Keeping IT Outsourcing in the Family | Article

Outsourcing staff around computerWhether you know it or not you are the keeper of very valuable information. Information that is bought, sold and traded. And covertly tracking your daily decisions to get this strategic intelligence are your bank, your credit card company and the web sites you visit on the Internet, among others.

The daily regimen you follow is valuable to the success of many businesses. Databases with your information and those of the people around you are strategic tools that are used to target consumers. And because of this valuable tool, says Dr. Armin Heinzl of the University of Bayreuth in Germany, companies can make better-informed buying decisions, get customers what they want more expediently, and target consumers with advertising. It isn’t about what the competition is doing anymore; it is about what the customer is doing.

“This information helps companies realize the aesthetic or dynamic pattern of the customers’ wants and what their purchasing behaviors are,” Heinzl says. “They didn’t look at your age and they don’t look at your income; they look at specific behavioral patterns which are similar and that is how the market is segmented — this would be impossible without information technology.”

The Disadvantages of the Advantages

Used for little more than payroll and inventory management 30 years ago, information technology (IT) has increased the strategic advantage of many companies, especially over the past ten years. But with this increased technological edge, comes increased complexity, and this can create managerial problems, Heinzl says. These problems have led companies to consider outsourcing to third-party vendors, or another viable option called “outsourcing within the company,” which is creating a subsidiary that is loyal to the mother company’s needs, but can also make money by being an IT service provider for other corporations.

The concept is catching on. In fact, according to Heinzl, it is the dominant form of outsourcing in continental Europe; mainly because it is less risk-aversive than outsourcing to third-party providers, while pure outsourcing still reigns in the United States.

According to a survey by IT expert Jurgen Selig, there are several managerial problems that companies face due to IT complexity. First, there is the difficulty of recruiting qualified IT workers and then, once you have them, being able to afford them. Second, a corporation’s inability to cover the rising costs of developing, operating and managing the IT function, and then keeping pace with evolving technology. Finally, a company must find ways to keep its workers motivated, and more specifically in European countries where there are strong unions, hope they won’t strike if they become discontent. Heinzl says that outsourcing within the company can potentially solve most, if not all of these problems.

According to Heinzl, the newly formed subsidiary becomes a very attractive environment to work in, which could possibly solve any motivation problems by workers. The service provider usually has better training programs, uses better practices and it is a real motivation for the employees to do business with other companies, Heinzl says. Usually, a large portion of the parent company’s workforce moves to the newly formed subsidiary and many of their roles change. “The vice president of IT becomes the chief executive officer of the new subsidiary and the managers have the possibility of gaining credibility by signing contracts with third-party clients,” Heinzl says. “Also, the employees are no longer programmers and operators, they become coordinators and coaches.”

Who Comes First?

The types of internal outsourcing differ, according to Heinzl’s 1993 survey of 359 fortune 500 companies in the United States and Europe. In more than two-thirds of all cases companies chose to make a 100 percent investment by the mother corporation into the new subsidiary; this is a desire by the parent company to be the controlling company. More than one-third of the companies exclusively provide services to the mother company, almost one-half provide service to the mother company along with service to other companies within the group, and about one-fifth offer services to companies outside the parent corporation.

The option of doing business with other companies outside the mother company may cause conflict. “What happens is that it is very hard to get internal service from your programmers and analysts because they are committed by contract to other companies. So who is going to wait? The company within the organization ends up being the company that can wait the longest,” Heinzl says. “If you want to make money, you should get away from the notion that it is still possible to provide internal services efficiently.”

The survey revealed some other possible problems with outsourcing within the company. Almost 17 percent of the companies said that its employees’ work council or union tried to stop the process (more typical in Europe) because there were inadequate policies and fear in the union or council of losing its power. And in 15 percent of the cases, the contractual agreements with the new subsidiaries were insufficient. “Some did not have good lawyers so the contracts they were offering to their clients were poorly designed and if you have a poorly designed contract you will reduce your margin.”

The positives were abundant though: Most companies increased their control of IS functions, the service mentality of the IS personal was better on average, the rate of innovation improved, and cost improvements on the whole were reported.

Heinzl concluded that outsourcing IT within the company works best when the function is not strategic, so that third-party commitments won’t affect the core operations of the corporation.

Along with his work as the chair of information systems at the School of Law and Managerial Economics at the University of Bayreuth in Germany, Dr. Armin Heinzl was also involved in the IS/T planning and organizational design of the former Mercedes Benz AG, Swiss Bank Corporation (Germany) GmbH, RWE Energie AG and Thyssen Telecom AG.

Lessons from the Outsourcing Primer:

  • During the past ten years the strategic value of information technology has increased.
  • Managerial problems have evolved because of the increasing complexity of information technology.
  • Managerial challenges have lead companies to consider alternative managerial concepts for the IT function.
  • Outsourcing within the company is a viable alternative to outsourcing to third party vendors.
  • Problems may arise if a company chooses to provide IT services outside of the mother companies group.

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