Outsourcing: The Reluctant Bridegroom

One third of IT outsourcing contracts signed during a brief 1990s honeymoon failed, leading CIOs to bring the functions back in-house. But, having reached a new maturity, outsourcing may be ready for a second chance.
In the mid-1990's the aerospace industry was in trouble. The end of the Cold War ushered in a new round of consolidations, restructuring, and layoffs. Finally, the industry turned to outsourcing as a way to drastically reduce costs.

"We outsourced almost everything in (information services) except application development and maintenance," confirms Dr. Wendell Jones, former general manager of McDonnell Douglas Aerospace Information Services Co. and one of the principal architects behind the 10-year, $3-billion deal that put IBM's newly formed outsourcing division on the map.

A lot has changed in the last seven years, says Jones, currently CEO of Outsourcing Advisors International, a New York-based consulting firm that advises executives on sourcing strategies.

"Minus a few notable exceptions, those gigantic deals where you outsource 80 percent or more of a department or function are rare today," he says.

Companies today are more selective in what they outsource, and they have to justify those decisions based on more strategic reasons than just cost reduction. That's partly because, following a brief honeymoon period in the 1990s, many outsourcing deals foundered, and, according to some estimates, fully a third of such projects were brought back in-house when contracts expired.

Outsourcing is still alive and well, but it's no longer considered a panacea. Today the CIO must leverage outsourcing as one strategic tool in a continuum that includes contracting out, alliances, and mergers. That means relinquishing control over some parts of the business while working closely with other senior managers to weigh the benefits and costs of various types of partnerships.

The Honeymoon Is Over

Overall, outsourcing continues to grow at a rate faster than the U.S. economy, according to The Outsourcing Institute, an industry trade group based in Jericho, N.Y. In 2000, information technology still represented more than 20 percent of all outsourced services, yet growth in that sector is slowing, outpaced by sourcing of business processes such as accounting, human resources and facilities management.

In their book Beyond the Information Systems Outsourcing Bandwagon, Rudy Hirschheim of the University of Houston and Mary Lacity of the University of Missouri describe "the honeymoon period" of IT outsourcing in the late 1980s and early 1990s. At that time, a company's stock usually rose after an outsourcing deal was announced, and the press heralded a new trend that promised to change the face of business.

Noticing the lack of follow-up on these deals after the initial positive press, the two academics studied 14 organizations that had two to 10 years of outsourcing experience, getting multiple perspectives from senior executives, IT personnel, and actual users of the technology. They found that, for many, cost savings had never materialized, and that a number of organizations had "backsourced," or brought the outsourced project back in house.

For one thing, Hirschheim and Lacity found that when deals were undertaken solely to cut costs, much of the savings turned out to be illusory. They explained this phenomena by pointing out that an internal IT department would probably always win on a head-to-head basis with a vendor because they did not have to make a profit.

"IT tends to be a high-profile area to cut back on capital investments," confirms Douglas Mikaelian, director of corporate technology for Playtex Products in Dover, Del. "So when senior management says we need to cut costs, we might call a service provider for a quote and then turn around and beat it."

Mikaelian, who outsources only about 10 percent of his IT budget on services such as Web hosting, concedes that he might get a better level of service with an outsourcer, but that his current level of service is "good enough." This apparently was the conclusion of those companies that decided to backsource.

Secondly, Hirschheim and Lacity found that some outsourcing deals had been mismanaged. Many contracts were undertaken haphazardly by senior executives who felt they couldn't control what was going on in IT and wanted to get rid of the headache.

"The problem back then was that the CEO would strike a deal with an outsourcer with no objectives, relationship management, or contract in place," explains Jones. "It was almost like the he was so sick of the IT function he was just trying to wash senior management's hands of it. So the CEO would kick the tires and end up with a deal."

Agreements made in that haphazard way often faced problems early and consistently -- and many CIOs felt threatened, perceiving that they had lost the confidence of the CEO.

Toward A Mature Marriage

The honeymoon period may be over for outsourcers, but the landscape has changed for CIOs too.

"The CIO should no longer be judged by the number of employees on his payroll," says Jones. "Today he's under a great deal of pressure to get to market quickly and competitively by whatever means necessary."

In addition, the CIO must work with business unit managers, who may not understand the limitations of legacy systems. Today, says Jones, the focus of outsourcing has shifted from cost reduction to more strategic factors such as entering a new market, reducing or avoiding the purchase of new assets, improving a product or service, focusing on core competencies, and gaining long-term profitability and growth.

Just as strategy has become a stronger force in the decision to outsource, it also plays a decisive role in determining success. According to a 2000 survey conducted by Dun & Bradstreet and The Outsourcing Institute, the three most important factors behind outsourcing success are: 1) selecting the right service provider; 2) understanding your company's goals and objectives; and 3) ensuring a strategic vision and plan.

"Some folks may have an idea that if they don't know how to do something themselves, then they should outsource it," says Ed Emig, director of customer solutions at OAO Corp., a private company with offices in Houston and Greenbelt, Md. His company, founded 30 years ago by a former NASA space flight engineer, provides outsourcing for NASA and Fortune 500 companies such as IBM, EDS, AT&T, and Lockheed-Martin. "The more you know about something, the better equipped you are to make a decision."

Many agreements fail because companies have not thoroughly analyzed their own metrics and goals, says Forrest Old, vice president of receivables management services at Dun & Bradstreet. His division, which collects current receivables in the outsourced customer's name, has grown 30 to 50 percent per year over the past five years, and he expects that trend to continue.

"The clients we lose are the ones that don't know what their costs are, what kind of performance they're looking to get and what it takes to set up an outsourcing relationship in terms of systems integration," he says. "We can turn around and install quickly, but that might not always be the case based on what legacy system they have in place."

Despite a high retention rate, Old says that the companies getting the relationship are those who manage it. "Our best clients are very active," he says. "Some manage our results on a day-to-day basis, sometimes to the point of actually having a manager on our site. We're responsible for supplying service against the specs but that does not mean the client is off the hook in terms of accountability for the performance of the relationship."

Emig believes that many executives trying to get quickly to market overlook the discipline of formulating the contract.

"I was fortunate to work on a government contract where the government did an excellent job of putting together its requirements," he says. "The government is not afraid of telling you their requirements, sometimes in ridiculous levels of detail."

Emig notes that NASA's rationale in outsourcing is not to cut costs, but to improve quality by "looking toward the best of the commercial world." In addition, they're sharing risk and using their limited staff to focus on core competencies: space exploration and flight.

Companies wishing to outsource should understand their own environment and do some benchmarking, says Emig: "The first time you set out to do that, it could take you several months. If you skip that just to get things done, you can sacrifice a lot of integrity. But if you make that investment, every subsequent contract becomes that much easier."

Even with benchmarking in place, selecting the perfect partner can be a long and arduous process, says Mike Howard, director of information technology for Quadstone Ltd., in Edinburgh, Scotland.

Howard has been on both sides of the equation: acting as a solutions provider in his current role and choosing outsourcers in the past. Howard describes the decision to outsource secondary support functions at his previous company, a large biotech firm with 450 employees and only 10 full-time IT staff.

"There were two distinct camps at the company, the IT people who understood and were in favor of outsourcing and those who feared they would lose their jobs," he says. "In their evaluation, the service provider got it completely wrong; they just confused the two camps entirely. They were fine on the technical stuff but they were not that astute politically." In the end, nine months elapsed between the evaluation phase and signing a contract.

Howard says the experience is not uncommon for small- and medium-sized firms. "There are many companies trying to market to SMEs but the industry is still much less mature than for big companies," he says. Smaller firms must be extra diligent in choosing partners that reflect their corporate culture and can sustain a commitment over time.

The Partnership Continuum

In some ways, IT outsourcing is a paradox, says Mikaelian, especially for mid-sized companies like Playtex.

"We're between a rock and a hard place," he says. "We have cash on hand and we already have established internal groups. It's almost always going to cost less to do it internally, so if we push it outside, that must mean there's a strategic advantage. Yet outsourcing requires that we understand the nature of the function and that we have enough skill and leadership to manage the outsourcer. So do we outsource or just develop the skills internally and manage it in-house?"

As a result, says Mikaelian, IT outsourcing for most medium-sized companies remains a patchwork of selected services.

Deciding whether to outsource ultimately depends on the culture, goals, and strategic vision of an individual company. Jones, an Army colonel, likens outsourcing to one weapon in a vast strategic arsenal of possible partnerships that ranges from contracting out to outright mergers. The ideal outsourcing arrangement draws elements from each.

Like a merger, outsourcing must be built on trust. The ideal partner is a "stakeholder," someone who buys into your company's vision and recognizes that its own success is determined by your company's growth.

"Some folks may have the absolute best thing on paper, but they're a pain to work with, your people are miserable, and you never receive what's promised," Emig says. And even if they do meet all their numbers, "better" can be the enemy of "good." "If they don't have that spark that says, 'I know what you're trying to do and I can do it better," then even if they have the best technical solution in the world, they are not a worthwhile partner."

Yet outsourcing can be enhanced by traditional elements of contracting, such as a clear division of labor, highly specific goal setting and a detailed service agreement. Emig has used NASA's contracts, including performance-based benchmarking, as templates for his own outsourcing agreements and recommends that other CIOs do the same.

"I went to consulting firms and asked what others were doing and what worked and didn't work. Most are willing to share their ideas because it helps to improve the market."

Frankly, he says, there's not a lot of original thought in the outsourcing market these days. "It's how you combine the best of a lot of different sources that makes your contract stand out."

Eva Marer is a freelance business and technology reporter based in New York. She covers investments, personal finance, and corporate technology issues for a variety of trade and consumer magazines. Contact her at egresspress@aol.com.






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