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Common Terms and Concepts Used in Outsourcing function is made primarily because it benefits the buyer of ITO
services and also provides benefits for the supplier of the same services in a win–win situation. This is also commonly referred to as the ‘make’ or ‘buy’ decision. The decision is not easy to make as the elements involved in the decision-making process are often varied and peculiar to the specific environment and organizational needs. There are, however, commonalities that often form the main reasons why organizations choose to outsource the IT function to a third-party supplier. These commonalities primarily derive from opportunities to benefit from specialization and then from economies of scale and economies of scope within the context of the IT function. These concepts are discussed in greater detail, with specific reference to ITO, in the next chapter. All these elements have been demonstrated to reduce cost and sharpen the organization’s focus on the strategic IT function.
Outsourcing has been increasingly used to provide a tangible means and path for many organizations to reduce costs and improve the quality of their products, among other considerations. In addition, it is used as a tool for strategic advantage. A summary, from this research, of the two key strategic reasons for outsourcing the IT services function includes the organization’s need to:
1. acquire additional competence – the organization cannot support or easily acquire support for the IT function; and, 2. move to be more competitive – the supplier of IT services has lower costs and faster availability for the IT function, which is viewed as a critical but directly substitutable item.
In addition, the key strategic reasons for not seeking a supplier include the protection and retention of:
1. Intellectual property – processes and information contained within the IT function provide proprietary or competitive information that is crucial to the organization’s performance (Venkatesan, 1992); and,
2. Market differentiation – the organization should retain what matters most to the customer or what differentiates its product(s) in the market-place.
The benefits of ITO are often already quite obvious to the individual involved with the exercise. Some of these benefits 21
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Managing the Risks of IT Outsourcing
Table 1.1
Buyer and supplier interests in outsourcing Buyer (business objectives
Supplier (supplier rewarded
Joint
aligned with supplier metrics)
for increased value)
• Well-defined objectives
• Service level targets
• Increase value relationship
• Internal benchmarking
• Financial target costs
• Initiative creation
• Evaluation rewards & penalties
• Revenue growth
• External benchmarking
• Control
• Objective evaluation
• Scenario planning
• Accountability
• Additional profit
• Cost savings
• Contract extensions
• Improved performance
• Improved profitability
accrued by the buyer and supplier are summarized in Table 1.1.
Similarly with any business transaction, all the benefits have related risks. Organizations that buy services that support the IT
function commonly do so to secure greater cost savings and improve performance and, hence, enhance profitability. Along with this are to be considered financial, operational and technical risk factors, which are discussed in the next chapter. As a purchaser of ITO services the buyer organization is able to define the supplier accountability and have control over the outcomes through a series of legal contracts and agreements.
Control is also enhanced through an incentive programme whereby the supplier’s rewards and penalties are based on a set of predefined and agreed benchmarks. These characteristics reduce the risk of errant outcomes often observed in a less structured arrangement (see Contracting). The risk of poor governance exists as the contract duration of an ITO exercise is often long and spans multiple financial periods.
The supplier organization also benefits synergistically from the ITO exercise. As the supplier provides services, it derives benefits from economies of scale (see later). This source of efficiency naturally leads to additional profit for each unit of work performed.
A major reason a supplier organization offers ITO services, however, is often always that a predictable income stream is established over long, contracted periods of time. Again, this makes the procurement of work processes a great deal more efficient.
At the same time, the supplier is able to focus on activities of core competency (Prahalad and Hamel, 1990; Quinn, 1993); this only serves to enhance the efficiency of its operations. As it delivers increasingly efficient operations, it is rewarded through contract extensions and additional profit from increasing margins.
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Common Terms and Concepts Used in Outsourcing The organizations involved are legally obliged to follow a series of agreed benchmarks and are equally motivated to improve these benchmarks. Jointly, both the buyer and supplier organizations benefit from this synergistic relationship wherein each organization exists to deliver common services. This leads to a common motivation to increase value in the relationship and the value of the products and services delivered as a result of the relationship. This combination also provides an environment wherein both parties initiate new processes, creating more value for common benefit.
While the benefits remain quite obvious, the risks that shadow each of the benefits often remain unnoticed, until the risks reveal themselves as an undesirable outcome. The causes of undesirable outcomes are obscured in the scenario where each party is so tightly engaged in an environment conducive only to productivity. The experienced manager would understand that each of the readily observable benefits carries major risk elements. In order to examine the risks, some of the commonly accepted definitions of risk in the ITO environment are introduced here.
The balance of the benefits and the risks or costs needs to be clear when an organization decides to outsource its IT function.
This is, however, seldom the case especially when the risks are difficult to understand, let alone quantify. Such an organization is susceptible to ‘normal operating risks’ and to even more risks because of the interplay of newly created forces that arise during the long-term partnerships that come into being in an outsourcing arrangement. Additional influencing factors or causes of the risks derive from a wide range of possibilities, including failed relationships, malicious action, purposeful or inadvertent contractual obligations, and natural, man-made disasters.
Supplier benefits
The argument on core competence (discussed in detail in Chapter 2) is that the greater specialization in the provision of services, through outsourcing, the greater the benefits of economies of scale (also discussed in Chapter 2). As activities are shared and contributing cost elements are increased, the natural economies of scale are realized. As costs are known to be a major consideration in the decision to outsource the IT function, the realization of benefits from economies of scale becomes critical. Until the 1990s, the main drivers for outsourcing IT were primarily cost-effective access to specialized skills and avoidance of 23
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building in-house IT skills. Cost-savings and freedom to focus upon core business are still major reasons for outsourcing.
Common (buyer and supplier) benefits
The intent of the ITO services is to deliver greater capacity for flexibility, especially in the purchase of rapidly developing new technologies and the myriad components of complex systems within the IT function. Through economies of scale, benefits from a significantly larger pool of resources are available to both the supplier and buyer of outsourcing services.
Outsourcing also decreases the product/process design cycle time, and the suppliers provide best-in-class service contributing to greater depth and sophisticated knowledge in specialized areas.
Outsourcing makes the full utilization of external suppliers’
investments, innovations, and specialized professional capabilities available to the buyer, which would be prohibitively expensive to replicate otherwise.
ITO provides organizations with greater capacity for flexibility, especially in the context of the purchase of rapidly developing new technologies, new people, and myriad components of complex systems.
Buyer benefits
An organization’s ability to compete successfully is based on consistent, superior performance, or the development of assets of high specificity that create value through differentiation.
Many organizations rely on the ability to deliver ‘better’ and/or
‘cheaper’ than the competition in order to successfully capture and hold a market. When internal performance (within the organization) falls below the performance levels of external suppliers a ‘surrogate’ arrangement is observed to deliver immediate benefits. Many benefits of the surrogate arrangement derive from economies of scale.
As organizations faced with intense competitive pressures are forced to shed non-essential functions, outsourcing becomes the driving force behind the ‘virtual corporation’. The search for greater flexibility and rapid changes in technology, and the emphasis on concentrating on core competencies have been cited as major drivers for the upsurge in outsourcing activity. The virtual organization appears less a discrete organization and more an ever-varying cluster of common activities in the midst of a vast fabric of relationships. The network of partners itself is seen 24
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Common Terms and Concepts Used in Outsourcing as a sequence of value-adding activities in a value chain. The well-put case for an organization to outsource its IT function has a very significant influence. The question is now not whether to outsource; rather, what and how to outsource the activities which do not contribute to these objectives.