Sourcing IT Ken Peffers UNLV February 2005 “Sell the mailroom.” Peter Drucker, 1989, WSJ

Outsourcing Data  14.8% of operations outsourced as of 2001  Outsourcing growing at 19.6% per year  IT 10% of global outsourcing

OUTSOURCING IT CONTRACTING:  COMPUTER CENTER OPERATIONS  TELECOMMUNICATIONS NETWORKS  APPLICATION DEVELOPMENT TO EXTERNAL VENDORS TO EXTERNAL VENDORS*

OUTSOURCING WHEN TO OUTSOURCE:  IF FIRM WON’T DISTINGUISH ITSELF BY DEVELOPING APPLICATION  IF PREDICTABILITY OF UNINTERRUPTED SERVICE NOT IMPORTANT  IF EXISTING SYSTEM IS LIMITED, INEFFECTIVE, INFERIOR

Generic Businesses  Supply Chain Management Acquiring resourcesAcquiring resources Dell, Walmart, FedExDell, Walmart, FedEx  Operations Producing the product or serviceProducing the product or service UNLVUNLV  Infrastructure Maintaining the underlying systemsMaintaining the underlying systems SprintSprint  Research and Innovation Coming up with value creating new products and servicesComing up with value creating new products and services Intel, MicrosoftIntel, Microsoft  Customer Relationship Management Delivering the product to the customer and extracting valueDelivering the product to the customer and extracting value StarbucksStarbucks  Which Business is Your Firm In? Other businesses candidates for outsourcingOther businesses candidates for outsourcing

Sourcing Alternatives  Development  Development and Operation  Operation  Service

Development  Obtain resources unavailable within firm  Obtain additional resources

Development and operation  Focus on core competencies  Management attention

Operation  Obtain operational expertise  Reduce costs

Service  Avoid investment in non-strategic activities  Reduce costs  Achieve superior service

Outsourcing Types  Total outsourcing  Joint venture/strategic alliance sourcing  Multi-supplier sourcing  Insourcing

Total Outsourcing  Outsource 70% or more of IT to single supplier  Long term contract  Partnership between vendor and client

Total Outsourcing motivation  Enable client to concentrate on core business  Client recoups capital investment from sale of IT assets  IT perceived as support function  Eliminate IT function

Multiple-supplier sourcing  Contracts with a variety of suppliers  Outsourcing as commercial relationship  Medium term contracts  Suppliers compete for the business  Fixed costs become variable costs  Difficulties in managing a variety of contracts

Joint Venture/Strategic Alliance  Shared risks and rewards  Create new company as supplier  Reduced risks of single supplier or multiple supplier  Client owns large share in supplier

Insourcing  Retain large IT staff in-house  Short term contracts for some staff to manage variance in personnel needs

Risks  Total outsourcing particularly risky (80% of IT budget outsourced) Of 116 outsourced contractsOf 116 outsourced contracts  38% successful  35% failures  27% mixed results For selective outsourcing (15-25% of IT budget outsourced)For selective outsourcing (15-25% of IT budget outsourced)  77% successful  20% failures  3% mixed results

Top 10 Reasons for Failure 1. Treating IT as undifferentiated commodity... needs and service levels differ 2. Incomplete contracting …inviting opportunistic behavior 3. Lack of active management of the supplier …contractors require day to day and long term management and supervision 4. Failure to build and retain in-house skills …necessary to manage the vendor, prepare new contracts, and negotiate subsequent investments 5. Power asymmetries accruing to supplier …who has the bargaining power?

Top 10 Reasons for Failure 6. Difficulties in adapting deals to changing conditions …system needs 5 + years out hard to anticipate 7. Lack of contracting experience …need for intermediary? 8. Outsourcing for short term financial restructuring or cash injection …cash benefits gone in 1-2 years. 9. Multiple objectives with unrealistic expectations …financial, performance, expertise, development resources 10. Poor sourcing …vendor mismatch

Treating IT as an undifferentiated commodity Differentiate between what is core to the firm and what is a commodity.Differentiate between what is core to the firm and what is a commodity. Keep core processes inside the firm. Retain business knowledge and logicKeep core processes inside the firm. Retain business knowledge and logic Be clear about what IT, if any, provides a strategic advantageBe clear about what IT, if any, provides a strategic advantage

Vendor Selection and Contracting  Be clear about the vendor requirements for experience, resources, etc.  Quality of resource critical, more so than cost. Lowest bid selection invites opportunistic behavior  Understand the systems to be outsourced  Stable systems first, then outsource  All development has a business case and approved by senior management

Incomplete Contracting  Complete contract  3-5 year initial contract  Regular review  Notice thereafter  ‘Smooth termination’ guarantees

Active Supplier Management  Internal staff assigned to monitor supplier performance Daily performance managementDaily performance management Regular management reviewsRegular management reviews

Retaining Essential IT Resources  Core IS capabilities necessary to run any IT sourcing regime effectively Relationship buildingRelationship building Business systems thinkingBusiness systems thinking Technical architectureTechnical architecture Technology adaptationTechnology adaptation IT governanceIT governance Informed buying capabilitiesInformed buying capabilities IT strategyIT strategy

Unrealistic Expectations  Careful delineation of what can be achieved by outsourcing

Power Asymmetries  Stable software makes switching costs lower  Retained ownership of software assets and data  Carefully delineated performance expectations

Lack of Contracting Experience  Staged 3 to 7 year contract  Competitive price terms  Keep key capabilities in-house

Successful Outsourcing  Selective (vs total) outsourcing to achieve cost savings Select most capable or efficient service for each functionSelect most capable or efficient service for each function  Sponsorship by Sr. general mgmt and IT, rather than either alone to achieve cost savings Sr mgrs often make decision based on short term finance considerationsSr mgrs often make decision based on short term finance considerations IT mgmt evaluation defensiveIT mgmt evaluation defensive  Inviting bids from both internal and external vendors to achieve cost savings Internal departments can achieve savings if they can overcome political resistance.Internal departments can achieve savings if they can overcome political resistance.

Successful Outsourcing  Short term contracts for cost savings Estimate term during which requirements will be stableEstimate term during which requirements will be stable Renewal term creates good incentives for vendorRenewal term creates good incentives for vendor

Detailed fee-for-service contracts to achieve cost savings  Fee-for-service contracts specify fees in exchange for provision of specified services StandardStandard Detailed—specify service scope, service levels, performance measurement, penaltiesDetailed—specify service scope, service levels, performance measurement, penalties LooseLoose MixedMixed  Strategic alliance/partnership—significant resources pooled from two or more organizations  Buy-in—client buys in to vendor

Successful Outsourcing  Recent contracts achieved cost savings more than older ones  Size of IT group not material