Making the Decision to Outsource - Pitfalls and Problems

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Defining Outsourcing Session 1
Royston E Morgan
roystonmorgan@1stOutsource.com
Do

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Today's Agenda
 What is Outsourcing?
 History and Types
 Why Outsource (business driver)
 What are the problems

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Outsourcing as example Strategic Change
 I.T. Outsourcing
 A decision taken to contract-out
or sell the organisation’s IT
assets, people and/or activities
to a third party supplier…over
agreed time period
 Enabled by Technology,
changes structure and culture.
 Externalisation of employment –
changing world of work
 Professional (vs) secondary
workers

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Defining Outsourcing
 ‘Outsourcing’ is an act of subcontracting a part, or all, of an
organization’s work to external vendor(s), to manage on its behalf.
 ‘Outsourcing’ is the transfer to an external supplier of the technical,
process and human resources of a function that includes the
management for the transferred staff.

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Outsourcing Information Systems Functions: Two
Driving Forces
 Focus on core businesses that adds value to end product or service
– Global competition in 1980s-2012 have forced efficiencies.
 Shareholder value: Companies ‘priced’ based on shareholder value
– With focus on short term profits.
– Some tendency for this to be a specific feature of US/UK.
This implies management must stress value, they
must consider outsourcing for their non-strategic
functions.

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Outsourcing is not a passing fad but is main-stream
 80% of large companies outsource at least one function or service
– 40% outsource two or more functions
– 20% annualised growth
 Most companies even in these credit crunch times expect to
outsource in the next two years
– Focus on cost savings may actually receive an extra impetus (especially
public sector)
 Still many large deals being struck…
– … focus on second generation deals and selective sourcing

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At the start focus was on the mega single source
 IT outsourcing
– Single outsourcer
 Big bang (common pre-1990)
– Sell IT assets to outsourcer
– Move personnel to outsourcer
– Get fixed costs off books and change to variable costs
– Outsourcers took loss for 2 years and then got economy of scale to
keep costs down
– Many problems with transition and culture shock of ex-employees being
treated like ‘temps’

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Outsourcing Alternatives
 Transitional outsourcing (common early to mid 1990s)
– Single outsourcer
 Stopgap outsourcing for a one-shot specific need
– Y2K
– Need to transition to new tech frame
 Two strategies:
– Outsource maintenance of legacy systems to focus on building new
systems in new frame (C/S or Internet)
– Or outsource development while maintaining legacy and then transition
with turnkey system

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Outsourcing Alternatives
 Best-of-breed outsourcing (common mid to late 1990s)
– Multiple outsourcers
– Choose each outsourcer based on their expertise
– Alternatively, could be ‘collaborative outsourcing’
 Prime contractor and subcontractor system
 Business process outsourcing (late 1990s)
– Buying radical innovation in processes via IT
– Is risky and sometimes risks and rewards are shared in joint ventures
(but not common)

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Early signs of risks in Outsourcing showed control a
key issue
 Risks/Rewards of outsourcing:
– IS Management loses an increasing amount of control
– Vendors take more risk to win the deal
– Vendors’ margins improve by simplifying service
– Choosing the right vendor very important
– Organizations lose learning and often intellectual property from
innovation
– Organizations lose management control (cannot demand immediate
help, etc.), quality control, and loyalty

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Other sourcing approaches also emerged
 Application service providers (ASPs)
– Software services for rent in remote location (e.g., no temps working in
house)
– Primarily with an Internet interface
– Pay by the transaction
– Can integrate company externally and someone else provides and
maintains hardware and software

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Outsourcing alternatives such as shared services also
common
 Shared services
– Insourcing within organization
– Across large organization, create centralized service unit that deals with
services of all sorts
– A spin off company that has its own management and autonomy and in
some cases is legal corporate entity
– Specialties within types of service (like IT or mailroom or legal) have
autonomous subunits within service unit
 Shared service group can become prime candidate for outsource

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A whole new vocabulary sprang up
 Out-sourcing
 In-sourcing
 Back-sourcing
 Competitive sourcing
 Off-shoring
 Near-shoring
 Right-shoring
 In-shore
The cheesy term Rightshore ™ is a trademark of Cap Gemini Ernst
& Young, with a filing date of May 27, 2003.

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Define what you think is meant by total outsourcing?
 Can you suggest advantages/disadvantages?
 How would you measure the benefits of an outsourcing decision
once it was completed?

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An active market attracted new entrants
 Consultants (Accenture, PWC)
– FM as entry to high value activities such as Business Process
Outsourcing
 System Houses (Atos, EDS)
– Long term provision of custom/package software
– IT & project management
 Hardware vendors
– Diversifying to avoid margin trap
 Ex IT departments
– Operational IT (FM focus)

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Suppliers diversify to gain more of the market potential
Their different backgrounds mean they have specific competences to offer
but the go-to-market position is they can do everything
Strategic & tactical
Application development
Operational IT/IS
Hardware
Consultancies
HWVendors
Ex IT Departments
System Houses
Margin
Traditional IT
vendors
acquiring
consultancies
to get up the
value chain

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What is important in vendor choice?
 Think about the vendor decision in an
outsource bid
 Discuss in your groups what would be the key
factors you would use when selecting a
vendor
 Rank you criteria in order and justify your
choice

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Important Factors
 Probably the most important is specific expertise in the technology or
process being outsourced
 Others:
– Sector specific competence (demonstrable)
– Scale and scope in outsource area
– Ability to deliver savings
– Culture match (to service delivery people)
– Good transition management capabilities
– …

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The Myths of Outsourcing
Costs Savings
Provide scarce IT skills
Better quality service
Assist cash flow
Over what time period?
Could do this anyway?
At what price?
In the contract?
Continuity?
How measured?
Paid for later?
Focus on core
competence
What is core?
Reliability of service?

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More Myths…
Flexibility
Utilises spare capacity
Accountability
Increases management
control
In the contract at what price?
True availability?
Shared services?
Switching costs?
Clear contracting? Detailed
SLA’s
Different type of skills required
to manage vendor
Manage demand variability
Over what range and at what
price?

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Reshoring/near shoring became more attractive due to
labour arbitrage but...
 Customers in US rated off-
shore call centres 26 points
lower than on-shore.
 First time call resolution
‘dramatically’ lower offshore.
 Evident contextual gap in
language use.
 Potential risk to customer
experience and loyalty
– 50% customers ready to
change over poor
experience.
Emphasises the need to do
proper due diligence

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Assessing the Myths and Issues of Outsourcing
 Cost reduction and control
 Focus on core competencies
 Access to staff and technology
 Performance improvement
 Mixed evidence, hidden costs
 Problems pinning down a core
competence, time invested in
managing outsourcing
contracts
 Complaints that supplier does
not staff well and pinches own
best
 Evidence of serious or difficult
service-level problems

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What is happening here?
 What do you think that some of these issues are
really telling us?
 Discuss in your groups what could be the
explanation for these problems
– Suggest remedial actions

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Objectives of this afternoons session
 To outline some of the key economic issues in the make or buy
decision to outsource.
 To review some of the key risk issues in managing the selection of
outsource processes.
 To begin the process of identification of services and products that
can be placed in the market.

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Recap: the outsourcing decision is basically a
make or buy choice
Reasons to buy
 Cost efficiencies
 Technology uncertainty
 Non core process (or
declining)
 Access to expertise
Reasons to make
 Core competency
 Competitive edge
 Asset specificity high
 Critical process
 Dependent on core or
critical process
 Risk
 Difficult to measure

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Outsourcing is about setting the Boundary of the
Organisation
In House
Service
Offshore
Outsource
Internal Governance Vendor
Organisationalboundary
In source
External
Division
Back source Market
Governance

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The make or buy decision driven by cost of doing
something externally or internally
 Transaction cost economics
– (offers an) Explanation of the boundary choice
 Model
– Hierarchical decomposition (form of governance)
– Asset specificity
– Externality
 Behavioural assumptions
– Bounded rationality
– Opportunism
 Point of departure from classical economics
– Economic agents under classical model act to maximise profit
– Economic agents from a TC perspective act to minimise cost

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Boundary where the costs internally and the costs
of the market just balance
 Costs are all aspects of
the control and
monitoring of the
performance of the
activity
 Make
– Training
– Management Time
– Direct cost
– Facilities
– Payroll etc.
 Buy
– Negotiating
– Monitoring
– Writing agreements
Accounting
Distribution
Customer Service
Information Systems
Manufacturing
$
$
$
Purchasing
Quality Assurance
Research & Development
Warehouse
Sales
Board of Directors
Shipping
Organisation
Boundary

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These core aspects define the boundary
Hierarchical
Decom-
position
Asset
Specificity
Externality
Frequency
Uncertainty
or risk Specific
investments
Quality
compliance
IPR
Confidential
ity
Measurement
risk
Organisation
Structure
Bounded
Rationality Opportunism
Agents act
to serve own
interests
Agents a
rationale but in
a limited way
can’t do
everything!

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Basic principles of market placement
 Market is favoured if relative demand client is less that of the market
– Vendors can aggregate all the clients demands
– Offering wider scale…
– … and wider scope
– Can specialise in the delivered service (competence)
 The advantage of the market dissipates if the service becomes
specific to the client
– The more specific a service is the less a vendor is able to ‘pool’ demand

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Specialisation and learning drive specificity
 Specificity arises when specialisation of an asset means it cannot be
used outside the context of the service.
– Vendor cannot realise scale effects as will need services to be generic
and spread across several clients
– Can reduce room for cost reduction (or left with labour cost arbitrage)
– This process inhibits switching of the client and locks the supplier in
 The process of service delivery acts to increase specificity
– Implicit knowledge transfer and …
– Learning by doing locks out competition

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Summary
 Value of market sourcing reduces as human and physical assets
become more specialised
 Specialism leads to single use (small numbers TC risk)
– Which is less transferable to other clients
– Can drive re-integration as economies of scale cannot be realised (and
client can do just as well)

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Reflection
 Research has shown that clients prefer to
have service that is customised to their
needs.
 What is the consequence of this for the
outsource deal?
 How might a vendor respond to this?

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Evidence from the field
 Large outsource deals typically tailored (100% according to Deloitts
survey)
 Corollary
– Vendors find it difficult to standardise services
– As need to tailor a solution increases the ability to deliver savings
decrease
‘if a project needs customising, it should not be the subject to outsourcing’
(Deloittes (2005) survey quote)

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The High Level Make or Buy Choice
Project type services
Specific investment
transfer difficult
Joint governance
Partner models
Joint ventures
Commodity type
Services (desktop,
payroll, transport)
Selective sourcing
may be favourable
Unified
management
(highly embedded
services)
OccasionalFrequent
Generic Mixed Highly Specific
ServiceFrequency
Need to sustain relationship
Service Characteristics

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The High Level Make or Buy Choice
Project type services
Specific investment
transfer difficult
Joint governance
Partner models
Joint ventures
Commodity type
Services (desktop,
payroll, transport)
Selective sourcing
may be favourable
Unified
management
(highly embedded
services)
OccasionalFrequent
Generic Mixed Highly Specific
ServiceFrequency
Need to sustain relationship
Service Characteristics
Marketsourcing
NormalcontractingRules
StandardSLA
Relational contracting
Continuous interaction and
evaluation of value
Arbitration extends formal
contracting
Demands
integrated
approach
supplier/buyer

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Reflection
 Suggest what circumstances might lead to
insourcing?
 Review the advantages and disadvantages of
Outsourcing

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What some of these theories tell us about conflict
Strategic Orientation
Needs Resource Based
view
Transaction costs Agency Theory
Client
Focus on core
competences
Service improvement
and reduction in cost
Measurement
Conflict Area
The specificity of
service
Asset specificity
Technological risk
Volume risk
Degree of investment
Alignment of goals
Length of contract
Contracts
Balance outcome
verses behaviour
Supplier
Focus on core
competences and
use existing services
Economies of scale
and scope
Service bundles
Increase profit
Measurement

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Reflection
 Why would an outsource be a conflict area is this necessarily so?
 How might conflict be reduced?

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Just some of the problems with outsourcing
relationships
 Breakdown of relationships
 Failure to meet service levels
 Constant contractual wrangles
 Unforeseen charges
 Poor contracting
 Losing control
 Selecting the wrong vendor
 Overlooking hidden cost
 No exit strategy
 Forgetting about personnel issues

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“...there's the unmeasurable aspect of what happens when a company
is no longer a culture but an amalgamation of outsourcing partners.
They may add great efficiency into the business, but they generally
add nothing to the long-term vision. As most companies that have
been around awhile are aware, great ideas don't always come from
the people at the top. Outsourcing can eliminate an entire interaction
layer that is impossible to measure with objective tools. Cultures are
inextricably linked to innovation and quality, and the less there is of
the former the more the latter two will suffer in the long term.”

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We will review over the next sessions why these
problems occur and hopefully how we might tackle
them!
Management Preparation
NegotiationTransition
Scoping
Relationship
Formation
Relationship
Maturity
Relationship
Engagement
The Outsource
Lifecycle
Definition
Interpretation
Renegotiation
Terminate
Selection
Reconnaissance

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Sainsbury’s Accenture Outsourcing bare bones…
 Outsource of entire IT function to Accenture.
– With guarantees to reduce cost of operations by 50% over the contract.
 Predicated on legacy replacement (technology refresh).
– All systems HR, Logistics, Data Warehousing, Front and Back of shop to be
replaced in three years.
– Reduction in diversity systems.
– Replace all PC’s and Office software.
 Standard system COTS and Oracle platform.
– Limited customization standard architecture.

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Sainsbury’s Accenture Outsourcing contract basis…
 No formal bidding process.
 Costs spread over life-time of deal.
– Avoided high up front investment.
– Contract devised by Accenture/Sainsbury’s.
– Business change included in contract but in a limited way.
 Some performance measure in place.
– Elements of risk/reward.
– Measurements of productivity cost performance etc.
 Change Management seemed embryonic

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Sainsbury’s Accenture Outsourcing the renegotiations
start…
 Three years into deal.
– Negotiated reduction in costs.
– Simplification of IT systems (legacy and pipeline).
 Some performance problem...
– Limited productivity gains.
– IT costs continuing to rise.
– Automated warehouses failure to perform.
 Large write-downs:
– $254 Million IT Assets, $218 Million automation, $54 Million inventory
losses.
 Rebuilding IT internal staff.

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Sainsbury’s Accenture Outsourcing the end (early
2005)…
 Rebuilding IT back in-house.
– Sainsbury re-gaining control strategic asset.
– Migration IT service and development to in-house service.
– Back source IT staff from Accenture to Sainsbury’s.
 More write offs...
– IT costs higher than before outsourcing.
 Termination of contract
 The people who presided over the disaster left Sainsbury’s.

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So what went wrong?
 What are the key lessons from this case what would you do
differently?

Making the Decision to Outsource - Pitfalls and Problems

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Making the Decision to Outsource - Pitfalls and Problems