Sourcing IT
Ken Peffers
UNLV February 2005
“Sell the mailroom.” Peter Drucker, 1989, WSJ
Outsourcing Data
14.8% of operations outsourced as
of 2001
Outsourcing growing at 19.6% per
year
IT 10% of global outsourcing
Global Outsourcing Spending
9
8
7
6
5
$ Trillion 2.09
4
3
2
1
0
1998 2000 2002 2004 2006 2008
OUTSOURCING IT
CONTRACTING:
COMPUTER CENTER OPERATIONS
TELECOMMUNICATIONS NETWORKS
APPLICATION DEVELOPMENT
TO EXTERNAL VENDORS
*
OUTSOURCING
WHEN TO OUTSOURCE:
IF FIRM WON’T DISTINGUISH ITSELF
BY DEVELOPING APPLICATION
IF PREDICTABILITY OF
UNINTERRUPTED SERVICE NOT
IMPORTANT
IF EXISTING SYSTEM IS
LIMITED, INEFFECTIVE,
INFERIOR
Generic Businesses
Supply Chain Management
• Acquiring resources
• Dell, Walmart, FedEx
Operations
• Producing the product or service
• UNLV
Infrastructure
• Maintaining the underlying systems
• Sprint
Research and Innovation
• Coming up with value creating new products and services
• Intel, Microsoft
Customer Relationship Management
• Delivering the product to the customer and extracting value
• Starbucks
Which Business is Your Firm In?
• Other businesses candidates for outsourcing
Sourcing Alternatives
Development
Development and Operation
Operation
Service
Development
Obtain resources unavailable within
firm
Obtain additional resources
Development and operation
Focus on core competencies
Management attention
Operation
Obtain operational expertise
Reduce costs
Service
Avoid investment in non-strategic
activities
Reduce costs
Achieve superior service
Outsourcing Types
Total outsourcing
Joint venture/strategic alliance
sourcing
Multi-supplier sourcing
Insourcing
Total Outsourcing
Outsource 70% or more of IT to
single supplier
Long term contract
Partnership between vendor and
client
Total Outsourcing motivation
Enable client to concentrate on core
business
Client recoups capital investment
from sale of IT assets
IT perceived as support function
Eliminate IT function
Multiple-supplier sourcing
Contracts with a variety of suppliers
Outsourcing as commercial
relationship
Medium term contracts
Suppliers compete for the business
Fixed costs become variable costs
Difficulties in managing a variety of
contracts
Joint Venture/Strategic Alliance
Shared risks and rewards
Create new company as supplier
Reduced risks of single supplier or
multiple supplier
Client owns large share in supplier
Insourcing
Retain large IT staff in-house
Short term contracts for some staff
to manage variance in personnel
needs
Risks
Total outsourcing particularly risky (80%
of IT budget outsourced)
• Of 116 outsourced contracts
38% successful
35% failures
27% mixed results
• For selective outsourcing (15-25% of IT
budget outsourced)
77% successful
20% failures
3% mixed results
Top 10 Reasons for Failure
1. Treating IT as undifferentiated commodity
... needs and service levels differ
2. Incomplete contracting
…inviting opportunistic behavior
3. Lack of active management of the supplier
…contractors require day to day and long term
management and supervision
4. Failure to build and retain in-house skills
…necessary to manage the vendor, prepare new contracts,
and negotiate subsequent investments
5. Power asymmetries accruing to supplier
…who has the bargaining power?
Top 10 Reasons for Failure
6. Difficulties in adapting deals to changing
conditions
…system needs 5 + years out hard to anticipate
7. Lack of contracting experience
…need for intermediary?
8. Outsourcing for short term financial
restructuring or cash injection
…cash benefits gone in 1-2 years.
9. Multiple objectives with unrealistic expectations
…financial, performance, expertise, development resources
10. Poor sourcing
…vendor mismatch
Treating IT as an undifferentiated
commodity
• Differentiate between what is core to
the firm and what is a commodity.
• Keep core processes inside the firm.
Retain business knowledge and logic
• Be clear about what IT, if any, provides
a strategic advantage
Vendor Selection and Contracting
Be clear about the vendor requirements
for experience, resources, etc.
Quality of resource critical, more so than
cost. Lowest bid selection invites
opportunistic behavior
Understand the systems to be outsourced
Stable systems first, then outsource
All development has a business case and
approved by senior management
Incomplete Contracting
Complete contract
3-5 year initial contract
Regular review
Notice thereafter
‘Smooth termination’ guarantees
Active Supplier Management
Internal staff assigned to monitor
supplier performance
• Daily performance management
• Regular management reviews
Retaining Essential IT Resources
Core IS capabilities necessary to run
any IT sourcing regime effectively
• Relationship building
• Business systems thinking
• Technical architecture
• Technology adaptation
• IT governance
• Informed buying capabilities
• IT strategy
Unrealistic Expectations
Careful delineation of what can be
achieved by outsourcing
Power Asymmetries
Stable software makes switching
costs lower
Retained ownership of software
assets and data
Carefully delineated performance
expectations
Lack of Contracting Experience
Staged 3 to 7 year contract
Competitive price terms
Keep key capabilities in-house
Successful Outsourcing
Selective (vs total) outsourcing to achieve cost
savings
• Select most capable or efficient service for each function
Sponsorship by Sr. general mgmt and IT, rather
than either alone to achieve cost savings
• Sr mgrs often make decision based on short term
finance considerations
• IT mgmt evaluation defensive
Inviting bids from both internal and external
vendors to achieve cost savings
• Internal departments can achieve savings if they can
overcome political resistance.
Successful Outsourcing
Short term contracts for cost savings
• Estimate term during which
requirements will be stable
• Renewal term creates good incentives
for vendor
Detailed fee-for-service contracts to
achieve cost savings
Fee-for-service contracts specify fees in
exchange for provision of specified
services
• Standard
• Detailed—specify service scope, service levels,
performance measurement, penalties
• Loose
• Mixed
Strategic alliance/partnership—significant
resources pooled from two or more
organizations
Buy-in—client buys in to vendor
Successful Outsourcing
Recent contracts achieved cost
savings more than older ones
Size of IT group not material