This is because the risks of losing information and the competitive advantage from the differential created is lost if the supplier ‘leaks’ or shares this information with competitors of the buyer organization.
Position
Leveraging
Is
Outsourcing
strengths but
outsourced
benefits
increased risk
Figure 2.1
Not
Inefficient use
Competitive
The role of IT and
outsourced
of resources
weapon
its position in the
organization value
chain (Tho, 2002)
Supporting
Primary
Function
Position
A
Leveraging
Is
Outsourcing
strengths but
outsourced
benefits
Figure 2.2
increased risk
In the transition
from support to
B
primary function,
path A involves high
risk if the supplier–
Not
Inefficient use
Competitive
outsourced
of resources
weapon
buyer relationship is
not managed, and
path B is optimal
Supporting
Primary
Function
(Tho, 2002)
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In the case where IT is a supporting function, shown in the left-hand quadrants in Figure 2.1, a decision to keep the supporting function internal often results in inefficient use of resources, loss of focus and unnecessary costs. A decision not to outsource in this situation is often ‘suboptimal’. Optimal outsourcing benefits are realized when supporting functions are outsourced.
In an environment where the outsourced IT function changes from a support to a primary (strategic) role within the organization, the decision to continue to outsource is based very much on the risk exposure in the operational, business and strategic areas, which influence the decision. The decision to maintain the strategy to outsource and the risks associated with this now need to be considered (path A or path B in Figure 2.2). Path A would mean that the IT function continues to be outsourced.
This will mean that the operational, business and other risks escalate because a third party has access to confidential and proprietary information. A decision to discontinue outsourcing, path B, may be selected if the ‘appetite’ of the organization for risk (‘risk appetite’) is exceeded. In this instance, the organization then decides to shift its IT function internally and to be managed using its internal resources.
Many instances have been cited where organizations which once had the IT function performing internal support functions have shifted this role to facilitate primary e-commerce operations; for example web channel marketing, purchasing online and supply chain management. A large group of IT functions have become standardized, or commoditized; these functions are prime can-didates for outsourcing.
The imposition of unplanned, higher fees backed up by the supplier’s threats to discontinue service or by other unmanageable threats, is frequently termed supplier hold-up. As a result of the complex characteristics of IT in the outsourcing situation, there is a high risk of exposure and a high probability of failure inherent in IT operations; this is in addition to the risks of the relationship between the supplier and buyer of outsourcing services also resulting in failure in this activity. There have been many warnings of organizations experiencing negative consequences of ITO activity including escalating costs, diminishing service levels, loss of expertise, and contract irreversibility.
Which activities should remain within the ‘buyer’ organization, in order to maximize the advantages of outsourcing? Unless the organization develops best-in-world capabilities, including transaction cost disciplines, it should purchase goods/services from 52
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providers who have best-in-world skills, in order to achieve a competitive edge. It has also been suggested that ‘ “core” means
“keep” ’, or that an organization’s core activities should be kept within the organization and never allowed to be performed by a third party.
As a result of the cumulative and tacit nature of technological knowledge, which is of particular relevance in so-called high-tech industries, it is assumed that this kind of knowledge is often very difficult to transfer from one organization to another and therefore cannot be acquired easily through arm’s-length transactions but only through very closely integrated networks.
The IT productivity paradox and
outsourcing
There is a choice between carrying out activities in-house and placing them under market governance (via outsourcing), as determined by the relative costs of production and transactions.
Not long ago, organizations were observed to have a voracious appetite for rapidly improving technology. Measured productivity gains were insignificant. Businesses have since been revo-lutionized, along with the way we work, with permanent change derived from the use of new technology, computers and related computer peripheral devices. Only a couple of decades ago, there was heated debate on the value of computers and computerization. Could it be argued that businesses are experiencing a similar phenomenon with the use of the familiar outsourcing services that now support the complete IT function? There were major success stories and equally many impressive failures in the use of IT only a decade ago, and there have been many case studies that indicate catastrophic consequences and failures in early ITO activity.
In a paper from research work at Harvard University, it was reported that most of the productivity slowdown was concentrated in the service sector. In the same paper it was argued that IT is an effectively used substitute for labour in most manufacturing industries, but has paradoxically been associated with bloating white-collar employment in services, especially finance.
At the same time, it was indicated that the apparent paradox could be attributed to several basic causes. The reasons used included the inappropriate measurement of outputs and inputs, lags in the learning and adjustment cycle, redistribution and dissipation of profits, and mismanagement of information and technology. Possible errors in measurement and statistical or 53
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research error appear to be the main causes of the paradox. The mismanagement of information and technology begs the question whether managers have improperly managed and used IT.
This is particularly relevant to the outsourcing of the IT function as observations of the current literature on ITO seem to mirror these arguments.
There are many examples of mismanagement and misappropri-ation of resources and activities in the IT function. There is also the point regarding hidden costs, which is glaringly obvious and high-profile.