New IBM Research Quantifies the Long-Term Impact of IT Outsourcing on Three Business Metrics | Article
(Click here for Lessons from the Outsourcing Journal).
A new IBM study based on “a rigorous statistical approach” revealed a correlation between major IT outsourcing deals and “significant improvements in key business metrics” for those companies that outsourced. The study concluded that “IT outsourcing was clearly a part of an effective management strategy” to build “better bottom-line results and please shareholders.”
Specifically, companies that outsourced IT outperformed their peers on three key business metrics, reports Samer Takriti, Senior Manager of Stochastic Analysis at IBM T.J. Watson Research Center. These metrics include selling, general, and administrative (SG&A) expenses; return on assets (ROA); and earnings before interest and taxes (EBIT). Further, the research indicates the larger the outsourcing contract, the more likely the improvement in bottom-line results.
“Buyers who outsource plan to outsource more. This report indicates that they have sound financial reasons for doing so,” says David Parker, Vice President of Business Line Marketing for IBM Global Services. He adds IT outsourcing (ITO) allows companies “to focus on cost containment and growth,” while knowing a professional is managing their crucial IT infrastructure.
Researchers at the IBM T.J. Watson Research Center took 18 months to produce the study, entitled “Business Impact of Outsourcing–A Fact-Based Analysis.” Takriti says the researchers were interested in the long-term impact of strategic IT outsourcing. He defined long term as two-to-three years after contract signing.
The Companies IBM Studied
IBM researchers analyzed outsourcing’s impact on the financials of 56 publicly traded companies that outsourced a major portion of their IT infrastructure between 1998 and 2002. Then the researchers compared the results for each company to its industry peers, sector by sector.
Some of these companies restructured during this period. Some changed leadership. Others also outsourced some business processes. “But the only common denominator was IT outsourcing,” notes Alexandra (Saska) Mojsilovic, a Senior Scientist at IBM Research. She says the research clearly demonstrated ITO “is part of a successful management strategy.”
Marc Bertoneche, Visiting Professor of Finance at the Harvard Business School, says previous studies measured outsourcing success based on a company’s stock price. “Stock prices are just a perception of the market. This study mathematically measures basic financial performance,” says the professor, who worked with the IBM researchers.
Major findings include:
- Lower growth in SG&A expenses
Almost three-quarters of the companies studied enjoyed significant reduction in SG&A expenses compared to their industry peers. Prior to outsourcing, the annual growth in SG&A expenses was already 4.2 points* lower than their sector’s median. The study posits this was due “to preexisting corporate cultures focused on business improvement.”
But within two years after outsourcing their IT, these companies improved even more. The IBM researchers found the annual growth in SG&A expenses was 9.9 points lower than the sector median.
The study cites a global telecommunications company that outsourced the management of its data centers in an agreement valued at $4 billion. The year before the company outsourced IT, its quarterly SG&A expense was $3.1 billion. Three years into the outsourcing agreement, quarterly SG&A expenses dropped 13 percent to $2.7 billion. Contrast this result to the sector’s 200 percent increase in SG&A expenses during the same period.
- Increased growth in ROA
Almost two-thirds of the companies studied outperformed their peers in ROA two to three years after outsourcing their IT. Prior to outsourcing, the annual ROA growth for companies in the study was 7.5 points lower than their sector median. After outsourcing, they experienced 8.6 points higher annual growth rate in ROA compared to their peers–a “substantial swing” of 16.1 points, according to the study.
“We were really surprised to see such consistent improvement across such different sectors,” says Takriti.
The study mentioned a global provider of travel and real estate services, whose ROA grew by more than 300 percent after outsourcing, while its competitors’ ROA dwindled by 29 percent.
- Higher growth in EBIT
Nearly two-thirds of the companies IBM Research studied grew earnings faster than their peers. Thirty-six months after outsourcing, these companies experienced an annual growth rate in earnings 11.8 points higher than the growth rate of the sector median. And 63 percent of the companies in the study grew EBIT faster than their sector peers.
The study cited a healthcare insurance company that outsourced management of its data centers, PC support, help desks, and data networks in a ten-year agreement worth over $700 million. Prior to outsourcing, the company’s quarterly EBIT was $47 million. Two years into the agreement, the company’s quarterly EBIT grew to $119 million, a 153 percent increase. This was ten times greater than the rate of earnings growth in the sector as a whole.
- The larger the outsourcing contract, the more likely the improvement in bottom-line results
While 54 percent of companies engaged in IT outsourcing agreements of less than $100 million per year did experience positive earnings growth, 71 percent of companies with agreements of more than $100 million did the same.
“This study used a mathematical methodology that provides insight into the long-term financial impact companies enjoy from outsourcing,” sums up Parker.
*The study points out the difference between points and percent. Points reflect the actual numerical increase or decrease in percent. For example, when the US Federal Reserve Bank raises interest rates from four to six percent, the bank raised rates by two points, not two percent.
How the study was done: Researchers in the Mathematical Sciences Department at the IBM T.J. Watson Research Center analyzed 56 publicly traded companies in a wide variety of industries. They analyzed each company’s financial performance in the year prior to outsourcing and then measured results up to three years after outsourcing began. The study normalized all financial data against industry peers. Similarly, it reported all results as improvement against industry peers.
Lessons from the Outsourcing Journal:
- IT outsourcing is clearly part of an effective management strategy. A new IBM study found companies that outsourced their IT outperformed their industry peers, in some cases substantially.
- The study found ITO lowered growth in back office expenses, increased return on asset growth, and produced higher earnings before taxes.
- The study found the larger the outsourcing contract, the greater the financial benefits; $100 million was the dividing line.