While the general trend of more IT outsourcing (via smaller, more focused deals) continues, these engagements remain difficult to navigate. Every large IT shop that I have turned around had significant problems caused or made worse by the outsourcing arrangement, particularly large deals. While those shops performed poorly for other reasons (ineffectual leadership, process failures, talent issues), improving performance required a substantial revamp or reversal of the outsourcing arrangements.
Failed outsourcing deals, involving reputable vendors and customers, litter various industries. While formal statistics are hard to come by, in part because companies are loathe to report their failures publicly, my estimate is that at least 25% and possibly more than half of these deals fail or perform very poorly. Why do these failures occur? And what should you do to improve the probability of success?
Much depends on what you choose to outsource and how you manage the vendor and service. A common misconception is that any activity that's not "core" to a company can and should be outsourced. In The Discipline of Market Leaders, authors Michael Treacy and Fred Wiersema argued that market leaders must recognize their competency in one of three areas: product and innovation leadership, customer service and intimacy, or operational excellence. They shouldn't try to excel at all three areas.
However, IT is critical to all three areas. And because of this intrinsic linkage, IT isn't like a security guard force or a legal staff, two areas companies commonly outsource successfully. And by outsourcing intrinsic capabilities, companies put their core competency at risk.
A recent University of Utah business school article found significantly higher rates of failure at companies that had outsourced IT and other operations. The authors concluded that "companies need to retain adequate control over specialized components that differentiate their products or have unique interdependencies, or they are more likely to fail to survive."
My IT best practice: Companies must control their critical intellectual property. If your company uses outsourcing vendors to develop and deliver key features or services that differentiate its products and define its success, then those vendors can typically turn around and sell those advances to your competitors. Or you are putting your success in the hands of someone with very different goals. Be wary of those who say IT isn't a core competency. With every year that passes, there's more IT content in products in nearly every industry.
Choose instead to outsource those activities where you don't have scale or cost advantages, or capacity or competence. But ensure that you either retain or build the key design, integration, and management capabilities in-house.
Another frequent reason for outsourcing is to achieve cost savings. While most small and midsized companies don't have the scale to achieve cost parity with a large outsourcer, nearly all large companies and many midsized ones do have that scale.
Nearly every outsourcing deal that I have reversed in the past 20 years yielded savings of at least 30% and often much more. Cost savings can be accomplished by an IT outsourcer for a large company for a broad set of services only if the current shop is mediocre. If your shop is well run, your all-in costs will be similar to those of the best outsourcing vendors. If you're world class, you can beat the outsourcer by 20% to 40%. A recent example: General Motors' new CIO, Randy Mott, is looking to reverse the company's dependence on IT outsourcing and improve time to market and quality, all while keeping costs in check.
Realize as well that any cost difference an IT outsourcer can deliver typically degrades over time. Consider that the goals of the outsourcer are to increase revenue and profit margin, so it invariably will find ways to charge you more, usually for changes to services, while minimizing the work it's doing. While the usual response is that the customer can put terms into the contract to avoid this situation, I have yet to see terms which ensure that the outsourcer does the "right" thing throughout the life of the contract.
One dysfunctional, $55-million-a-year outsourcing contract I reversed a few years back was for desktop provisioning and field support for a major bank. During a surprise review of the relationship, we found warehouses full of both obsolete equipment that should have been disposed of and new equipment that should have been deployed. Why? Because the outsourcer was paid to maintain all equipment, whether in use in our offices or in a warehouse, and it had full control of the logistics function (here, the critical intellectual property). So the outsourcing vendor had ordered up its own revenue, in effect. Furthermore, the service had degraded over the years as the vendor hollowed out its initial workforce and replaced it with less qualified people.
The solution? We immediately insourced the logistics function and established quality goals. Then we split the field support geography and conducted a competitive bid to select two vendors for that work. Every six months we evaluated each vendor's quality, timeliness, and cost. We gave more territory to the higher-performing vendor and took away territory from the lower-performing one, which was on notice for possible replacement. We maintained a small team of field support experts to keep training and capabilities up to par, update service routines, and resolve problems.
The result was far better quality and service--at a 40% lower cost. These results are typical with similar actions across a wide range of services, organizations, and locales.
When I was at Bank One more than a decade ago, working under CEO Jamie Dimon and COO Austin Adams, they supported our unwinding of the largest IT outsourcing deal ever consummated at the time. Three years into the contract, it had become a millstone around Bank One's neck. Costs were going up every year and quality eroded to the point where system availability and customer complaints were the worst in the industry.
In 2001 we cut the deal short--it was scheduled to run another four years. During the next 18 months, after hiring 2,200 infrastructure staff and revamping the processes and infrastructure, we reduced defects (and downtime) to 1/20th the levels in 2001 while reducing our ongoing expenses by more than $220 million per year. This effort aided the bank's turnaround and allowed for the merger with JP Morgan a few years later.
As for having in-house staff do critical work, Dimon said it best: "Who do you want doing your key work? Patriots or mercenaries?"
In Proper Moderation
Like any tool or management approach, outsourcing is quite valuable when used properly and in the right circumstances. As an executive leader, you can't focus on all company priorities at once, nor would you have the staff. And in some areas, such as field support, outsourcing provides natural economies of scale for many companies.
When outsourcing, ensure that your company retains critical IP and control. Or use outsourcing to augment your capacity, or to leverage best-in-class specialized services.
Since effective management of large outsourcing deals is nearly impossible, do small deals. Handle the management like any significant in-house function, establishing SLAs, gathering operational metrics, reviewing performance with management every three to six months, and addressing problems. Stipulate consequences for bad performance and rewards for good performance. Use contractors, including cloud providers, for peak workloads. With these best practices and a selective hand, your IT shop and company can benefit from outsourcing and avoid the failures.
What experiences have you had with IT outsourcing? Do you see companies getting better at managing and using these services? Let us know in the comments section below.
New outsourcing opportunities for insurance companies are emerging around cloud and Web-based initiatives, mobility, real-time interactive customer service, and data management. What is the new thinking in insurance about outsourcing and what are the new opportunities--and risks--in the current hyperconnected global financial services environment? Download our Optimizing The New Outsourcing Model report. (Free registration required.)