An Introduction to the Outsourcing and Offshoring Landscape

Origins of Outsourcing

Roman Empire (approx. 150 B.C.)

Tax farmers (Publicani) were used to collect taxes from the provincials. Rome, in eliminating its own burden for this process, would put the collection of taxes up for auction every few years. The Publicani would bid for the right to collect in particular regions, and pay the state in advance of this collection. These payments were, in effect, loans to the state and Rome was required to pay interest back to the Publicani. As an offset, the Publicani had the individual responsibility of converting properties and goods collected into coinage, alleviating this hardship from the treasury. In the end, the collectors would keep anything in excess of what they bid plus the interest due from the treasury; with the risk being that they might not collect as much as they originally bid.


Early American History

The production of wagon

covers

Was outsourced to

Scottish Manufacturers

Who used raw material

imported from India


Manufacturing Organizations

• Outsourcing remained popular in manufacturing with part of the assembling being subcontracted to other organizations and locations where the work could be done more efficiently and cheaply

• Pastin and Harrison (1974) wrote that such outsourcing was creating a new form of organization which the termed the “Hollow Corporation”

(An organization that designs and distributes, but does not produce anything)

• Now: Virtual Organizations

The world’s largest supplier of telecommunications product; manufacturer of none

Origins of OutsourcingIS/IT Outsourcing

• In the early 1960’s Electronic Data Systems (EDS) in Dallas, Texas, approached large corporations to get them to outsource their data processing services. for his data processing services.

• Perot was refused 77 times before he got his first contract

• EDS received lucrative contracts from the U.S. government in 1963, computerizing Medicare records.

• EDS went public in 1968 and the stock price shot up from $16 a share to $160 within days.

• In 1984 General Motors bought controlling interest in EDS for $2.4 billion.

http://upload.wikimedia.org/wikipedia/commons/8/80/Ross_Perot.jpg

• On Oct 2, 1989, Eastman Kodak announced that it was outsourcing its information systems (IS) function 1989 to IBM (IBM Global Services' first customer)

• That year, the head of IT at KODAK was named information chief of the year by CIO Magazine.

• Eastman Kodak’s decision to outsource the information technology systems that undergird its business was considered revolutionary in 1989, but it was actually the result of rethinking what their business was about.

Katherine M. Hudson

• While Kodak signed on with IBM to outsource its mainframe data management, Kodak chose to outsource the provisioning of its PC purchases to desktop systems-integration firm Businessland Inc. and its network operations to Digital Equipment Corp.

Origins of OutsourcingIS/IT Outsourcing

• IBM has since taken over Digital's role and now provides direct PC sales to Kodak as well.

• "She led Kodak to what was a counterintuitive move for the time: She showed that running data centers was no more a core competency of Kodak's than running a power plant would be," says F. Warren McFarlan, senior associate dean and professor in the Advanced Management Program at the Harvard Business School.

Outsourcing Today (These figures are dated)

• 2003: $178 Billion

• 2007: $235 Billion

• 2008: $261 Billion

• IT outsourcing is estimated to be 67% of all outsourcing deals

Basic Terminology• Outsourcing:

• Delegation of non-core operations from internal production to an external entity. Sharing organizational control.

• Best Sourcing:• Associating with the ‘best of the best’ (Tom Peters)

• Offshoring:• Transferring Activities to another country by hiring local subcontractors or by building a

facility in an area where labor is cheap(er).

• Nearsourcing:• Offshore to a nearby country where language and cultural differences are smaller

• Insourcing:• Keeping Operations in-house

The globalization of outsourcing operating models has resulted in new terms

• Rightsourcing:• Restructuring a company's workforce to find the optimum mix of jobs performed

locally and jobs moved to foreign countries

Related terms

• Backsourcing:• Returning outsourced operation to in-house operations

• Multisourcing:• large outsourcing agreements

Outsourcing is ….

A free market thing A Special form of international trade (CES IFO

Institute ,Germany) A matter of polarized public debate (European Foundation

for ILWC,2004) About your “core” A question of trust Unevenly dispersed on the globe (yet growing) Generating fear (fear of change?- Cochrane,2004) A relationship and arrangement Partner quality Subject to areas of high attrition ? (ex-Call centers)

Reasons for Outsourcing

Every Morning in Africa, a gazelle wakes up.

It knows it must run faster than the fastest lion or it will be killed.

Every morning a lion wakes up.

It knows it must outrun the slowest gazelle or it will starve to death.

It doesn’t matter whether you are a lion or a gazelleWhen the sun comes up,

YOU BETTER START RUNNING!

African Proverb

Reasons for Outsourcing*• Cost savings. The lowering of the overall cost of the service to the business. This will

involve reducing the scope, defining quality levels, re-pricing, re-negotiation, cost re-structuring. Access to lower cost economies through offshoring called "labor arbitrage" generated by the wage gap between industrialized and developing nations.

• Focus on Core Business. Resources (e.g., investment, people, infrastructure) are focused on developing the core business. For example often organizations outsource their IT support to specialized IT services companies.

• Cost restructuring. Operating leverage is a measure that compares fixed costs to variable costs. Outsourcing changes the balance of this ratio by offering a move from fixed to variable cost and also by making variable costs more predictable.

• Improve quality. Achieve a step change in quality through contracting out the service with a new service level agreement.

• Knowledge. Access to intellectual property and wider experience and knowledge.

• Contract. Services will be provided to a legally binding contract with financial penalties and legal redress. This is not the case with internal services

• Operational expertise. Access to operational best practice that would be too difficult or time consuming to develop in-house.

* Some of this is taken from Wikipedia – NOT necessarily reliable

Reasons for Outsourcing*• Capacity management. An improved method of capacity management of services and

technology where the risk in providing the excess capacity is borne by the supplier.

• Catalyst for change. An organization can use an outsourcing agreement as a catalyst for major step change that can not be achieved alone. The outsourcer becomes a Change agent in the process.

• Enhance capacity for innovation. Companies increasingly use external knowledge service providers to supplement limited in-house capacity for product innovation

• Reduce time to market. The acceleration of the development or production of a product through the additional capability brought by the supplier.

• Commodification. The trend of standardizing business processes, IT Services, and application services which enable to buy at the right price, allows businesses access to services which were only available to large corporations

• Operational expertise. Access to operational best practice that would be too difficult or time consuming to develop in-house.

Reasons for Outsourcing*• Risk management. An approach to risk management for some types of risks is to partner

with an outsourcer who is better able to provide the mitigation

• Venture Capital. Some countries match government funds venture capital with private venture capital for startups that start businesses in their country.

• Tax Benefit. Countries offer tax incentives to move manufacturing operations to counter high corporate taxes within another country.

• Scalability. The outsourced company will usually be prepared to manage a temporary or permanent increase or decrease in production.

• Access to talent. Access to a larger talent pool and a sustainable source of skills, in particular in science and engineering.

• India has over 2,100,000 English-speaking graduates added annually and 460,000 of them are IT grads.

• China has over 200,000 IT professionals and 50,000 new graduates are added to the pool every year.

• China produces 52% of all Science and Engineering graduates

• Work Attitudes “In China today, Bill Gates is Britney Spears. In America today, Britney Spears is Britney Spears and that is our problem.”

Thomas Friedman

Criticisms of outsourcing

Loss of Jobs

• A University of California Study that estimates 14 million U.S. white collar jobs - one in nine - are at risk.

• A 2004 report by Forrester Research suggests that a total of 3.4 million U.S. white collar jobs will move overseas by 2015, with 830,000 jobs leaving by the end of 2005.

• A Progressive Policy Institute report claims 12 million jobs are vulnerable, with most paying more than the U.S. median wage.

Criticisms of outsourcing

Loss of Control

• "I've had people approach me and offer to save us money by consolidating our technical support," said Monad.net President George Scott. "But I think technical support is a major competitive advantage. I therefore want control of that -- I don't want to give it away."

• "Everyone knows that differentiation is the key in the ISP business, and this also goes for dealing with the pressures of handling technical support," said the operations manager of a Massachusetts ISP. "No ISP is happy with the fact that they have to handle so many calls from customers who are not adept with their PCs, but we understand that handing them over to a third party is the wrong business move."

Criticisms of outsourcing * Quality Risks

• Quality Risk is the propensity for a product or service to be defective, due to operations-related issues. Quality risk in outsourcing is driven by a list of factors. One such factor is opportunism by suppliers due to misaligned incentives between buyer and supplier, information asymmetry, high asset specificity, or high supplier switching costs. Other factors contributing to quality risk in outsourcing are poor buyer-supplier communication, lack of supplier capabilities/resources/capacity, or buyer-supplier contract enforceability.

Quality of service

• Quality of service is measured through a service level agreement (SLA) in the outsourcing contract. In poorly defined contracts there is no measure of quality or SLA defined. Even when an SLA exists it may not be to the same level as previously enjoyed. This may be due to the process of implementing proper objective measurement and reporting which is being done for the first time. It may also be lower quality through design to match the lower price. There are a number of stakeholders who are affected and there is no single view of quality. The CEO may view the lower quality acceptable to meet the business needs at the right price. The retained management team may view quality as slipping compared to what they previously achieved. The end consumer of the service may also receive a change in service that is within agreed SLAs but is still perceived as inadequate. The supplier may view quality in purely meeting the defined SLAs regardless of perception or ability to do better.

Criticisms of outsourcing * Language skills

• In the area of call centers end-user-experience is deemed to be of lower quality when a service is outsourced. This is exacerbated when outsourcing is combined with off-shoring to regions where the first language and culture are different. In addition to language and accent differences, a lack of local social and geographic knowledge is often present, leading to misunderstandings or miscommunications

Public opinion

• There is a strong public opinion regarding outsourcing (especially when combined with offshoring) that outsourcing damages a local labor market. Outsourcing is the transfer of the delivery of services which affects both jobs and individuals. It is difficult to dispute that outsourcing has a detrimental effect on individuals who face job disruption and employment insecurity; however, its supporters believe that outsourcing should bring down prices, providing greater economic benefit to all. There are legal protections in the European Union regulations called the Transfer of Undertakings (Protection of Employment). Labor laws in the United States are not as protective as those in the European Union.

Staff turnover

• The staff turnover of employee who originally transferred to the outsourcer is a concern for many companies. Turnover is higher under an outsourcer and key company skills may be lost with retention outside of the control of the company. In outsourcing offshore there is an issue of staff turnover in the outsourcer companies call centers. It is quite normal for such companies to replace its entire workforce each year in a call center. This inhibits the build-up of employee knowledge and keeps quality at a low level.

Criticisms of outsourcing * Social responsibility

• Outsourcing sends jobs to the lower-income areas where work is being outsourced to, which provides jobs in these areas and has a net equalizing effect on the overall distribution of wealth. Some argue that the outsourcing of jobs (particularly off-shore) exploits the lower paid workers. A contrary view is that more people are employed and benefit from paid work. Despite this argument, domestic workers displaced by such equalization are proportionately unable to outsource their own costs of housing, food and transportation.

• On the issue of high-skilled labor, such as computer programming, some argue that it is unfair to both the local and off-shore programmers to outsource the work simply because the foreign pay rate is lower. On the other hand, one can argue that paying the higher-rate for local programmers is wasteful, or charity, or simply overpayment. If the end goal of buyers is to pay less for what they buy, and for sellers it is to get a higher price for what they sell, there is nothing automatically unethical about choosing the cheaper of two products, services, or employees.

• Social responsibility is also reflected in the costs of benefits provided to workers. Companies outsourcing jobs effectively transfer the cost of retirement and medical benefits to the countries where the services are outsourced. This represents a significant reduction in total cost of labor for the outsourcing company. A side effect of this trend is the reduction in salaries and benefits at home in the occupations most directly impacted by outsourcing.

Criticisms of outsourcing * Company knowledge

• Outsourcing could lead to communication problems with transferred employees. For example, before transfer staff have access to broadcast company e-mail informing them of new products, procedures etc. Once in the outsourcing organization the same access may not be available. Also to reduce costs, some outsource employees may not have access to e-mail, but any information which is new is delivered in team meetings.

Qualifications of outsourcers

• The outsourcer may replace staff with less qualified people or with people with different non-equivalent qualifications. In the engineering discipline there has been a debate about the number of engineers being produced by the major economies of the United States, India and China. The argument centers around the definition of an engineering graduate and also disputed numbers. The closest comparable numbers of annual graduates of four-year degrees are United States (137,437) India (112,000) and China (351,537)

Failure to deliver business transformation

• Business transformation promised by outsourcing suppliers often fails to materialize. In a commoditised market where many service providers can offer savings of time and money, smart vendors have promised a second wave of benefits that will improve the client’s business outcomes. According to Vinay Couto of Booz & Company “Clients always use the service provider’s ability to achieve transformation as a key selection criterion. It’s always in the top three and sometimes number one.” While failure is sometimes attributed to vendors overstating their capabilities, Couto points out that clients are sometimes unwilling to invest in transformation once an outsourcing contract is in place

Criticisms of outsourcing * Productivity

• Offshore outsourcing for the purpose of saving cost can often have a negative influence on the real productivity of a company. Rather than investing in technology to improve productivity, companies gain non-real productivity by hiring fewer people locally and outsourcing work to less productive facilities offshore that appear to be more productive simply because the workers are paid less. Sometimes, this can lead to strange contradictions where workers in a developing country using hand tools can appear to be more productive than a U.S. worker using advanced computer controlled machine tools, simply because their salary appears to be less in terms of U.S. dollars. In contrast, increases in real productivity are the result of more productive tools or methods of operating that make it possible for a worker to do more work. Non-real productivity gains are the result of shifting work to lower paid workers, often without regards to real productivity. The net result of choosing non-real over real productivity gain is that the company falls behind and obsoletes itself overtime rather than making investments in real productivity.

Security

• Before outsourcing an organization is responsible for the actions of all their staff and liable for their actions. When these same people are transferred to an outsourcer they may not change desk but their legal status has changed. They no-longer are directly employed or responsible to the organization. This causes legal, security and compliance issues that need to be addressed through the contract between the client and the suppliers. This is one of the most complex areas of outsourcing and requires a specialist third party adviser.

Criticisms of outsourcing * Security (continued)

• Fraud is a specific security issue that is criminal activity whether it is by employees or the supplier staff. However, it can be disputed that the fraud is more likely when outsourcers are involved, for example credit card theft when there is scope for fraud by credit card cloning. In April 2005, a high-profile case involving the theft of $350,000 from four Citibank customers occurred when call center workers acquired the passwords to customer accounts and transferred the money to their own accounts opened under fictitious names. Citibank did not find out about the problem until the American customers noticed discrepancies with their accounts and notified the bank.

Standpoint of labor

• From the standpoint of labor within countries on the negative end of outsourcing this may represent a new threat, contributing to rampant worker insecurity, and reflective of the general process of globalization. While the "outsourcing" process may provide benefits to less developed countries or global society as a whole, in some form and to some degree - include rising wages or increasing standards of living - these benefits are not secure. Further, the term outsourcing is also used to describe a process by which an internal department, equipment as well as personnel, is sold to a service provider, who may retain the workforce on worse conditions or discharge them in the short term. The affected workers thus often feel they are being "sold down the river."

Criticisms of outsourcing Hidden Costs

• The Cost of Managing an Offshore Contract

• "There's a significant amount of work in invoicing, in auditing, in ensuring cost centers are charged correctly, in making sure time is properly recorded," explains DHL's Kifer. "We have as many as 100 projects a year, all with an offshore component, so you can imagine the number of invoices and time sheets that have to be audited on any given day."

• We knew there would be invoicing and auditing," he says. "But we didn't fully appreciate the due diligence and time it would require."

• Bottom line: Expect to pay an additional 6 percent to 10 percent on managing your offshore contract


• The Cost of Selecting a Vendor

• “With any outsourced service, the expense of selecting a service provider can cost from .2 percent to 2 percent in addition to the annual cost of the deal. In other words, if you're sending $10 million worth of work to India, selecting a vendor could cost you anywhere from $20,000 to $200,000 each year”.

• “Some companies hire an outsourcing adviser for about the same cost as doing it themselves. To top it off, the entire process can take from six months to a year, depending on the nature of the relationship”.

• Source: The Hidden Costs of Offshore Outsourcing. Sep. 1, 2003 Issue of CIO Magazine

• “Bottom line: Expect to spend an additional 1 percent to 10 percent on vendor selection and initial travel costs”.


• The Cost of Transition


• “The transition period is perhaps the most expensive stage of an offshore endeavor. It takes from three months to a full year to completely hand the work over to an offshore partner. If company executives aren't aware that there will be no savings—but rather significant expenses—during this period, they are in for a nasty surprise.”.

• “It took an awful lot of time to bridge the Pacific and getting that to work correctly," remembers Textron Financial's Raspallo, who spent six months and $100,000 to set up a transoceanic data line with Infosys in 1998, It also cost an extra $10,000 a month to keep that network functional.”.

• Bottom Line: Expect to spend an additional 2 percent to 3 percent on transition costs”.


• The Cost of Layoffs


• “To begin with, you have to pay workers severance and retention bonuses. You need to keep employees there long enough to share their knowledge with their Indian replacements. People think if they give generous retention bonuses it will destroy the business proposition. They cut corners because they want quick payback. But then they lose the people that can help with the transition and incur the even bigger cost of not doing the transition right.".”.

• Bottom line: Expect to pay an extra 3 percent to 5 percent on layoffs and related costs.


• The Cultural Cost


• “You simply cannot take a person sitting here in America and replace them with one offshore worker," GE Real Estate's Zupnick says. "Whether they're in India or Ireland or Israel”

• Bottom line: Expect to spend an extra 3 percent to 27 percent on productivity lags.

• “a project that's common sense for a U.S. worker—like creating an automation system for consumer credit cards—may be a foreign concept offshore.”

Critical areas for a successful outsourcing program

• Understanding company goals and objectives

• A strategic vision and plan

• Selecting the right vendor

• Ongoing management of the relationships

• A properly structured contract

• Open communication with affected individual/groups

• Senior executive support and involvement

• Careful attention to personnel issues

• Short-term financial justification

The Pre-Outsourcing Process Program Initiation

• At the start of any outsourcing program, there are a variety of ideas and opinions about the purpose and scope of the program, what the final result of the program will be, and how the program will be carried out. The Program Initiation Stage is concerned with taking these ideas and intentions and documenting them to form the basis of a draft contract.

Service Implementation

• Service Implementation covers the activities required to take these ideas and intentions and develop them into a formal, planned outsourcing program and to make the transition to the outsourced service.

• Specifically these activities are:

• Defining the transition project• Transferring staff• Defining the Service Level Agreement (SLA)• Defining service reporting• Implementing and handing over the service• Implementing service management procedures

• During the hand–over phase it is imperative that continuity of service is maintained at all times, that there is no reduction in the quality of the delivery and that timescales and deadlines are not compromised.

The Pre-Outsourcing Process Final Agreement

• The draft contract produced at the Initiation stage is generally amended during negotiations and the final Contract is produced on completion of the negotiation cycle.

Program Closure• In order to gain maximum benefit, the program should go through a formal close down.

There is no point in continuing to argue lost causes once irrevocable decisions have been taken. Staff and companies alike need to accept the new situation and move forward. However, there will be a lot of information generated during the life of the program, and this will have been stored with varying degrees of formality by the team members. This information needs to be formally filed away for future reference.

Degree of Ownership Outsourcing Internal Partial External

TotalSpin-offs Joint

Traditional Outsourcing

Selective(Wholly Owned

Subsidiary)Venture Selective

Outsourcing

NoneInsourcing /

BacksourcingFacilities Sharing among

multiple clientsN/A

Types of Sourcing Arrangements• There are four fundamental parameters that determine the kind of outsourcing

arrangement that a firm may enter into: degree (total, selective, and none); mode (single vendor/client or multiple vendors/clients); ownership (totally owned by the company, partially owned, externally owned); and time frame (short term or long term). The combination of specific instances of these parameters yields different types of sourcing arrangements such as joint ventures, facilities sharing, and spin-offs.

* Dibbern, J. and Goles, T. and Hirschheim, R. and Jayatilaka, B. (2004) "Information Systems Outsourcing: A Survey and Analysis of the Literature“ In: The DATA BASE for Advances in Information Systems, Volume 34, Issue Number 4, pp 6-102

Intelligence

Design

Choice

Implementation

Why

What

Which

How

Outcome

• Determinants• Advantages/Disadvantages

Outsourcing Alternatives:• Degree of Ownership• Degree of Outsourcing

Guidelines, Procedures, stakeholders of decision initiation, Evaluation

• Vendor Selection• Relationship buildings• Relationship Management

• Experiences/Learning• Types of Success• Determinants of Success

Simon’s Decision Making Model Outsourcing Stages

Application of Outsourcing Stages

Ph

ase 1: D

ecision

Pro

cessP

hase 2:

Imp

lemen

tation

Stage model of IS outsourcing

Course Organization

Basic IT Outsourcing Life Cycle

Outsourcing Experiences and

Outcomes

Outsourcing Decision

Determinant

Outsourcing Relationships:

Arrangement and Management

Global Challenges

Application Service Providing

(ASP) and Business Process

Outsourcing (BSO)

Offshoring and Global

Outsourcing

Perspectives

Individual View Vendor View

An Introduction to the Outsourcing and Offshoring Landscape

Documents

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