L09: IT Outsourcing 1 of 2

1
L09 IT Outsourcing (1 of 2)

• References
• Domberger, The Contracting Organization, Oxford
  1998
• Lacity and Willcocks, Global IT Outsourcing,
  Wiley 2001
• Hamel and Prahalad, Competing for the Future,
  Harvard, 1994

2
Plan for today

• Review of this subject to date
• What is IT outsourcing (ITO)?
• ITO Mail Survey, 1999
• Why do organizations outsource IT?
• Dombergers benefit drivers
• Survey Reasons for benefits from IT
  outsourcing
• What are the keys to success with ITO?
• Summary

3
615-352 Managing the IT Function Webraft
4
Feeny Willcocks (1998) The Four Tasks of the
Emerging IT Function

• Demand
• Opportunity
• Strategy

Elicitation and Delivery of Business Requirements
IS/IT Governance Organisation
Ensuring Technical Ability
Managing External Supply

• Technology
• Integration
• Architecture

• Market Monitoring
• Supplier Relations
• Contracts

5
IS/IT Governance Organisation

• Demand
• Opportunity
• Strategy

Elicitation and Delivery of Business Require-ments

• Market Monitoring
• Supplier Relations
• Contracts

• Technology
• Integration
• Architecture

Managing External Supply
Ensuring Technical Ability
Managing Internal Service Delivery

• Human Resource and Skills Management
• Project and Change Management
• Software Development and Testing
• Building and Maintaining the IT Infrastructure
• Security and Business-Continuity Planning

6
615-352 Managing the IT Function
L02, L03, and L10
IS/IT Governance Organisation

• Demand
• Opportunity
• Strategy

L04, L06
Elicitation and Delivery of Business Require-ments
L09
L05

• Market Monitoring
• Supplier Relations
• Contracts

• Technology
• Integration
• Architecture

L11
Managing External Supply
Ensuring Technical Ability
Managing Internal Service Delivery

• Human Resource and Skills Management
• Project and Change Management
• Software Development and Testing
• Building and Maintaining the IT Infrastructure
• Security and Business-Continuity Planning

L07
L08
615-2405
615-237?
615-360
7
The Key Argument in this Subject IT
Management Matters
L03
L02
Organizational Learning (t)
L07
L09, L11
L08
L04
L05
L06
8
Possible structure of a number of exam questions

• Define the term xxx and discuss the importance
  of xxx to the management of the IT function in
  medium-to-large organizations. Where possible,
  illustrate your answer with examples, e.g., from
  the case studies discussed in class this year.
• xxx might be
• CIO L02, L10
• IT alignment L03
• IT evaluation L04
• IT archi infrastructure L05
• IT applic. Portfolio L06
• managing IT staff L07
• project management L08
• IT outsourcing L09, L11

9
Possible structure of a number of exam questions

• Define the terms xxx and yyy and discuss the
  way xxx affects yyy in the management of the IT
  function in medium-to-large organizations. Where
  possible, illustrate your answer with examples,
  e.g., from the case studies discussed in class
  this year.
• xxx and yyy might be
• CIO L02, L10
• IT alignment L03
• IT evaluation L04
• IT archi infrastructure L05
• IT applic. Portfolio L06
• managing IT staff L07
• project management L08
• IT outsourcing L09, L11

10
615-352 Managing the IT Function
L02, L03, and L10
IS/IT Governance Organisation

• Demand
• Opportunity
• Strategy

L04, L06
Elicitation and Delivery of Business Require-ments
L09
L05

• Market Monitoring
• Supplier Relations
• Contracts

• Technology
• Integration
• Architecture

L11
Managing External Supply
Ensuring Technical Ability
Managing Internal Service Delivery

• Human Resource and Skills Management
• Project and Change Management
• Software Development and Testing
• Building and Maintaining the IT Infrastructure
• Security and Business-Continuity Planning

L07
L08
615-2405
615-237?
615-360
11
2. What is IT Outsourcing?

• Based on Loh and Venkatraman (1992 9) we may
  define IT outsourcing as
• A significant contribution by external vendors
  to the management and provision of physical
  and/or human resources associated with the
  organizations ICT function and services. This
  does not include use of contract ICT staff nor
  the cost of purchasing packaged software.
• Loh, L. and Venkatraman, N (1992). Determinants
  of information technology outsourcing A
  cross-sectional analysis, Journal of Management
  Information Systems, 9, 1, pp. 7-25.
• ICT Information and Communications Technology

12
What is IT Outsourcing?

• Domberger The Contracting Organization (1998
  12)
• Contracting refers to the design and
  implementation of contractual relationships
  between purchasers and suppliers.
• Outsourcing refers to the process whereby
  activities traditionally carried out internally
  are contracted out to external providers.
• In this book the term contracting will be used
  in a generic way to describe both the process of
  outsourcingthe search for and appointment of
  contractors for the provision of goods and
  servicesand the execution of the contractual
  relations needed to support such activities.

13
3. ITO Mail survey, Australia, Late 1999

• Research team consisting of Willcocks, Cullen,
  Rouse, Reilly and Seddon
• Questions were a synthesis of Qs from Lacity and
  Willcocks (2000) and Cullen (1994, 1997).
• Identified 500 largest organizations, by
  employment, and a 50 random sample from the next
  1000 largest organizations in Australia (private
  and government)
• November 1999 (near the height of the dot-com
  boom) sent 8-page questionnaire to the senior IT
  officer.
• We received 235 responses from 1,000
  questionnaires.

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What were firms outsourcing?
15
What were firms outsourcing?
16
4. Why do organizations outsource?

• Why is not all production carried out in one big
  firm? (Coase 1937)
• Answer
• Apparently, one large firm would be inefficient
  (otherwise we would have one, or a few, very
  large firms).
• There are costs associated with planning and
  coordinating activity within firms.
• There are also (different) costs associated with
  planning and coordinating activity through
  markets.
• The surviving organizations we see today
  presumably semi-optimize the tradeoffs between
  both types of cost.

17
The tradeoff between market-based and firm-based
coordination costs
Market High market search, contracting,
enforcement, etc. costs
Firm High planning, agency, coordination,
information, etc. costs

Organization size
18
For IT, it is not obvious where the right balance
between insourcing and outsourcing lies. Example

• Insourcing? JPMorgan Reverses Outsourcing Deal
  With IBM Sept. 15, 2004
• The financial-services powerhouse is taking back
  about 4,000 employees and contractors from IBM.
  By Associated Press
• NEW YORK (AP) -- JPMorgan Chase Co. plans to
  undo a technology outsourcing deal with
  International Business Machines Corp., taking
  back about 4,000 employees and contractors from
  the computer giant.
• The bank's technology operations, including data
  centers, help desks, and telephone networks were
  fully outsourced to IBM in April 2003.
• The seven-year deal was valued at 5 billion when
  it was signed in December 2002, making it one of
  the largest outsourcing contracts ever.
• In a press release Wednesday, JPMorgan Chase said
  it will begin to transfer the workers back to the
  company in January.

http//www.informationweek.com/showArticle.jhtml?a
rticleID47208432
19
(No Transcript)
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Why might JPMorganChase outsource its IT service
provision to IBM?

• JPMorganChase (JPMC)
• makes money by offering banking, financial,
  securities and investment services.
• Although IT is critical to its service delivery,
  IT is not its core competence.
• IBM
• core competence is IT.
• with over 320,000 employees in 2003, has much
  more strength in IT service provision than JPMC.
• can buy IT cheaper, and is less likely to make
  poor technology investment decisions.

21
Why might JPMorganChase reverse its decision to
outsource IT services?

• If it outsources, JPMC will incur contract
  management costs of approx. 5 of annual contract
  value to manage the relationship from their side.
  
• JPMCs contract managers goal will be to keep
  costs down and service levels up.
• IBM has to make a profit (say 10 of revenue), in
  what is a notoriously low-margin business.
• IBMs managers will be trying to push its profits
  (i.e., JPMCs costs) up as high as possible.
• Therefore, IBM has to be able to deliver services
  comparable to in-house service provision at a
  roughly 15 lower cost than JPMC if both parties
  are to be better off.

22
Why might JPMorganChase reverse its decision to
outsource IT services?

• Given the high risk of IT project failure and
  poor IT investment decisions, mainly due to lack
  of detailed knowledge, 15 savings may be
  possible.
• Much depends on good IT management by IBM!
• How much more skillful are IBM employees compared
  to JPMCs 4,000 staff?
• JPMorganChases decision to reverse their 7-year,
  5 billion outsourcing deal signed two years ago
  shows how marginal the economics of many
  outsourcing decisions is (at least for
  outsourcing within one country, where wage costs
  for similar skills may be presumed to be
  similar).

23
5. Domberger sample of publications, strong
economic flavor, little on IT outsourcing

• 1986 Domberger, S., Meadowcroft, S.A., and
  Thompson, D.J., Competitive Tendering and
  Efficiency The case of refuse collection. Fiscal
  Studies 7(4) November 69-87.
• 1987 ____ , The impact of competitive tendering
  on the costs of hospital domestic services.
  Fiscal Studies 8(4) 39-54.
• 1995 Domberger, S., Hall, C., and Li, E., The
  determinants of quality in competitively tendered
  contracts. Economic Journal 105 1454-70.
• 1997 Domberger, S. and Jensen, P.H. Contracting
  out by the Public Sector Theory, Evidence,
  Prospects, Oxford Review of Economic Policy,
  13(4) 67-78.
• 1998 Domberger, S.,The Contracting Organization
  A Strategic Guide to Outsourcing. Oxford
  University Press
• 2000 Domberger, S., Fernandez, P., and Fiebig,
  D.G., Modelling the price, performance and
  contract characteristics of IT outsourcing,
  Journal of Information Technology, 15(2) June
  107-118. (cites the 1998 book)

24
Domberger (1998 51) Drivers of Benefits from
Contracting
25
Dombergers Benefit 1 Specialization

• Specialization yields demonstrable economic
  benefits. By concentrating on activities in which
  an organization is relatively more efficient,
  total value added is maximized. It also
  facilitates the exploitation of scale economies.
  (1998 51)
• Translation to purchaser of IT Outsourcing
• The purchaser sees benefits from concentration on
  its own core business in terms of increased
  profitability, through cost efficiencies and
  revenue gains.
• The purchaser will have access to expert
  knowledge and skills, a particular benefit for
  smaller organizations. Such access can lead to
  improved IT services, and cost savings to the
  vendor that may be passed on to the purchaser to
  more or less degree.
• The purchaser will see cost savings if the vendor
  gains from specialization AND competition
  motivates vendor to share those benefits.

26
DECEMBER 8, 1998 ATT to Acquire IBM's Global
Network Business for 5 Billion

• NEW YORK ATT and IBM today announced a series
  of strategic agreements under which ATT will
  acquire IBM's Global Network business for 5
  billion in cash, and the two companies will enter
  into outsourcing contracts with each other. IBM
  will outsource a significant portion of its
  global networking needs to ATT. ATT will
  outsource certain applications processing and
  data center management operations to IBM. The
  transactions could represent 2.5 billion in
  additional revenue to ATT in the first full year
  of operation.

IBMs CEO Gerstner explained that he expected
ATT to do a better job managing its network than
IBM could do itself "We are delighted that
ATT will be the new home for our Global Network
operation. "With this agreement, the network
will receive the management focus and resources
necessary to maintain its standing as a
world-class provider of connectivity to IBM and
millions of customers.
27
Dombergers Benefit 2 Market Discipline

• Market discipline provides a range of
  benefits, namely, focus by the purchaser on
  outputs not inputs, competition (contestability)
  between suppliers, choices by purchasers, and
  innovative work practices. (1998 51)
• Translation to purchaser of IT Outsourcing
• Competitive pressure is crucial to achieving cost
  savings without a drop in quality of service.
• 'As a rule, efficiency gains need not lead to
  lower quality' (Domberger 1998).
• Clearer definition of services the purchaser
  requires can result in less wasted effort.
• Competitive pressure motivates the vendor to
  innovate.

28
Telstra Selects EDS For Major Outsourcing
Contract For Billing and Shared Services

• FOR RELEASE Thursday, March 1, 2001
• Australias Largest Telco Set To Reduce Costs,
  Increase Speed-to-Market and Improve Delivery
  Quality
• MELBOURNE, Australia -- Telstra, Australias
  largest telecommunications company, has awarded
  EDS a major five-year contract worth
  approximately US 300 million (AUD 500 million)
  to provide software maintenance and development
  for its billing functions and shared services.
• This alignment with EDS will allow Telstra to
  significantly reduce IT costs through process
  efficiency, increase our speed-to-market for
  infrastructure and solutions that support
  customer initiatives and improve quality of
  information and delivery, Dwight King, Telstras
  managing director of business and wholesale,
  said. We are confident this relationship will
  contribute to the long-term success of both
  companies.

Benefits Specialization, Cost savings
29
The Telstra deal shows the importance of Market
discipline and contestability

• The contract itself is not remarkable. What is
  interesting is that Telstra decided to award the
  contract to EDS when it is a 26 shareholder in a
  major competitor of EDS, namely IBM Global
  Services Australia (GSA) (IBM 1997).
• Because of concerns that they were being
  overcharged by IBM GSA, Telstra decided to test
  the market by requesting tender proposals for the
  services above.
• Despite board-level protests from IBM GSA, EDS
  won the contract.

30
Dombergers Benefit 3 Flexibility

• Networks of small organizations linked to
  their clients via contract can adjust more
  quickly and at lower cost to changing demand
  conditions compared to integrated organizations.
  (1998 51)
• Translation to purchaser of IT Outsourcing
• The purchaser will find it easier to add and
  change vendors than to build and maintain
  services in-house.
• Such flexibility can result in considerable
  future cost savings.
• Contracting out can provide scale and scope
  numerical, functional and financial
  flexibilities.
• For the IT industry, switching costs are high
  (Lacity Willcocks 2001).

31
Dombergers Benefit 4 Cost Saving (Access to
lower-cost resources)

• International studies show that significant
  cost savings are achieved by contracting, on
  average of the order of 20. As a rule,
  efficiency gains need not lead to lower quality.
  (1998 51)
• Translation to purchaser of IT Outsourcing
• In various contracts he studied, Domberger found
  that contracting out achieved cost savings
  averaging 20.
• Because of changing needs and technologies over
  the life of the contract, cost savings are
  notoriously hard to measure (Seddon 2001, based
  on data from the Aust. National Audit Office).
• So-called offshore outsourcingitself enabled
  by now relatively low ICT costsallows firms in
  high-wage countries to access labour in firms in
  low-wage countries. Despite potentially higher
  management costs, and cultural difficulties, this
  may still represent an attractive source of cost
  savings.

32
6. ITO Survey, 1999 Reasons for IT Outsourcing
33
ITO Survey, 1999 Outcomes from IT Outsourcing
34
Overall, our organization is satisfied with the
benefits from outsourcing (strongly
disagree..agree)
35
7. Keys to success with ITO

• Received wisdom
• Selective sourcing is better
• Only outsource non-core activities
• Relationship management
• IT function should retain nine core competencies

36
Rule 1 Selective outsourcing is better?

• Lacity and Willcocks (2001) and Sambamurthy et
  al. (2001) suggest that selective outsourcing
  is more likely to be successful than total
  outsourcing. (Total outsourcing is where 80 or
  more of the annual IT budget is outsourced to a
  single supplier.)
• The underlying argument appears to be that
  different suppliers have different core
  competencies (e.g., some are better than others
  for managing networks, datacenter, software
  development, desktops, helpdesks, and so on).
• So despite the additional management overhead
  for the client in having to manage multiple
  contracts and relationships, it is better to
  source IT services from multiple suppliers.
  (Also, spreads risk)

37
Evidence Lacity and Willcocks (2001 p.156)
Interviewed 271 people about 116 sourcing
decisions in 76 organizations in a wide range of
industries. 102 decisions had discernable
outcomes. Data http//www.umsl.edu/lacity/cases.
htm
Other factors, e.g., world wide learning?
38
Our ITO survey 1999 data Satisfaction vs of IT
budget outsourced (n191)
191 responses
39
Conclusion on Rule 1 Selective outsourcing is
better

• The evidence is very mixed!

40
Rule 2 Only outsource non-core/non-strategic
activities?

• Google outsourcing non-core 50,500 hits (21
  Sep 2004)
• e.g., Accenture (2002, discussing support
  functions for the Utilities industry)
• The key challenge is to identify what is core,
  and therefore must stay in-house, and what is
  non-core and can be outsourced to specialists.
• Accenture defines business transformation
  outsourcing as a programme to change the way a
  company works by using outsourcing to achieve a
  rapid, sustainable, radical improvement in
  performance across the entire enterprise.
• http//www.accenture.com/xdoc/en/industries/resou
  rces/utilities/outsourcing.pdf

41
What is a core competence?

• What does core mean?
• Is it what we have always done?
• What does non-core mean?
• What are Dells core competencies?
• Is the IT function core or non-core to an
  organization like Royal Caribbean, Cisco, or
  Zara?

42
The idea of non-core/non-strategic activities
seems to come from Hamel and Prahalad, 1994

• A competence is a bundle of skills and
  technologies rather than a single discrete skill
  or technology. (Hamel and Prahalad, p.223)
• The core competence Federal Express possesses in
  package routing and delivery rests on the
  integration of bar-code technology, wireless
  communications, network management, and linear
  programming to name a few. It is this
  integration that is the hallmark of a core
  competence. (Hamel and Prahalad, p.223)
• A core competence is, most decidedly, a source
  of competitive advantage in that it is
  competitively unique and makes a contribution to
  customer value or cost. (Hamel and Prahalad,
  p.229).
• (Hamel and Prahalad, Competing for the Future,
  Harvard, 1994, p.232)

43
The idea of non-core/non-strategic activities
seems to come from Hamel and Prahalad, 1994

• Core competencies are valuable, rare, costly to
  imitate, and non-substitutable.
• Decisions on what to own and what to outsource
  are aided by a deep understanding of what is and
  isnt a core competence.
• (Hamel and Prahalad, Competing for the Future,
  Harvard, 1994, p.232)
• PBS The idea that outsourcing should be guided
  by identification of core competencies seems to
  be based on logic, not evidence Why outsource
  the very parts of ones organization that
  distinguish it from others?
• PBS Although Hamel and Prahalad make the above
  strong claim, and although it is much repeated in
  industry publications, I can find no empirical
  evidence that only non-core activities should be
  outsourced.

44
Rule 2 Only outsource non-core/non-strategic
activities?

• Conclusion Rule 2 is much-advocated, but
  definitions of core competence are often
  confused (see below), and the evidence to support
  Rule 2 is not clear.
• In the U.K., banks are adapting to the
  competitive landscape by outsourcing cash
  management and payments, processes once
  considered core. While these functions are
  integral to banking, they do not represent a
  distinctive competitive asset. Similarly, banks
  in North America have begun to outsource a range
  of functions formerly considered fundamental. The
  Bank of Americas decision to outsource human
  resources and accounts payable, for example, did
  not diminish the banks profile at all.

http//www.accenture.com/xdoc/en/industries/financ
ial/point19/ThePoint_19_SV_final.pdf
45
Conclusion on Rule 2 Only outsource
non-core/non-strategic activities?

• Rule 2 may be true, and it makes sense to retain
  competencies that lead to competitive advantage,
  but I cannot find evidence to support it.
• What are the core competencies of a government
  department?

46
Rule 3 Good relationships is a key success
factor.

• Alborz Quality of Relationship
• Communication
• Commitment to building and sustaining the
  relationship
• Cooperative
• Trust
• Listens
• Participates in planning and goal setting
• Conflict resolution
• Personal bonds
• Shares information including critical and
  strategic
• Is flexible to changes in other partys needs
• Success Today, from our point of view, the IT
  outsourcing arrangement is successful.

47
Alborz (2004) Quality of Relationship vs
Perceived ITO Success
(Is this general? Data from only 4
client-supplier pairs)
48
Conclusion on Rule 3 Good relationships is a key
success factor.

• Yes, good relationships seem to matter.

49
Rule 4 The in-house group should consist of a
team of relatively few high-performing
individuals with distinctive capabilities
BUSINESS and I.T. VISION
Note Project Management is assumed to be an
organization-wide capability.
Business Systems Thinking
Relationship Building
Leadership
Architecture Planning
Making Technology Work
DESIGN of I.T. ARCHITECTURE
DELIVERY of I.T. SERVICES
50
Conclusion on Rule 4 Nine core capabilities

• Rule 4 is concerned with IT management generally,
  not just outsourcing.
• Working with Commonwealth Bank in Australia and
  DuPont in the US, Willcocks says the evidence
  supporting rule 4 is clear.
• It would be nice to have more data, from more
  organizations.

51
Conclusions Does the evidence support the keys
to ITO success?
?

• Selective sourcing is better
• Only outsource non-core activities
• Relationship management
• IT function should retain nine core capabilities

?
?
?
52
Summary (Lecture 9)

• IT outsourcing is a widely-used management
  technique
• To be successful, the vendor must be able to
  provide similar quality (or better) services for
  approximately 15 lower cost. (This should be
  easy for offshore outsourcing, where labour
  costs are much lower.)
• Benefit drivers are specialization, market
  discipline, flexibility and lower-cost resources.
• Keys to success with ITO are not clear. Claimed
  keys include (a) selective sourcing, (b)
  outsourcing non-core services, (c) good
  relationships, and (d) retaining nine core
  competencies. But there is little evidence to
  support (a) and (b).

53
Next two lectures

• Week 10 Guest lecture from the CIO of a major
  Australian company, PaperLinx.
• Week after that (Week 11)
• Look at research from Sara Cullen and Shawn Aborz
  (PhD students at The University of Melbourne)
  that may help us understand IT outsourcing better.