Tall oaks from little acorns grow. That old Latin saying applies to the staggering growth taking place in international Information Technology (IT) outsourcing. The growth trends predicted over the next few years in the US and around the world are rooted in a strong and established corporate practice of outsourcing, as revealed in the 1996 IT Strategy Census and COMPASS outsourcing studies done worldwide. As this growth continues, COMPASS sees a worldwide need for more effective, corporate outsourcing strategies.
The IT Strategy Census is the product of a 1996 survey performed by the London School of Economics (LSE) and funded by COMPASS to provide an updated view of worldwide corporate IT strategies. From the survey, which included management of the top 5 percent of companies in the US, UK, Sweden, and Germany, a three-year pattern on outsourcing usage by country and industry has emerged. The worldwide average of corporate IT outsourcing rose to 16 percent in 1996, up from an average of 9 percent in 1993.
As of 1996, US companies had outsourced only 12 percent of IT services, but that figure represents almost 100 percent growth over 1993. Similarly, IT outsourcing in the UK had almost doubled in three years’ time, with outsourcing providing 25 percent of UK companies’ IT services in 1996.
In Sweden the story was even more astounding. Over the same 3-year period, that country experienced a 19 percent boom in outsourcing usage. Anders Snihs, Sales Director at Nordic COMPASS, offers an explanation. “Sweden is now a member of the common market in Europe. This has caused increased competition for Swedish companies in their home market and in other countries in Europe as well,” he said. “Consequently, companies have pointed a finger at reducing IT operating costs, due to lower profit margins and high marketing costs in new markets.”
Overall, survey comments emphasize that companies worldwide still believe that outsourcing IT services will provide:
- an easier way to provide IT services,
- a greater focus on corporate core competencies,
- less time management of IT services, and
- greater efficiency and productivity at lower costs
The Changing Landscape
However, the situation is shifting. As the industry matures, companies pursuing outsourcing relationships face an imperative to understand the true costs and benefits of outsourcing. From that understanding will come new opportunities. In the U.K., for example, many older or original outsourcing contracts have come to maturity or are up for re-negotiation. There, COMPASS is seeing stronger cost competition between outsourcers.† In fact, some outsourcers (AT&T, Andersen, and SEMA) have contracted with us to provide recommendations for their own greater efficiency.
New insight has been gained on time management, as well. U.K. companies, like those in the US, have begun to realize that managing their outsourcers requires more time than they projected. Although a greater focus on core competencies may emerge, this does not necessarily mean less focus and time management expended on IT services. Outsourcers are responding to this increasing awareness by marketing trends/strategies to provide “risk/ reward” contracts, based on sales/revenue performance. “Smart applications” that provide overall contributions to business are being promoted now as key drivers to outsourcing.
IT services are hyped by outsourcers as providing added value or strategic capabilities to companies’ core business processes.† Although these types of contracts are in their early days, clients are finding it very difficult to measure the bottom line impact of outsourcing IT services. (In general, it is hard to measure the impact of IT services on the corporate bottom line or on a return on investment (ROI) basis.)
Overall bottom line improvement can result from employee training, reorganization, new management, new business products, etc., versus an impact from the outsourcer’s contribution. Other explanations for revenue gains can include seasonal business cycles or booms in the market, which have nothing to do with outsourcing contributions.
Overall, COMPASS believes that the mainframe environment can learn from the client/server (CS) environment where the tendency is to outsource only some functions. For example, when CS outsourcing occurs as a partnership (i.e., by not outsourcing the total CS environment), COMPASS generally sees overall lower CS unit costs.
Knowing Where to Trim
COMPASS believes that although usage of outsourcing is growing worldwide, some of the same general (mis)perceptions exist.† Commonly, companies don’t recognize “best of class” IT functions currently provided in-house (these functions should STAY in-sourced and NOT be outsourced). Another common outsourcing problem occurs when organizations continue to outsource their desktop IT functions without a detailed baseline of current costs and service levels.
Without this original baseline data, outsourcing contracts become time-consuming and often hard to manage.
Finally, although companies may pay less to outsourcers, they often don’t know the “lowest fair price” for IT services.There is a worldwide need for companies to determine the true costs of outsourcing. (This is where comparative analysis helps.) Armed with this information, companies can determine what they are willing to pay or in what range fair market value prices should be. Often unaware of economies of scale based on an outsourcer’s capability, companies may pay lower than an in-house rate but much higher than actual cost of services. On the other hand, outsourcers are very aware they have economies of scale in a data center environment. They know only too well, for example, how their cost-plus prices rate against the in-house IT service costs of a small company’s data center.
This further enhances the already strong negotiation skills that outsourcers commonly bring to the table. In fact, in 1996, three companies–IBM, EDS, and CSC–dominated 65 percent of the top 100 worldwide outsourcing contracts, according to International Data Corporation.
Companies worldwide must consider the strength and expertise outsourcing companies possess when contracting outsourcing services. In response, a company should be equally well-armed when looking to contract services initially or re-negotiate a contract.† They should know the range for fair market prices for services–something only comparative analysis can provide. Corporations can counter an outsourcer’s negotiation skills with comparative analysis input on costs, service levels, and quality metrics to be established by the client (not the outsourcer) in an outsourcing contract.
Lessons from the Outsourcing Primer:
- Know the true cost of outsourcing.
- Be aware that managing outsourcers requires a significant time commitment.
- Understand that measuring the bottom line impact of outsourcing can be difficult.
- Maintain a detailed baseline of cost and service levels.
Alan Gonchar, president of COMPASS America, Inc., has 12 years of experience in IT sales, marketing and management. He joined COMPASS in 1993 as director of sales and, in 1996, began serving as vice president of operations of COMPASS North America. COMPASS is an international management consulting firm that has completed over 4,000 comparitive analysis studies for 600 clients in 25 countries.