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Defining The Business Value Of Technology
November 15, 1999
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Outsourcing Flexes Its Muscle
Technology advances and business realities fuel a new generation of choices
The third wave of outsourcing is descending, according to Frank Casale, president and founder of TheOutsourcing Institute. The first wave, which reigned from the 1980s to about 1993, was perceived as a last resort for companies in trouble; they could only turn to a few large companies like EDS and IBM.
The second wave, which ran until 1998, saw more companies adopting outsourcing to boost their competitive advantage and improve their business processes. Now, the industry is at the dawning of the third wave, where emerging companies are turning to outsourcing as a growth strategy and increasingly choosing from niche and specialty providers.
The technological trends behind this next generation of outsourcing include the growth of universal IP networking, development of server-based computing, and better distributed systems management. The combination of adaptability, flexibility, and network readiness make outsourcing particularly appealing to fast-growing, supple companies that must cope with mobile workforces, changing head counts, numerous branches, and supply-chain communications.
To be sure, companies have a wider range of choices beyond the one-stop-shopping giants of yesteryear. The marketplace has fragmented into a confusing quilt of application service providers, Web-host- ing and E-commerce providers, and network-integration experts, all positioned for different industries and offering various levels of service. The options for outsourcing include everything from soup-to-nuts transaction processing to co-location to pay-as-you-go application usage. For example, the off-site document-management services unit of Xerox Corp. uses an export compliance application from Syntra Technologies Inc. to ensure that its international shipments of books and documentation conform to U.S. governmental regulations. "By using a Web-based service and paying only according to usage, we avoid the expenses of infrastructure and keeping up with near-daily changes," says Peter Serrao, chief technologist of the unit.
The array of choices doesn't take managers off the hook; if anything, it places a premium on selecting and managing vendors, negotiating outsourcing contracts, and monitoring ongoing performance. There's so much uncertainty that outsourcing contracts have decreased from a once-standard 10 years to as little as one year.
But if the choices are complex, the business imperatives are compelling. Companies turn to outsourcing after determining that the burden of building and maintaining an IT infrastructure is not a core competency.
At other times, speed is key. Companies can take months to evaluate software, work out bugs, and test security for a new E-commerce site. An outsourcing vendor can establish a basic site overnight.
More than 70% of customers cite cost savings as their outsourcing motivation through 2002, according to Gartner Group. While acquisition costs can generally be forecast, more than one IT budget has been ambushed by operational crises. With outsourcing, there are no extra costs for unforeseen breakdowns or rapid operational changes.
Outsourcing is also generally considered to be less expensive than outright equipment purchase, although Gartner Group says real savings aren't possible unless the customer's internal costs are 150% or more of the vendor's direct cost.
Savings, however, can be lost through poor contract negotiations and lack of continuing oversight. And experts warn about being held hostage by outsourcing companies that know that customers will sometimes endure the costs of poor service rather than suffer the trauma of changing vendors.
A PricewaterhouseCoopers survey of 110 companies in early 1999 found that 66% make outsourcing decisions on dollar-to-dollar comparisons or cash flow. About 20% employ efficiency measures such as return on equity or return on assets. Only 14% use advanced value-creation methodologies such as total business return or economic value added.
What will the future of outsourcing look like? Providers will increasingly sell enterprise solutions, and customer-relationship or performance management solutions that incorporate a range of applications. This trend will place an in- creasing burden on providers to integrate software at their site or serve as application aggregators who can make their own alliances and partnerships work well.
The outsourcing decision will become easier and as accepted as janitorial or security services. However, that will place increased importance on managing and monitoring the relationships.
Shareholder value may even be measured in terms of the ability to manage outsourcers. The importance of relationship management will exacerbate a shortage of professionals skilled in negotiating and handling outsourcing relationships. The fourth wave will see a greater move away from easy-to-measure metrics such as responsiveness and uptime toward "softer" metrics, such as customer satisfaction andproductivity improvements.
Finally, even the most complex contracts will become more standardized, making it easier to swap outsourcing providers when good relationships go bad.
Nick Wreden is a freelance business writer in Atlanta. He can be reached at aspen@mediaone.net.
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t's the new business paradox: Outsourcing may be a fundamental core competency. It's far from new, yet outsourcing is muscling in on IT departments. According to research firm the Yankee Group, the outsourcing market is growing by tens of billions of dollars annually and will reach $116 billion in the United States by next year. This hypergrowth is being fueled by technological advances and new business realities. But be forewarned: Those who hop on this fast-moving bandwagon may find their IT objectives derailed unless they understand the potential risks and the rules of the game.
After all, few companies are in business to keep up with hardware and software upgrades or ensure round-the-clock system care. Sometimes, the decision revolves around skills: Either the appropriate Internet skills are not available in-house, or companies want "economies of skill"--leveraging the in-depth outsourcing expertise that comes from managing multiple applications for multiple environments.
Go on to the next story, "The Search For Commitment."
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