An Introduction to the Outsourcing and Offshoring Landscape

1
An Introduction to the Outsourcing and Offshoring
Landscape
2
Origins of Outsourcing
3
Origins of Outsourcing
Early American History
The production of wagon covers
Was outsourced to Scottish Manufacturers
Who used raw material imported from India
4
Origins of Outsourcing
Manufacturing Organizations

• Outsourcing remained popular in manufacturing
  with part of the assembling being subcontracted
  to other organizations and locations where the
  work could be done more efficiently and cheaply

• Pastin and Harrison (1974) wrote that such
  outsourcing was creating a new form of
  organization which the termed the Hollow
  Corporation

(An organization that designs and distributes,
but does not produce anything)

• Now Virtual Organizations

The worlds largest supplier of
telecommunications product manufacturer of none
5
Origins of Outsourcing
IS/IT Outsourcing

• In the early 1960s Electronic Data Systems (EDS)
  in Dallas, Texas, approached large corporations
  to get them to outsource their data processing
  services. for his data processing services.

• Perot was refused 77 times before he got his
  first contract

• EDS received lucrative contracts from the U.S.
  government in 1963, computerizing Medicare
  records.

• EDS went public in 1968 and the stock price shot
  up from 16 a share to 160 within days.

• In 1984 General Motors bought controlling
  interest in EDS for 2.4 billion.

6
Origins of Outsourcing
IS/IT Outsourcing

• On Oct 2, 1989, Eastman Kodak announced that it
  was outsourcing its information systems (IS)
  function 1989 to IBM (IBM Global Services' first
  customer)

• That year, the head of IT at KODAK was named
  information chief of the year by CIO Magazine.

• Eastman Kodaks decision to outsource the
  information technology systems that undergird its
  business was considered revolutionary in 1989,
  but it was actually the result of rethinking what
  their business was about.

• "She led Kodak to what was a counterintuitive
  move for the time She showed that running data
  centers was no more a core competency of Kodak's
  than running a power plant would be," says F.
  Warren McFarlan, senior associate dean and
  professor in the Advanced Management Program at
  the Harvard Business School.

• While Kodak signed on with IBM to outsource its
  mainframe data management, Kodak chose to
  outsource the provisioning of its PC purchases to
  desktop systems-integration firm Businessland
  Inc. and its network operations to Digital
  Equipment Corp.

• IBM has since taken over Digital's role and now
  provides direct PC sales to Kodak as well.

7
Outsourcing Today (These figures are dated)

• 2003 178 Billion

• 2007 235 Billion

• 2008 261 Billion

• IT outsourcing is estimated to be 67 of all
  outsourcing deals

8
Basic Terminology

• Outsourcing

• Delegation of non-core operations from internal
  production to an external entity. Sharing
  organizational control.

• Offshoring

• Transferring Activities to another country by
  hiring local subcontractors or by building a
  facility in an area where labor is cheap(er).

The globalization of outsourcing operating models
has resulted in new terms

• Nearsourcing

• Offshore to a nearby country where language and
  cultural differences are smaller

• Rightsourcing

• Restructuring a company's workforce to find the
  optimum mix of jobs performed locally and jobs
  moved to foreign countries

Related terms

• Insourcing

• Keeping Operations in-house

• Backsourcing

• Returning outsourced operation to in-house
  operations

• Best Sourcing

• Associating with the best of the best (Tom
  Peters)

• Multisourcing

• large outsourcing agreements

9
Outsourcing is .

• A free market thing
• A Special form of international trade (CES IFO
  Institute ,Germany)
• A matter of polarized public debate (European
  Foundation for ILWC,2004)
• About your core
• A question of trust
• Unevenly dispersed on the globe (yet growing)
• Generating fear (fear of change?- Cochrane,2004)
• A relationship and arrangement
• Partner quality
• Subject to areas of high attrition ? (ex-Call
  centers)

10
Reasons for Outsourcing

• Every Morning in Africa, a gazelle wakes up.
• It knows it must run faster than the fastest lion
  
• or it will be killed.
• Every morning a lion wakes up.
• It knows it must outrun the slowest gazelle
• or it will starve to death.
• It doesnt matter whether you are a lion or a
  gazelle
• When the sun comes up,
• YOU BETTER START RUNNING!
• African Proverb

11
Reasons for Outsourcing

• Cost savings. The lowering of the overall cost of
  the service to the business. This will involve
  reducing the scope, defining quality levels,
  re-pricing, re-negotiation, cost re-structuring.
  Access to lower cost economies through offshoring
  called "labor arbitrage" generated by the wage
  gap between industrialized and developing nations.

• Focus on Core Business. Resources (e.g.,
  investment, people, infrastructure) are focused
  on developing the core business. For example
  often organizations outsource their IT support to
  specialized IT services companies.

• Cost restructuring. Operating leverage is a
  measure that compares fixed costs to variable
  costs. Outsourcing changes the balance of this
  ratio by offering a move from fixed to variable
  cost and also by making variable costs more
  predictable.

• Improve quality. Achieve a step change in quality
  through contracting out the service with a new
  service level agreement.

• Knowledge. Access to intellectual property and
  wider experience and knowledge.

• Contract. Services will be provided to a legally
  binding contract with financial penalties and
  legal redress. This is not the case with internal
  services

• Operational expertise. Access to operational best
  practice that would be too difficult or time
  consuming to develop in-house.

Some of this is taken from Wikipedia NOT
necessarily reliable
12
Reasons for Outsourcing

• Capacity management. An improved method of
  capacity management of services and technology
  where the risk in providing the excess capacity
  is borne by the supplier.

• Catalyst for change. An organization can use an
  outsourcing agreement as a catalyst for major
  step change that can not be achieved alone. The
  outsourcer becomes a Change agent in the process.

• Enhance capacity for innovation. Companies
  increasingly use external knowledge service
  providers to supplement limited in-house capacity
  for product innovation

• Reduce time to market. The acceleration of the
  development or production of a product through
  the additional capability brought by the supplier.

• Commodification. The trend of standardizing
  business processes, IT Services, and application
  services which enable to buy at the right price,
  allows businesses access to services which were
  only available to large corporations

• Operational expertise. Access to operational best
  practice that would be too difficult or time
  consuming to develop in-house.

13
Reasons for Outsourcing

• Risk management. An approach to risk management
  for some types of risks is to partner with an
  outsourcer who is better able to provide the
  mitigation

• Venture Capital. Some countries match government
  funds venture capital with private venture
  capital for startups that start businesses in
  their country.

• Tax Benefit. Countries offer tax incentives to
  move manufacturing operations to counter high
  corporate taxes within another country.

• Scalability. The outsourced company will usually
  be prepared to manage a temporary or permanent
  increase or decrease in production.

• Access to talent. Access to a larger talent pool
  and a sustainable source of skills, in particular
  in science and engineering.

• India has over 2,100,000 English-speaking
  graduates added annually and 460,000 of them are
  IT grads.

• China has over 200,000 IT professionals and
  50,000 new graduates are added to the pool every
  year.

• China produces 52 of all Science and Engineering
  graduates

• Work Attitudes

In China today, Bill Gates is Britney Spears.
In America today, Britney Spears is Britney
Spears and that is our problem. Thomas
Friedman
14
Criticisms of outsourcing
Loss of Jobs

• A University of California Study that estimates
  14 million U.S. white collar jobs - one in nine -
  are at risk.

• A 2004 report by Forrester Research suggests that
  a total of 3.4 million U.S. white collar jobs
  will move overseas by 2015, with 830,000 jobs
  leaving by the end of 2005.

• A Progressive Policy Institute report claims 12
  million jobs are vulnerable, with most paying
  more than the U.S. median wage.

15
Criticisms of outsourcing
Loss of Control

• "I've had people approach me and offer to save us
  money by consolidating our technical support,"
  said Monad.net President George Scott. "But I
  think technical support is a major competitive
  advantage. I therefore want control of that -- I
  don't want to give it away."

• "Everyone knows that differentiation is the key
  in the ISP business, and this also goes for
  dealing with the pressures of handling technical
  support," said the operations manager of a
  Massachusetts ISP. "No ISP is happy with the fact
  that they have to handle so many calls from
  customers who are not adept with their PCs, but
  we understand that handing them over to a third
  party is the wrong business move."

16
Criticisms of outsourcing
Quality Risks

• Quality Risk is the propensity for a product or
  service to be defective, due to
  operations-related issues. Quality risk in
  outsourcing is driven by a list of factors. One
  such factor is opportunism by suppliers due to
  misaligned incentives between buyer and supplier,
  information asymmetry, high asset specificity, or
  high supplier switching costs. Other factors
  contributing to quality risk in outsourcing are
  poor buyer-supplier communication, lack of
  supplier capabilities/resources/capacity, or
  buyer-supplier contract enforceability.

Quality of service

• Quality of service is measured through a service
  level agreement (SLA) in the outsourcing
  contract. In poorly defined contracts there is no
  measure of quality or SLA defined. Even when an
  SLA exists it may not be to the same level as
  previously enjoyed. This may be due to the
  process of implementing proper objective
  measurement and reporting which is being done for
  the first time. It may also be lower quality
  through design to match the lower price. There
  are a number of stakeholders who are affected and
  there is no single view of quality. The CEO may
  view the lower quality acceptable to meet the
  business needs at the right price. The retained
  management team may view quality as slipping
  compared to what they previously achieved. The
  end consumer of the service may also receive a
  change in service that is within agreed SLAs but
  is still perceived as inadequate. The supplier
  may view quality in purely meeting the defined
  SLAs regardless of perception or ability to do
  better.

17
Criticisms of outsourcing
Language skills

• In the area of call centers end-user-experience
  is deemed to be of lower quality when a service
  is outsourced. This is exacerbated when
  outsourcing is combined with off-shoring to
  regions where the first language and culture are
  different. In addition to language and accent
  differences, a lack of local social and
  geographic knowledge is often present, leading to
  misunderstandings or miscommunications

Public opinion

• There is a strong public opinion regarding
  outsourcing (especially when combined with
  offshoring) that outsourcing damages a local
  labor market. Outsourcing is the transfer of the
  delivery of services which affects both jobs and
  individuals. It is difficult to dispute that
  outsourcing has a detrimental effect on
  individuals who face job disruption and
  employment insecurity however, its supporters
  believe that outsourcing should bring down
  prices, providing greater economic benefit to
  all. There are legal protections in the European
  Union regulations called the Transfer of
  Undertakings (Protection of Employment). Labor
  laws in the United States are not as protective
  as those in the European Union.

Staff turnover

• The staff turnover of employee who originally
  transferred to the outsourcer is a concern for
  many companies. Turnover is higher under an
  outsourcer and key company skills may be lost
  with retention outside of the control of the
  company. In outsourcing offshore there is an
  issue of staff turnover in the outsourcer
  companies call centers. It is quite normal for
  such companies to replace its entire workforce
  each year in a call center. This inhibits the
  build-up of employee knowledge and keeps quality
  at a low level.

18
Criticisms of outsourcing
Social responsibility

• Outsourcing sends jobs to the lower-income areas
  where work is being outsourced to, which provides
  jobs in these areas and has a net equalizing
  effect on the overall distribution of wealth.
  Some argue that the outsourcing of jobs
  (particularly off-shore) exploits the lower paid
  workers. A contrary view is that more people are
  employed and benefit from paid work. Despite this
  argument, domestic workers displaced by such
  equalization are proportionately unable to
  outsource their own costs of housing, food and
  transportation.
• On the issue of high-skilled labor, such as
  computer programming, some argue that it is
  unfair to both the local and off-shore
  programmers to outsource the work simply because
  the foreign pay rate is lower. On the other hand,
  one can argue that paying the higher-rate for
  local programmers is wasteful, or charity, or
  simply overpayment. If the end goal of buyers is
  to pay less for what they buy, and for sellers it
  is to get a higher price for what they sell,
  there is nothing automatically unethical about
  choosing the cheaper of two products, services,
  or employees.
• Social responsibility is also reflected in the
  costs of benefits provided to workers. Companies
  outsourcing jobs effectively transfer the cost of
  retirement and medical benefits to the countries
  where the services are outsourced. This
  represents a significant reduction in total cost
  of labor for the outsourcing company. A side
  effect of this trend is the reduction in salaries
  and benefits at home in the occupations most
  directly impacted by outsourcing.

19
Criticisms of outsourcing
Company knowledge

• Outsourcing could lead to communication problems
  with transferred employees. For example, before
  transfer staff have access to broadcast company
  e-mail informing them of new products, procedures
  etc. Once in the outsourcing organization the
  same access may not be available. Also to reduce
  costs, some outsource employees may not have
  access to e-mail, but any information which is
  new is delivered in team meetings.

Qualifications of outsourcers

• The outsourcer may replace staff with less
  qualified people or with people with different
  non-equivalent qualifications. In the engineering
  discipline there has been a debate about the
  number of engineers being produced by the major
  economies of the United States, India and China.
  The argument centers around the definition of an
  engineering graduate and also disputed numbers.
  The closest comparable numbers of annual
  graduates of four-year degrees are United States
  (137,437) India (112,000) and China (351,537)

Failure to deliver business transformation

• Business transformation promised by outsourcing
  suppliers often fails to materialize. In a
  commoditised market where many service providers
  can offer savings of time and money, smart
  vendors have promised a second wave of benefits
  that will improve the clients business outcomes.
  According to Vinay Couto of Booz Company
  Clients always use the service providers
  ability to achieve transformation as a key
  selection criterion. Its always in the top three
  and sometimes number one. While failure is
  sometimes attributed to vendors overstating their
  capabilities, Couto points out that clients are
  sometimes unwilling to invest in transformation
  once an outsourcing contract is in place

20
Criticisms of outsourcing
Productivity

• Offshore outsourcing for the purpose of saving
  cost can often have a negative influence on the
  real productivity of a company. Rather than
  investing in technology to improve productivity,
  companies gain non-real productivity by hiring
  fewer people locally and outsourcing work to less
  productive facilities offshore that appear to be
  more productive simply because the workers are
  paid less. Sometimes, this can lead to strange
  contradictions where workers in a developing
  country using hand tools can appear to be more
  productive than a U.S. worker using advanced
  computer controlled machine tools, simply because
  their salary appears to be less in terms of U.S.
  dollars. In contrast, increases in real
  productivity are the result of more productive
  tools or methods of operating that make it
  possible for a worker to do more work. Non-real
  productivity gains are the result of shifting
  work to lower paid workers, often without regards
  to real productivity. The net result of choosing
  non-real over real productivity gain is that the
  company falls behind and obsoletes itself
  overtime rather than making investments in real
  productivity.

Security

• Before outsourcing an organization is responsible
  for the actions of all their staff and liable for
  their actions. When these same people are
  transferred to an outsourcer they may not change
  desk but their legal status has changed. They
  no-longer are directly employed or responsible to
  the organization. This causes legal, security and
  compliance issues that need to be addressed
  through the contract between the client and the
  suppliers. This is one of the most complex areas
  of outsourcing and requires a specialist third
  party adviser.

21
Criticisms of outsourcing
Security (continued)

• Fraud is a specific security issue that is
  criminal activity whether it is by employees or
  the supplier staff. However, it can be disputed
  that the fraud is more likely when outsourcers
  are involved, for example credit card theft when
  there is scope for fraud by credit card cloning.
  In April 2005, a high-profile case involving the
  theft of 350,000 from four Citibank customers
  occurred when call center workers acquired the
  passwords to customer accounts and transferred
  the money to their own accounts opened under
  fictitious names. Citibank did not find out about
  the problem until the American customers noticed
  discrepancies with their accounts and notified
  the bank.

Standpoint of labor

• From the standpoint of labor within countries on
  the negative end of outsourcing this may
  represent a new threat, contributing to rampant
  worker insecurity, and reflective of the general
  process of globalization. While the "outsourcing"
  process may provide benefits to less developed
  countries or global society as a whole, in some
  form and to some degree - include rising wages or
  increasing standards of living - these benefits
  are not secure. Further, the term outsourcing is
  also used to describe a process by which an
  internal department, equipment as well as
  personnel, is sold to a service provider, who may
  retain the workforce on worse conditions or
  discharge them in the short term. The affected
  workers thus often feel they are being "sold down
  the river."

22
Criticisms of outsourcing
Hidden Costs

• The Cost of Managing an Offshore Contract

• "There's a significant amount of work in
  invoicing, in auditing, in ensuring cost centers
  are charged correctly, in making sure time is
  properly recorded," explains DHL's Kifer. "We
  have as many as 100 projects a year, all with an
  offshore component, so you can imagine the number
  of invoices and time sheets that have to be
  audited on any given day."

• We knew there would be invoicing and auditing,"
  he says. "But we didn't fully appreciate the due
  diligence and time it would require."

• Bottom line Expect to pay an additional 6
  percent to 10 percent on managing your offshore
  contract

23
Criticisms of outsourcing
Hidden Costs

• The Cost of Managing an Offshore Contract

• "There's a significant amount of work in
  invoicing, in auditing, in ensuring cost centers
  are charged correctly, in making sure time is
  properly recorded," explains DHL's Kifer. "We
  have as many as 100 projects a year, all with an
  offshore component, so you can imagine the number
  of invoices and time sheets that have to be
  audited on any given day."

• We knew there would be invoicing and auditing,"
  he says. "But we didn't fully appreciate the due
  diligence and time it would require."

• Bottom line Expect to pay an additional 6
  percent to 10 percent on managing your offshore
  contract

24
Criticisms of outsourcing
Hidden Costs

• The Cost of Selecting a Vendor

• With any outsourced service, the expense of
  selecting a service provider can cost from .2
  percent to 2 percent in addition to the annual
  cost of the deal. In other words, if you're
  sending 10 million worth of work to India,
  selecting a vendor could cost you anywhere from
  20,000 to 200,000 each year.

• Some companies hire an outsourcing adviser for
  about the same cost as doing it themselves. To
  top it off, the entire process can take from six
  months to a year, depending on the nature of the
  relationship.

• Bottom line Expect to spend an additional 1
  percent to 10 percent on vendor selection and
  initial travel costs.

• Source The Hidden Costs of Offshore Outsourcing.
  Sep. 1, 2003 Issue of CIO Magazine

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Criticisms of outsourcing
Hidden Costs

• The Cost of Transition

• The transition period is perhaps the most
  expensive stage of an offshore endeavor. It takes
  from three months to a full year to completely
  hand the work over to an offshore partner. If
  company executives aren't aware that there will
  be no savingsbut rather significant
  expensesduring this period, they are in for a
  nasty surprise..

• It took an awful lot of time to bridge the
  Pacific and getting that to work correctly,"
  remembers Textron Financial's Raspallo, who spent
  six months and 100,000 to set up a transoceanic
  data line with Infosys in 1998, It also cost an
  extra 10,000 a month to keep that network
  functional..

• Bottom Line Expect to spend an additional 2
  percent to 3 percent on transition costs.

• Source The Hidden Costs of Offshore Outsourcing.
  Sep. 1, 2003 Issue of CIO Magazine

26
Criticisms of outsourcing
Hidden Costs

• The Cost of Layoffs

• To begin with, you have to pay workers severance
  and retention bonuses. You need to keep employees
  there long enough to share their knowledge with
  their Indian replacements. People think if they
  give generous retention bonuses it will destroy
  the business proposition. They cut corners
  because they want quick payback. But then they
  lose the people that can help with the transition
  and incur the even bigger cost of not doing the
  transition right."..

• Bottom line Expect to pay an extra 3 percent to
  5 percent on layoffs and related costs.

• Source The Hidden Costs of Offshore Outsourcing.
  Sep. 1, 2003 Issue of CIO Magazine

27
Criticisms of outsourcing
Hidden Costs

• The Cultural Cost

• You simply cannot take a person sitting here in
  America and replace them with one offshore
  worker," GE Real Estate's Zupnick says. "Whether
  they're in India or Ireland or Israel

• a project that's common sense for a U.S.
  workerlike creating an automation system for
  consumer credit cardsmay be a foreign concept
  offshore.

• Bottom line Expect to spend an extra 3 percent
  to 27 percent on productivity lags.

• Source The Hidden Costs of Offshore Outsourcing.
  Sep. 1, 2003 Issue of CIO Magazine

28
Critical areas for a successful outsourcing
program

• Understanding company goals and objectives

• A strategic vision and plan

• Selecting the right vendor

• Ongoing management of the relationships

• A properly structured contract

• Open communication with affected individual/groups

• Senior executive support and involvement

• Careful attention to personnel issues

• Short-term financial justification

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The Pre-Outsourcing Process
Program Initiation

• At the start of any outsourcing program, there
  are a variety of ideas and opinions about the
  purpose and scope of the program, what the final
  result of the program will be, and how the
  program will be carried out. The Program
  Initiation Stage is concerned with taking these
  ideas and intentions and documenting them to form
  the basis of a draft contract.

Service Implementation

• Service Implementation covers the activities
  required to take these ideas and intentions and
  develop them into a formal, planned outsourcing
  program and to make the transition to the
  outsourced service.

• Specifically these activities are

• Defining the transition project

• Transferring staff

• Defining the Service Level Agreement (SLA)

• Defining service reporting

• Implementing and handing over the service

• Implementing service management procedures

• During the handover phase it is imperative that
  continuity of service is maintained at all times,
  that there is no reduction in the quality of the
  delivery and that timescales and deadlines are
  not compromised.

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The Pre-Outsourcing Process
Final Agreement

• The draft contract produced at the Initiation
  stage is generally amended during negotiations
  and the final Contract is produced on completion
  of the negotiation cycle.

Program Closure

• In order to gain maximum benefit, the program
  should go through a formal close down. There is
  no point in continuing to argue lost causes once
  irrevocable decisions have been taken. Staff and
  companies alike need to accept the new situation
  and move forward. However, there will be a lot of
  information generated during the life of the
  program, and this will have been stored with
  varying degrees of formality by the team members.
  This information needs to be formally filed away
  for future reference.

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Types of Sourcing Arrangements

• There are four fundamental parameters that
  determine the kind of outsourcing arrangement
  that a firm may enter into degree (total,
  selective, and none) mode (single vendor/client
  or multiple vendors/clients) ownership (totally
  owned by the company, partially owned, externally
  owned) and time frame (short term or long term).
  The combination of specific instances of these
  parameters yields different types of sourcing
  arrangements such as joint ventures, facilities
  sharing, and spin-offs.

Degree of   Ownership  
Outsourcing Internal Partial External
Total Spin-offs Joint Traditional Outsourcing
Selective (Wholly Owned Subsidiary) Venture Selective Outsourcing
None Insourcing / Backsourcing Facilities Sharing among multiple clients N/A
Dibbern, J. and Goles, T. and Hirschheim, R.
and Jayatilaka, B. (2004) "Information Systems
Outsourcing A Survey and Analysis of the
Literature In The DATA BASE for Advances in
Information Systems, Volume 34, Issue Number 4,
pp 6-102
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Stage model of IS outsourcing
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Course Organization
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