History of Outsourcing

Raeef Hijazi Final Paper Outsourcing: Past, Present and Future….. 05/04/2005 ENTR 573 1 Table of Contents: Abstract.................................................................................................................................................................. 4 Overview ................................................................................................................................................................... 5 The international context ........................................................................................................................................... 6 Reasons for Outsourcing ........................................................................................................................................... 8 Critical Issues with Outsourcing .............................................................................................................................. 10 Stages of Outsourcing .............................................................................................................................................. 13 Application Service Providers ................................................................................................................................. 15 Conclusion .............................................................................................................................................................. 20 References ............................................................................................................................................................... 21 List of Tables Table 1: Comparison of Utility Computing and ASPs ................................................................................................ 19 Abstract We are living in one of the most important times in the history, the rapid international changes of the past decades and those currently underway signify improvement globally. A topic of considerable interest is the outsourcing of professional jobs from the West to India, China, and elsewhere in Asia and South America. Articles in almost every major news publication— Business Week, The financial Times, Forbes, Fortune, The New York Times, Time Magazine, The Wall Street Journal, and Wired—have commented on the trend in depth. What is happening? And what can we expect in the future? The goal of this paper is to study the trends in outsourcing, Newspapers, magazines, television, and the internet have been buzzing about the significant numbers of high-technology jobs going off-shore. It is estimated that America has lost anywhere between 300,000 to 995,000 jobs in the last three years [1] out of 130 million jobs. Although it’s only a fraction compared to the total no of jobs, still it is a meteoric rise and deserves attention. 2 The first part of the paper discusses about the history of outsourcing in general. In this part, the paper discuss what where the causes that led to the beginning of this phenomenon. The second part discusses the current situation and trends in outsourcing. We also discuss how there has been a shift from non-core and non-strategic functions of a company being outsourced in early 90’s to non-core strategic functions being outsourced now. The third part of the paper covers insights about what can we expect in future. Can we expect companies to outsource core and strategic functions? Overview Outsourcing is the delegation of tasks or jobs from internal production to an external entity (such as a subcontractor). Most recently, it has come to mean the elimination of native staff to staff overseas, where salaries are markedly lower. This is despite the fact that the majority of outsourcing that occurs today still occurs within country boundaries, especially in North America. It became a popular buzzword in business and management in the 1990s. Outsourcing is defined as the management and/or day-to-day execution of an entire business function by a third party service provider. Outsourcing and out-tasking involve transferring a significant amount of management control to the supplier. Buying products from another entity is not outsourcing or out-tasking, but merely a vendor relationship. Likewise, buying services from a provider is not necessarily outsourcing or out-tasking. Outsourcing always involves a considerable degree of two-way information exchange, co-ordination, and trust. 3 The concept started with Ross Perot when he founded Electronic Data Systems in 1962. EDS would tell a prospective client, "You are familiar with designing, manufacturing and selling furniture, but we're familiar with managing information technology. We can sell you the information technology you need, and you pay us monthly for the service with a minimum commitment of two to ten years." Organizations that deliver such services feel that outsourcing requires the turning over of management responsibility for running a segment of business. In theory, this business segment should not be mission-critical, but practice often dictates otherwise. Outsourcing business is characterized by expertise not inherent to the core of the client organization. A related term is out-tasking: turning over a narrowly-defined segment of business to another business, typically on an annual contract, or sometimes a shorter one. This usually involves continued direct or indirect management and decision-making by the client of the outtasking business. The international context With the rise of Globalization, many companies are turning to either off shoring or offshore outsourcing. Off shoring can be defined as relocation of business processes (including production/manufacturing) to a lower cost location, usually overseas. Offshore outsourcing is the practice of hiring an external organization to perform some or all business functions in a country other than the one where the product will be sold or consumed. Offshore outsourcing more and more takes the shape of Business Process Outsourcing, where Business Process Outsourcing refers to the increasing trend of relocating entire business functions to either self owned or third 4 party service providers, typically in low cost locations. The client is usually free to choose who provides the outsourced business processes, while stock markets press the company to do more for less. This requires that manager’s search out the cheapest sources they can find. In countries like India and China (primarily Bangalore in India), companies like IBM, Microsoft, Hewlett Packard, and Novell choose to get services from sub-contractors in these countries or move many development and support jobs there. Smaller businesses can also take advantage of freelancing on the Internet to get smaller projects done by offshore developers at minimum cost. This practice became even more popular after the dot-com crash of the early 21st century. As many businesses struggled with cash-flow problems, many investors were leery of investing money in high-tech companies, which many felt were still vulnerable to the dot-com effect. Struggling to do more with less, companies looked for less expensive avenues of development and support. For the United States, India seemed like a perfect resource for these needs since most nationals spoke English—a side-effect of several decades of British colonial rule. A company can hire an engineer in India, for example, for US$10,000 a year where an equally qualified engineer in the U.S. could cost $60,000-$90,000 a year. A side effect of this practice led to the domestic unemployables of thousands of high-tech professionals, many of whom were new college graduates. Many of these new graduates studied high-tech fields specifically because a few years earlier, they were told there was an earnest need for people with the skills they actively acquired. Many companies required their employees to train their off-shore replacements, after which they were downsized (laid off). In practice, this trend has experienced mixed results. Some companies, which were required to hire off-shore talent by investors, reported communication barriers and high foreign personnel turnover rates. They would often ask for one thing, but be delivered a different item. 5 Communication between onsite and offshore teams is a must. Attrition in the offshore company is another issue. Because of the outsourcing of many jobs from the United States to India, the prominence of Bangalore as a high-tech region has caused the rise of the term "Don't Get Bangalored" in American business. The term refers to loss of American jobs overseas. There are several US websites that sell "Don't Get Bangalored" T-shirts. Outsourcing, especially BPO (Business Process Outsourcing), has long been a factor in American business, but the trend is beginning to reach Europe. More outsourcing deals were signed there last quarter than in any single quarter since 2000. According to a recent Zogby International poll, 71% of Americans feel that outsourcing is bad for the nation's economy[1]. But most economists feel that it will inevitably remain a part of global trade. Outsourcing is not just related to the services sector. A lot of manufacturing of products is also outsourced to countries like China and Taiwan. Consumer products including clothes and computer hardware are manufactured in these countries due to cheap labor. These products in turn lead to cheaper prices in the consuming nations. Reasons for Outsourcing There are many factors involved in the outsourcing equation, and the importance given to them will depend on the circumstances of each case. 1. Cost Savings Outsourcing can reduce both fixed and recurrent costs. Outsourcing vendors should be in a position to reap economies of scale that may not be available to the client alone. The vendor can 6 save on IT hardware and software costs through consolidation of operations and through operating from a stronger bargaining, bulk purchaser position in the market for both products and support services. However, recent research indicates that economies of scale may have changed for IS[2]. 2. Focus on Core Business Outsourcing can allow a client organization to focus on its core business. If Information Technology, computing and/or communications, are not core line of business, or are not in an area in which the organization has a comparative advantage, then outsourcing can be of benefit. 3. Access to Skills Client organizations can gain access to the skills they require as and when they are required, and can call on resources of the supplier for highly specialized skills and/or in unusual situations. 4. Access to Technology Many organizations find keeping up with technical developments in computing and communications very difficult. Operational decisions in regard to the operation of computing and communications are often adversely effected by a lack of in-depth knowledge of the full range of technical options available. This can lead to using inappropriate technology and/or inappropriately using technology. 5. Flexibility Many organizations find that they bear high fixed costs to cover an unbalanced workload. Maintaining the level of equipment and human resources required to cover workload peaks can leave an organization with unfertilized resources for a significant proportion of the time. 7 Outsourcing the workload peaks can bring considerable savings. 6. Accountability Formalizing service delivery brings greater accountability. A well written contract can clarify responsibilities and sharpen management focus on key deliverables at project, operational and tactical levels. A further outcome of this formalization can be a greater focus on service quality, and a consequent quality improvement. Many of these advantages can accrue just from the process of examining the outsourcing option, as a consequence of self-examination and formalization. That is to say that they can accrue without outsourcing per se. Critical Issues with Outsourcing While there can be advantages in outsourcing there are a number of things that can go wrong. It is prudent to stop and ask several questions [2]: what are organization’s intentions, what problems is it intended to solve questions [3], have vendor’s solutions to these problems? Organizational initiate outsourcing for reasons other than cost efficiency. 1. Transaction Costs Outsourcing involves considerable costs in the administration of tendering and in the ongoing supervision and management of contracts. 2. Hidden / Additional Costs One potential disadvantageous trade-off is the existence of hidden or additional costs. One of the hidden costs in an outsourcing contract can be the erosion of staff skills. Contracts generally provide for IT staff to move to the outsource company, with a guaranteed period of employment. 8 This provides a pool of staff with knowledge of the client's business and local conditions. However, over time there may be cost pressures to use less trained and overseas staff, with a resulting lower quality of service. 3. Lack of Flexibility Entering a long-term contract with a mainframe computer vendor may prove to be a disadvantage when changing business or technological circumstances bring a need to migrate to an alternative solution. 4. Loss of Control It is essential that control over the information resource be carefully considered. 5. Human Resource Problems If human resource management (HRM) issues are not handled well, any outsourcing venture will likely fail to realize advantages. It is essential in all cases to develop `career options plans' for affected staff at an early stage. These must, at the least, involve an outline of the alternative career paths and employment options that the proposed outsourcing arrangements might involve. 6. Lock-In, Vulnerability and Dependence Lock-in to a long-term contract and to a single supplier can lead users back to a kind of vendor dependence that open systems promised to move them away from. Contract failure and "backout" scenarios must also be explored and costed. Rebuilding in-house IT capabilities from scratch will be time consuming and expensive. The risk of having to do so must be quantified as far as possible, and backout and failure plans prepared. 9 7. Privacy and Confidentiality Concerns over privacy and confidentiality are often cited as a major barrier to outsourcing IT functions. The issues of privacy and confidentiality must be covered within the contract, to protect the client’s commercial interest and the interests of customers, suppliers, and employees of the client. But this need not be an insurmountable barrier. 8. Intellectual Property and Competition Clear delineation of right over intellectual property within a contract is essential. This should be built on the foundation of a thorough intellectual property audit undertaken as a pre-cursor to outsourcing. The interests of third parties also need to be identified. Suppliers of IT hardware and software may place conditions on access to IP by staff of outsourcing company, where the company is a business competitor. 9. Opportunity Cost A cost of the use of outsourcing is forgone benefits which come from alternative strategies. Before surrendering management control of a "strategic asset" and entering "partnerships", organizations should ask not "should we outsource IS (Information Systems?" "Where and how can we take advantage of the rapidly developing market of IS services providers?” History of IT outsourcing: IT outsourcing is not a new phenomenon; it originated from the professional services and facility management services in the financial and operation support areas during the 1960s and 1970s [4]. In the 1960s, the use of external vendors was confined to time-sharing or processing services. Since computers were large and expensive, most companies relied on service bureaus, systems houses, and other professional firms to provide facilities management services. The 1 0 1970s marked the beginning of the standard application package concept. To overcome the increasing demand for IT applications and the inadequate supply of IT personnel, managers began to rely on contract programming, which became the predominant form of outsourcing during the 1970s. Then came the rapid decline of some processing services from the end of the 1970s, which can be seen in historical perspective as an early manifestation of technological downsizing. The arrival of low-cost minicomputers and then PCs also hit the processing services business at the beginning of the 1980s. By the time the focus shifted to IT-supported vertical integration in the 1980s [4], the outsourcing trend of the 1970s had lost steam. Controlling the product-development cycle from raw materials through product delivery grew in importance, and IT was now considered a valued in-house function. Organizations generally operated their information systems environment on a custom basis, buying standard equipment, system and application software, and communications, and assembling them into an infrastructure unique to each organization. Interest in outsourcing resurfaced in the early 1990s, not for contract programming and specific processing services, but for network and telecommunication management, distributed systems integration, application development, and systems operations. While the data processing service bureaus of the 1960s provided service from an offsite location, the outsourcing vendors of the 1990s aggressively targeted onsite facilities management. IT personnel were shifted from the customer to the vendor, with some vendors purchasing customers' mainframe hardware and managing client services onsite. System integration was another popular outsourcing segment in the 1990s and involved highly complex technology, including network management and telecommunications, along with associated education and training. 1 1 Stages of Outsourcing The acceptance of strategic alliances among business partners is good evidence for the growing popularity of partner-based outsourcing [5]. In the early stages of outsourcing, from the 1960s through the early 1980s, a client normally dictated projects, with control and ownership clearly spelled out in a hierarchical relationship. What was best for the client might not necessarily be best for the service providers. We characterize the first stage of IT outsourcing evolution as driven by client self-interest, shaped by a hierarchical relationship and dictated by a win-lose strategy. During the second stage of IT outsourcing, marking the beginnings of the partnership concept, organizations begin to realize the strategic advantage not just in owning IT but in using it in specific ways. At this stage, managers tend to be more interested in IT's impact on efficiency and effectiveness than in the technical superiority of their organizational IT infrastructure [6]. As the extent and scope of outsourcing projects increase during this stage, service providers begin to take on management responsibility and risk [5], eventually joining clients as stakeholders in the process. Mutual trust characterizes the second stage, rather than the pursuit of self-interest, as organizations recognize the mutual-exchange relationship in the long term is a win-win for them, and competitive advantage is to be gained through developing and sustaining high-quality partnerships. Outsourcing in the second stage is no longer viewed only as a strategic management issue, a commodity, or a social relation, but rather encompasses all of these perspectives. This integrative viewpoint allows companies to minimize the limitations [4] of one-dimensional views of outsourcing. For example, the strategic view (involving resource-dependency, core 1 2 competencies, and coordination theories) focuses on competitive advantage, without considering how relationships between an organization and its external environment are managed. Similarly, while the economic view (involving transaction cost, economic efficiency, and agency cost theories) stresses cost efficiency, it fails to consider other important environmental, structural, and strategic factors that affect an organization. Although the social view (involved with political, social contract, and social exchange theories) provides meaningful implications and suggests frameworks for analysis of partnership relationship, it fails to explain why a large percentage of partnerships do not succeed. The Future Application Service Providers Among the new ideas for outsourcing in the era of e-commerce is the ASP (Application Service Providers), a company that offers the deployment and management of applications via the Internet or a private network based on monthly or per-user fees. Its core concept, based on providing software as a service driven by the Internet, enables software and IT infrastructure markets to converge. Typical services provided by ASPs are packaged software applications developed by independent software vendors; systems implementation and integration offered by systems integrators; data centers and connectivity from hosting companies, hardware vendors, and telecommunication providers; application monitoring and ongoing support from consulting firms; and ongoing support from systems integrators or independent software vendors. Faster time to market, IT expertise, ease of use, and lower cost make ASPs attractive, but potential drawbacks also exist. ASP system failure can shut down critical operations and result in 1 3 a major loss of client productivity. Also, system incompatibility can complicate the integration between the client and its ASP, and system security and trust issues can complicate the sharing of important data between the client and its ASP. The ultimate dream of the application service provider (ASPs) is enticing: Imagine users accessing any of their applications and data whenever, wherever. For the IT department, this means reduced support costs, pay-per-use or subscription-based price flexibility, continuous access to upgrades and the ability for users to run the product anywhere, no matter what computer they happen to be using. One of the most tedious tasks facing any IT department— installing and supporting applications and managing users' data—would disappear. In essence, companies would be able to do more with less infrastructure and fewer people. Companies that subscribe to an ASP’s services, use the applications just as consumers use telephone voice-mail that’s offered through, say, AT&T or Verizon. The voice-mail technology does not exist in the person’s house; it lives at the phone company. The user simply pays the phone company a monthly bill to access its technology. This saves the consumer the cost of buying, maintaining and replacing an answering machine. Subscribing to an ASP allows a company to avoid purchasing, installing, supporting and upgrading expensive software applications. Some of the companies which are actively involved are leasing company GATX Capital; GATX outsourced its data center to HP managed services, which oversees the bulk of the company's IT infrastructure. Hewlett-Packard sends a monthly statement which is similar to that of a phone bill. Jim Mathison, vice president of IT for GATX Capital says the decision to go with utility computing came down to economics: The company didn't want to pay to set up and maintain infrastructure that ran full tilt for two weeks, only to go silent for the rest of the month. 1 4 The rise and fall of ASP: In 1999, IT analysts at International Data Corporation (IDC) predicted a worldwide ASP market worth $16 billion in 2002, and Forrester expected $21 billion by 2001. Gartner Dataquest forecasted that the worldwide ASP market would reach $22.7 billion by 2003. In reality, the total ASP market accounted for a paltry $300 million in 1999, and by 2000, Since then IDC has scaled its 2002 revenue estimate for the ASP industry back to $2.4 billion. The Gartner Group has predicted that of the 500 ASPs spun out in the last few years, only about 60 will remain by 2002 [7]. Some of the largest entrants, such as the SAP/Intel joint venture, Pandesic, were calling it quits, while others, such as USInternetworking, were losing hundreds of millions of dollars. Analysts say that Pandesic's failure to generate revenues was tied to a faulty business model that relied too heavily on flimsy dot-coms for a customer base. Initially, Pandesic provided a packaged comprised of business applications from SAP, Intel-based PC hardware, Web site management and support to quickly get small and midsized companies operating on the Web. At the time, only a few companies were offering a so-called one-stop shop to help build and host Web sites [8]. Eventually, Pandesic broadened its offerings to provide e-commerce software that allows companies to conduct more complicated transactions with their suppliers and partners over the Web. The company also jumped on the application service provider (ASP) trend, offering hosted applications and services. It’s not clear when the first ASP emerged but by the year 2000 they had become the next greatest thing since applications themselves. From a hype perspective the timing was good. ASP proponents were able to ride the wave of inflated expectations created by the dot.com mania. 1 5 Everyone – even the big telecommunications firms such as AT&T and Sprint – jumped on the ASP bandwagon. It seemed so compelling. A third party operates and maintains your applications resulting in cost savings and better performance Soon the users found out that a generic piece of software really can’t work as well for a company that sells chemicals as it does for one that sells cars or computer chips, with no modifications or extra functionality built in to serve the particular quirks and needs of those industries. Given the marginal economics, the questionable business models of many of the ASPs, and the consequences of failure, the lack of user enthusiasm is understandable. Utility Computing: A Different Paradigm Utility computing starts by asking what the user wants. Utility computing is IT-based functionality on demand. A true utility computing service provider builds an IT architecture from the ground up that takes advantage of shared resources, whether it be the Internet itself or shared application resources such as a database. The result is an order of magnitude cost saving over owning the infrastructure and applications yourself. Best of all, utility computing costs are scalable – users only pay for what they use [9]. Some of the companies which are actively involved are leasing company GATX Capital; GATX outsourced its data center to HP managed services, which oversees the bulk of the company's IT infrastructure. Hewlett-Packard sends a monthly statement which is similar to that of a phone bill. Jim Mathison, vice president of IT for GATX Capital says the decision to go with utility computing came down to economics: The company didn't want to pay to set up and maintain infrastructure that ran full tilt for two weeks, only to go silent for the rest of the month [8]. IBM--seen as the leader in commercializing the utility computing concept--said e1 6 business hosting sales were up 20 percent, courtesy of its e-business on-demand products. Big Blue says it now offers a wide range of utility computing options, such as Linux Virtual Services, where customers consolidate Unix and Intel systems on a network-based Linux server, paying only for what they use. Another example is what IBM calls "Leveraged Procurement," where Big Blue procures parts and goods, and the customer pays by the purchase order. That way, customers don't have to build a procurement network of their own. Comparison of Utility Computing and ASPs [9]: Factors ASPs Utility Computing High-pay only for current Cost Savings Marginal. needs. Reduced complexity, reduced Marginally reduced costs – Benefits results are mixed. costs, and increased responsiveness. High –an immature market Medium – the market is Risk with many providers failing or immature but the model limits dropping out. financial exposure. Low – limited by the terms of High – as flexible as the users Flexibility the ASP contract as well as ability to switch providers as 1 7 the application license. necessary. – functionality and Low – determined by the High Scalability license terms interest. and vendor number of users adjustable on demand. Table 1: Comparison of Utility Computing and ASPs Conclusion The future prosperity of an organization depends on the quality of its information services. An organization's overarching objective in managing its information resources should be to maximize flexibility and control in order to pursue different options as its circumstances change. To accomplish this objective, we find that more and more organizations are looking to IT outsourcing through external service providers. As the scope and complexity of IT expand, many organizations are less inclined to shoulder the burden of in-house development, since outsourcing allows them to better leverage their resources and focus on core applications to increase IT's value to corporate missions. In the era of e-commerce, IT outsourcing is quickly transforming into numerous partnership types that demand not only IT know-how but also the conception of innovative ideas 1 8 and the creative forging of critical and scarce resources. Crafting an outsourcing partnership involves many challenges, including understanding the service provider's focus, core competency, and organizational structure, as well as establishing relationships with key personnel. It is also important to evaluate the service provider's corporate values. References 1. www.zogby.com. 2. Information Systems Outsourcing: Myths, Metaphors and Realities, M. Lacity & R. Hirschheim, J. Wiley & Sons, Chichester, May 1993, 296pp 3. Investigation of Outsourcing Internet Services, M. da Cruz, ACS NSW Branch Conference, 1996. 4. Lee, J.N. Outsourcing reference list.www.is.cityu.edu.hk/staff/isjnlee/out_frame_tot.htm. 5. Lee, J.N. and Kim, Y.G. Effect of partnership quality on IS outsourcing success: Conceptual framework and empirical validation. Journal of Management Information Systems 15, 4 (1999), 29–61. 6. Willcocks, L.P. and Kern, T. IT outsourcing as strategic partnering: The case of the UK Inland Revenue. European Journal of Information Systems 7 (1998), 29–45. 7. www.zdnet.com 8. www.cnet.com 9. www.utilitycomputing.com 1 9 2 0