Background
Outsourcing is subcontracting a specific process, such as manufacturing or product design, to a third-party company that has expertise in performing the process. It involves the transfer of the management and/or day-to-day execution of an entire business function to the external third-party service provider on an ongoing basis. IT outsourcing, or Information Technology outsourcing, can be plainly described as the outsourcing of computer or Internet related work, such as programming or software development, to third-party companies that specialize in IT. It is the fastest growing area for outsourcing in the present day. Examples of IT outsourcing include contracting with an organization to operate a computer centre, support a telecommunications network, or staff a computer support help desk.
In the 1970s, IT executives adopted the idea of outsourcing as they began to supplement their IT staff with contractors and consultants. This eventually led to a trend where companies started outsourcing entire IT business units to organizations such as Accenture, Electronic Data Systems, and IBM, which undertook the operation of data centres and many other IT functions. As the use of outsourcing is rapidly increasing in the IT industry, large pools of experienced IT professionals are readily available throughout the whole world as IT professionals can do much of their work anywhere, on a company’s premises or many miles away in a foreign country.
According to an annual survey conducted by Ernst & Young, outsourcing is now used by 70% of European companies. The survey highlights that 70% of the respondents have already outsourced at least 1 function of their businesses, with 20% set to increase their level of outsourcing in the next 2 years, as more companies view it as a mean of gaining a competitive edge.
Why? Why is outsourcing so remarkably popular among companies these days? So much so that even Microsoft Corporation, the Colossus of the high-tech world, had outsourced its worldwide management and operation of their 16,000 computers and computer networks to Entex Information Services, Inc. Why do companies outsource their processes and functions to third-parties? There are several reasons attributed to this question. According to an annual executive survey conducted by The Outsourcing Institute, the top 10 reasons why companies outsource were namely to:
· Accelerate benefits of re-engineering. Re-engineering aims for histrionic improvements in critical measures of performance such as cost, quality, service and speed.
· Gain access to world class capabilities.
· Seek cash infusion.
· Redirect internal resources for other purposes.
· Function difficult to manage or out of control.
· Improve company focus.
· Make capital funds available.
· Reduce and control operating costs.
· Reduce risks.
· Resources are not available internally.
In earlier periods of outsourcing, cost savings or reduction were the most common reasons to outsource. However, in today’s context, organizations are turning towards more strategic drivers, focusing on carrying out core value-adding activities in-house where they can best utilize their own core competencies. Although it has its advocates, outsourcing is also often a subject of criticism and some of those issues will be covered later.
Chronology
1770s: Adam Smith, in his book ‘The Wealth of Nations’, formulates a theory of competitive advantage, extracting the notion of outsourcing as a mean to cut costs by hiring cheap labour in developing countries.
1960s: It became common to outsource IT functions that involve massive amounts of information, such as data processing, to external vendors, due to the high costs and physical storage requirements associated with computers, signifying the genesis of the trend to IT outsourcing.
1963: Electronic Data Systems signed an agreement with Blue Cross of Pennsylvania for the handling of its data-processing services. It was the first time a large company had turned over its entire data-processing department to a third party.
1970s: It became common for computer companies to export their payrolls to outside service providers for processing.
1980s: Outsourcing enters the business lexicon. Functions such as accounting services, payroll, billing and word processing all became outsourced work due to a widespread development of workstations, personal computers and LANs.
1985: The Internet became a well-established technology supporting a wide community of researchers and developers.
1989: Outsourcing became formally identified as a business strategy. Eastman Kodak made a revolutionary move for business that was seen as a watershed event as it decided to outsource its IT systems that underpinned its business.
1990s: Marked the shift to outsourcing mainframes, PCs, and telecommunications as outsourcing became very profitable with the advent of the World Wide Web. As organizations began to focus more on cost-saving measures, they started outsourcing non-core functions necessary to run a company but not specifically related to their core business.
1998: Outsourcing became a US$100 billion-per-year industry.
2003: The outsourcing industry accumulates US$298.5 billion in global revenues.
2004: Outsourcing became one of the topics of debate between candidates in the United States presidential election.
Legal & Ethical Issues
Many a times, business organizations face the dilemma of ethical decision making. It is said that "If a CIO says ‘I’ve never faced an ethical issue’, they’re not living in the real world." Ethical compliance in an organization presents a strong public image and also upholds the integrity and character of an organization. Some legal and ethical issues faced in IT outsourcing include:
· Legal perceptions in different countries. Legal perceptions are subjective from one nation to the other and the incertitude arisen when a dispute occurs would leave both parties in a fix. Association becomes easier to handle when parties have a legal and ethical obligation to comply with the agreement, with all due respect to international law.
· Compromise of customer data. Confidential information security is the core concern of outsourcing ethics. Cases have been reported that customer data were taken from customer databases by third-party vendors and offered for sale on the black market.
· Exploitation of wages. Economists have heavily debated the ethical issue regarding the exploitation of wages in less developed countries. Some find it unethical to lay off domestic staff in favour of the cheap labour available in countries such as India, just to save on costs of the organization.
· Poor working environment. Ethical concerns over poor working environment and exploitative HR polices suggest that workers may have been overworked and not receiving the salaries promised by their employers.
· Vendor reliability. Trust is one of the most important and significant aspect of an outsourcing relationship with the vendor. There have been cases whereby staff of the vendor’s organization stole trade secrets, undisclosed contracts and invaluable intellectual property of the client’s organization. It is important to weigh the dependability of an organization before outsourcing to them. Organizations that implement strict employee credibility measures directly imply how serious they are in promoting good outsourcing ethics.
Pitfalls & Problems
Outsourcing arrangements are often time-consuming and substantial amount of effort is needed ensure that expected outcomes are realized. It should not be perceived as an opportunity to push the responsibility of doing your work to some one else. Some issues that organizations face when outsourcing include the following:
· Deterioration in service quality. Most companies that outsource face a widespread concern about drops in service quality. With regards to offshoring, some begs the question whether services delivered from half-way across the globe by a set of people who are culturally different from the parent company meet quality expectations. Some organizations get buffed by "sweet talkers" and end up finding themselves facing employees that are not as well-trained and experienced as they were claimed to be.
· Cultural differences. The cultural differences between the two countries where the vendor and client companies operate in are often a cause for worry in an outsourcing venture. Concerns such as governmental issues, bribes and language barriers often arise for companies who engage in offshore outsourcing.
· Geographical distance. While an onsite employee can always inquire his manager or an analyst within the office, a small problem that arises in offshore outsourcing may cause a huge ruckus with a pandemonic result.
· Communication barriers. Communicating with people over long distances can be perilous and difficult, especially if English is not taught passively in the country. Asking every employee of the vendor’s organization to be fluent in English can be over demanding, but it is crucial that project managers and leaders have adequate communication and language skills. If the client organization does not establish good communication channels with the vendor, certain things may be misrepresented and things can go awry.
· Failure to meet cost reduction expectations. Many companies enter outsourcing without calculating the real costs of the enterprise, expecting it to provide a quick fix for their financial difficulties. Despite being an excellent alternative to trim the organization’s budget, that fact, in initial stages, savings will neither be instantaneous nor exaggeratingly dramatic. If one turned to outsource for the single reason to rescue a failing operation, he or she would likely be utterly disappointed.
· Poor Planning. Adhering to the word "poor", planning can lead to a disastrous array of problems that may have been avoided with a little forethought. The process of risk analysis can prove to be vital to avoiding mistakes such as outsourcing too early, selecting a less-than-optimal vendor and following an inefficient business model. Potential secondary shortcomings should also be thought through and laid out. A software developer from the United States once when to India in anticipation of the cheap labour available through outsourcing but instead found himself charged with huge tariffs by customs officials when his company tried to ship the necessary development software and manuals.
Possible Courses of Action
Like any organization decision, outsourcing is not immune to risks and requires effective management from the outset of the outsourcing evaluation through the life of the contractual relationship with a vendor. There are fifteen critically important factors for a successful outsourcing and they are as followed:
1. Define the objectives.
Outsourcing must be done carefully, systematically, and with clear explicit goals in mind. Outsourcing can turn out to be a double-edged sword when companies rush into it without fully understanding what they hope to gain, and finding themselves mired in a contractual battle with the vendor over service standards that are not up to the organization’s expectations.
2. Outsource for the right reasons.
Organizations should outsource for the right reasons such as to assess outsourcing’s potential tactical and strategic benefits and not just to delegate the work to outside vendors. These reasons are stated under the Background.
3. Answer key questions.
An organization should evaluate how the functions being outsourced are fitted into the company. As part of the outsourcing evaluation, organizations should answer key questions such as:
· What are our core competencies?
· What are the goals we want to achieve through outsourcing?
· Can we fix ourselves internally before considering outsourcing?
4. Use a methodical approach.
The decision whether to outsource is a process involving voluminous steps and phases such as identifying requirements; preparing a request for proposal (RFP); examining proposals; evaluating vendors; negotiating contracts; and lastly, implementing the outsourcing. The various phases are as followed:
· Planning Phase. The objectives, scope and feasibility of the outsourcing idea are defined and effort is planned in terms of time, budget and resources required.
· Analysis Phase. Baselines or constraints are determined. Functions to be outsourced and functions that will remain in-house are also clarified. The RFP is developed and responses from vendors are compiled and analysed. A vendor is then chosen to helm the outsourcing.
· Design Phase. Negotiations are set in motion with the vendor and a contract is developed and signed.
· Implementation Phase. The transfer from in-house provision of services to the vendor is made.
· Operations Phase. Outsourcing relationship with the vendor is managed and any changes that occur in the relationship are negotiated and implemented accordingly.
· Termination Phase. At the end of the contractual agreement, a decision is made whether to negotiate a new contract with the same vendor, a new vendor, or to bring the function back inside the organization.
5. Consider all stakeholders.
An organization that has made the decision to outsource would have prognosticated the impact outsourcing will have on the stakeholders, who include stockholders, customers, suppliers, and employees.
6. Get the right people involved.
Prior to the evaluation process, persons must be identified who will helm the leadership responsibility, perform the analysis and make the decisions. The people involved should be dependent on what is to be outsourced and the circumstances surrounding the outsourcing decision. The team should include representatives from user areas that will be directly affected by the outsourcing under consideration. Their views may be critical for setting the scope and for assessing risks.
7. Understand the vendors.
Managers should not be misled by what other companies are paying as the ultimate price paid is often subjective between organizations and is set in actual negotiations related to specific requirements. After short-listing a handful of potential vendors, better pricing and service agreements can be negotiated between them and a deal is struck based on the best final offer.
8. Realize that outsourcing is not "All or Nothing".
Total outsourcing transfers most equipments, staff and responsibility for delivery of services to a vendor. It is a major endeavour and no organization should do it without significant thought as these deals often span across long periods, usually more than five years. This is not to say that total outsourcing should never be contemplated, but that it should not be undertaken lightly.
9. Choose the right relationship with vendors.
Market relationships, where contract duration with vendors are relatively short, cost the least and are relevant for work that is simple and straightforward. Intermediate relationships are those that must remain amicable until a major phase of work is completed. They cost more and are relevant for work that is more complex with substantial benefits. Partnerships-like relationships cost the most and are only relevant when benefits of a close relationship are substantial. Choosing the wrong relationship could results in excess costs or failures.
10. Negotiate a sound contract.
There are various critical components of a good outsourcing agreement. Some of the important contract considerations are:
· Terms of the agreement. The contract should stipulate that a renewal of contract only occurs if a renewal notice is sent.
· Minimum service levels. The contract should specify the services to be provided meticulously. Examples include establishing minimum service levels and identifying any subsidiary services to be provided.
· Ownership and confidentiality of data. The contract should specify that the client retains ownership of the data it submits to the vendor and should be kept strictly confidential.
· Warranty. The services provided by the vendor should be warranted as defined in the agreement and should accommodate a specified increase in requirements.
· Exhibits. Exhibits should be given considerable notice as in a complex transaction, the first drafts of outsourcing contracts usually contain incomplete exhibits.
· Incentives. Chew over the idea of providing incentives for vendors to perform. Examples include guaranteed savings, profitability index and shared benefits/risks.
· Disclaimers. Disclaimers are inevitable in a contract but ensure that a disclaimer does not void the warranty and indemnity sections.
· Bankruptcy. The contract should consider the possibility that either one party may go bankrupt as it entirely changes the outsourcing situation and obligations.
· Force Majeure (Acts of God). Under these provisions, vendors are excused from performance, limited to between 30 to 60 days, if it experiences certain conditions.
· Anticipating change. Contracts should provide for both good and bad times of the economy and accommodate a fluctuation of demand that require an adjustment in services.
11. Use performance incentives and penalties.
Reward incentives such as bonuses when the vendor exceeds expectations and charge penalties when performances do not make the mark. Ensure that incentives of the individual managers are consistent with the overall goals and with each others’.
12. Establish a relationship management structure and processes as part of the contract.
A formal relationship management structure, typically in the form of joint management teams with responsibilities in various aspects of the relationship, should be established to link the client and vendor. Each team has clearly defined goals to fulfil. Identification, resolution and expeditious escalation of issues should be a key responsibility of each team.
13. Use objective performance criteria.
Successful outsourcing relationships focus on results. A properly defined performance criterion must be objective, quantifiable, and collectable at a reasonable cost and should be metrics which can be benchmarked against the performance of other organizations.
14. Emphasize the development of the people responsible for relationship management.
Individuals responsible for managing the outsourcing relationship should receive specific training on how to do the job, which includes a complete understanding of business goals of the contract, specific performance criteria agreed upon, individual roles, responsibilities, authority and reporting structure. Although being experts in their fields, vendor personnel also require specific, ongoing training on the client’s business and its goals. This way, they develop the needed sensitivity to issues regarding the client’s needs.
15. Manage the people issues.
Communication is one of the most important aspects to evaluate outsourcing. It often requires more effort than anticipated, but it is critical to a successful evaluation process. Various forms of communications, like newsletters and organization-wide meetings, help ensure that the right message is sent. Keeping employees informed in every step of the outsourcing process and working out a deal perceived as fair for them is important as they are ultimately the ones that carry out the work. Those who feel that they have been mistreated have the power to bring systems down.
Conclusion
In conclusion, outsourcing is a business strategy used by companies, for reasons such as the lack of expertise, through the subcontracting of their business functions to outside organizations. Outsourcing is receiving much response from companies all around the world these days, with 70% of european companies already using it for reason such as to seek cash infusion, reduce risk and operating costs, etc.
Companies that offer services at a low prices can be easily found. However, due to several ethical concerns, some companies prefer the costlier route as the price difference could be deceptive because the variation will only be in the initial cost. Compromise of customer data and vendor reliability are one of the main ethical concerns companies tend to face, especially in offshore outsourcing contracts.
Outsourcing is not the right tool for ever job but it is a good tool for the right job. There are a couple of typical and traditional problems faced in outsourcing. Poor planning and less-than-expected results are some of the problems faced by outsourcing players. There are solutions to these problems however, there is no silver bullet and some situations can never be predicted.
All in all, the future of outsourcing appears to be fairly bright and positive. The information technology era enables new outsourcing players to take advantage of the different stages of an organization's value chain. Besides that, there are also clear signs indicating the broadening confidence in the outsourcing industry, which would ultimately lead to more companies adopting the business strategy over an increasingly wide range of business processes and functions.