Chapter 9: Managing IT Outsourcing
Q: Why are companies outsourcing all or significant parts of their IT management?
A: Concern for cost and quality, lagging IT performance, supplier pressure, access to special technical
and application skills, financial factors.
The challenge is how to manage a strategic alliance.
Major outsourcing programs, as compared to incremental outsourcing programs:
• involve larger investments, higher stakes, and greater overall management complexity than does
• Are born of strategic rather than operational motivations.
• Impact more broadly on the outsourcing company.
A. Why Outsourcing Alliances are so Difficult
• Major outsourcing contracts are often structured to expand over 8-10 years, but
technical and business realities and needs change frequently. A deal that made sense at
the beginning of a contract may not make economic sense 3 years later and may require
• The timing of benefits to the customer and the vendor exacerbates the situation.
o In the first year, customer benefits are clear. Customers often receive a one-time capital
payment in exchange for assets that are transferred to the vendor. Customer’s problems
and issues have been shifted to the vendor, and outputs closely resemble those anticipated
in the contract. In each subsequent year, the contract payment stream becomes less and
less tied to the initial set of planned outputs.
o From the outsourcing vendor’s point of view, the first year may require a heavy capital
payment followed by the huge costs of taking on responsibility for the customer’s IT
operations and executing agreed-upon cost reduction and quality control initiatives. By
the time the vendor finally realizes profits, the customer often begins to be dissatisfied
with the terms and wants IT architecture upgrades.
o Only a few outsourcing vendors have the critical mass and access to capital markets to
undertake large data center outsourcing contracts. Ex: EDS, Computer Sciences
Corporation, Perot Systems, and IBM. Some application service providers like Lockheed
Martin, Cap Gemini provide niche services in the outsourcing market, and Tata
Consulting Service, Wipro, and Infosys are big in global outsourcing market.
o If an outsourcing relationship is not working, a company’s options for resolving the
situation include insourcing or offshoring.
o The evolution of technologies often changes the strategic relevance of IT to a firm. A
firm may be willing to outsource a commodity service, but less likely to outsource its
B. Outsourcing in Retrospect
• Outsourcing dates back to the 1960s, when computer services bureaus developed turnkey
applications for organizations that actually required large or specialized staff, but chose not
to retain them.
• At the time, outsourcing for midsize to large companies was a sideshow, and outsourcing was
reserved for small and medium-size companies with problematic, grossly mis-managed IS
• The major drivers for outsourcing in the pre-1990 period included:
o Cost-effective access to specialized or occasionally needed computing power or systems
o Avoidance of building in-house IT skills (more an issue for small, low-tech firms)
o Access to special functional capabilities.
• In 1990, Kodak’s decision to outsource IT was the seminal event that legitimized the idea of
allowing a vendor to provide major components of IT services. Kodak began to outsource
mainframes, telecommunications, and PC maintenance and service.
C. Outsourcing in the Twenty-First Century
By 1995, more than half of midsize to large firms had outsourced or were considering
outsourcing significant IT activities.
Two major factors affect the growth of IT outsourcing:
• Acceptance of Strategic Alliances
o Finding a strong partner to complement an area of weakness gives an organization an
island of stability in a turbulent world.
o Alliances allow a firm to leverage a key part of its value chain by bringing in a strong
partner that complements its skills, enabling them to innovate synergistically, so that the
whole become greater than the sum of the parts.
o Early and successful experiences with alliance increase a firm’s confidence in
undertaking new alliances in other parts of the value chain as a profitable way to do
o Successful alliances depend on both firms’ belief that they are winners because they both
benefit from the opportunities the alliance opens up.
• IT’s Changing Environment
o Today’s firms are integrating internal systems with those of their customers and
suppliers, and changing their organizational structure to compete efficiently in the global
marketplace. Outsourcing helps them to keep the old services running while developing
the interconnections and services demanded by the new environment.
o Most of the code companies use is outsourced, for reasons of economies of scale and
scarcity of competent staff. Computer Associates, Oracle, SAP, IBM, Microsoft are
major software providers to most companies.
o Many organizations see outsourcing as a means to transform legacy applications so that
they interact effectively as part of real-time internetworking infrastructure.
D. What Drives Outsourcing?
• General Managers’ Concerns about Costs and Quality—an outsourcing vendor can save
money for a customer in several ways:
o Tighter overhead cost control of fringe benefits.
o More aggressive use of low-cost labor pools (ex: India and Northern Ireland) by using
o Tough world-class standards applied to the company’s existing staff, all of whom have to
requalify for appointment at the time of outsourcing.
o More effective bulk purchasing and leasing arrangements for all aspects of the
hardware/software configuration through discounts and better use of capacity.
o Better management of excess hardware capacity. Outsourcing vendors often combine
many firms’ work in the same operations center.
o Better control over software licenses through negotiation and realistic examination.
o More aggressive management of service and response time to meet corporate standards
and tighter control over inventories.
o The ability to run with a leaner management structure because of increased competence
and critical-mass volumes of work.
o The ability to access higher levels of IT staff skills, IT application skills, or special
customer industry skills.
o Creative and more realistic structuring of leases.
However, before entering into a strategic outsourcing alliance, a firm must assess the
outsourcing vendor carefully, to get the true picture of the benefits that will result. For
instance, can the vendor mobilize its staff rapidly for quick-response development jobs?
• Breakdown in IT Performance
o Failure to meet service standards forces general management to find other ways to
o Or, companies sometimes need to retool backward It structures rapidly in order to remain
• Intense Vendor Pressures
o Vendors’ aggressive sales forces often enable them to approach general managers with
compelling reasons to outsource. Ex: IBM, EDS, CSC.
• Simplified General Management Agenda
o A firm under intense cost or competitive pressures which does not see IT as its core
competence may find outsourcing a way to delegate time-consuming, messy problems, so
that the firm can focus its energy on other competitive differentiators.
• Financial Factors
o With IT outsourcing, a firm an liquidate intangible IT asset and thus strengthen the
balance sheet and avoid a future stream of sporadic capital investments. Vendors often
pay significant upfront capital to customers for both the real value of the hard/software
assets and the intangible value of its IT systems.
o Outsourcing can turn a fixed-cost business into one with variable costs. For a firm that is
downsizing, the vendor can make room for IT employees on its own staff.
o With outsourcing, a firm is dealing with a hard-dollar expenditure that all users must take
seriously. IT comes to be viewed as more important and viewed as adding special value.
o When a division of a firm is purchased, the acquirer often encounters fewer problems to
deal with in assimilating the firm.
• Corporate Culture
o Sometimes a company’s value makes it hard for managers to take certain actions that
make business sense. Simply outsourcing IT can provide a solution to impasses over, for
instance, centralized or decentralized strategy.
• Eliminating an Internal Irritant
o Outsourcing can eliminate the problem of IT management/end user friction within a
• Other Factors
o Outsourcing can reduce corporate risk while providing needed access to specialized
o Outsourcing vendors can provide a level of commitment and energy that is not always
available from in-house developers.
E. When to Outsource
• Position on the Strategic Grid
o Support quadrant-yes to outsourcing, particularly for large firms, because it:
Provides access to higher IT professionalism and technologies
Reduces risk of inappropriate IT architecture.
o Factory quadrant-yes to outsourcing, unless they are huge and well-managed, because:
Provides small/midsize firms with economies of scale.
Management focus facilitated.
Fiber-optic and extended channel technologies facilitate international IT
o Turnaround quadrant---yes/no. Reasons to consider outsourcing:
Internal IT units not capable in required technologies or project management
Access to technology applications and staffing not available.
o Strategic quadrant—yes/no. Reasons to consider outsourcing:
Rescue an out-of-control internal IT unit.
Tap source of cash.
Facilitate cost flexibility and management of divestiture.
Provide access to technology applications and staffing skills otherwise not
• Development Portfolio
o The higher the % of IT resources working on maintenance or high-structured projects is,
the more the portfolio is a candidate for outsourcing.
o High-structured projects are those in which the end outputs are clearly defined and little
organizational change is involved in implementing them. Outsourcing to vendors with
access to high-quality, cheap labor pools and good project management skills is very
advantageous for these projects.
o Large, low-structured projects, on the other hand, pose difficult coordination problems
for outsourcing, because the end outputs and processes tend to evolve as the project
unfolds and numerous iterations and trial and error experimentation is needed, often
onsite in the customer’s venue.
• Organizational Learning
o Projects aimed at process reengineering and organizational transformation require
internal staff to radically change the way it works.
o Firms that have substantial experience with restructuring will be more successful with
projects like this that are outsourced.
• A Firm’s Position in the Market
Firms that are far behind their peers often do not have the IT leadership, staff skills, or
architecture to upgrade quickly to state of the art technology. Outsourcing is the answer.
• Current IT Organization
The more IT activities are already segregated in organizational and accounting terms, the
easier it is to negotiate an enduring outsourcing contract.
F. Structuring the Alliance
• Contract Flexibility
Outsourcing contracts must reflect evolution in technology, economic conditions, and
new service options.
Noncontractual, personal aspects of relationships with vendors are extremely
important, since contract changes are often needed.
• Standards and Control
Outsourcing operations is much less risky than outsourcing innovation and
responsibility for new service and products.
Firms in the turnaround and strategic quadrants, in particular, often have concerns
about outsourcing innovations.
Whatever a firms grid location, it must carefully develop detailed performance
standards for systems response time, availability of service, responsiveness to
systems requests, and so on.
• Areas to Outsource
Can the portion of IT proposed for outsourcing be separated easily from the rest of
the firm, or will the complexities of disentangling systems absorb most of the
Do the activities proposed for outsourcing require particular specialized competencies
that we do not possess or lack the time to build?
How central are the activities to be outsourced to the strategy of our firm? Are they
more or less significant to the firm’s value chain than the other IT activities?
• Cost Savings
If properly engaged by senior managers, outsourcing consultants can make a real
contribution to efforts to evaluate cost savings as well as in negotiating a contract
with an outsourcing vendor.
• Supplier Stability and Quality
Before making a strategic outsourcing alliance, a customer should be sure that the
vendor is committed to ongoing modernization and retaining itself and that its
financial structure is sound.
• Management Fit
A shared approach to problem solving, similar values, and good personal chemistry
among key staffers are critical determinants of long-term success.
• Conversion Problems
The sooner plans and processes for dealing with staff career issues, outplacement
processes, and separation pay are addressed, the more effective the results from an
outsourcing alliance will be.
G. Managing the Alliance
• The CIO Function
o Partnership/contract management—An informed CIO who monitors performance against
the contract and plans for and deals with issues that arise helps an outsourcing alliance
adapt to change.
o Architecture planning—A CIO’s staff must visualize and coordinate a long-term
approach to networks, hardware, and software standards and database architectures.
o Emerging technologies—To have a clear grasp of emerging technologies and their
potential applications, managers need to attend vendor briefings and peer group seminars
and visit firms that currently use the technologies.
o Continuous learning
• Performance Management
o Companies must develop performance standards, measure results, and interpret them
continuously, as well as keeping in mind long-term, intangible measures of success.
• Mix and Coordination of Tasks
o Large systems development projects using advanced technology play directly to
outsourcing vendors’ strengths, but issues that require significant coordination among
customer employees, on-site, are better handled in-house.
• Customer-Vendor Interface
Both customer and outsourcing vendor need regular, full-time relationship managers and
coordinating groups lower in the organization to deal with narrow operational issues and
Questions for Discussion
1. Why are companies now outsourcing all or significant parts of their IT management?
2. How are major outsourcing programs different from incremental outsourcing programs?
3. Discuss the two major difficulties in the formation of outsourcing alliances.
4. Prior to the 1990s, what were the major drivers for outsourcing, and which type of companies
used it? And, when and due to what company’s actions, was the turning point in the used of
5. Discuss the two major factors that can affect the growth of today’s IT outsourcing.
6. What are some of the major drivers of the use of outsourcing by today’s companies?
7. For each of the four quadrants in the strategic grid—support, factor, turnaround, and strategic
—discuss reasons why a company in each grid might consider outsourcing.
8. Discuss why and how a company’s development portfolio is an important consideration in
the decision to outsourcing.
9. Discuss factors that are important in structuring an outsourcing alliance.
10. Discuss the roles a CIO should play in managing an outsourcing alliance.
11. Besides the important role of the CIO, what other factors are important in managing an